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MBA

(DISTANCE MODE)

DBA 1703 STRATEGIC MANAGEMENT

III SEMESTER COURSE MATERIAL

DBA 1703 STRATEGIC MANAGEMENT III SEMESTER COURSE MATERIAL Centre for Distance Education Anna University Chennai

Centre for Distance Education

Anna University Chennai Chennai – 600 025

MANAGEMENT III SEMESTER COURSE MATERIAL Centre for Distance Education Anna University Chennai Chennai – 600 025

Author

Mr.R.Magesh

Senior Lecturer Department of Managment Studies Anna University Chennai Chennai - 600 025

Reviewer

Ms.Yasmeen Haider

Senior Lecturer Department of Managment Studies BSA Cresent Engineering College, Vandallur Chennai - 600 048

Editorial Board

Dr.T.V.Geetha

Professor Department of Computer Science and Engineering Anna University Chennai Chennai - 600 025

Dr.H.Peeru Mohamed

Professor Department of Management Studies Anna University Chennai Chennai - 600 025

Dr.C. Chellappan

Professor Department of Computer Science and Engineering Anna University Chennai Chennai - 600 025

Copyrights Reserved (For Private Circulation only)

ii

Dr.A.Kannan

Professor Department of Computer Science and Engineering Anna University Chennai Chennai - 600 025

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ACKNOWLEDGEMENT

The author has drawn inputs from several sources for the preparation of this course material, to meet the requirements of the syllabus. The author gratefully acknowledges the following sources:

Charles W.l.Hill & Gareth R.Jones –Strategic Management Theory, An integrated approach’–Houghton Miflin Company, Princeton New Jersey,All India Publisher and Distributors, Chennai, 1998.

Thomas l. Wheelen, J.David Hunger –‘Strategic Management’Addison Wesley Longman Singapore Pvt. Ltd., 6th edition, 2000.

Arnoldo C.Hax, Nicholas S.Majluf – ‘The strategy concept and process’ –A Pragmatic Approach – Pearson Education Publishing Company, Second Edition, 2005.

Azhar kazmi –‘Business Policy & Strategic Management’Tata McGraw Hill Publishing company Ltd., New Delhi- Second Edition, 1998.

Harvard Business Review –‘Business Policy’ –parts I & II Harvard Business School.

Saloner, Shepard, Podolny –‘Strategic Management ‘ –John Wiley 2001.

Lawrence G.Hrebiniak,’Making strategy work’, Person Publishing Company, 2005.

Gupta, Gollakota & Srinivasan –business Policy and strategic Management – Concepts andApplication ‘ Prentice Hall of India, 2005.

Inspite of at most care taken to prepare the list of references any omission in the list is only accidental and

not purposeful.

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Mr.R.Magesh

Author

DBA 1703

STRATEGIC MANAGEMENT

UNIT I –STRATEGIC AND PROCESS

Conceptual framework for strategic management, the concept of strategy and strategy formation process –A formal Strategic planning process, corporate governance and social responsibility.

UNIT II –COMPETITIVE ADVANTAGE External environment –Porter’s five forces model-Strategic groups competitive changes during industry evolution – globalization and industry structure-National context and competitive advantage resources –Capabilities and competencies- core competencies – Low cost and differentiation generic, buildings blocks of competitive advantage –Distinctive competencies-Resources and capabilities durability of competitive advantage –avoiding failures and sustaining competitive advantage.

UNIT III – STRATEGIES

Building competitive advantage through functional level strategies –Business level strategy-strategy in the global environment –Corporate strategy –Vertical integration –Diversification and strategic alliances –Building and restructuring the corporation –Choice of strategies –Balance score Card.

UNIT IV – STRATEGY IMPLEMENTATION

& EVALUATION

Designing organizational structure –Designing strategic control systems – Matching structure and control to strategy –Implementing strategic change politics-Power and conflict –Techniques of strategic evaluation & control.

UNIT V –OTHER STRATEGIC ISSUES

Managing technology and innovation –Entrepreneurial ventures and small business strategic issues for non-profit organizations. Cases in strategic management

REFERENCES

1. Charles W.l.Hill & Gareth R.Jones –Strategic Management Theory, An integrated approach’–Houghton Miflin Company, Princeton New Jersey,All India Publisher and Distributors, Chennai, 1998.

2. Thomas l. Wheelen, J.David Hunger –‘Strategic Management’Addison Wesley Longman Singapore Pvt. Ltd., 6th edition, 2000.

3. Arnoldo C.Hax, Nicholas S.Majluf – ‘The strategy concept and process’ –A Pragmatic Approach – Pearson Education Publishing Company, Second Edition, 2005.

4. Azhar kazmi –‘Business Policy & Strategic Management’Tata McGraw Hill Publishing company Ltd., New Delhi- Second Edition, 1998.

5. Harvard Business Review –‘Business Policy’ –parts I & II Harvard Business School.

6. Saloner, Shepard, Podolny –‘Strategic Management ‘ –John Wiley 2001.

7. Lawrence G.Hrebiniak,’Making strategy work’, Person Publishing Company, 2005.

8. Gupta, Gollakota & Srinivasan –business Policy and strategic Management – Concepts andApplication ‘ Prentice Hall of India, 2005.

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CONTENTS

UNIT I STRATEGY AND PROCESS

1.1

CONCEPTUAL FRAMEWORK FOR STRATEGIC MANAGEMENT

1

1.2

THE CONCEPT OF STRATEGIC MANANGEMENT

2

1.3

BIRTH OF STRATEGIC MANAGEMENT

3

1.4

STRATEGIC ANALYSIS

4

1.5

BENEFITS OF STRATEGIC MANAGEMENT

6

1.6

VARIOUS APPROACHES OF STRATEGIC MANAGEMENT

8

1.7

STRATEGYAND STRATEGY FORMATION PROCESS

9

1.7.1

Strategic Management Processes

9

1.7.2

Top Management Decisions on Strategic Issues

11

1.7.3

Strategic Issues Likely to Have Long Term Impact

11

1.8

STRATEGY PLANNING PROCESS

12

1.8.1 Strategic Planning Model

12

1.8.2 Strategic Management Models

14

1.8.3 Working Model of Strategic Management

14

1.9

MINTZBERG’S MODES OF STRATEGIC DECISION MAKING

18

1.10

CORPORATE GOVERNANCE & SOCIAL RESPONSIBILITY

18

1.10.1 Definition of Corporate Governance

19

1.10.2 History of Corporate Governance

20

1.10.3 Impact of Corporate Governance

22

1.10.4 Parties to corporate governance

24

1.10.5 Principles of Corporate Governance

25

1.10.6 Mechanisms and controls

27

1.10.7 Systemic problems of corporate governance

28

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1.10.8

Corporate governance models around the world

31

 

1.10.9 Corporate governance and firm performance

35

1.10.10 Initiative of Indian Government of Corporate governance

37

 

UNIT II COMPETITIVE ADVANTAGE

2.1

EXTERNAL ENVIRONMENT

42

2.2

MICHAEL PORTER FIVE FORCES MODEL

44

2.3

DYNAMIC NATURE OF INDUSTRY RIVALRY

54

2.3.1

A Combination of Generic Strategies — Stuck in the Middle?

54

2.4

GLOBALIZATIONAND INDUSTRY STRUCTURE

57

2.5

PORTER’S GENERIC STRATEGIES

60

2.6

CAPABILITIES AND COMPETENCIES

70

2.6.1

Capabilities – the Basis of Your Competitive Advantage

70

2.6.2

Creating a Culture for Innovation

71

2.6.3

Building Capability through LeadershipAttributes

72

2.7

CORE COMPETENCIES AND DISTINCTIVE COMPETENCIES

73

2.7.1 Core Competencies to End Products

73

2.7.2 Developing Core Competencies

74

2.8

GENERIC STRATEGIES AND THE INTERNET

77

2.9

MICHAEL PORTER COMPETITIVEADVANTAGE

78

 

UNIT III STRATEGIES

3.1

BUILDING COMPETITIVE ADVANTAGE THROUGH

 

FUNCTIONAL LEVEL STRATEGIES

84

3.1.1

Functional level strategies

84

3.2

BUSINESS-LEVEL STRATEGIES

88

3.3

STRATEGY IN THE GLOBAL ENVIRONMENT

92

x

3.3.1

Portfolio Planning experiences in Global Environment

94

3.4

CORPORATE-LEVEL STRATEGY

97

3.4.1

Corporate PortfolioAnalysis

99

3.4.2

Corporate Grand Strategies

103

3.5

DIVERSIFICATIONAND STRATEGIC ALLIANCES

105

3.5.1 Diversification Strategy

105

3.5.2 Strategic alliances and partnerships

106

3.6

STRATEGIC CHOICE

106

3.6.1 Importance of choice in the strategy formulation process

106

3.6.2 Structure of strategic choice

108

3.6.3 Options for markets and products/services

109

3.6.4 Options for building resources, capabilities, and competence

110

3.6.5 Options in methods of implementation

111

3.6.6 Contractual arrangements

112

3.7

GROUPING OPTIONS INTO STRATEGIC OPTIONS

113

3.7.1 General tests of strategic options

114

3.7.2 Who should be involved with the choice?

114

3.7.3 Theoretical frameworks for assisting strategic choice

115

3.7.4 Strategic choices in the case examples

117

3.8

BALANCE SCORE CARD

117

3.8.1

The Learning & Growth Perspective

119

3.8.2

The Balanced Scorecard and Measurement-Based Management

120

3.8.3

Management by Fact

121

 

UNIT IV STRATEGY IMPLEMENTATION & EVALUATION

4.1

DESIGNING ORGANIZATIONAL STRUCTURE

131

4.1.1

The Essentials checklists of organization structure design

135

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4.2

DESIGNING STRATEGIC CONTROL SYSTEMS

142

 

4.2.1

Characteristics of a Strategic Control system

145

4.3

MATCHING STRUCTURE AND CONTROL TO STRATEGY

146

4.4

STRATEGY IMPLEMENTATIONS

149

4.4.1 Fourth Task of Strategic Management in Strategy Implementation

150

4.4.2 Strategic Implementation and Evaluating Performance

150

4.5

POLITICS, POWER AND CONFLICT INFLUENCES IN

STRATEGIC IMPLEMENTATION

152

4.6

TECHNIQUES OF STRATEGY EVALUATION AND CONTROL

168

4.6.1 Financial Performance Control

168

4.6.2 Social Performance Control

177

4.6.3 Social Cost-BenefitAnalysis

178

 

UNIT V OTHER STRATEGIC ISSUES

5.1

MANAGING TECHNOLOGYAND INNOVATION

184

5.1.1 Managing Toward Success

184

5.1.2 Choosing a Partner

185

5.1.3 Negotiating

the Alliance

186

5.1.4 Managing Toward Collaboration

189

5.1.5 Managing Innovation

190

5.2

ENTREPRENEURIAL VENTURES &

SMALL BUSINESS STRATEGIC ISSUES

194

5.2.1 Entrepreneurship

194

5.2.2 Entrepreneurship vs. Small Business

200

5.3

STRATEGIC ISSUE OF NON- PROFIT ORGANIZATION

206

5.4

CASES IN STRATEGIC MANAGEMENT

213

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STRATEGIC MANAGEMENT

UNIT I

NOTES

STRATEGYAND PROCESS

INTRODUCTION

Strategy word derives from the greek word stratçgos, which derives from two words: stratos (army) and ago (ancient greek for leading). Stratçgos referred to a ‘military commander’during the age of Athenian Democracy.

Strategy - originally a military term, in a business planning context strategy/strategic means/pertains to why and how the plan will work, in relation to all factors of influence upon the business entity and activity, particularly including competitors (thus the use of a military combative term), customers and demographics, technology and communications

LEARNING OBJECTIVES

After learning this unit you must be able to:

Understand the concepts of strategic management

Analyze the strategic formation process

Explain the strategic planning process

Describe the role of corporate governance

Know the corporate governance responsibilities for society

1.1 CONCEPTUAL FRAMEWORK FOR STRATEGIC MANAGEMENT

Definition of strategy

Johnson and Scholes (Exploring Corporate Strategy) define strategy as follows:

“Strategy is the direction and scope of an organization over the long-term: which achieves advantage for the organization through its configuration of resources within a

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challenging environment, to meet the needs of markets and to fullfil stakeholder expectations”.

In other words, strategy is about:

Where is the business trying to get to in the long-term (direction)

Which markets should a business compete in and what kind of activities is involved in such markets? (markets; scope)

How can the business perform better than the competition in those markets? (Advantage)?

What resources (skills, assets, finance, relationships, technical competence, and facilities) are required in order to be able to compete? (Resources)?

What external, environmental factors affect the businesses’ ability to compete? (Environment)?

What are the values and expectations of those who have power in and around the business? (stakeholders)

1.2 THE CONCEPT OF STRATEGIC MANAGEMENT

Strategic management is the art and science of formulating, implementing and evaluating cross-functional decisions that will enable an organization to achieve its objectives. It is the process of specifying the organization’s objectives, developing policies and plans to achieve these objectives, and allocating resources to implement the policies and plans to achieve the organization’s objectives. Strategic management, therefore, combines the activities of the various functional areas of a business to achieve organizational objectives. It is the highest level of managerial activity, usually formulated by the Board of Directors and performed by the organization’s Chief Executive Officer (CEO) and executive team. Strategic management provides overall direction to the enterprise and is closely related to the field of organization Studies.

“Strategic management is an ongoing process that assesses the business and the industries in which the company is involved; assesses its competitors and sets goals and strategies to meet all existing and potential competitors; and then reassesses each strategy annually or quarterly [i.e. regularly] to determine how it has been implemented and whether it has succeeded or needs replacement by a new strategy to meet changed circumstances,

STRATEGIC MANAGEMENT

new technology, new competitors, a new economic environment., or a new social, financial, or political environment.” (Lamb, 1984:ix)

1.3 BIRTH OF STRATEGIC MANAGEMENT

NOTES

Strategic management as a discipline originated in the 1950s and 60s. Although there were numerous early contributors to the literature, the most influential pioneers were Alfred D. Chandler, Jr., Philip Selznick, Igor Ansoff, and Peter Drucker.

Alfred Chandler recognized the importance of coordinating the various aspects of management under one all-encompassing strategy. Prior to this time the various functions of management were separate with little overall coordination or strategy. Interactions between functions or between departments were typically handled by a boundary position, that is, there were one or two managers that relayed information back and forth between two departments. Chandler also stressed the importance of taking a long term perspective when looking to the future. In his 1962 groundbreaking work Strategy and Structure, Chandler showed that a long-term coordinated strategy was necessary to give a company structure, direction, and focus. He says it concisely, “structure follows strategy.”

