Business Strategy Formulation
Entrepreneur Success Series
Resource Note # 10
As discussed in last edition of SATTVA, a strategy might be formulated for broad, long-term, corporate goals and objectives, for more specific business unit goals and objectives, or for a functional unit. Since strategies exist at various levels of the organization, the strategic plans also exist at all three levels. Though the scope and scale of plans, thinking, and managerial activity varies; all plans have two fundamental aspects: ends and means — what is to be achieved and how it is to be achieved. A great deal of strategic thinking is required for developing a strategic plan at all three levels: corporate, business unit and functional. In this edition of SATTVA we will focus on the ingredients and process of business strategy formulation.
1. Strategic Thinking
Strategic thinking as a concept is different from strategic planning. According to Henry Mintzberg strategic planning, is an analytical process aimed at programming already identified strategies. Its outcome is a plan. Strategic thinking, on the other hand, is a synthesizing process, utilizing intuition and creativity, whose outcome is “an integrated perspective of the enterprise.” As shown in Exhibit 1, while planning is external and tangible, thinking is internal and intangible.
Exhibit 1: Difference between Planning & Thinking
(Source: Conway, M. (2014).Strategic Thinking: What it is and how to do it. Thinking Futures.)
Maree Conway, a Strategy Consultant, has identified three components of strategic thinking.
- Thinking Big. This means seeing a bigger picture in terms of how the organisation is connected to other organisations and the outside world as also the internal linkages.
- Thinking Deep. This means questioning the ways of your organisation’s working, challenging the assumptions on which the industry or your organisation operates.
- Thinking Long. This involves thinking far into the future, envisioning alternative future for your industry and organisation.
2. Strategic Management Process
Strategy has been defined as “the determination of the basic long-term goals and objectives of an enterprise, and the adoption of courses of action and the allocation of resources for carrying out these goals.” As per this conception, the process of strategy formulation begins with determination of ‘basic long term goals and objectives’ which in common management parlance amounts to setting ‘Mission.’ The Harvard Professor Kenneth Andrews, proposed a framework for strategy formulation that focused on matching a company’s “strengths” and “weaknesses” —its distinctive competence—with the “opportunities” and “threats” (or risks) it faced in the marketplace. This framework became popular by the acronym SWOT. According to Professors Barney and Hesterly a good strategy is the strategy that generates ‘competitive advantage.’ They suggest that a firm needs to choose its strategy carefully and systematically by following the Strategic Management Process as shown in Exhibit 2.
Exhibit 2: Strategic Management Process
(Source: Barney, J. B. and Hesterly, W. S. (2006). Strategic Management & Competitive Advantage.New Delhi: Prentice Hall, p. 15)
Mission is the purpose for which an organisation exists in the society or the function it performs in the society. Some mission statements also include nature of business of a firm and type of customers it wants to serve.
Ex. Google :To organize the world’s information and make it universally accessible and useful.
While mission answers the question “why do we exist”, vision answers “what we want to be”. It is like a dream about organisation’s shape, role, position etc. Vision is a vividly descriptive image of what an organisation wants to be or wants to be known for. The description can be of organisation, a corporate culture, a business, a technology, an activity in the future. Vision is like a mental perception of the kind of environment an individual, or an organisation aspires to create within a broad time horizon and underlying conditions for actualisation of this perception.
Ex. Unilever :Accelerating growth in the business, while reducing our environmental footprint and increasing our positive social impact.
2.1.2 Strategic Intent
Management gurus Gary Hamel and C.K. Prahlad have proposed Strategic Intent as an alternative to the concept of Mission & Vision. According to them traditional view of strategy focuses on “fit” between existing resources and emerging opportunity. Managers tend to get bogged down by questions like ‘Do we have resources?, Is the market ready?, Is the net present value (NPV) positive?’. This view of strategy as a fit involves identifying opportunities & threats and choosing targets and strategies in the light of current resources & capabilities. Strategic fit is based on the principle of being “realistic.” It is guided more by “today’s problems” rather than “tomorrow’s opportunities.” Hamel and Prahalad exhort managers to be futuristic. Instead of remaining confined to what is ‘feasible’, managers need to ask what is ‘desirable.’
Hamel & Prahalad define Strategic Intent as an obsession of having ambitions that may even be out of proportion to organisation’s resources & capabilities. Strategic Intent is a broadly shared dream, a sense of purpose or an exciting view of future opportunity. For instance, Komatsu’s the Japanese company when outlined its strategic intent as ‘encircle Caterpillar’ was much smaller player as compared to Caterpillar. For Komatsu strategy was not just a ‘fit’, it was rather a ‘stretch.’
