Chapter Four: Strategy Formulation

3. 0. Introduction
Strategy formulation is often referred to as strategic planning or long run planning and is
concerned with developing a corporation’s mission, objectives, strategies and policies. It begins
with situation analysis: the process of finding a strategic fit between external opportunities and
internal strengths while working around external threats and internal weaknesses.

3.1. Corporate level strategic alternatives

Corporate level strategies detail actions taken to gain a competitive advantage through the
selection and management of a mix of businesses competing in several industries or product
market. The primary concerns of corporate level strategy are:
 What businesses should the firm be in?
 How the corporate office could manage its group of businesses?
 How to make the corporation as a whole add up to more than the sum of its business
parts?
Corporate strategy is primarily about the choice of direction for the whole firm. This is true
whether the firm is small, one – product company or a large – multinational corporation. In a
large multi business company, how ever, corporate strategy is also about managing various
product lines and business units for maximum value. In this instance, corporate head quarters
must play the role of the organizational “parent”, in that it must deal with various product and
business unit “children”.
A corporation’s direction strategy (also known as grand strategies) is composed of three key
alternatives.
 growth strategies
 Stability strategies
 defensive strategies

A) Growth Strategies
The growth strategy seeks to significantly increase a firm's revenues or market share. Many top
executives believe that growth is the only strategy for a healthy firm. However, a firm should
adopt a growth strategy only if that growth is expected to result in an increase in firm value.
Growth may be attained in a variety of ways. Internal growth is accomplished when a firm
increases revenues, production capacity, and its workforce, whereas external growth is
accomplished when other firms are acquired or merged with or through strategic alliance.
Although internal growth enables the firm the preserve its corporate culture and image while
expanding at a more controlled pace, external growth can enable the firm to grow more
expediently. Internal growth can occur by expanding an existing business or creating new ones.

The major types of growth strategies are discussed as follows.

1. Concentration
The most common grand strategy is concentration on the current business. The firm directs its
resource to the profitable growth of a single product, in a single market, and with a single
technology.

The reasons for selecting a concentration strategy are easy to understand. Concentration is
typically lowest in risk and in additional resources required. It is also based on the known
competencies of the firm. On the negative side for most companies concentration tends to result
in steady but slow increases in growth and profitability and a narrow range of investment
options.
Firms use this strategy to gain competitive advantage in production skill, marketing know–how
and reputation in the market place. Broadly speaking, the business can attempt to capture a large
market share by increasing present customer rate of usage, by attracting competitor’s customer,
or by interesting non users in the product or service.
2. Integration strategy
This focuses on moving to different industry level, different product and technology but the basic
market remain the same. There are two major types of integrative growth strategies:

a. Horizontal integration
This long term strategy of a firm is based on growth through the acquisition of one or more
similar business operating at the same stage of the production–marketing chain. Thus
combination of two textile producers, two shirt manufacturers or two closing stores chains would
be classified as horizontal integrations.
b. Vertical integration
Vertical integration allows the firm to enlarge its scope of operations within the same overall
industry. It is characterized by the firm’s expansion in to other parts of the industry value chain
directly related to the design, production, distribution and / or marketing of the firm’s existing set
of products or services. Many companies practice vertical integration in some way. Companies
engage in vertical integration primarily to strengthen their hold on resources deemed critical to
their competitive advantage. It is also an important strategy for firms that face great uncertainty,
especially as it concerns their sources of supply or future buyers of their products. Moreover, it
enables the firm to reduce the external transaction costs of working with numerous suppliers and
customers.
Full versus partial integration
Full integration occurs when the firm seeks to control all stages of the value chain related to the
final end products or services. On the other hand, firms can also attempt a limited form of
vertical integration known as partial integration. Partial integration refers to a selective choice of
those value- adding stages that are brought in–house.
Backward versus forward integration
The degree of vertical integration may be as important as its degree. Backward integration an
activity currently carried out by a supplier. It can allow firms to convert moves the firms into a
previously external supplier into an internal profit.
Backward integration is particularly common in industries where low cost and certainty of
supply are vital to maintain the firm’s competitive advantage in its end markets. For example,
drug companies often exhibit high level of backward integration to ensure supply of necessary
chimerical ingredients for their pharmaceuticals.