In 1957, Philip Selznick introduced the idea of matching the organization’s internal factors with external environmental circumstances. This core idea was developed into what we now call SWOT anlysis by Learned, Andrews, and others at the Harvard Business School General Management Group. Strengths and weaknesses of the firm are assessed in light of the opportunities and threats from the business environment.

Igor Ansoff built on Chandler’s work by adding a range of strategic concepts and inventing a whole new vocabulary. He developed a strategy grid that compared market penetration strategies, product development strategies, market development strategies and horizontal and vertical integration and diversification strategies. He felt that management could use these strategies to systematically prepare for future opportunities and challenges. In his 1965 classic Corporate Strategy, he developed the gap analysis still used today in which we must understand the gap between where we are currently and where we would like to be, then develop what he called “gap reducing actions”.

Peter Drucker was a prolific strategy theorist, author of dozens of management books, with a career spanning five decades. His contributions to strategic management

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were many but two are most important. Firstly, he stressed the importance of objectives. An organization without clear objectives is like a ship without a rudder. As early as 1954 he was developing a theory of management based on objectives. This evolved into his theory of management by objectives (MBO). According to Drucker, the procedure of setting objectives and monitoring your progress towards them should permeate the entire organization, top to bottom. His other seminal contribution was in predicting the importance of what today we would call intellectual capital. He predicted the rise of what he called the “knowledge worker” and explained the consequences of this for management. He said that knowledge work is non-hierarchical. Work would be carried out in teams with the person most knowledgeable in the task at hand being the temporary leader.

In1985, Ellen-Earle Chaffee summarized what she thought were the main elements of strategic management theory by the 1970s:

 

Strategic management involves. adapting the organization to its business environment.

Strategic management is fluid and complex Change creates novel combinations of circumstances requiring unstructured non-repetitive responses.

Strategic management affects the entire organization by providing direction.

Strategic management involves both strategy formation (she called it content) and also strategy implementation (she called it process).

Strategic management is partially planned and partially unplanned.

Strategic management is done at several levels: overall corporate strategy, and individual business strategies.

Strategic management involves both conceptual and analytical thought processes.

1.4

STRATEGIC ANALYSIS

This is all about the analyzing the strength of businesses’ position and understanding the important external factors that may influence that position. The process of Strategic Analysis can be assisted by a number of tools, including:

STRATEGIC MANAGEMENT

STRATEGIC MANAGEMENT NOTES PEST Analysis - a technique for understanding the “environment” in which a business

NOTES

PEST Analysis - a technique for understanding the “environment” in which a business operates

Scenario Planning - a technique that builds various plausible views of possible futures for a business

Five Forces Analysis - a technique for identifying the forces which affect the level of competition in an industry

Market Segmentation - a technique which seeks to identify similarities and differences between groups of customers or users

Directional Policy Matrix - a technique which summarizes the competitive strength of a businesses operations in specific markets

Competitor Analysis - a wide range of techniques and analysis that seeks to summaries a businesses’ overall competitive position

Critical Success Factor Analysis - a technique to identify those areas in which a business must outperform the competition in order to succeed

SWOTAnalysis - a useful summary technique for summarizing the key issues arising from an assessment of a businesses “internal” position and “external” environmental influences.

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1.5

BENEFITS OF STRATEGIC MANAGEMENT

NOTES

Studies have revealed that organizations following strategic management have out performed those that do not. Strategic planning ensures a rational allocation of resources and improves co-ordination between various divisions of the organization. It helps managers to think ahead and anticipate problems before they occur. The main benefit of the planning process is a continuous dialogue about the organisation’s future between the hierarchical levels in the organization. In short, the most highly rated benefits of strategic management are:

 

Clarity of strategic vision for the organization

Focus on what is strategically important to the organization

Better understanding of the rapidly changing business environment.

Strategic management need not always be a formal process. It can begin with answering a few simple questions:

 

1. Where are we now?

2. In no changes are made, where will we be in the next one year? Next two years? Next three years? Next five years?

Are the answers acceptable, if the answers are not acceptable, what actions should the top management take with what results and payoffs. Today, as you know that business is becoming more complex due to rapid changes in environment. It is becoming increasingly difficult to predict the environment accurately. The internal and external environments of organizations are now driven by multitudes of forces that were hitherto nonexistent. Earlier the changes in technology were not so rapid but today the information from all over the globe is pouring in through the computers. The world in fact has shrunk. This has created fierce competition as the customers and stakeholders have become more aware of their rights. Think of yourself as a consumer who has got several alternatives to choose from you as a customer look for real value for your money. You have become aware of quality and cost ratios and then diligently select the products. You are now more demanding for better service in the least possible time. This has brought in new rules of business that companies all over the world are evolving through their experience. The obsolence has become so rapid that the time when you are in the process of buying a computer it might

STRATEGIC MANAGEMENT

have already become obsolete in some part of the globe. The number of events that affect domestic and world market are now far too many and too often.

NOTES

Over reliance on experience in such situations may really work out to be very costly for companies. (e.g) Reliance has shifted to more creativity, innovation and new ways of looking at business and doing it in novel ways. The earlier concept of having highly functionalized departments and developing specialization of labour is losing its credibility. Organizations are becoming more responsive, flexible, and adaptable to changing business situations. In such environments that are charged with high level of competition, developing competitive edge for survival and growth has become imperative for companies. What do you think will business strategy concepts and techniques benefit foreign businesses as much as domestic firms? Fig1.1 The role of core values, purpose and visionary goals in a strategy formation process

purpose and visionary goals in a strategy formation process The need is now to distinguish between

The need is now to distinguish between long-range planning and strategic planning. The importance of strategic management in setting the directions for growth of organizations is being increasingly realized these days. The evolution of objectives after setting directions for growth of organisations has become necessary. The technique of strategic management is used as a major vehicle for planning and implementing major changes in organisation. The implementation of the strategic plans needs good teamwork and understanding of the concept at grass root Have a look at the difference between the two:

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1.6 VARIOUS APPROACHES OF STRATEGIC MANAGEMENT

NOTES

In general terms, there are two main approaches, which are opposite but complement each other in some ways, to strategic management:

Major approach of strategic management

I-The Industrial OrganizationalApproach

Based on economic theory — deals with issues like competitive rivalry, resource allocation, economies of scale

Assumptions — rationality, self discipline behaviour, profit maximization

II-The Sociological Approach

Deals primarily with human interactions

Assumptions — bounded rationality, satisfying behaviour, profit sub-optimality.An example of a company that currently operates this way is Google.

Strategic management techniques can be viewed as bottom-up, top-down, or collaborative processes. In the bottom-up approach, employees submit proposals to their managers who, in turn, funnel the best ideas further up the organization. This is often accomplished by a capital budgeting process. Proposals are assessed using financial criteria such as return on investment or cost benefit analysis. The proposals that are approved form the substance of a new strategy, all of which is done without a grand strategic design or a strategic architect. The top-down approach is the most common by far. In it, the CEO (such as Don Sheelen, Jeff Bezos and Samuel J. Palmisano) possibly with the assistance of a strategic planning team, decides on the overall direction the company should take. Some organizations are starting to experiment with collaborative strategic planning techniques that recognize the emergent nature of strategic decisions.

STRATEGIC MANAGEMENT

1.7

STRATEGY AND STRATEGY FORMATION PROCESS

NOTES

1.7.1

Strategic Management Processes

The strategic management formulation and implementation methods vary with product profile, Company profile, environment within and outside the Organization and various other factors. Large organizations which use sophisticated planning use detailed strategic management Models whereas smaller organizations where formality is low use simpler models. Small businesses concentrate on planning steps compared to larger companies in the same industry. Large firms have diverse products, operations, markets, and technologies and hence they have to essentially use complex systems. In spite of the fact that companies have different structures, systems, product profiles, etc, various components of models used for analysis of strategic management are quite similar. You must have observed that different thinkers have defined business strategy differently, yet there are some common elements in the way it is defined and understood. The strategic management consists of different phases, which are sequential in nature.

There are four essential phases of strategic management, they are process. In different companies these phases may have different, nomenclatures and the phases may have a different sequences,

however, the basic content remains same. The four phases can be listed as below.

1. Defining the vision, business mission, purpose, and broad objectives.

2. Formulation of strategies.

3. Implementation of strategies.

4. Evaluation of strategies.

These phases are linked to each other in a sequence as shown in

It may not be possible to draw a clear line of difference between each phase, and the change over from one phase to another is gradual. The next phase in the sequence may gradually evolve and merge into the following phase. An important linkage between the phases is established through a feedback mechanism or corrective action. The feedback mechanism results in a course of action for revising, reformulating, and redefining the past phase. The process is highly dynamic and compartmentalization of the process is difficult.

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The change over is not clear and boundaries of phases overlap. My purpose to depict this diagram is to assist you in remembering and recalling it with ease Exhibit Phases of Strategic Management Process

Strategic management process that could be followed in a typical organization is presented in .The process takes place in the following stages:

1. The Strategic Planner has to define what is intended to be accomplished (not just desired). This will help in defining the objectives, strategies and policies.

2. In the light of stage I, the results of the current performance of the organization are documented.

of stage I, the results of the current performance of the organization are documented. 1 0

STRATEGIC MANAGEMENT

3.

The Board of Directors and the top management will have to review the current performance of the documented.

NOTES

4.

In view of the review, the organization will have to scan the internal environment for strengths and weaknesses and the external environment for opportunities and threats.

5.

The internal and external scan helps in selecting the strategic factors.

6.

These have to be reviewed and redefined in relation to the Mission and Objectives.

7.

At this stage a set of strategic alternatives and generated.

8.

The best strategic alternative is selected and implemented through programmed budgets and procedures.

9.

Monitoring, evaluation and review of the strategic alternative chosen is undertaken in this mode. This can provide a feedback on the changes in the implementation if required. As can be seen, this provides a rational approach to strategic decision making and it can be successfully practiced by Indian organizations, which now have to operate in a competitive environment.

1.7.2

Top Management Decisions On Strategic Issues

To establish the vision of the firm, stating of corporate objectives, and strategic thrust areas, defining a comprehensive corporate philosophy and values, identifying the domains in which an organization would operate, learning and recognizing worldwide business trends, and allocation of resources in line with corporate priorities, are some of the key areas wherein top management of organisations take decisions. Let us now look at the domain of top management? Strategic Issues for Sharing of Concern and Resources to meet certain specific needs of certain customers, use of common upgraded technologies by certain business units, deployment of people, physical assets or money from internal or external sources and to achieve economics of scale in deployment, certain decisions may be taken by the management.

1.7.3

Strategic Issues Likely To Have Long Term Impact

Strategic decisions for implementing a course of action have broad implications and long term ramifications and the people of an organisation have to commit themselves to the decisions and plans for a long period of time. Once a firm takes strategic decisions and implements the action programs, the impact is seen slowly on its competitive image and the advantage tied to the particular strategy start pouring in. The companies become

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NOTES

known in certain markets, products, or technologies or the decisions may adversely affect the previous progress. In today’s business world, where changes are by leaps and bounds, some organisations may decide for radical changes through reengineering of their business processes to gain strategically better position

Strategic Directions are Futuristic

Strategies are essentially for the future. Strategic decisions are taken based o forecasts that are in turn based on available data on trends. The managers involved in strategic planning concentrate on developing projections that would take the company to better strategic position. The companies thus become proactive rather than being reactive to business situations. Strategies have Multi Functional and Multi Business Effects Every company has several business units. Strategic decisions are coordinative in nature among all the business units of the company. Many strategic decisions on product mix, competitive edge, organisational structure etc. affect various departments and functions that may be classified as strategic business units (SBUs). Each of these units get affected by the decision taken at the top level, regarding allocation of resources and deployment of personnel etc. So, Business Strategy as a discipline focuses at the organization as one single unit. Strategies are Defined Based on Study of Environment The organisation culture internal to the organisation and also the external environment must be thoroughly scanned and studied to decide on strategies. The interaction between the organisations and the external environment affects both of them. The organisation tends to change the environment and the same environment makes an impact on the organisation. The firms have to define their strategic position with regard to the environment and decide strategies that will take it to the desired position. The firms are part of the system, where customers, stake holders, competitors etc. exist and the firm cannot remain insulated from these determinants of the external environment

1.8 STRATEGY PLANNING PROCESS

1.8.1 Strategic Planning Model

Elements In Strategic Management Process

Each phase of strategic management process can be viewed to be consisting of a number of elements, which can be clearly defined with input and output relationships.

STRATEGIC MANAGEMENT

The steps have logical connectivity and hence these are sequential. These steps can be illustrated with the help of a flow diagram. The following discrete twelve steps can be considered as comprehensive.

1. Defining the vision of the company

2. Defining the mission of the company

3. Determining the purposes or goals

4. Defining the objectives

5. Environment scanning

6. Carrying out corporate appraisal

7. Developing strategic alternatives

8. Selecting a strategy

9. Formulating detailed strategy

10. Preparing a plan

11. Implementing a strategy

12. Evaluating a strategy

a plan 11. Implementing a strategy 12. Evaluating a strategy F i g u r e

Figure 1.2 The Strategic Planning Process

NOTES

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1.8.2

Strategic Management Models

NOTES

Firstly have a look at the various models which has got relevance to the strategic process. Now think of a firm which in your opinion has been successful over the past 15 years and list down the things you think have attributed to its success: Some of the strategic management models are shown. Now, I will discuss each of the elements of strategic management model.

Exhibit Strategic Management Model:

Company vision statement

Company mission statement

Company profile

External environment and internal environment

Evolution strategic choices and selection

Long term objectives

Grand strategy

Annual objective

Functional strategy

Operating policies

Institutionalizing Strategy

Control and evaluation

1.8.3

Working Model Of Strategic Management

After looking at the above given fig 1.2, we will now discuss each phase in detail.

Vision

Let us, now discuss in details the model of strategic management Vision of The Company

Vision of a company is rather a permanent statement articulated by the CEO of the company who may be Managing Director, President, Chairman, etc.

STRATEGIC MANAGEMENT

The purpose of a vision statement is to:

NOTES

1. Communicate with the people of the organisation and to those who are in some way connected or concerned with the organisation about its very existence in terms of corporate purpose, business scope, and the competitive leadership.

2. Cast a framework that would lead to development of interrelationships between firm and stakeholders viz. employees, shareholders, suppliers, customers, and various communities that may be directly or indirectly involved with the firm.