Goals & Objectives are the targets that an organisation’s vision & mission are translated into. Generally goals are qualitative in nature, and objectives are quantitative. Objectives are the ends that state specifically how the goals shall be achieved. Objectives are an organisation’s performance targets, the results & outcomes an organisation wants to achieve. While mission, vision or strategic intent are broad statements of a firm’s purpose or what it wants to be; its objectives are specific measurable targets, which help in evaluating the extent to which the firms has realized its mission & vision. Objectives should ideally answer: what, when & how much?
– A 15% increase in annual revenues
– An annual increase of 10% in after tax profit
– An annual increase of 15% in earning per share
– Gaining 20% market share
– Achieving 10% reduction in operating cost
– Launching at least five new models in next three years
– Doubling the sales and distribution network in next five years
2.3 External & Internal Analysis
External analysis involves studying a firm’s external environment at macro & micro level. Macro level analysis can be carried out by using PESTEL framework. This involves monitoring Political, Economic, Social, Technological, Environmental & Legal forces at global, national and local level. Micro level industry analysis can be carried out by using Porter’s Five Forces model which has been covered in the resource note on Market & Industry Analysis of SATTVA. External analysis reveals opportunities and threats.
A firm’s internal analysis involves studying its resources and capabilities. This can be done by systematically evaluating the firm’s products, markets, strategic assets, core competencies, core processes and value chain. Each resource and capability needs to be examined for its value, rarity, inimitability and organisation’s capacity to use it well. Internal analysis reveals strengths and weaknesses.
2.4 Strategic Choice
According to Barney and Hesterly a strategy is nothing but ‘a firm’s theory about how to gain competitive advantage.’ For instance, Apple’s theory of how to gain competitive advantage in the music download –for-a-fee business was to use the music download business to help drive sales of their portable listening devices. In the strategic management process, at the stage of strategy choice, a firm needs to choose its theory of how to gain competitive advantage.
Choice of strategy depends on many factors. The first being the level for which strategy is formulated i.e. corporate level or business unit level. According to Andrews, corporate strategy defines the businesses in which a company will compete, preferably in a way that focuses resources to convert distinctive competence into competitive advantage. On the other hand business strategy is the determination of how a company will compete in a given business, and position itself among its competitors. Strategic alternatives at corporate strategy level are expansion, stability and retrenchment, while for business unit level the alternatives are cost leadership, differentiation and focus.
Strategic choice is governed by answers to following questions.
- Does the strategy support firm’s mission?
- Is it consistent with firm’s objectives?
- Does it help in exploiting opportunities in firm’s environment by leveraging its strengths? and
- Does it help neutralise environmental threats while avoiding firm’s weaknesses?
2.5 Strategy Implementation
Strategy implementation occurs when a firm adopts organisational policies and programmes that are consistent with its strategy. This issue will be discussed in greater detail in next edition of SATTVA.
2.6 Competitive Advantage
Ultimate objective of strategic management process is to create a competitive advantage for the firm. Competitive advantage results when a firm produces higher economic value than its rivals. According to Barney & Hesterly economic value is the difference between perceived benefits gained by the customers of company’s products & services and company’s cost. Consider two firms as shown in Exhibit 3.
Exhibit 3: Competitive Advantage
(Source: Barney & Hesterly, Op.cit.)
While in situation A, Firm I’s competitive advantage is derived from its differentiation strategy, in situation B, the source of competitive advantage is cost leadership strategy.
A firm’s competitive advantage or disadvantage may be temporary or sustained. When two firms produce same economic value, they have competitive parity.
2.6.1 Measures of Competitive Advantage
Competitive advantage can be measured in terms of accounting ratios such as Return on Assets, Return on Equity, Gross Profit Margin etc. The other popular method of measuring competitive advantage is through ‘Economic Value Added (EVA)’. EVA compares a firm’s return to its cost of capital instead of to the average level of return in the industry. McKinsey carried out analysis of economic profit (Net Profit – Cost of Capital) for nearly 3,000 large nonfinancial companies in it’s proprietary corporate-performance database from 2007 to 2011 period. It was found that a very small number of companies create most economic profit.
