Strategy formulation is vital to the well-being of a company or organization. There are two major types of strategy: (1) corporate strategy, in which companies decide which line or lines of business to engage in; and (2) business or competitive strategy, which sets the framework for achieving success in a particular business. While business strategy often receives more attention than corporate strategy, both forms of strategy involve planning, industry/market analysis, goal setting, commitment of resources, and monitoring.
The formulation of a sound strategy facilitates a number of actions and desired results that would be difficult otherwise. A strategic plan, when communicated to all members of an organization, provides employees with a clear vision of what the purposes and objectives of the firm are. The formulation of strategy forces organizations to examine the prospect of change in the foreseeable future and to prepare for change rather than to wait passively until market forces compel it. Strategic formulation allows the firm to plan its capital budgeting. Companies have limited funds to invest and must allocate capital funds where they will be most effective and derive the highest returns on their investments.
On the other hand, a firm without a clear strategic plan gives its decision makers no direction other than the maintenance of the status quo. The firm becomes purely reactive to external pressures and less effective at dealing with change. In highly competitive markets, a firm without a coherent strategy is likely to be outmaneuvered by its rivals and face declining market share or even declining sales.
The formulation of sound strategy may be seen as having six important steps:
While this would appear to be the easiest of the six steps listed above, the simplicity of this first step is deceptive. Businesses must be defined in terms of their customers. Without customers, there is no business. They are a firm's only real source of revenue and, hence, of power. Successful businesses are those that create profitable customers. With this in mind, it makes sense to define any business in terms of its customers. Some companies achieve success by concentrating on product development, product quality, efficient production, and other product related functions. However, it is important to remember that the success of these companies is entirely dependent upon customers valuing a firm's products above others, or appreciating the lower prices provided through the firm's abilities to produce at lower costs. One cannot assume that customers always want to pay less for their goods and services. In the markets for luxury goods like perfumes, for example, few companies have been successful in pursuing the strategy of being the low-cost supplier, whereas in other markets this is a highly coveted industry status.
Business scholars have long urged corporate leaders to define their businesses broadly and in terms of the end benefits their customers receive. Hence, oil companies should not view themselves as being in the "oil business," but in terms of the broader category of "energy," when attempting to market oil as a fuel. Automobile drivers don't necessarily have a strong preference for exactly what fuels their vehicle. If ethanol could power their vehicle as conveniently as gasoline, the consumer would have little preference between the two systems. If ethanol were more convenient and less expensive than gasoline, consumers would buy ethanol and not gasoline. Drivers aren't buying gasoline for its own sake when they visit a service station; rather, what they are buying is energy to facilitate transportation.
An example of an effectively broad industry definition comes from Charles Revson (1906-1975), founder of Revlon cosmetics, who often said he was in the business of selling "the promise of hope." This insightful business definition led Revson to concentrate his efforts on meticulously creating advertising depicting feminine images that were unrealistic to the vast majority of his customers, yet were perfectly consistent with their deepest hopes for themselves. Lotteries operate on the same principles. Few people expect to win, so the benefit is the hope of winning. Hope can be a very profitable business to be in even if it is difficult to imagine as an industry.
Many successful companies have defined themselves in terms of their customers. A general store in a remote area would do well to define its business as serving the customers in its trading area. While such a business definition might lead the firm in directions that would be at the whim of the local clientele, that business should remain profitable as long as customers are happy. An example of such a business is L.L. Bean, which was started when Leon L. Bean developed a superior hunting boot well suited for his native Maine and sold it through the mail to a mailing list of Maine residents who had purchased hunting licenses. The mail order company grew by first serving the needs of hunters and later by expanding the concept to all wilderness activities. While this might seem to be a definition based upon an activity, careful examination of L.L. Bean shows that the firm has identified a psychographic market segment to which it continually caters. Many of its buyers really don't care for wilderness sports as much as they simply identify with the targeted market segment and wish to buy products that conform to the segment's norms.
Genentech Inc. is a firm engaged in the development of genetic research and biotechnology for pharmaceuticals: it has defined itself as being in the biotech business. Business definition by technology leads to a very tumultuous corporate existence, as the business enterprise turns direction every time there's a new invention.
The strategic mission of an organization embodies a long-term view of what sort of organization it wishes to become. The value to management of having a lucid mission statement—the second step in strategy formulation—can be in rendering tangible the firm's long-term course and in guiding decisions toward a rational design. Among the elements that are key to a good mission statement are a statement of corporate values and philosophy, a statement of the scope and purpose of the business, an acknowledgement of special competencies, and an articulation of the corporate vision for its future.