3. Define broad objective regarding performance of the firm and its growth in various fields vital to the firm. So, lets talk about our own Rai University, find out what is the vision statement and list down various purposes of our vision statement.

Vision is a theme which gives a focused view of a company. It is a unifying statement and a vital challenge to all different units of an organisation that may be busy pursuing their independent objectives. It consists of a sense of achievable ideals and is a fountain of inspiration for performing the daily activities. It motivates people of an organisation to behave in a way which would be congruent with the corporate ethics and values. Many firms do not have clear vision statements. An indirect method of knowing whether a firm has reached the stage of corporate strategic management is emergence of a vision statement. Vision of a firm cannot be high jacked from a company; however, a firm may definitely get inspired by the vision statement of another firm. It has to be evolved after a lot of deliberations, brain storming, and thinking. It is pertinent that you as an individual working in a firm should become an active participant and collaborator in accomplishing corporate objectives. You must understand and share the vision of the firm because you would have to contribute in transformation of vision into a reality through his or her actions. Total behaviour of people of an organization should get conditioned by the basic framework of vision. Personal objectives of individuals are very important to them and only to fulfill these objectives people join organisations.

Vision of a company when translated into action programme must be able to meet personal needs of people. This includes the need of achievement also. Vision of a firm thus encompasses personal objectives of people which they try to achieve.

Step 1: Name of the company

Step 2: Practices that have made the company successful

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The primary purpose of the strategic management process is to enable companies

to

achieve strategic competitiveness and earn above average returns. Researches have

indicated that companies that engage in strategic management generally out perform those that do not. The attainment of an appropriate match or fit between a company’s environment and its strategy, structure, and processes has positive effects on the company’s performance. Bruce Henderson, founder of the Boston Consulting Group, pointed out that a company

cannot afford to follow intuitive strategies once it becomes large, has layers of management,

its environment changes substantially. As the world’s environment becomes increasingly complex and changing, today’s companies, as one way to make the environment more manageable, use strategic management.

or

Strategic competitiveness is achieved when a company successfully formulates and implements a value creating strategy. By implementing a value creating strategy that current and potential competitors are not simultaneously implementing and that competitors are unable to duplicate, a company achieves a sustained or sustainable competitive advantage. So long as a company can sustain (or maintain) a competitive advantage, investors will earn above average returns. Above average returns represent returns that exceed returns that investors expect to earn from other investments with similar levels of risk (investor

uncertainty about the economic gains or losses that will result from a particular investment).

In

other words, above average returns exceed investors’ expected levels of return for

given levels of risk. In the long run, companies must earn at least average returns and provide investors with average returns if they are to survive. If a company earns below average returns and provides investors with below average returns, investors will withdraw

their funds and place them in investments that earn at least average returns. Internationally these types of companies are prime take over targets, a concept that is picking up in India.

A

framework that can assist companies in their quest for strategic competitiveness is the

strategic management process, the full set of commitments, decisions and actions required for a company to systematically achieve strategic competitiveness and earn above average.

 

Mission

An organization’s mission is the purpose or reason for the organizations existence. A well convinced mission statement defines the fundamental, unique purpose that sets a company apart other firms of its and identifies the scope of the company’s operations in terms of products offered and market served.

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Objectives

 

It is the end results of planned activity. The corporate objectives achievement should result in the fulfillment of a corporation’s mission.

NOTES

Some of the areas in which corporations might establish its goals and objectives are:

Profitability

Efficiency

Growth

Shareholder wealth

Utilization of resources

Reputation

Contribution to employees

Contribution to society through taxes paid etc ,

Market leadership

Technological leadership

Survival

Strategy

Strategy at Different Levels of a Business

Strategies exist at several levels in any organization - ranging from the overall business (or group of businesses) through to individuals working in it.

Corporate Strategy - is concerned with the overall purpose and scope of the business to meet stakeholder expectations. This is a crucial level since it is heavily influenced by investors in the business and acts to guide strategic decision-making throughout the business. Corporate strategy is often stated explicitly in a “mission statement”.

Business Unit Strategy - is concerned more with how a business competes successfully in a particular market. It concerns strategic decisions about choice of products, meeting needs of customers, gaining advantage over competitors, exploiting or creating new opportunities etc.

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Operational Strategy - is concerned with how each part of the business is organized to deliver the corporate and business-unit level strategic direction. Operational strategy therefore focuses on issues of resources, processes, people etc.

Policies

 
 

A

Policy is a broad guideline for decision making that links the formulation of

strategy with its implementation

Programs

 
 

A

program is a statement of the activities or steps needed to accomplish a single

use plan. It makes the strategy action oriented.

Budgets

 
 

A

Budget is a statement of a corporation’s programs in term of dollars/money

Used in planning and control, a budget lists the detailed cost of each program.

Procedures

 

It is a system of sequential steps or techniques that describe in detail how a particular task or job is to be done.

1.9

MINTZBERG’S MODES OF STRATEGIC DECISION MAKING

Entrepreneurial Mode

Adaptive Mode

Planning Mode

Logical Incrementalism

1.10

CORPORATE GOVERNANCE & SOCIAL RESPONSIBILITY

Corporate governance is the set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled. Corporate

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governance also includes the relationship stakeholders among the many players involved (the stakeholders) and the goals for which the corporation is governed. The principal players are the shareholders, management and the board of directors. Other stakeholders include employees, suppliers, customers, banks and other lenders, regulators, the environment and the community at large.

NOTES

Corporate governance is a multi-faceted subject. An important theme of corporate governance is to ensure the accountability of the impact of a corporate governance system in economic efficiency, with a strong emphasis on shareholders welfare. There are yet other aspects to the corporate governance subject, such as the stake holder view and certain individuals in an organization through mechanisms that try to reduce or eliminate the principal –agent problem. A related but separate thread of discussions focus on the corporate governance models around the world.

1.10.1 Definition Of Corporate Governance

In A Board Culture of Corporate Governance business author Gabrielle O’Donovan defines corporate governance as ‘an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business savvy, objectivity and integrity. Sound corporate governance is reliant on external marketplace commitment and legislation, plus a healthy board culture which safeguards policies and processes’.

O’Donovan goes on to say that ‘the perceived quality of a company’s corporate governance can influence its share price as well as the cost of raising capital. Quality is determined by the financial markets, legislation and other external market forces plus the international organisational environment; how policies and processes are implemented and how people are led. External forces are, to a large extent, outside the circle of control of any board. The internal environment is quite a different matter, and offers companies the opportunity to differentiate from competitors through their board culture. To date, too much of corporate governance debate has centred on legislative policy, to deter fraudulent activities and transparency policy which misleads executives to treat the symptoms and not the cause.

Corporate Governance is a system of structuring, operating and controlling a company with a view to achieve long term strategic goals to satisfy shareholders, creditors,

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employees, customers and suppliers, and complying with the legal and regulatory requirements, apart from meeting environmental and local community needs.

Report of SEBI committee (India) on Corporate Governance defines corporate governance as the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company.”

The definition is drawn from Gandhian principle of Trusteeship and Directive Principle of constitution. Corporate Governance is viewed as ethics and a moral duty.

1.10.2 History Of Corporate Governance

In the 19 th century, state corporation law enhanced the rights of corporate boards to govern without unanimous consent of shareholders in exchange for statutory benefits like appraisal rights, to make corporate governance more efficient. Since that time, and because most large publicly traded corporations in the US are incorporated under corporate administration friendly Delaware law, and because the US’s wealth has been increasingly securitized into various corporate entities and institutions, the rights of individual owners and shareholders have become increasingly derivative and dissipated. The concerns of shareholders over administration pay and stock losses periodically has led to more frequent calls for corporate governance reforms.

In the 20th century in the immediate aftermath of the Wall Street Crash of 1929 legal scholars such as Adolf Augustus Berle, Edwin Dodd, and Gardiner C. Means pondered on the changing role of the modern corporation in society. Berle and Means’ monograph “The Modern Corporation and Private Property” (1932, Macmillan) continues to have a profound influence on the conception of corporate governance in scholarly debates today.

From the Chicago school of economics, Ronald Coase’s “Nature of the Firm” (1937) introduced the notion of transaction costs into the understanding of why firms are founded and how they continue to behave. Fifty years later, Eugene Fama and Michael Jensen’s “The Separation of Ownership and Control” (1983, Journal of Law and Economics) firmly established agency theory as a way of understanding corporate

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governance: the firm is seen as a series of contracts. Agency theory’s dominance was highlighted in a 1989 article by Kathleen Eisenhardt (Academy of Management Review).

NOTES

US expansion after World War II through the emergence of multinational corporations saw the establishment of the managerial class. Accordingly, the following Harvard Business School Management professors published influential monographs studying their prominence: Myles Mace (entrepreneurship), Alfred D Chandler, Jr (business history), Jay Lorsch (organizational behavior) and Elizabeth MacIver (organizational behavior). According to Lorsch and MacIver “many large corporations have dominant control over business affairs without sufficient accountability or monitoring by their board of directors.”

Since the late 1970’s, corporate governance has been the subject of significant debate in the U.S. and around the globe. Bold, broad efforts to reform corporate governance have been driven, in part, by the needs and desires of shareowners to exercise their rights of corporate ownership and to increase the value of their shares and, therefore, wealth. Over the past three decades, corporate directors’ duties have expanded greatly beyond their traditional legal responsibility of duty of loyalty to the corporation and its shareowners.

In the first half of the 1990s, the issue of corporate governance in the U.S. received considerable press attention due to the wave of CEO dismissals (e.g.: IBM, Kodak, Honey well) by their boards. CALERS led a wave of institutional shareholder activism (something only very rarely seen before), as a way of ensuring that corporate value would not be destroyed by the now traditionally cozy relationships between the CEO and the board of directors (e.g., by the unrestrained issuance of stock options, not infrequently back dated).

In 1997, the East Asian Financial Crisis saw the economies of Thailand, Indonesia, South Korea, Malaysia and The Philippines severely affected by the exit of foreign capital after property assets collapsed. The lack of corporate governance mechanisms in these countries highlighted the weaknesses of the institutions in their economies.

In the early 2000s, the massive bankruptcies (and criminal malfeasance) of Enron and Worldcom, as well as lesser corporate debacles, such as Aldelphia Communications,AOL,ArthurAndersen, Global Crossing Tyco, and, more recently, Fannie Mae and Freddie Mac, led to increased shareholder and governmental interest in corporate governance. This culminated in the passage of the Sarbanes-Oxley Act of 2002. But, since then, the stock market has greatly recovered, and shareholder zeal has waned accordingly.

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1.10.3 Impact Of Corporate Governance

Positive effect of good corporate governance on different stakeholders ultimately results into strong economy and hence good corporate governance is tool for socio- economic development. After East Asia economy collapse in late 20th century, World Bank president warned those countries, that for sustainable development, corporate governance is must to be good. Economic health of a nation depends substantially how sound and ethical businesses are.

Enlightened Corporate Governance

Corporate governance, the unwieldy name given to the systems that guide the control and management of corporations, is a relatively recent term that came into being in the 1970s. Because corporate governance structures and processes specify the various roles and duties of corporate directors, senior executives, shareholders, and other stakeholders in the corporation, they play a large role in determining how responsible and accountable a corporation’s leaders will be in exercising their authority. When properly designed, governance processes guide companies toward useful objectives and help them monitor and measure their progress in achieving those objectives; when poorly designed, these processes permit companies to drift toward painful losses for shareholders and everyone else with a stake in the company.

A company’s corporate governance—whether good or bad—is established by its board of directors. Ideally, these directors will be energetic, experienced people deeply concerned about the company’s welfare. Because the board’s most pivotal responsibilities are to hire and supervise the company’s chief executive officer (CEO), these directors should not be company employees who work under the CEO’s direction; instead, they should be independent of the company’s management. When independent directors know how to work effectively with the company’s senior management team, they are likely to produce a corporate climate that accelerates the growth of long-term shareholder value.

Role of Institutional Investors

Many years ago, worldwide, buyers and sellers of corporation stocks were individual investors, such as wealthy businessmen or families, who often had a vested, personal and emotional interest in the corporations whose shares they owned. Over time,

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markets have become largely institutionalized: buyers and sellers are largely institutions (e.g., pension funds, insurance companies, mutual funds, hedge funds, investor groups, and banks).

NOTES

The rise of the institutional investor has brought with it some increase of professional diligence which has tended to improve regulation of the stock market (but not necessarily in the interest of the small investor or even of the naïve institutions, of which there are many). Note that this process occurred simultaneously with the direct growth of individuals investing indirectly in the market (for example individuals have twice as much money in mutual funds as they do in bank accounts). However this growth occurred primarily by way of individuals turning over their funds to ‘professionals’ to manage, such as in mutual funds. In this way, the majority of investment now is described as “institutional investment” even though the vast majority of the funds are for the benefit of individual investors.

Program trading, the hallmark of institutional trading, is averaging over 60% a day in 2007. Unfortunately, there has been a concurrent lapse in the oversight of large corporations, which are now almost all owned by large institutions. The Board of Directors of large corporations used to be chosen by the principal shareholders, who usually had an emotional as well as monetary investment in the company (think Ford), and the Board diligently kept an eye on the company and its principal executives (they usually hired and fired the President, or Chief Executive Officer— CEO).

Nowadays, if the owning institutions don’t like what the President/CEO is doing and they feel that firing them will likely be costly (think “golden handshake”) and/or time consuming, they will simply sell out their interest. The Board is now mostly chosen by the President/CEO, and may be made up primarily of their friends and associates, such as officers of the corporation or business colleagues. Since the (institutional) shareholders rarely object, the President/CEO generally takes the Chair of the Board position for his/ herself (which makes it much more difficult for the institutional owners to “fire” him/her). Occasionally, but rarely, institutional investors support shareholder resolutions on such matters as executive pay and anti-takeover measures.

Finally, the largest pools of invested money (such as the mutual fund ‘Vanguard 500’, or the largest investment management firm for corporations, State Street Corp) are designed simply to invest in a very large number of different companies with sufficient liquidity, based on the idea that this strategy will largely eliminate individual company financial

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or other risk and, therefore, these investors have even less interest in a particular company’s governance.

Since the marked rise in the use of Internet transactions from the 1990’s, both individual and professional stock investors around the world have emerged as a potential new kind of major (short term) force in the direct or indirect ownership of corporations and in the markets: the casual participant. Even as the purchase of individual shares in any one corporation by individual investors diminishes, the sale of derivatives (e.g., exchange traded funds (ETFs), Stock market index options, etc.) has soared. So, the interests of most investors are now increasingly rarely tied to the fortunes of individual corporations.