Forward integration moves the firm close to its customer. Forward integration is designed to
help the firm capture more of the value added in the product or service offered to the customer.
3. Diversification growth strategy
This refers to an attempt to change the characteristic of the business through either of new
products, markets and technology or all the three.
Diversification growth strategy is classified into two categories:
A. Concentric (related) diversification
This involves the addition of a business related to the firm in terms of technology, market, or
products. With this type of growth strategy the new business selected process a high degree of
compatibility with the firm’s current businesses.
Firms implement related diversification strategies to enable them to achieve and exploit
economies of scope and, by building on existing resources, capabilities and core competencies,
build a competitive advantage.
Economies of scope represent cost saving attributed to entering an additional business using
capabilities and core competencies developed in another business that can be transferred to a new
business without significant additional costs. In other words, firms that successfully transfer core
competencies from one business to another without incurring significant additional costs will
realize economies of scope.
The two primary operations-related economies through which firms hope to realize or create
value from economies of scope are by sharing activates or by sharing core competencies.
Tangible resources such as factories and equipment and an intangible resource, such as a sale
force or know how, can be shared to achieve scope economies.
Example of activity sharing possibilities
 Inbound logistics: warehouse facilities
 Operations : assembly facilities, maintenance operations
 Outbound logistics: sales force, distribution
 Support activities: procurement, technology development.
Firms also must recognize that, while activity sharing is attended to reduce costs through
relieving economies of scope, there are incremental costs related to sharing activates (costs
that are created by sharing)
2. Conglomerated (unrelated) diversification
This is a strategy of seeking growth by appealing to new markets with new products that have
no technology relationship to current product.
Firms implementing unrelated diversification strategies hope to create value by realizing
financial economies. Financial economies are cost savings realized through improved
allocation of financial resources based on investments inside or outside the firm.
 Major reasons for diversification
1. low performance
When firms are able to earn above average or superior returns in a single business,
they have little incentive to diversify. On the other hand, it has been shown that lower
returns are related to greater level of diversification.
2. Uncertain future cash flows.
Firms also may implement diversification strategies when their products reach
majority (in the product life cycle) or are threatened by external factors that the firm
can not overcome.
3. firm risk reduction
4. Sufficient tangible and intangible resources.
Managerial motives to diversify include
 Reduction of managerial risk.
Diversification may enable managers to reduce employment risk (the risk related to the
loss of their jobs or a reduction in compensation) because by diversifying the firm
managers may be able to diversify their employment risk if profitability does not decline
significantly as a result of the diversification.
 Desire for increased compensation
Diversification also may enable managers to increase their compensation because of
positive correlation between diversification, firm size and executive compensation.
2. Stability strategy
A corporation may choose stability over growth by continuing its current activates without any
significant change in direction. Although sometimes viewed as a lack of strategy, the stability
family of corporate strategies can be appropriate for a successful corporation operating in a
reasonably predictable environment. They are very popular with small business owners who
have found a niche and are happy with their success and the manageable size of their firms.
Stability strategies can be very useful in the short run, but they can be dangerous if followed for
too long.
Some of the more popular of these strategies are the pause/proceed with caution, no change, and
profit strategies
(1) Pause/proceed with caution strategy
A pause/proceed with caution strategy is, in effect, a timeout- an opportunity to rest before
continuing a growth or retrenchment strategy. It is a very deliberate attempt to make only
incremental improvements until a particular environmental situation changes. It is typically
conceived as a temporary strategy to be used until the environment becomes more hospitable or
to enable a company to consolidate its resources after prolonged rapid growth.

(2) No change Strategy

A no change strategy is a decision to do nothing new-a choice to continue current operations and
policies for the foreseeable future. Rarely articulated as a definite strategy, a no change
strategy’s success depends on a lack of significant change in a corporation’s situation. The
relative stability created by the firm’s modest competitive position in an industry facing little or
no growth encourages the company to continue on its current course, making only small
adjustments for inflation in its sales and profit objectives. There are no obvious opportunities or
threats nor much in the way of significant strengths or weaknesses.

(3) Profit Strategy

A profit strategy is a decision to do nothing new in a worsening situation but instead to act as
though the company’s problems are only temporary. The profit strategy is an attempt to
artificially support profits when a company’s sales are declining by reducing investment and
short-term discretionary expenditures. Rather than announcing the company’s poor position to
shareholders and the investment community at large, top management may be tempted to follow
this very seductive strategy such as blaming the company’s problems on a hostile environment
(such as anti-business government policies).
3. Defensive strategy
This strategy is used to reverse a negative trend. There are three major types of defensive
strategies
A. Retrenchment / turnaround
For any of a large number of reasons a business can find itself with declining profits. Economic
recessions, production inefficiencies, and innovative breakthrough by competitors are only three
causes. In many cases strategic managers believe that firm can survive and eventually recovered
if a converted effort if made over a period of a few years to fortify basic distinctive
competencies. It is typically accomplished in one of two ways, employed singly or in
combination:
a. Cost reduction – example include decreasing the workforce through employee
attrition, leasing rather than purchasing equipment, and eliminating elaborate
promotional activities.
b. Asset reduction: example include the sale of land, building and equipment not
essential to the basic activity of the business, and eliminations of “perks” like
the company airplane and executive cars.
If these initial approached fail to achieve the required reductions, more drastic action may be
necessary. It is sometime essential to lay off employees, drop items from a production line, and
even low margin customers. Since the underlying purpose of retrenchment is to reverse current
negative trends, the method is often refereed to as a turnaround strategy.
B. Divestiture
A divestiture strategy involves the sale of a business or a major business component. When
retrenchment fails to accomplish the desired turnaround, strategic managers often decide to sell
the business. However, because the intent is to find a buyer willing to pay a premium above the
value of fixed assets for on going concern, the term marketing for sale is more appropriate.