The 60 percent of companies in the middle three quintiles generate a little over $29 billion in economic profit, or around $17 million each—only 10 percent of the total pie. On the other hand in the top quintile total economic profit produced is $677 billion, where each company creates almost 70 times more economic profit than do companies in the middle three.
3. Strategy – Environment Fit
The ‘classical’ approach to strategy formulation described in previous section though is most popular, it has limitations. Reeves, Haanaes and Sinha, the strategy consultants from Boston Consulting Group (BCG), point out that the kinds of strategies that would work in the oil industry have practically no hope of working in the far less predictable and far less settled arena of internet software. BCG has developed a framework which it calls as ‘Strategy Palette’ that divides strategy planning into five styles according to how predictable the environment of a firm is and how much power the firm or the industry has to change it. The managers can match their strategy style to particular environments facing their firm, business unit or function. The five approaches to strategy can be applied to different parts of business: from geographies to industries, to functions to stages in a firm’s life cycle tailored to a particular environment faced by the firm.
Business environments differ along three dimensions: predictability (can you forecast it), malleability (can you mould the environment singly or in collaboration with others) and harshness (can you survive it). The five approaches to strategy are as follows.
- Classical. This style is used in environments that are predictable but hard to shape. The approach involves analysis of external & internal environment, developing plans to create and sustain competitive advantage and execute rigorously and efficiently.
- Adaptive. This style is used in environments that are neither predictable nor malleable. This approach calls for fast adaptation to change through continuous experimentation, identifying new options more quickly and efficiently than others and scaling up. Tata Consultancy Services (TCS), the leading Indian IT company faces an environment of technological change and the resulting change in its clients businesses and basis of competition. By using adaptive approach that focuses on continuous monitoring of environment, strategic experimentation and organisational flexibility, TCS has grown from a $ 1 bn company in 2003 to $ 13 bn in 2013.
- Visionary. In contrast to the analysis and planning of classical strategy and iterative experimentation of adaptive strategy, visionary approach is creative. This approach involves envisaging an opportunity, where others don’t see it; building that opportunity and persisting till its full potential is achieved. Amazon is an exemplar of this strategy.
- Shaping. These strategies concern ecosystems rather than individual enterprises and rely as much on collaboration as competition. The firms engage with other stakeholders to create a shared vision of the future at the right point in time. They build platform through which they can orchestrate collaboration and then evolve platform and its stakeholder ecosystem by scaling it and maintaining its flexibility and diversity. Like an adaptive strategy, a shaping strategy embraces short or continual planning cycles. When ‘Novo Nordisk’ entered the Chinese diabetes care market in 1990s, it couldn’t predict the exact path of market development, since the diabetes challenge was just beginning to emerge in China. By collaborating with patients, regulators, and doctors, the company could influence the rules of the game to emerge as uncontested market leader in diabetes care in China, with over 60 percent insulin market share.
- Renewal. When the external circumstances are so challenging that company’s current way of doing business cannot be sustained, it needs to adopt renewal strategy. A company must first recognize and react to the deteriorating environment as early as possible. Then it needs to act decisively to restore its viability – economizing by refocusing the business, cutting costs, and preserving capital, while also freeing up resources to fund the next part of the renewal journey. Finally, the firm must pivot to one of the four other approaches to strategy to ensure that it can grow and thrive again. As the credit crisis hit in 2008, American Express (Amex) faced the triple punch of rising default rates, slipping consumer demand, and decreasing access to capital. To survive, the company initiated several cost cutting measures. By 2009, Amex had saved almost $2 billion in costs and pivoted toward growth and innovation by engaging new partners, investing in its loyalty program, entering the deposit raising business, and embracing digital technology. As of 2014, its stock was up 800 percent from recession lows.
4. Framework for Formulation of Business Strategy
For most managers, mission and vision of the company are given. They are tasked with the responsibilities of developing business strategies within defined corporate premises. This is where a ‘possibilities’ based approach to strategy formulation proposed by former chairman of Procter & Gamble A.G. Lafley along with management professors Roger Martin, Jan W. Rivkin, and Nicolaj Siggelkow becomes relevant. The possibilities based approach begins with the recognition that the organization must make a choice and that the choice has consequences.
Step 1: Move from Issues to Choice
Instead of focussing only on issues, such as declining profits or market share, the management team should define two mutually exclusive options that could resolve the issue in question. Once the problem has been framed as a choice—any choice—the analysis and emotions will focus on what managers have to do next, not on describing or analyzing the challenge.