But, the ownership of stocks in markets around the world varies; for example, the majority of the shares in the Japanese market are held by financial companies and industrial corporations (there is a large and deliberate amount of cross-holding among Japanese keirestu corporations and within S. Korean chaebol ‘groups’), whereas stock in the USA or the UK and Europe are much more broadly owned, often still by large individual investors.

1.10.4

Parties To Corporate Governance

Parties involved in corporate governance include the regulatory body (e.g. the Chief Executive Officer, the board of directors, management and shareholders). Other stakeholders who take part include suppliers, employees, creditors, customers and the community at large.

 

In

corporations, the shareholder delegates decision rights to the manager to act in

the principal’s best interests. This separation of ownership from control implies a loss of effective control by shareholders over managerial decisions. Partly as a result of this separation between the two parties, a system of corporate governance controls is implemented to assist in aligning the incentives of managers with those of shareholders. With the significant increase in equity holdings of investors, there has been an opportunity for a reversal of the separation of ownership and control problems because ownership is not so diffuse.

 

A

board of directors often plays a key role in corporate governance. It is their

responsibility to endorse the organisation’s strategy, develop directional policy, appoint,

STRATEGIC MANAGEMENT

supervise and remunerate senior executives and to ensure accountability of the organisation to its owners and authorities.

NOTES

The Company Secretary, known as a Corporate Secretary in the US and often referred to as a Chartered Secretary if qualified by the Institute of Charted Secretaries and Administrators (ICSA), is a high ranking professional who is trained to uphold the highest standards of corporate governance, effective operations, compliance and administration.

All parties to corporate governance have an interest, whether direct or indirect, in the effective performance of the organisation. Directors, workers and management receive salaries, benefits and reputation, while shareholders receive capital return. Customers receive goods and services; suppliers receive compensation for their goods or services. In return these individuals provide value in the form of natural, human, social and other forms of capital.

A key factor in an individual’s decision to participate in an organisation e.g. through providing financial capital and trust that they will receive a fair share of the organisational returns. If some parties are receiving more than their fair return then participants may choose to not continue participating leading to organizational collapse.

1.10.5 Principles Of Corporate Governance

Key elements of good corporate governance principles include honesty, trust and integrity, openness, performance orientation, responsibility and accountability, mutual respect, and commitment to the organization.

Of importance is how directors and management develop a model of governance that aligns the values of the corporate participants and then evaluate this model periodically for its effectiveness. In particular, senior executives should conduct themselves honestly and ethically, especially concerning actual or apparent conflicts of interests, and disclosure in financial reports.

Commonly accepted principles of corporate governance include:

Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can

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help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings.

Interests of other stakeholders: Organizations should recognize that they have legal and other obligations to all legitimate stakeholders.

Role and responsibilities of the board: The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors. The key roles of Chairperson and CEO should not be held by the same person.

Integrity and ethical behaviour: Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that systemic reliance on integrity and ethics is bound to eventual failure. Because of this, many organizations establish Compliance and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal boundaries.

Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company’s financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information.

Issues involving corporate governance principles include:

oversight of the preparation of the entity’s financial statements

internal controls and the independence of the entity’s auditors

review of the compensation arrangements for the chief executive officer and other senior executives

the way in which individuals are nominated for positions on the board

the resources made available to directors in carrying out their duties

oversight and management of risk

dividend policy

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1.10.6

Mechanisms And Controls

 

Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from morald hazard and adverse selection. For example, to monitor managers’ behaviour, an independent third party (the auditor) attests the accuracy of information provided by management to investors. An ideal control system should regulate both motivation and ability.

NOTES

Internal corporate governance controls

Internal corporate governance controls monitor activities and then take corrective action to accomplish organisational goals. Examples include:

Monitoring by the board of directors: The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided. Whilst non-executive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase performance. Different board structures are optimal for different firms. Moreover, the ability of the board to monitor the firm’s executives is a function of its access to information. Executive directors possess superior knowledge of the decision- making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes, ex ante. It could be argued, therefore, that executive directors look beyond the financial criteria.

Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance. It may be in the form of cash or non-cash payments such as shares and share options, superannuation or other benefits. Such incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behaviour, and can elicit myopic behaviour.

External corporate governance controls

External corporate governance controls encompass the controls external stakeholders exercise over the organisation. Examples include:

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debt covenants

government regulations

media pressure

takeovers

competition

managerial labour market

telephone tapping

1.10.7

Systemic Problems Of Corporate Governance

Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors. Imperfections in the financial reporting process will cause imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the working of the external auditing process.

Demand for information:A barrier to shareholders using good information is the cost of processing it, especially to a small shareholder. The traditional answer to this problem is the efficient market hypothesis (in finance, the efficient market hypothesis (EMH) asserts that financial markets are efficient), which suggests that the shareholder will free ride on the judgements of larger professional investors.

Monitoring costs: In order to influence the directors, the shareholders must combine with others to form a significant voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting.

Role of the Accountant

Financial reporting is a crucial element necessary for the corporate governance system to function effectively. Accountants and Auditors are the primary providers of information to capital market participants. The directors of the company should be entitled to expect that management prepare the financial information in compliance with statutory and ethical obligations, and rely on auditors’ competence.

Current accounting practice allows a degree of choice of method in determining the method of measurement, criteria for recognition, and even the definition of the accounting entity. The exercise of this choice to improve apparent performance (popularly known as

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creative accounting) imposes extra information costs on users. In the extreme, it can involve non-disclosure of information.

NOTES

.

One area of concern is whether the accounting firm acts as both the independent auditor and management consultant to the firm they are auditing. This may result in a conflict of interest which places the integrity of financial reports in doubt due to client pressure to appease management. The power of the corporate client to initiate and terminate management consulting services and, more fundamentally, to select and dismiss accounting firms contradicts the concept of an independent auditor. Changes enacted in the United States in the form of the Sarbanes-Oxley Act (in response to the Enron situation as noted below) prohibit accounting firms from providing both auditing and management consulting services. Similar provisions are in place under clause 49 of SEBI Act in India.

The Enron collapse is an example of misleading financial reporting. Enron concealed huge losses by creating illusions that a third party was contractually obliged to pay the amount of any losses. However, the third party was an entity in which Enron had a substantial economic stake. In discussions of accounting practices with Arthur Andersen, the partner in charge of auditing, views inevitably led to the client prevailing.

However, good financial reporting is not a sufficient condition for the effectiveness of corporate governance if users don’t process it, or if the informed user is unable to exercise a monitoring role due to high costs.

Rules versus principles

Rules are typically thought to be simpler to follow than principles, demarcating a clear line between acceptable and unacceptable behaviour. Rules also reduce discretion on the part of individual managers or auditors.

In practice rules can be more complex than principles. They may be ill-equipped to deal with new types of transactions not covered by the code. Moreover, even if clear rules are followed, one can still find a way to circumvent their underlying purpose - this is harder to achieve if one is bound by a broader principle.

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Principles on the other hand are a form of self regulation. It allows the sector to determine what standards are acceptable or unacceptable. It also pre-empts over zealous legislations that might not be practical.

Enforcement

Enforcement can affect the overall credibility of a regulatory system. They both deter bad actors and level the competitive playing field. Nevertheless, greater enforcement is not always better, for taken too far it can dampen valuable risk-taking. In practice, however, this is largely a theoretical, as opposed to a real, risk.

Action Beyond Obligation

Enlightened boards regard their mission as helping management lead the company. They are more likely to be supportive of the senior management team. Because enlightened directors strongly believe that it is their duty to involve themselves in an intellectual analysis of how the company should move forward into the future, most of the time, the enlightened board is aligned on the critically important issues facing the company.

Unlike traditional boards, enlightened boards do not feel hampered by the rules and regulations of the Sarbanes-Oxley Act. Unlike standard boards that aim to comply with regulations, enlightened boards regard compliance with regulations as merely a baseline for board performance. Enlightened directors go far beyond merely meeting the requirements on a checklist. They do not need Sarbanes-Oxley to mandate that they protect values and ethics or monitor CEO performance.

At the same time, enlightened directors recognize that it is not their role to be involved in the day-to-day operations of the corporation. They lead by example. Overall, what most distinguishes enlightened directors from traditional and standard directors is the passionate obligation they feel to engage in the day-to-day challenges and strategizing of the company. Enlightened boards can be found in very large, complex companies, as well as smaller companies.

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1.10.8 Corporate Governance Models Around The World

NOTES

Although the US model of corporate governance is the most notorious, there is a considerable variation in corporate governance models around the world. The intricated shareholding structures of keiretsus in Japan, the heavy presence of banks in the equity of german firms, the chaebols in South Korea and many others are examples of arrangements which try to respond to the same corporate governance challenges as in the US.

Anglo-American Model

There are many different models of corporate governance around the world. These differ according to the variety of capitalism in which they are embedded. The liberal model that is common in Anglo-American countries tends to give priority to the interests of shareholders. The coordinated model that one finds in Continental Europe and Japan also recognizes the interests of workers, managers, suppliers, customers, and the community. Both models have distinct competitive advantages, but in different ways. The liberal model of corporate governance encourages radical innovation and cost competition, whereas the coordinated model of corporate governance facilitates incremental innovation and quality competition. However, there are important differences between the U.S. recent approach to governance issues and what has happened in the U.K

In the United States, a corporation is governed by a board of directors, which has the power to choose an executive officer, usually known as the chief executive officer. The CEO has broad power to manage the corporation on a daily basis, but needs to get board approval for certain major actions, such as hiring his/her immediate subordinates, raising money, acquiring another company, major capital expansions, or other expensive projects. Other duties of the board may include policy setting, decision making, monitoring management’s performance, or corporate control.

The board of directors is nominally selected by and responsible to the share holders, but the bylaws of many companies make it difficult for all but the largest shareholders to have any influence over the makeup of the board; normally, individual shareholders are not offered a choice of board nominees among which to choose, but are merely asked to rubberstamp the nominees of the sitting board. Perverse incentives have pervaded many corporate boards in the developed world, with board members beholden to the chief

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executive whose actions they are intended to oversee. Frequently, members of the boards of directors are CEOs of other corporations, which some see as a conflict of interest.

The U.K. has pioneered a flexible model of regulation of corporate governance, known as the “comply or explain” code of governance. This is a principle based code that lists a dozen of recommended practices, such as the separation of CEO and Chairman of the Board, the introduction of a time limit for CEOs’ contracts, the introduction of a minimum number of non-executives Directors, of independent directors, the designation of a senior non executive director, the formation and composition of remuneration, audit and nomination committees. Publicly listed companies in the U.K. have to either apply those principles or, if they choose not to, to explain in a designated part of their annual reports why they decided not to do so. The monitoring of those explanations is left to shareholders themselves. The tenet of the Code is that one size does not fit all in matters of corporate governance and that instead of a statuary regime like the Sarbanes-Oxley Act in the U.S., it is best to leave some flexibility to companies so that they can make choices most adapted to their circumstances. If they have good reasons to deviate from the sound rule, they should be able to convincingly explain those to their shareholders.

The code has been in place since 1993 and has had drastic effects on the way firms are governed in the U.K. A study by Arcot, Bruno and Faure-Grimaud from the Financial Markets Group at the London School of Economics shows that in 1993, about 10% of the UK companies member of the FTSE 350 were compliants on all dimensions while they were more than 60% in 2003. The same success was not achieved when looking at the explanation part for non compliant companies. Many deviations are simply not explained and a large majority of explanations fail to identify specific circumstances justifying those deviations. Still, the overall view is that the U.K.’s system works fairly well and in fact is often branded as a benchmark, followed by several countries.

NonAnglo-American Model

In East Asian countries, family-owned companies dominate.A study by Claessens, Djankov and Lang (2000) investigated the top 15 families in East Asian countries and found that they dominated listed corporate assets. In countries such as Pakistan, Indonesia and the Philippines, the top 15 families controlled over 50% of publicly owned corporations through a system of family cross-holdings, thus dominating the capital markets. Family- owned companies also dominate the Latin model of corporate governance, that is companies

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in Mexico, Italy, Spain, France (to a certain extent), Brazil, Argentina, and other countries in South America.

NOTES

Europe and Asia exemplify the insider system: Shareholder and stakeholder • a small number of listed companies, • an illiquid capital market where ownership and control are not frequently traded • high concentration of shareholding in the hands of corporations, institutions, families or government. • the insider model uses a system of interlocking networks and committees.

At the same time that developing countries are undergoing a process of economic growth and transformation, they are also experiencing a revolution in the business and political relationships that characterize their private and public sectors. Establishing good corporate governance practices is essential to sustaining long-term development and growth as these countries move from closed, market-unfriendly, undemocratic systems towards open, market-friendly, democratic systems. Good corporate governance systems will allow organizations to realize their maximum productivity and efficiency, minimize corruption and abuse of power, and provide a system of managerial accountability. These goals are equally important for both private corporations and government bodies.

Because of the implicit relationship between private interests and the larger government, good corporate governance practices are essential to establishing good governance at the national level in developing countries. A number of ties the keep the public and private sectors closely linked. On one hand, judiciary and regulatory bodies as well as legislatures play a role in corporate management and oversight. At the same time cartels and large corporate interests use their size to exert not only economic, but also political power. These two sectors are so intertwined that a country cannot significantly change one without simultaneously instituting changes in the other.

According to Nicolas Meisel, there are four priorities which developing countries should concentrate on while experimenting with new forms of corporate and public governance. The first is to focus on improving the quality of information and increasing the speed at which it is created and distributed to the public. Good communication is important to the functioning of any organization. The second is to allow individual actors more autonomy while at the same time maintaining or increasing accountability. Thirdly, if a hierarchical organization used to orient private activities toward the general interest, new countervailing powers should be encouraged to fill this role. Finally, the part the state plays and how

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government officials are selected must be considered if a developing economy is to achieve sustainable growth. This may involve making it easier for newcomers with new ideas incumbents who may hold to older, possibly outdated, models.

Codes and guidelines

Corporate governance principles and codes have been developed in different countries and issued from stock exchanges, corporations, institutional investors, or associations (institutes) of directors and managers with the support of governments and international organizations.As a rule, compliance with these governance recommendations is not mandated by law, although the codes linked to stock exchange listing requirements may have a coercive effect.

For example, companies quoted on the London and Toronto Stock Exchanges formally need not follow the recommendations of their respective national codes. However, they must disclose whether they follow the recommendations in those documents and, where not, they should provide explanations concerning divergent practices. Such disclosure requirements exert a significant pressure on listed companies for compliance.