Clearly stated strategic objectives, the third step of strategy formulation, outline the position in the marketplace that the firm seeks. Performance targets state the measurable milestones that the firm needs to reach or obtain to achieve its strategic objectives.
Some strategic objectives relate to the positioning of goods and services in the competitive marketplace while others concern the structure of the company itself and how it plans to produce goods or manage its operations. Typical strategic objectives involve profitability, market share, return on investment, technological achievement, customer service level, revenue size, and diversification.
In order to make strategic planning work, the goals, missions, objectives, performance targets, or other hopes of top management must somehow be made real by others in more distant locations down the organizational chart. Merely communicating to each member of the business the vision that top management has for the firm is not sufficient. Strategic objectives and performance targets should penetrate every corner of the organizational chart. There should be a hierarchy of strategic formulation starting with the highest levels of the firm, from which it is consistently translated from level to level so that each department knows what its contribution to the overall mission of the firm is to be. This process should end with each individual in the firm having strategic objectives and performance targets tailored to their specific role in the firm.
This is top management's plan for achieving its aims. These strategies are for the entire organization and should not concern the specific affairs of individual business units.
Organization-wide strategy requires schemes for overseeing the extent and combinations of companies' assorted actions in order to achieve a superior corporate performance. When numerous activities are being managed simultaneously, there are interactive effects in managing the group of activities as a whole. Such a group of activities is often referred to as the "business portfolio." Proper management of the business portfolio demands actions and decisions about how and when the firm should enter new ventures and what areas the firm needs to exit. Further, in all management, timing is crucial. Top management needs to set the timetable for business entry, exit, growth, and downsizing. Often a sound strategy goes awry when management attempts to move too quickly, too slowly, or just fails to set any timetable for action allowing for little temporal coordination of the firm's efforts. Further, organization-wide strategy should address the balance of resources across the firm's various activities. These resources need to be allocated to direct the company's activities toward the strategic objectives of the organization. Through these activities at the corporate-wide level, decisions about balancing business risks can maximize security for the firm.
The fourth step in strategy formulation requires developing the business or competitive strategy. Business strategy refers to the strategy used in directing one coherent business unit or product line. The most crucial question business strategy should address is how the unit plans to be competitive within its specific business market. Important logistical issues to consider include (1) what role each of the functional areas within the business unit will play in creating this competitive advantage in the marketplace; (2) what the potential responses are to prospective changes in marketplace; and (3) how to allocate the business unit's resources between its various divisions.
The overall competitive strategy should take into account three main factors: (1) the status, make-up, and prognosis of the industry as a whole and its market(s); (2) the firm's position relative to its competitors; and (3) internal factors at the firm, such as particular strengths and weaknesses.
An industry or market analysis should consider the structure of the industry, the forces compelling change within the industry, the cost and price economics of the industry, elements critical to success in the industry, and imminent problems and issues in the industry.
A review of the industry's structure should evaluate factors such as these:
Change in an industry may occur along several lines, and the direction of change often has major implications for the competitive strategy. In an obvious example, if a manufacturing industry is facing in the medium term a massive technological overhaul due to phase-in of environmental regulations, it would probably make little sense to bring a major new factory on line using the older technology, even if for the moment it is still more widely used. Other noteworthy industry changes to consider include what stage of development the industry and its market are at (developing, mature, declining), what technological advances could impact the industry, what regulatory changes are new or on the horizon, and whether there are major patents about to expire that will allow cheaper entry into the market.
It is also important to examine in detail the economics of doing business in a particular industry. One area of particular concern is the cost structure. For instance, industries characterized by a high percentage of fixed costs are subject to extreme price wars during competitive times in the market. Airlines are an example of a high-fixed-cost industry. Industries with high variable costs tend to have smaller swings in their pricing structure. Cost structure also has implications for capital and cash flow requirements, as well as for the overall entry barriers to participating in the industry.
Production costs tend to decline over time in proportion to the total quantity of goods produced. This is mainly due to two factors: learning and experience. Each has its own curve, the "learning curve" and the "experience curve." While each of these effects might be diagnosed separately, the end effect of both may be the same: the firm that produces the most goods in the industry tends to have the lowest cost of production in the long term. All things being equal, this will give that firm the long term cost advantage in the industry for the life of the product.
In a typical scenario, being the low-cost producer allows the firm to receive not only the greatest margin on its products when all firms in the market participate in an established price structure, but when price competition arises the low-cost producer can make a profit or break even on its goods, while its competitors lose money. This is a key strategic advantage. This is why many firms during the development of a new and potentially large long-term market will forgo a profitable, small, prestige niche strategy for a less profitable market penetration strategy that demands heavy investment and expansion of production. This second strategy can yield a long-term advantage in the industry by allowing the firm to gain from the learning and experience effects. Competitors later may not be able to catch up since they lack the cumulative production experience and assets of the pioneer in the industry.