Step 2: Generate Strategic Possibilities
After recognizing that a choice needs to be made, the management team should develop full range of possibilities that can be considered. To generate creative options, managers need a clear idea of what constitutes a possibility. A possibility is essentially a happy story that describes how a firm might succeed. Each story lays out ‘where the company plays’ in its market and ‘how it wins’ there. It should have internally consistent logic, but it need not be proved at this point. Characterizing possibilities as stories that do not require proof helps people discuss what might be viable but does not yet exist. It is much easier to tell a story about why a possibility could make sense than to provide data on the odds that it will succeed. The managers should specify in detail the advantage they aim to achieve or leverage, the scope across which the advantage applies, and the activities throughout the value chain that would deliver the intended advantage across the targeted scope.
The status quo must also be among the possibilities considered. This forces the team in later stages to specify what must be true for the status quo to be viable, thereby eliminating the common implicit assumption “Worst case, we can just keep doing what we’re already doing.”By including it among the possibilities, a team makes it subject to investigation and potential doubt.
Step 3: Specify the Conditions for Success
The purpose of this step is to specify what must be true for each possibility to be a good choice. This step is not intended for arguing about what is true. It is not intended to explore or assess the soundness of the logic behind the various possibilities or to consider data that may or may not support the logic—that comes later. When the discussion of a possibility centers on what is true, the person most sceptical about the possibility attacks it vigorously and the originator defends it, providing arguments in its favour. If, instead, the dialogue is about what would have to be true, then the sceptic can say, “For me to be confident in this possibility, I would have to know that consumers will embrace this sort of offering.” That is a very different sort of statement from “That will never work!” It helps the proponent understand the sceptic’s reservations and develop the proof to overcome them. It also makes the sceptic specify the exact source of the scepticism rather than issue a blanket denunciation. The attempt should be to seek out what would have to be true for every member of the strategy formulation group to feel cognitively and emotionally committed to each possibility under consideration.
Once the management team finishes reviewing, it should ask, “If all these conditions were true, would you advocate for and support this choice?” If any member says no, then the group needs to return to the first-stage discussion and add any necessary conditions that were initially overlooked or mistakenly removed.
Step 4: Identify the Barriers to Choice
This step begins by asking group members to imagine that they could buy a guarantee that any particular condition will hold true. To which condition would they apply it? The condition they choose represents the biggest barrier to choosing the possibility under consideration. The next condition to which they would apply a guarantee is the next biggest barrier, and so on. The ideal output is an ordered list of barriers to each possibility, two or three of which really worry the group.
Team members must be encouraged to raise, not suppress, their concerns. Even if only one person is concerned about a given condition, the condition must be kept on the list.
Step 5: Design Tests for the Barrier Conditions
Once the key barrier conditions are identified and ranked, the group must test each one to see whether it holds true. For each key barrier condition, a test needs to be designed that will be considered valid and sufficient to generate commitment by all team members irrespective of nature of test such as quantitative or qualitative. The entire group should believe that the test is valid and can form the basis for rejecting the possibility in question or generating commitment to it.
Step 6: Conduct the Tests
For each possibility, the management team should describe ‘what must be true for it to be strategically sound’. The team may start with the tests for the barrier conditions in which it has the least confidence. The tests cannot eliminate all uncertainty. Even the best performing possibility will entail some risk. That is why it is so crucial to set testable conditions for the status quo: The team then clearly sees that the status quo is not free of risk. Rather than compare the best-performing possibility with a nonexistent risk-free option, the team can compare the risk of the leading option with the risk of the status quo and reach a decision in that context.
Step 7: Make the Choice
Review key conditions in light of test results in order to reach a decision.
The ‘possibilities-based approach’ requires at least three fundamental shifts in mind-set. First, in the early steps, managers must avoid asking “What should we do?” and instead ask “What might we do?” Second, in the middle steps, managers must shift from asking “What do I believe?” to asking “What would I have to believe?” This requires a manager to imagine that each possibility, including ones he does not like, is a great idea, and such a mind-set does not come naturally to most people. It’s needed, however, to identify the right tests for a possibility. Finally, by focusing a team on pinpointing the critical conditions and tests, the possibilities-based approach forces managers to move away from asking “What is the right answer?” and concentrate instead on “What are the right questions? What specifically must we know in order to make a good decision?” The possibilities-based approach relies on and fosters a team’s ability to inquire.
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