In the United States, companies are primarily regulated by the state in which they incorporate though they are also regulated by the federal government and, if they are public, by their stock exchange. The highest number of companies are incorporated in Delaware, including more than half of the Fortune 500. This is due to Delaware’s generally business-friendly corporate legal environment and the existence of a state court dedicated solely to business issues (Delaware Court of Chancery).

Most states’corporate law generally follow theAmerican BarAssociation’s Model Business Corporation Act. While Delaware does not follow the Act, it still considers its provisions and several prominent Delaware justices, including former Delaware Supreme Court Chief Justice E.Norman veasey participate on ABA committees.

One issue that has been raised since the Disney decision in 2005 is the degree to which companies manage their governance responsibilities; in other words, do they merely try to supersede the legal threshold, or should they create governance guidelines that ascend to the level of best practice. For example, the guidelines issued by associations of directors (see Section 3 above), corporate managers and individual companies tend to be wholly

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voluntary. For example, The GM Board Guidelines reflect the company’s efforts to improve its own governance capacity. Such documents, however, may have a wider multiplying effect prompting other companies to adopt similar documents and standards of best practice.

NOTES

One of the most influential guidelines has been the 1999 OECD Principles of Corporate Governance. This was revised in 2004. The OECD remains a proponent of corporate governance principles throughout the world.

The World Business Council for Sustainable DevelopmentWBCSD has also done substantial work on corporate governance, particularly on accountability and reporting, and in 2004 created an Issue Management Tool: Strategic challenges for business in the use of corporate responsibility codes, standards, and frame works. This document aims to provide general information, a “snap-shot” of the landscape and a perspective from a think-tank/professional association on a few key codes, standards and frameworks relevant to the sustainability agenda.

1.10.9 Corporate Governance And Firm Performance

In its ‘Global Investor Opinion Survey’ of over 200 institutional investors first undertaken in 2000 and updated in 2002, McKinsey found that 80% of the respondents would pay a premium for well-governed companies. They defined a well-governed company as one that had mostly out-side directors, who had no management ties, undertook formal evaluation of its directors, and was responsive to investors’ requests for information on governance issues. The size of the premium varied by market, from 11% for Canadian companies to around 40% for companies where the regulatory backdrop was least certain (those in Morocco,Egypt and Russia).

Other studies have linked broad perceptions of the quality of companies to superior share price performance. In a study of five year cumulative returns of Fortune Magazine’s survey of ‘most admired firms’, Antunovich et al found that those “most admired” had an average return of 125%, whilst the ‘least admired’ firms returned 80%. In a separate study Business Week enlisted institutional investors and ‘experts’to assist in differentiating between boards with good and bad governance and found that companies with the highest rankings had the highest financial returns.

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On the other hand, research into the relationship between specific corporate governance controls and firm performance has been mixed and often weak. The following examples are illustrative.

Board composition

Some researchers have found support for the relationship between frequency of meetings and profitability. Others have found a negative relationship between the proportion of external directors and firm performance, while others found no relationship between external board membership and performance. In a recent paper Bagahat and Black found that companies with more independent boards do not perform better than other companies. It is unlikely that board composition has a direct impact on firm performance.

Remuneration/Compensation

The results of previous research on the relationship between firm performance and executive compensation have failed to find consistent and significant relationships between executives’ remuneration and firm performance. Low average levels of pay-performance alignment do not necessarily imply that this form of governance control is inefficient. Not all firms experience the same levels of agency conflict, and external and internal monitoring devices may be more effective for some than for others.

Some researchers have found that the largest CEO performance incentives came from ownership of the firm’s shares, while other researchers found that the relationship between share ownership and firm performance was dependent on the level of ownership. The results suggest that increases in ownership above 20% cause management to become more entrenched, and less interested in the welfare of their shareholders.

Some argue that firm performance is positively associated with share option plans and that these plans direct managers’ energies and extend their decision horizons toward the long-term, rather than the short-term, performance of the company. However, that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and, in particular, the backdating of option grants as documented by University of Iowa academic Erik Lie and reported by James Blander and Charles Forelle of the Wall Street Journal.

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Even before the negative influence on public opinion caused by the 2006 backdating scandal, use of options faced various criticisms. A particularly forceful and long running argument concerned the interaction of executive options with corporate stock repurchase programs. Numerous authorities (including U.S. Federal Reserve Board economist Weisbenner) determined options may be employed in concert with stock buybacks in a manner contrary to shareholder interests. These authors argued that, in part, corporate stock buybacks for U.S. Standard & Poors 500 companies surged to a $500 billion annual rate in late 2006 because of the impact of options. A compendium of academic works on the option/buyback issue is included in the study Scanda by author M.Gumport issued in 2006.

NOTES

A combination of accounting changes and governance issues led options to become a less popular means of remuneration as 2006 progressed, and various alternative implementations of buybacks surfaced to challenge the dominance of “open market” cash buybacks as the preferred means of implementing a share repurchase plan.

1.10.10

Initiative Of Indian Government Of Corporate Governance

National foundation for corporate governance (A Trust formed by MCA, CII, ICAI & ICSI)

Vision:

Be A Catalyst In Making India The Best In Corporate Governance PracticesMission:

To foster a culture for promoting good governance, voluntary compliance and facilitate effective participation of different stakeholders;

To create a framework of best practices, structure, processes and ethics;

To make significant difference to Indian Corporate Sector by raising the standard of corporate governance in India towards achieving stability and growth

Invites Companies to Showcase their Good Corporate Governance Practices:

In order to promote Corporate Governance in India, NFCG has undertaken a major campaign to disseminate, to public at large, the good corporate governance practices

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followed by the Industries especially among the Small and Medium Enterprises (SMEs) and unlisted Companies.

 

In case you believe that your company has initiated some benchmark Corporate

Governance initiatives then we invite you to forward. A brief audio-visual presentation

highlightingthefollowing:-

The Corporate Governance practices followed in your Company;

The net worth of the Company in the terms of assets, turnover and profit before the implementation of the good Corporate Governance practices;

The cost of implementation of the Corporate Governance Practices;

The effect on the net worth and business Operations of the Company after the implementation of the good Corporate Governance practices

The short listed presentations will be telecast on one of the prominent business TV Channels and also given awards /certificate by NFCG.

SUMMARY

Strategic management is the art and science of formulating, implementing and evaluating cross-functional decisions that will enable an organization to achieve its objectives. It is the process of specifying the organization’s objectives, developing policies and plans to achieve these objectives, and allocating resources to implement the policies and plans to achieve the organization’s objectives. Strategic management as a discipline originated in the 1950s and 60s. Although there were numerous early contributors to the literature, the most influential pioneers were Alfred D. Chandler, Jr., Philip Selznick, Igor Ansoff, and Peter Drucker.

The steps involved in strategic management process are:

1.

Defining the vision, business mission, purpose, and broad objectives.2. Formulation of strategies.3. Implementation of strategies. 4. Evaluation of strategies.

The four phases can be listed as below. 1. Defining the vision, business mission, purpose, and broad objectives.2. Formulation of strategies.3. Implementation of strategies.4. Evaluation of strategies.

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Corporate governance is the set of processes, customs, policies, laws and institutions affecting the way a corporation is directed anagement are: Clarity of strategic vision for the? organization, Focus on what is strategically? important to the organization,Better understanding of the rapidly? changing business environment.

NOTES

The four phases can be listed as administered or controlled. Corporate governance also includes the relationship stakeholders among the many players involved (the stakeholders) and the goals for which the corporation is governed. The principal players are the shareholders, management and the board of directors. Other stakeholders include employees, suppliers, customers, banks and other lenders, regulators, the environment and the community at large.

Short Questions

Q1.Define strategy. Q2. What is policy, procedure and budget? Q3. Mention the three types of strategies. Q4.Define Corporate Governanace.

Review questions

Q5.Explain the strategic formulation process. Q6.Discuss the evolution and growth of strategic management. Q7.Explain the different approaches of strategic management. Q8. Discuss the key role to be played by the all levels of management in strategic formulations. Q9.Discuss the role of corporate governance and its influences in corporations performances.

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NOTES

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UNIT II

NOTES

COMPETITIVE ADVANTAGE

INTRODUCTION

The interaction of the four environmental dimensions creates further sub-dimensions such as political and economic environments that act as a filter between the internal and external environment and profoundly affect the performance of the corporation. Culture here refers to transmitted patterns of behaviour shared by members of a group which provide them with effective mechanisms for interaction (Krefting & Krefting, 1991). Culture can be thought of as an overriding concept (eg. western cultures and indigenous cultures) that directs the sociocultural specificity of group environments each with its own beliefs and rituals that are used to determine behavioural norms.

Michael Porter provided a framework that models an industry as being influenced by five forces. The strategic business manager seeking to develop an edge over rival firms can use this model to better understand the industry context in which the firm operates.When a rival acts in a way that elicits a counter-response by other firms, rivalry intensifies.The intensity of rivalry commonly is referred to as being cutthroat, intense, moderate, or weak,based on the firms’ aggressiveness in attempting to gain an advantage

Learning Objectives

After learning this unit you must be able to:

Analyze the external environment influencing the industry as well as strategy

Understand the porter’s five forces model and its uses in strategic management

Know the competitive changes and the stages of industrial analysis

Predict the changes in the industry structure due to the globalization

Analyze the importance of capabilities and competencies in gaining competitive advantage

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Implement the porter’s model on Gaining Competitive Advantage

NOTES

Planning for the sustainability of competitiveness.

2.1

EXTERNAL ENVIRONMENT

The external environment is all the conditions surrounding a person, and has been classified in various ways. Any organization before they begin the work of strategy formulations, it must scan the external environment to identify possible opportunities and threats and its internal environment for strengths and weaknesses. Environmental scanning is the monitoring , evaluating, and disseminating of information from the external and internal environment to key people within the corporation.

The major four environmental dimensions are as follows

 

1. Economical factors

2. Technological factors

3. Political factors

4. Socio-cultural factors

Let us see each of the factors some influencing variables:

A

Economical factors :

 

GDP trends

Interest rates

Money supply

Inflation rates

Unemployment levels

Wage/price controls

Devaluation/revaluation

Energy availability and cost

Disposable and discretionary income

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B Technological factors:

NOTES

Government spending for R&D

Technological efforts

 

Patent protection

New products

Technology transfer

Automation

Internet availability

Infrastructure

C Political and Legal factors:

Antitrust regulations

Environment protection laws

Tax laws

Special incentives

Foreign trade regulations

Attitude towards foreign companies

Laws on hiring and promotion

Stability of the government

D Socio-Cultural factors

Life style changes

Career expectations

ConsumerActivism

Rate of family formation

Growth rate of population

Age distribution of population

Regional shifts in population

Life expectancies

Birth rates

The interaction of these four environmental dimensions creates further sub- dimensions such as political and economic environments that act as a filter between the internal and external environment and profoundly affect the performance of the corporation.

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Although aspects of this environment are defined separately, the environmental impact that is brought to bear on occupational performance is an integration of sensory, physical, social and cultural dimensions V (Llorens, 1984b, Spencer, 1987).

Physical aspects of the environment refer to the natural and constructed surroundings that form physical boundaries. This physical environment contributes to shaping occupational performance by influencing the extent to which self maintenance; productivity; leisure and rest occupations can be performed.

Culture here refers to transmitted patterns of behaviour shared by members of a group which provide them with effective mechanisms for interaction (Krefting & Krefting, 1991). Culture can be thought of as an overriding concept (eg. western cultures and indigenous cultures) that directs the sociocultural specificity of group environments each with its own beliefs and rituals that are used to determine behavioural norms.

2.2 MICHAEL PORTER FIVE FORCES MODEL

A model for industry analysis

The model of pure competition implies that risk-adjusted rates of return should be constant across firms and industries. However, numerous economic studies have affirmed that different industries can sustain different levels of profitability; part of this difference is explained by industry structure.

Michael Porter provided a framework that models an industry as being influenced by five forces. The strategic business manager seeking to develop an edge over rival firms can use this model to better understand the industry context in which the firm operates.

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NOTES
NOTES

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I. Rivalry

In the traditional economic model, competition among rival firms drives profits to zero. But competition is not perfect and firms are not unsophisticated passive price takers. Rather, firms strive for a competitive advantage over their rivals. The intensity of rivalry among firms varies across industries, and strategic analysts are interested in these differences.

Economists measure rivalry by indicators of industry concentration. The Concentration Ratio (CR) is one such measure. The Bureau of Census periodically reports the CR for major Standard Industrial Classifications (SIC’s). The CR indicates the percent of market share held by the four largest firms (CR’s for the largest 8, 25, and 50 firms in an industry also are available). Ahigh concentration ratio indicates that a high concentration of market share is held by the largest firms - the industry is concentrated. With only a few firms holding a large market share, the competitive landscape is less competitive (closer to a monopoly). A low concentration ratio indicates that the industry is characterized by many rivals, none of which has a significant market share. These fragmented markets are said to be competitive. The concentration ratio is not the only available measure; the trend is to define industries in terms that convey more information than distribution of market share.

If rivalry among firms in an industry is low, the industry is considered to be disciplined. This discipline may result from the industry’s history of competition, the role of a leading firm, or informal compliance with a generally understood code of conduct. Explicit collusion generally is illegal and not an option; in low-rivalry industries competitive moves must be constrained informally. However, a maverick firm seeking a competitive advantage can displace the otherwise disciplined market.

When a rival acts in a way that elicits a counter-response by other firms, rivalry intensifies. The intensity of rivalry commonly is referred to as being cutthroat, intense, moderate, or weak, based on the firms’ aggressiveness in attempting to gain an advantage.

In pursuing an advantage over its rivals, a firm can choose from several competitive

moves:

Changing prices - raising or lowering prices to gain a temporary advantage.

Improvingproductdifferentiation -improvingfeatures,implementinginnovations in the manufacturing process and in the product itself.

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Creatively using channels of distribution - using vertical integration or using a distribution channel that is novel to the industry. For example, with high-end jewelry stores reluctant to carry its watches, Timex moved into drugstores and other non- traditional outlets and cornered the low to mid-price watch market.

NOTES

Exploiting relationships with suppliers - for example, from the 1950’s to the 1970’s Sears, Roebuck and Co. dominated the retail household appliance market. Sears set high quality standards and required suppliers to meet its demands for product specifications and price.

The intensity of rivalry is influenced by the following industry characteristics:

A larger number of firms increases rivalry because more firms must compete for the same customers and resources. The rivalry intensifies if the firms have similar market share, leading to a struggle for market leadership.