One alternative to the low-cost strategy is a highvalue strategy, in which customers pay more but also expect to receive a product or service somehow better than that offered by the low-cost supplier. The improvement may be tangible in durability and features, or it may be an appeal to status, image, or lifestyle that makes the product or service more compelling to some consumers.
However, even industry leaders must guard against complacency; they might be on top in the traditional market paradigm, but there may be a new paradigm emerging that will make them obsolete if they fail to change. The accumulation of learning and experience does little good if these assets are directed at the wrong vision of the market. This has strategic implications not only for the market leader, but also its competitors, who may be able to benefit from the leader's slow rate of change. A real-life example was the rise of Wal-Mart Stores, Inc. from a regional discount chain to the world's largest retailer. Arguably its older competitors like Kmart had more experience, but they failed to adapt to the market changes, technologies, and aggressive management practices that helped propel Wal-Mart to market dominance. Wal-Mart embodied a new paradigm in general consumer merchandise retailing, a model that the former market leaders have since tried to emulate.
A fundamental part of developing a business strategy is to understand in detail who the main competitors are and where their strengths and weaknesses lie. Competitors can be analyzed by the type of goods they produce, their price, markets served, or channels of distribution used. Many industries have clear niching, with each firm or group of firms avoiding direct competition through some combiniation of product differentiation or market segmentation. Other industries are characterized by large-scale head-on competition. Coca-Cola and Pepsi, in the soft drink industry, are a highly visible example.
Not all future competition originates from present competitors, however. New market entrants are most often found lurking on the sidelines of the firm. For example, suppliers are often looking to forward integrate into an industry. Suppliers of the raw materials that go into a product may have a competitive cost advantage through such vertical integration. Suppliers are often motivated in such moves by the assurance of having a guaranteed market for their output.
On the flip side, customers may decide to backward integrate into business. Customers considering backward integration usually first attempt to establish their own "private labeled" product prior to integration. When customers put considerable time and effort into their private label version of a product, it may well be a sign of a growing intent to backward integrate. The notion of private label is most associated with retailing, where, for example, grocery stores have house labels, but may or may not actually manufacture the products bearing their labels. However, similar practices exist in many other lines of business.
Firms that produce either substitutes for a product or complementary goods to a product may also be a competitor. These firms have experience in the market, and a competitor's product niche in the market represents a simple product line extension for their firm. Often the threat of competitive retaliation into these firms' product areas is useful in deterring such moves.
Barriers to market entry are often responsible for setting the level of competition in an industry. Historically, retail has tended to be a competitive industry due to the relatively low costs of entry into the market (although this has changed somewhat as large chains consolidate and have significant price and marketing advantages over smaller competitors). But compared to manufacturing heavy industrial goods, retail still has relatively few barriers. American auto manufacturers probably worry very little about other American firms entering the market of passenger automobiles, because both the financial and regulatory barriers to entry are far too high. Not all barriers are financial. Drug firms enjoy oligopoly status due to their abilities to interface with the U.S. Food and Drug Administration in getting new drugs approved. New firms would have great difficulty in developing the same working relationships. Military suppliers also enjoy an oligopoly status due to political barriers to entering the market. Each firm must analyze what factors keep its competitors at bay when assessing the potential for others to want to share in their profits.
A strategy is of course only as good as its implementation. A company may have an impressive strategy for conquering the market, but if it fails to take the right steps the strategy is meaningless. The means of implementing strategies are called tactics. The tactical execution, while crucial to the success of any strategy, is not a traditional part of the formulation of that strategy. However, many firms have been successful in discovering successful tactics and building their strategies about "what works." The implementation experience, whether favorable or unfavorable, also directly informs the strategy revision process or any new strategies, as the company will take into account its successes and failures when choosing future paths.
Strategy formulation should be done on a regular basis, as often as required by changes in the industry. Firms need to track the company's progress, or lack thereof, on the key goals and objectives outlined in the strategic plan. The company must be objective and flexible enough to realize whether the strategy is no longer appropriate as it was first conceived, and whether it needs revision or replacement. In other cases, the strategy itself may be fine, but the communication of the strategy to employees has been inadequate or the specific steps to implementation haven't worked out as planned. This evaluation and feedback of the strategy formulation, the final step, provides the foundation for successful future strategy formulation.
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