Slow market growth causes firms to fight for market share. In a growing market, firms are able to improve revenues simply because of the expanding market.

High fixed costs result in an economy of scale effect that increases rivalry. When total costs are mostly fixed costs, the firm must produce near capacity to attain the lowest unit costs. Since the firm must sell this large quantity of product, high levels of production lead to a fight for market share and results in increased rivalry.

High storage costs or highly perishable products cause a producer to sell goods as soon as possible. If other producers are attempting to unload at the same time, competition for customers intensifies.

Low switching costs increases rivalry. When a customer can freely switch from one product to another there is a greater struggle to capture customers.

Low levels of product differentiation is associated with higher levels of rivalry. Brand identification, on the other hand, tends to constrain rivalry.

Strategic stakes are high when a firm is losing market position or has potential for great gains. This intensifies rivalry.

High exit barriers place a high cost on abandoning the product. The firm must compete. High exit barriers cause a firm to remain in an industry, even when the venture is not profitable. A common exit barrier is asset specificity. When the plant and equipment required for manufacturing a product is highly specialized, these assets cannot easily be sold to other buyers in another industry. Litton Industries’ acquisition of Ingalls Shipbuilding facilities illustrates this concept. Litton was successful in the 1960’s with its contracts to build Navy ships. But when the Vietnam war ended, defense spending declined and Litton saw a sudden decline in its earnings. As the firm restructured, divesting from the shipbuilding plant was not

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feasible since such a large and highly specialized investment could not be sold easily, and Litton was forced to stay in a declining shipbuilding market.

A diversity of rivals with different cultures, histories, and philosophies make an industry unstable. There is greater possibility for mavericks and for misjudging rival’s moves. Rivalry is volatile and can be intense. The hospital industry, for example, is populated by hospitals that historically are community or charitable institutions, by hospitals that are associated with religious organizations or universities, and by hospitals that are for-profit enterprises. This mix of philosophies about mission has lead occasionally to fierce local struggles by hospitals over who will get expensive diagnostic and therapeutic services. At other times, local hospitals are highly cooperative with one another on issues such as community disaster planning.

Industry Shakeout. A growing market and the potential for high profits induces new firms to enter a market and incumbent firms to increase production. A point is reached where the industry becomes crowded with competitors, and demand cannot support the new entrants and the resulting increased supply. The industry may become crowded if its growth rate slows and the market becomes saturated, creating a situation of excess capacity with too many goods chasing too few buyers.Ashakeout ensues, with intense competition.

BCG founder Bruce Henderson generalized this observation as the Rule of Three and Four: a stable market will not have more than three significant competitors, and the largest competitor will have no more than four times the market share of the smallest. If this rule is true, it implies that:

If there is a larger number of competitors, a shakeout is inevitable

Surviving rivals will have to grow faster than the market

Eventual losers will have a negative cash flow if they attempt to grow

All except the two largest rivals will be losers

The definition of what constitutes the “market” is strategically important.

Whatever the merits of this rule for stable markets, it is clear that market stability and changes in supply and demand affect rivalry. Cyclical demand tends to create cutthroat competition. This is true in the disposable diaper industry in which demand fluctuates with

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birth rates, and in the greeting card industry in which there are more predictable business cycles.

NOTES

II.

Threat of Substitutes

In Porter’s model, substitute products refer to products in other industries. To the economist, a threat of substitutes exists when a product’s demand is affected by the price change of a substitute product. A product’s price elasticity is affected by substitute products - as more substitutes become available, the demand becomes more elastic since customers have more alternatives. Aclose substitute product constrains the ability of firms in an industry to raise prices.

The competition engendered by a Threat of Substitute comes from products outside the industry. The price of aluminum beverage cans is constrained by the price of glass bottles, steel cans, and plastic containers. These containers are substitutes, yet they are not rivals in the aluminum can industry. To the manufacturer of automobile tires, tire retreads are a substitute. Today, new tires are not so expensive that car owners give much consideration to retreating old tires. But in the trucking industry new tires are expensive and tires must be replaced often. In the truck tire market, retreating remains a viable substitute industry. In the disposable diaper industry, cloth diapers are a substitute and their prices constrain the price of disposables.

While the treat of substitutes typically impacts an industry through price competition, there can be other concerns in assessing the threat of substitutes. Consider the substitutability of different types of TV transmission: local station transmission to home TV antennas via the airways versus transmission via cable, satellite, and telephone lines. The new technologies available and the changing structure of the entertainment media are contributing to competition among these substitute means of connecting the home to entertainment. Except in remote areas it is unlikely that cable TV could compete with free TV from an aerial without the greater diversity of entertainment that it affords the customer.

III.

Buyer Power

The power of buyers is the impact that customers have on a producing industry. In general, when buyer power is strong, the relationship to the producing industry is near to what an economist terms a monopsony - a market in which there are many suppliers and

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NOTES one buyer. Under such market conditions, the buyer sets the price. In reality few
NOTES
one buyer. Under such market conditions, the buyer sets the price. In reality few pure
monopsonies exist, but frequently there is some asymmetry between a producing industry
and buyers. The following tables outline some factors that determine buyer power.
IV.
Supplier Power
Aproducing industry requires raw materials - labor, components, and other supplies.
This requirement leads to buyer-supplier relationships between the industry and the firms
that provide it the raw materials used to create products. Suppliers, if powerful, can exert
an influence on the producing industry, such as selling raw materials at a high price to
capture some of the industry’s profits. The following tables outline some factors that determine
supplier power.

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NOTES V. Barriers to Entry / Threat of Entry It is not only incumbent rivals
NOTES
V.
Barriers to Entry / Threat of Entry
It is not only incumbent rivals that pose a threat to firms in an industry; the possibility
that new firms may enter the industry also affects competition. In theory, any firm should be
able to enter and exit a market, and if free entry and exit exists, then profits always should
be nominal. In reality, however, industries possess characteristics that protect the high
profit levels of firms in the market and inhibit additional rivals from entering the market.
These are barriers to entry.
Barriers to entry are more than the normal equilibrium adjustments that markets
typically make. For example, when industry profits increase, we would expect additional

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firms to enter the market to take advantage of the high profit levels, over time driving down profits for all firms in the industry. When profits decrease, we would expect some firms to exit the market thus restoring a market equilibrium. Falling prices, or the expectation that future prices will fall, deters rivals from entering a market. Firms also may be reluctant to enter markets that are extremely uncertain, especially if entering involves expensive start- up costs. These are normal accommodations to market conditions. But if firms individually (collective action would be illegal collusion) keep prices artificially low as a strategy to prevent potential entrants from entering the market, such entry-deterring pricing establishes a barrier.

Barriers to entry are unique industry characteristics that define the industry. Barriers

reduce the rate of entry of new firms, thus maintaining a level of profits for those already in the industry. From a strategic perspective, barriers can be created or exploited to enhance

a firm’s competitive advantage. Barriers to entry arise from several sources:

Government creates barriers. Although the principal role of the government in

a market is to preserve competition through anti-trust actions, government also restricts

competition through the granting of monopolies and through regulation. Industries such as utilities are considered natural monopolies because it has been more efficient to have one electric company provide power to a locality than to permit many electric companies to compete in a local market. To restrain utilities from exploiting this advantage, government permits a monopoly, but regulates the industry. Illustrative of this kind of barrier to entry is the local cable company. The franchise to a cable provider may be granted by competitive bidding, but once the franchise is awarded by a community a monopoly is created. Local governments were not effective in monitoring price gouging by cable operators, so the federal government has enacted legislation to review and restrict prices.

The regulatory authority of the government in restricting competition is historically evident in the banking industry. Until the 1970’s, the markets that banks could enter were limited by state governments. As a result, most banks were local commercial and retail banking facilities. Banks competed through strategies that emphasized simple marketing devices such as awarding toasters to new customers for opening a checking account. When banks were deregulated, banks were permitted to cross state boundaries and expand their markets. Deregulation of banks intensified rivalry and created uncertainty for banks as they attempted to maintain market share. In the late 1970’s, the strategy of banks

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shifted from simple marketing tactics to mergers and geographic expansion as rivals attempted to expand markets.

NOTES

Patents and proprietary knowledge serve to restrict entry into an industry. Ideas and knowledge that provide competitive advantages are treated as private property when patented, preventing others from using the knowledge and thus creating a barrier to entry. Edwin Land introduced the Polaroid camera in 1947 and held a monopoly in the instant photography industry. In 1975, Kodak attempted to enter the instant camera market and sold a comparable camera. Polaroid sued for patent infringement and won, keeping Kodak out of the instant camera industry.

Asset specificity inhibits entry into an industry. Asset specificity is the extent to which the firm’s assets can be utilized to produce a different product. When an industry requires highly specialized technology or plants and equipment, potential entrants are reluctant to commit to acquiring specialized assets that cannot be sold or converted into other uses if the venture fails. Asset specificity provides a barrier to entry for two reasons: First, when firms already hold specialized assets they fiercely resist efforts by others from taking their market share. New entrants can anticipate aggressive rivalry. For example, Kodak had much capital invested in its photographic equipment business and aggressively resisted efforts by Fuji to intrude in its market. These assets are both large and industry specific. The second reason is that potential entrants are reluctant to make investments in highly specialized assets.

Organizational (Internal) Economies of Scale. The most cost efficient level of production is termed Minimum Efficient Scale (MES). This is the point at which unit costs for production are at minimum - i.e., the most cost efficient level of production. If MES for firms in an industry is known, then we can determine the amount of market share necessary for low cost entry or cost parity with rivals. For example, in long distance communications roughly 10% of the market is necessary for MES. If sales for a long distance operator fail to reach 10% of the market, the firm is not competitive.

The existence of such an economy of scale creates a barrier to entry. The greater the difference between industry MES and entry unit costs, the greater the barrier to entry. So industries with high MES deter entry of small, start-up businesses. To operate at less than MES there must be a consideration that permits the firm to sell at a premium price - such as product differentiation or local monopoly.

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Barriers to exit work similarly to barriers to entry. Exit barriers limit the ability of a firm to leave the market and can exacerbate rivalry - unable to leave the industry, a firm must compete. Some of an industry’s entry and exit barriers can be summarized as follows:

Easy to Enter if there is: Common technologyLittle brand franchiseAccess to distribution channelsLow scale threshold Difficult to Enter if there is: Patented or proprietary know-howDifficulty in brand switchingRestricted distribution channelsHigh scale threshold Easy to Exit if there are: Salable assetsLow exit costsIndependent businesses Difficult to Exit if there are: Specialized assetsHigh exit costsInterrelated businesses

2.3 DYNAMIC NATURE OF INDUSTRY RIVALRY

Our descriptive and analytic models of industry tend to examine the industry at a given state. The nature and fascination of business is that it is not static. While we are prone to generalize, for example, list GM, Ford, and Chrysler as the “Big 3” and assume their dominance, we also have seen the automobile industry change. Currently, the entertainment and communications industries are in flux. Phone companies, computer firms, and entertainment are merging and forming strategic alliances that re-map the information terrain. Schumpeter and, more recently, The existence of such an economy of scale creates a barrier to entry. The greater the difference between industry MES and entry unit costs, the greater the barrier to entry. So industries with high MES deter entry of small, start-up businesses. To operate at less than MES there must be a consideration that permits the firm to sell at a premium price - such as product differentiation or local monopoly.

In Schumpeter’s and Porter’s view the dynamism of markets is driven by innovation. We can envision these forces at work as we examine the following changes:

2.3.1 A Combination Of Generic Strategies —Stuck in the Middle?

These generic strategies are not necessarily compatible with one another. If a firm attempts to achieve an advantage on all fronts, in this attempt it may achieve no advantage at all. For example, if a firm differentiates itself by supplying very high quality products, it risks undermining that quality if it seeks to become a cost leader. Even if the quality did not suffer, the firm would risk projecting a confusing image. For this reason, Michael Porter argued that to be successful over the long-term, a firm must select only one of these three generic strategies. Otherwise, with more than one single generic strategy the firm will be “stuck in the middle” and will not achieve a competitive advantage.

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Porter argued that firms that are able to succeed at multiple strategies often do so
Porter argued that firms that are able to succeed at multiple strategies often do so
by creating separate business units for each strategy. By separating the strategies into
different units having different policies and even different cultures, a corporation is less
likely to become “stuck in the middle.”
NOTES
However, there exists a viewpoint that a single generic strategy is not always best
because within the same product customers often seek multi-dimensional satisfactions such
as a combination of quality, style, convenience, and price. There have been cases in which
high quality producers faithfully followed a single strategy and then suffered greatly when
another firm entered the market with a lower-quality product that better met the overall
needs of the customers.
2.3.2.1 Generic Strategies And Industry Forces
These generic strategies each have attributes that can serve to defend against
competitive forces. The following table compares some characteristics of the generic
strategies in the context of the Porter’s five forces.
Figure 2.3.1: Generic Strategies And Industry Forces

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2.3.2.2 Significance of strategic group

A strategic group is a concept used in strategic management that groups companies within an industry that have similar business models or similar combinations of strategies. For example, the fast-food industry can be portrayed as consisting of several strategic groups. The number of groups within an industry and their composition depends on what dimensions you use to define the groups. Strategists often use a two dimensional grid to display the position of each company along to the two most important dimensions. Strategy is the Direction and scope of an organization over the long term which achieves advantages for the organization.

The term was coined by Hunt (1972) in his analysis of the appliance industry where he discovered less competitive rivalry than industry concentration ratios suggest there should be. He attributed this to the existence of subgroups within the industry that effectively reduce the number of competitors in each market.

Michael Porter (1980) developed the concept and applied it within his overall system of strategic analysis. He explained strategic groups in terms of what he called “mobility barriers”. These are similar to the entry barriers that exist in industries, except they apply to groups within an industry. Because of these mobility barriers a company can get drawn into one strategic group or another. Strategic groups are not to be confused with Porter’generic strategies which are internal strategies and do not reflect the diversity of strategic styles within an industry.

Originally, the analysis of intra-industry variations in the competitive behaviour and performance of firms was based primarily on the use of secondary financial and accounting data. The study of strategic groups from a cognitive perspective, however, has gained prominence during the past years (Hodgkinson 1997).

Strategic Group Analysis

Strategic GroupAnalysis (SGA) aims to identify organizations with similar strategic characteristics, following similar strategies or competing on similar bases.

Such groups can usually be identified using two or perhaps three sets of characteristics as the bases of competition.

STRATEGIC MANAGEMENT

Examples of Characteristics

NOTES

Extent of product (or service) diversity

Extent of Geographic coverage

 

Number of Market segments served

Distribution Channels used

Extent of Branding

Marketing Effort

Product (or service) quality

Pricing policy

Use of Strategic Group Analysis : This analysis is useful in several ways:

Helps identify who the most direct competitors are and on what basis they compete.

Raises the question of how likely or possible it is for another organization to move

from

one strategic group to another.

Strategic Group mapping might also be used to identify opportunities.

Can also help identify strategic problems.

2.4 GLOBALIZATION AND INDUSTRY STRUCTURE

The word globalization often appears as a description rather than an analytical concept, describing a certain phenomenon in an extremely wide range of fields. Thus, a large list of concepts of globalization includes the globalization of financial markets, corporate strategies, technology, consumption patterns, regulatory capabilities and governance, world politics, and socio-cultural processes. It is easy to perceive the increase in the flow of trade, especially intra-firm transactions by multinational corporations, and the even faster growth of global capital markets that are obvious signs of globalization. The globalization of production is the most visible evidence that can be detected from the growth of manufacturing FDI, and even more significant is the expansion of the international capital market.

The sheer scope of the globalization debate, however, raises the question about the plausibility of a ‘universal’ understanding of globalization across political, economic and social arenas. Under such circumstances, accumulating stories of globalization in various fields would contribute to a more comprehensive picture of globalization. When focusing

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on global economy, globalization has two components: finance and production. Globalization of these factors appears in the form of the increased international mobility of capital and the growing incidence of mergers and acquisitions and strategic alliances. And for both finance and production, markets have facilitated the globalization process, while markets themselves also became globalized.

The level of globalization in those various aspects, however, differs significantly depending on industrial sectors; Strange (1997) emphasized that globalization is not a universal phenomenon, but it differs depending on sectors and firms rather than on states. Among various industries, only a few are practicing ‘globalism’ in all aspects of sales, production, personnel, research and development, and financing. Individual firms often seek for localization of their activities along with their ‘global strategies’. Only a handful of multinational corporations specifically target the global market instead of focusing on several local markets, and operate their production globally rather than having local production independent and separate from production in other areas. In this sense, globalization has not permeated as thoroughly as the popularity of the word suggest

Despite the unevenness of the development, globalization has brought changes in commitment-rules that have caused systemic transition, though not yet complete, of cross- border economic transactions. Globalization was preceded by internationalization, which differs from globalization in that the nation-state system itself was not in question at the

time. Internationalization is still based on ‘a comparatively stable system of sovereign states, each with an internal hierarchy of more or less subservient local governments’, whereas globalization is based on a system ‘characterized by emerging and still primitive governance ’

The current trend aggrandizes a situation that is better described as globalization,

structures

‘in which national economies are evolving from a condition in which they are less like billiard balls in holistic interaction than they are permeable entities in various states of amalgamation with one another.’Therefore, ‘The term globalization suggests a quantum leap beyond previous internationalization stage.’

Globalization in relation to India has been a two way process. Global forces have had a considerable impact on India at all levels of its life. They are penetrating its economy and reshaping its structure and mode of operation. They are forcing India to redefine its place in the world and its relation to its neighbors and the west. India’s educational and cultural life, TV and print media, and its perception of itself and the world are also undergoing profound changes. Not surprisingly, India today is quite different from what it was barely ten years ago, and it is not easy to predict how it will progress during the next few years.

STRATEGIC MANAGEMENT

India has not been a passive recipient of global impact. Both directly and through its diasporas, it has increasingly become a significant global presence. India’s literature, arts, films, religions, food, textiles, fashions and music are now an integral part of life in the west. Its doctors, IT specialists, computer scientists, small and large industrialists, managers and engineers are present in the west in large numbers and have made a very considerable impact. Indeed, they are admired for their skills and hard work and are much sought after.

NOTES

Consider Globalization and Indian industry. In the seventies, India was just emerging

from the first stage. After 30 years from then, it has crossed second stage and going into the third one. Year 2003 was pivotal as it saw manifestation of India’s global aspiration. The number as well as size of the foreign targets showed steep rise. Close to 50 overseas acquisitions, amounting $1.8 billion took place last year, which was only $0.21 billion in

2002. The increase in average deal size is from $7.5 million in 2002 to $36.5 million in

2003. India has adopted domestic policies and institutions that have enabled people to

take advantage of global markets and have thus sharply increased the share of trade in their GDP. India has been catching up with the rich ones – our annual growth rates increased from 1 percent in the 1960s to 5 percent in the 1990s. Now it is above 8%. Indians saw their wages rise, and the number of people in poverty declined.

Industry wise, the software and services sector lead the mergers and acquisitions charge overseas but now this list includes both old and new economy industries like auto ancillaries, pharmaceuticals, telecom, agro-chemicals and steel. There are thus no stereotypes that only new economy companies are invited to the mergers and acquisitions ball or that only the blue chip companies are partaking of the action. It is more democratic as smaller auto ancillary companies are also in the fray.

Globalization has changed the face of business all over the world. Those countries who opened their doors for liberalization and globalization have recorded a tremendous economic growth. India is one among those countries who enjoyed these benefits. Though India opened its door very lately to these, currently she is in a better position. Globalization has never been a remote experience. It affected industries directly and common man both directly or indirectly. There is lot of industries or sectors, in India, which showed a tremendous growth after the liberalization and globalization struck India. Like wise MNCs over the world showed an exceptional growth as the globalization spread. In days to come it’s sure that the face and nature of business will change dramatically and globalization will have a key role to play. Here we have made an attempt to study the Impact of Globalization on MNCs and we have succeeded in a better way.

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2.5 PORTER’S GENERIC STRATEGIES

If the primary determinant of a firm’s profitability is the attractiveness of the industry

in which it operates, an important secondary determinant is its position within that industry. Even though an industry may have below-average profitability, a firm that is optimally positioned can generate superior returns.

A firm positions itself by leveraging its strengths. Michael Porter has argued that a

firm’s strengths ultimately fall into one of two headings: cost advantage and differentiation. By applying these strengths in either a broad or narrow scope, three generic strategies result: cost leadership, differentiation, and focus. These strategies are applied at the business unit level. They are called generic strategies because they are not firm or industry dependent. The following table illustrates Porter’s generic strategies:

following table illustrates Porter’s generic strategies: Figure 2.6.1 Porter’s Generic Strategies 6 0 ANNA

Figure 2.6.1 Porter’s Generic Strategies

STRATEGIC MANAGEMENT

Cost Leadership Strategy

 

This generic strategy calls for being the low cost producer in an industry for a given level of quality. The firm sells its products either at average industry prices to earn a profit higher than that of rivals, or below the average industry prices to gain market share. In the event of a price war, the firm can maintain some profitability while the competition suffers losses. Even without a price war, as the industry matures and prices decline, the firms that can produce more cheaply will remain profitable for a longer period of time. The cost leadership strategy usually targets a broad market.

NOTES

Some of the ways that firms acquire cost advantages are by improving process efficiencies, gaining unique access to a large source of lower cost materials, making optimal outsourcing and vertical integration decisions, or avoiding some costs altogether. If competing firms are unable to lower their costs by a similar amount, the firm may be able to sustain a competitive advantage based on cost leadership.

Firms that succeed in cost leadership often have the following internal strengths:

Access to the capital required making a significant investment in production assets; this investment represents a barrier to entry that many firms may not overcome.

Skill in designing products for efficient manufacturing, for example, is having a small component count to shorten the assembly process.

High level of expertise in manufacturing process engineering.

Efficient distribution channels.

Each generic strategy has its risks, including the low-cost strategy. For example, other firms may be able to lower their costs as well. As technology improves, the competition may be able to leapfrog the production capabilities, thus eliminating the competitive advantage.Additionally, several firms following a focus strategy and targeting various narrow markets may be able to achieve an even lower cost within their segments and as a group gain significant market share.

Differentiation Strategy

A differentiation strategy calls for the development of a product or service that offers unique attributes that are valued by customers and that customers perceive to be

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better than or different from the products of the competition. The value added by the uniqueness of the product may allow the firm to charge a premium price for it. The firm hopes that the higher price will more than cover the extra costs incurred in offering the unique product. Because of the product’s unique attributes, if suppliers increase their prices the firm may be able to pass along the costs to its customers who cannot find substitute products easily.

Firms that succeed in a differentiation strategy often have the following internal strengths:

Access to leading scientific research.

Highly skilled and creative product development team.

Strong sales team with the ability to successfully communicate the perceived strengths of the product.

Corporate reputation for quality and innovation.

The risks associated with a differentiation strategy include imitation by competitors and changes in customer tastes. Additionally, various firms pursuing focus strategies may be able to achieve even greater differentiation in their market segments

Focus Strategy

The focus strategy concentrates on a narrow segment and within that segment attempts to achieve either a cost advantage or differentiation. The premise is that the needs of the group can be better serviced by focusing entirely on it.A firm using a focus strategy often enjoys a high degree of customer loyalty, and this entrenched loyalty discourages other firms from competing directly.

Because of their narrow market focus, firms pursuing a focus strategy have lower volumes and therefore less bargaining power with their suppliers. However, firms pursuing a differentiation-focused strategy may be able to pass higher costs on to customers since close substitute products do not exist.

Firms that succeed in a focus strategy are able to tailor a broad range of product development strengths to a relatively narrow market segment that they know very well.

STRATEGIC MANAGEMENT

Some risks of focus strategies include imitation and changes in the target segments. Furthermore, it may be fairly easy for a broad-market cost leader to adapt its product in order to compete directly. Finally, other focusers may be able to carve out sub-segments that they can serve even better.

Generic Competitive Strategies

NOTES

Three of the most widely read books on competitive analysis in the 1980s were Michael Porter’s Competitive Strategy, Competitive Advantage, and Competitive Advantage of Nations. In his various books, Porter developed three generic strategies that, he argues, can be used singly or in combination to create a defendable position and to outperform competitors, whether they are within an industry or across nations. Porter states that the strategies are generic because they are applicable to a large variety of situations and contexts. The strategies are (1) overall cost leadership; (2) differentiation; and (3) focus on a particular market niche. The generic strategies provide direction for firms in designing incentive systems, control procedures, and organizational arrangements. Following is a description of this work.

Overall Cost Leadership Strategy

Overall cost leadership requires firms to develop policies aimed at becoming and remaining the lowest-cost producer and/or distributor in the industry. Company strategies aimed at controlling costs include construction of efficient-scale facilities, tight control of costs and overhead, avoidance of marginal customer accounts, minimization of operating expenses, reduction of input costs, tight control of labor costs, and lower distribution costs. The low-cost leader gains competitive advantage by getting its costs of production or distribution lower than those of the other firms in its market. The strategy is especially important for firms selling unbranded commodities such as beef or steel.

firms selling unbranded commodities such as beef or steel. Figure- Competitive Advantage through Low Cost Leadership

Figure- Competitive Advantage through Low Cost Leadership

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The above Figure shows the competitive advantage firms may achieve through cost leadership. C is the original cost of production. C is the new cost of production. SP is the original selling price. SP is the new selling price. P is the original profit margin. P is the new profit margin.

If we assume our firm and the other competitors are producing the product for a cost of C and selling it at SP, we are all receiving a profit of P. As cost leader, we are able to lower our cost to C while the competitors remain at C. We now have two choices as to how to take advantage of our reduced costs.

Department stores and other high-margin firms often leave their selling price as SP, the original selling price. This allows the low-cost leader to obtain a higher profit margin than they received before the reduction in costs. Since the competition was unable to lower their costs, they are receiving the original, smaller profit margin. The cost leader gains competitive advantage over the competition by earning more profit for each unit sold.

Discount stores such as Wal-Mart are more likely to pass the savings from the lower costs on to customers in the form of lower prices. These discounters retain the original profit margin, which is the same margin as their competitors. However, they are able to lower their selling price due to their lower costs (C). They gain competitive advantage by being able to under-price the competition while maintaining the same profit margin.

Overall cost leadership is not without potential problems. Two or more firms competing for cost leadership may engage in price wars that drive profits to very low levels. Ideally, a firm using a cost leader strategy will develop an advantage that is not easily copied by others. Cost leaders also must maintain their investment in state-of-the- art equipment or face the possible entry of more cost-effective competitors. Major changes in technology may drastically change production processes so that previous investments in production technology are no longer advantageous. Finally, firms may become so concerned with maintaining low costs that needed changes in production or marketing are overlooked. The strategy may be more difficult in a dynamic environment because some of the expenses that firms may seek to minimize are research and development costs or marketing research costs, yet these are expenses the firm may need to incur in order to remain competitive.

STRATEGIC MANAGEMENT

Differentiation Strategy

 

The second generic strategy, differentiating the product or service, requires a firm to create something about its product or service that is perceived as unique throughout the industry. Whether the features are real or just in the mind of the customer, customers must perceive the product as having desirable features not commonly found in competing products. The customers also must be relatively price-insensitive. Adding product features means that the production or distribution costs of a differentiated product may be somewhat higher than the price of a generic, non-differentiated product. Customers must be willing to pay more than the marginal cost of adding the differentiating feature if a differentiation strategy is to succeed.

NOTES

Differentiation may be attained through many features that make the product or service appear unique. Possible strategies for achieving differentiation may include:

warranties (e.g., Sears tools)

brand image (e.g., Coach handbags, Tommy Hilfiger sportswear)

technology (e.g., Hewlett-Packard laser printers)

features (e.g., Jenn-Air ranges, Whirlpool appliances)

service (e.g., Makita hand tools)

quality/value (e.g., Walt Disney Company)

dealer network (e.g., Caterpillar construction equipment)

Differentiation does not allow a firm to ignore costs; it makes a firm’s products less susceptible to cost pressures from competitors because customers see the product as unique and are willing to pay extra to have the product with the desirable features. Differentiation can be achieved through real product features or through advertising that causes the customer to perceive that the product is unique.

Differentiation may lead to customer brand loyalty and result in reduced price elasticity. Differentiation may also lead to higher profit margins and reduce the need to be a low-cost producer. Since customers see the product as different from competing products and they like the product features, customers are willing to pay a premium for these features. As long as the firm can increase the selling price by more than the marginal cost of adding the features, the profit margin is increased. Firms must be able to charge more for their differentiated product than it costs them to make it distinct, or else they may be better off

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making generic, undifferentiated products. Firms must remain sensitive to cost differences. They must carefully monitor the incremental costs of differentiating their product and make certain the difference is reflected in the price.

Firms pursuing a differentiation strategy are vulnerable to different competitive threats than firms pursuing a cost leader strategy. Customers may sacrifice features, service, or image for cost savings. Customers who are price sensitive may be willing to forgo desirable features in favor of a less costly alternative. This can be seen in the growth in popularity of store brands and private labels. Often, the same firms that produce name- brand products produce the private label products. The two products may be physically identical, but stores are able to sell the private label products for a lower price because very little money was put into advertising in an effort to differentiate the private label product.

Imitation may also reduce the perceived differences between products when competitors copy product features. Thus, for firms to be able to recover the cost of marketing research or R&D, they may need to add a product feature that is not easily copied by a competitor.

A final risk for firms pursuing a differentiation strategy is changing consumer tastes. The feature that customers like and find attractive about a product this year may not make the product popular next year. Changes in customer tastes are especially obvious in the apparel industry. Polo Ralph Lauren has been a very successful brand in the fashion industry. However, some younger consumers have shifted to Tommy Hilfiger and other youth-oriented brands.

Ralph Lauren, founder and CEO, has been the guiding light behind his company’s success. Part of the firm’s success has been the public’s association of Lauren with the brand. Ralph Lauren leads a high-profile lifestyle of preppy elegance. His appearance in his own commercials, his Manhattan duplex, his Colorado ranch, his vintage car collection, and private jet have all contributed to the public’s fascination with the man and his brand name. This image has allowed the firm to market everything from suits and ties to golf balls. Through licensing of the name, the Lauren name also appears on sofas, soccer balls, towels, table-ware, and much more.

STRATEGIC MANAGEMENT

Combination Strategies

NOTES

Can forms of competitive advantage be combined? Porter asserts that a successful strategy requires a firm to aggressively stake out a market position, and that different strategies involve distinctly different approaches to competing and operating the business. An organization pursuing a differentiation strategy seeks competitive advantage by offering products or services that are unique from those offered by rivals, either through design, brand image, technology, features, or customer service. Alternatively, an organization pursuing a cost leadership strategy attempts to gain competitive advantage based on being the overall low-cost provider of a product or service. To be “all things to all people” can mean becoming “stuck in the middle” with no distinct competitive advantage. The difference between being “stuck in the middle” and successfully pursuing combination strategies merits discussion. Although Porter describes the dangers of not being successful in either cost control or differentiation, some firms have been able to succeed using combination strategies.

Research suggests that, in some cases, it is possible to be a cost leader while maintaining a differentiated product. SouthwestAirlines has combined cost cutting measures with differentiation. The company has been able to reduce costs by not assigning seating and by eliminating meals on its planes. It has then been able to promote in its advertising that one does not get tasteless airline food on its flights. Its fares have been low enough to attract a significant number of passengers, allowing the airline to succeed.

Another firm that has pursued an effective combination strategy is Nike. When customer preferences moved to wide-legged jeans and cargo pants, Nike’s market share slipped. Competitors such as Adidas offered less expensive shoes and undercut Nike’s price. Nike’s stock price dropped in 1998 to half its 1997 high. However, Nike reported a 70 percent increase in earnings for the first quarter of 1999 and saw a significant rebound in its stock price. Nike achieved the turn-around by cutting costs and developing new, distinctive products. Nike reduced costs by cutting some of its endorsements. Company research suggested the endorsement by the Italian soccer team, for example, was not achieving the desired results. Michael Jordan and a few other “big name” endorsers were retained while others, such as the Italian soccer team, were eliminated, resulting in savings estimated at over $100 million. Firing 7 percent of its 22,000 employees allowed the company to lower costs by another $200 million, and inventory was reduced to save additional money. While cutting costs, the firm also introduced new products designed to differentiate Nike’s products from those of the competition.

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Some industry environments may actually call for combination strategies. Trends suggest that executives operating in highly complex environments such as health care do not have the luxury of choosing exclusively one strategy over the other. The hospital industry may represent such an environment, as hospitals must compete on a variety of fronts. Combination (i.e., more complicated) strategies are both feasible and necessary to compete successfully. For instance, DRG-based reimbursement (diagnosis related groups) and the continual lowering of reimbursement ceilings have forced hospitals to compete on the basis of cost. At the same time, many of them jockey for position with differentiation based on such features as technology and birthing rooms. Thus, many hospitals may need to adopt some form of hybrid strategy in order to compete successfully, according to Walters and Bhuian.

Focus Strategy

The generic strategies of cost leadership and differentiation are oriented toward industry-wide recognition. The final generic strategy, focusing (also called niche or segmentation strategy), involves concentrating on a particular customer, product line, geographical area, channel of distribution, stage in the production process, or market niche. The underlying premise of the focus strategy is that a firm is better able to serve a limited segment more efficiently than competitors can serve a broader range of customers. Firms using a focus strategy simply apply a cost leader or differentiation strategy to a segment of the larger market. Firms may thus be able to differentiate themselves based on meeting customer needs, or they may be able to achieve lower costs within limited markets. Focus strategies are most effective when customers have distinctive preferences or specialized needs.

A focus strategy is often appropriate for small, aggressive businesses that do not have the ability or resources to engage in a nationwide marketing effort. Such a strategy may also be appropriate if the target market is too small to support a large-scale operation. Many firms start small and expand into a national organization. For instance, Wal-Mart started in small towns in the South and Midwest. As the firm gained in market knowledge and acceptance, it expanded through-out the South, then nationally, and now internationally. Wal-Mart started with a focused cost leader strategy in its limited market, and later was able to expand beyond its initial market segment.

STRATEGIC MANAGEMENT

A firm following the focus strategy concentrates on meeting the specialized needs of its customers. Products and services can be designed to meet the needs of buyers. One approach to focusing is to service either industrial buyers or consumers, but not both. Martin-Brower, the third-largest food distributor in the United States, serves only the eight leading fast-food chains. With its limited customer list, Martin-Brower need only stock a limited product line; its ordering procedures are adjusted to match those of its customers; and its warehouses are located so as to be convenient to customers.

NOTES

Firms utilizing a focus strategy may also be better able to tailor advertising and promotional efforts to a particular market niche. Many automobile dealers advertise that they are the largest volume dealer for a specific geographic area. Other car dealers advertise that they have the highest customer satisfaction scores within their defined market or the most awards for their service department.

Firms may be able to design products specifically for a customer. Customization may range from individually designing a product for a customer to allowing customer input into the finished product. Tailor-made clothing and custom-built houses include the customer in all aspects of production, from product design to final acceptance. Key decisions are made with customer input. However, providing such individualized attention to customers may not be feasible for firms with an industry-wide orientation.

Other forms of customization simply allow the customer to select from a menu of predetermined options. Burger King advertises that its burgers are made “your way,” meaning that the customer gets to select from the predetermined options of pickles, lettuce, and so on. Similarly, customers are allowed to design their own automobiles within the constraints of predetermined colors, engine sizes, interior options, and so forth.

Potential difficulties associated with a focus strategy include a narrowing of differences between the limited market and the entire industry. National firms routinely monitor the strategies of competing firms in their various submarkets. They may then copy the strategies that appear particularly successful. The national firm, in effect, allows the focused firm to develop the concept, then the national firm may emulate the strategy of the smaller firm or acquire it as a means of gaining access to its technology or processes. Emulation increases the ability of other firms to enter the market niche while reducing the cost advantages of serving the narrower market.

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Market size is always a problem for firms pursing a focus strategy. The targeted market segment must be large enough to provide an acceptable return so that the business can survive. For instance, ethnic restaurants are often unsuccessful in small U.S. towns, since the population base that enjoys Japanese or Greek cuisine is too small to allow the restaurant operator to make a profit. Likewise, the demand for an expensive, upscale restaurant is usually not sufficient in a small town to make its operation economically feasible.

Another potential danger for firms pursuing a focus strategy is that competitors may find submarkets within the target market. In the past, United Parcel Service (UPS) solely dominated the package delivery segment of the delivery business. Newer competitors such as Federal Express and Roadway Package Service (RPS) have entered the package delivery business and have taken customers away from UPS. RPS contracts with independent drivers in a territory to pick up and deliver packages, while UPS pays unionized wages and benefits to its drivers. RPS started operations in 1985 with 36 package terminals. By 1999 it was a $1 billion company with 339 facilities.

2.6

CAPABILITIES AND COMPETENCIES

Definition of capability

Capability represents the identity of your firm as perceived by both your employees and your customers. It is your ability to perform better than competitors using a distinctive and difficult to replicate set of business attributes. Capability is a capacity for a set of resources to integrative performs a stretch task.

2.6.1 Capabilities – The Basis Of Your Competitive Advantage

Through continued use, capabilities become stronger and more difficult for competitors to understand and imitate. As a source of competitive advantage, a capability “should be neither so simple that it is highly imitable, nor so complex that it defies internal steering and control.” 4 Capabilities grow through use, and how fast they grow is critical to your success.

According to the new resource based view of the company, sustainable competitive advantage is achieved by continuously developing existing and creating new resources and capabilities in response to rapidly changing market conditions.Among these resources and capabilities, in the new economy, knowledge represents the most important value-creating asset.

STRATEGIC MANAGEMENT

Distinctive and Reproducible Capabilities

 

The opportunity for your company to sustain your competitive advantage is determined by your capabilities of two kinds – distinctive capabilities and reproducible capabilities - and their unique combination you create to achieve synergy. Your distinctive capabilities – the characteristics of your company which cannot be replicated by competitors, or can only be replicated with great difficulty - are the basis of your sustainable competitive advantage. Distinctive capabilities can be of many kinds: patents, exclusive licenses, strong brands, effective leadership, teamwork, or tacit knowledge.

NOTES

Reproducible capabilities are those that can be bought or created by your competitors and thus by themselves cannot be a source of competitive advantage. Many technical, financial and marketing capabilities are of this kind. Your distinctive capabilities need to be supported by an appropriate set of complementary reproducible capabilities to enable your company to sell its distinctive capabilities in the market it operates.

2.6.2 Creating a Culture for Innovation

The first step is to understand where the greatest deficiencies lie, and which levers will deliver the most impact. For many organizations, the most critical levers to assess initially include structure and metrics, though establishing innovation processes and providing employees with new skill sets are also critical drivers of culture. The act of visibly sponsoring (let alone personally driving) specific initiatives focused on creating new organizational capabilities that promote innovation serves to send a message and establish new symbols and stories that reinforce a culture of innovation ….more.

Seven Dimensions of Strategic Innovation

The Strategic Innovation framework weaves together seven dimensions to produce a range of outcomes that drive growth.

Core Technologies and Competencies is the set of internal capabilities

1. Organizational competencies and assets that could potentially be leveraged to deliver value to customers, including technologies, intellectual property, brand equity

2. Strategic relationships

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3.

Strategies of Market Leaders

4.

Innovative Organization

5.

Growth Culture

6.

Winning Leaders

7.

Team

2.6.3

Building Capability Through Leadership Attributes

Leaders are responsible for building organizational capability. You need the ability to translate organizational direction into road maps, vision into action, and purpose into process. To do so, you must demonstrate at least five abilities 7 :

To build your organizational infrastructure

To leverage diversity

To deploy teams

To design human resource systems

To make change happen.

Inspirational Leadership: Roles

Inspirational leaders create an inspiring culture within their organization. They supply a shared vision and inspire people to achieve more than they may ever have dreamed possible. They are able to articulate a shared vision in a way that inspires others to act.

People do what they have to do for a manager; they do their best for an inspirational leader More

Organizational Capability Approach vs. Traditional Functional Paradigm

“In the capability model, senior managers are predominantly concerned with issues about the quality of products and services provided to customers (external and internal), the flow of value-added work, and roles and responsibilities.

The dominant view on performance measurement shifts from the traditional focus of actual-vs.-budget to a more balanced model that includes the timeliness, quality, and cost of providing products and services to customers.

STRATEGIC MANAGEMENT

Allocation and budgeting of resources moves from the traditional practice of individual units vying for resources based on their own needs toward cross group -teams that jointly assess resource needs based on the flow of work needed to create value for customers. Problem solving would seldom involve situations in which unit managers had to compete with each another; instead, organizations would adapt to departmental interdependence, recognizing that issues are best addressed through cross-group problem- solving sessions focused on providing services to customers and the required flow of work.

NOTES

2.7 CORE COMPETENCIES AND DISTINCTIVE COMPETENCIES

In their 1990 article entitled, The Core Competence of the Corporation, C.K. Prahalad and Gary Hamel coined the term core competencies, or the collective learning and coordination skills behind the firm’s product lines. They made the case that core competencies are the source of competitive advantage and enable the firm to introduce an array of new products and services.

According to Prahalad and Hamel, core competencies lead to the development of core products. Core products are not directly sold to end users; rather, they are used to build a larger number of end-user products. For example, motors are a core product that can be used in wide array of end products. The business units of the corporation each tap into the relatively few core products to develop a larger number of end user products based on the core product technology. This flow from core competencies to end products is shown in the following diagram:

2.7.1 Core Competencies to End Products

to end products is shown in the following diagram: 2.7.1 Core Competencies to End Products 73

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The intersection of market opportunities with core competencies forms the basis for launching new businesses. By combining a set of core competencies in different ways and matching them to market opportunities, a corporation can launch a vast array of businesses.

Without core competencies, a large corporation is just a collection of discrete businesses. Core competencies serve as the glue that bonds the business units together into a coherent portfolio.

2.7.2

Developing Core Competencies

According to Prahalad and Hamel, core competencies arise from the integration of multiple technologies and the coordination of diverse production skills. Some examples include Philip’s expertise in optical media and Sony’s ability to miniaturize electronics.

There are three tests useful for identifying a core competence.Acore competence should:

provide access to a wide variety of markets, and

contribute significantly to the end-product benefits, and

be difficult for competitors to imitate.

Core competencies tend to be rooted in the ability to integrate and coordinate various groups in the organization. While a company may be able to hire a team of brilliant scientists in a particular technology, in doing so it does not automatically gain a core competence in that technology. It is the effective coordination among all the groups involved in bringing a product to market that result in a core competence.

It is not necessarily an expensive undertaking to develop core competencies. The missing pieces of a core competency often can be acquired at a low cost through alliances and licensing agreements. In many cases an organizational design that facilitates sharing of competencies can result in much more effective utilization of those competencies for little or no additional cost.

To better understand how to develop core competencies, it is worthwhile to understand what they do not entail. According to Prahalad and Hamel, core competencies are not necessarily about:

STRATEGIC MANAGEMENT

outspending rivals on R&D

NOTES