C. Liquidation / bankruptcy strategy

When a company finds itself in the worst possible situation with a poor competitive position in an
industry with few prospects, management has only a few alternatives all of them distasteful.
Because no one is interested in buying a weak company in an unattractive industry, the firm must
pursue a bankruptcy or liquidation strategy. Bankruptcy involves giving up management of the
firm to the courts in return for some settlement of the corporation’s obligations. Top management
hopes that once the court decides the claims on the company, the company will be stronger and
better able to compete in a more attractive industry.

In contrast to bankruptcy, which seeks to perpetuate the corporation, liquidation is the

termination of the firm. Because the industry is unattractive and the company too weak to be sold
as a going concern, management may choose to convert as many saleable assets as possible to
cash, which is then distributed to the shareholders after all obligations are paid. The benefit of
liquidation over bankruptcy is that the boards of directors, as representatives of the shareholders,
together with top management make the decisions instead of turning them over to the court,
which may choose to ignore shareholders completely.

3.1.1. Portfolio analysis

The business portfolio is the collection of businesses (SBUs) and products that make up the
company. There are different types of portfolio techniques in use, the most well known of which
are:
 The Boston consulting Group – BCG matrix
 The general Electric screen – GE- matrix

1. The BCG growth / share matrix

One of the most widely used portfolio approaches to corporate strategic analysis has been the
growth / share matrix pioneered by the Boston consulting Group (BCG). This matrix facilities
corporate strategic analysis of likely “generators” and optimum “users” of corporate resources.
To use the BCG matrix, each of the company’s business (SBUs) is plotted according to market
growth rate and relative competitive position (relative market share).Market growth is the
projected rate of sales growth for the market to be served by a particular business. It is usually
measured as the percentage increase in a market’s sales or unit volume over the two most recent
years. Market growth rate provides an indicator of the relative attractiveness of the markets
served by each of the businesses in the corporation’s portfolio of businesses. Relative
competitive position is usually expressed as the ratio of a business’s market share divided by the
market share of the largest competitor in that market. The matrix has four cells with differing
implication for their in an overall corporate – level strategy.
1. Stars
The stars, as the BCG matrix labeled them, are businesses in a rapidly growing market
with large market shares. They represent the best long- run opportunities (growth and
profitability) in the firm’s portfolio. These business require substantial investment to
maintain (and expand) their dominant position in a growing market. This investment
requirement is often in excess of what can be generated internally.
2. Cash Cows
These are high market share businesses in maturing, low-growth markets or industries
because of their strong position and minimal reinvestment requirements for growth.
These businesses often generate cash in excess of their needs. Therefore, these businesses
are selectively “milked” as a source of corporate resources for deployment elsewhere.

3. Dogs
These are businesses that have low market share and low market growth. They are in a
saturated, mature market with intense competition and low profit margins. Because of
their weak position, these businesses are managed for short term cash flow to supplement
corporate – level resource needs. These businesses are eventually divested or liquidated
once the short-term harvesting is maximized.
4. Question marks
These businesses have considerable appeal because of their high growth rate yet present
questionable profit potential because of low market share. They are known as cash
 guzzlers because their cash needs are high as a result of rapid growth, while their cash
generation is low due to small market share. At the corporate level the concern is
identifying the question market that would most benefit from extra corporate resources
resulting in increased market share and movement in to the star group.

Conventional strategic thinking suggests there are four possible strategies for each SBU:

(1) Build Share: here the company can invest to increase market share (for example
turning a "question mark" into a star)

(2) Hold: here the company invests just enough to keep the SBU in its present position

(3) Harvest: here the company reduces the amount of investment in order to maximize
the short-term cash flows and profits from the SBU. This may have the effect of turning
Stars into Cash Cows.

(4) Divest: the company can divest the SBU by phasing it out or selling it - in order to use
the resources elsewhere (e.g. investing in the more promising "question marks").

Strategic implication of the BCG –Matrix

 The cash surplus from any cash cows should be used to support the development of
selected question marks and nurture stars.
 The long term position is to consolidate the position of stars and turn favored question
marks in to stars, thus making the company‘s portfolio more attractive.
 Question mark with the weakest or most uncertain long-term prospects should be
divested to reduce demands on a company’s cash resources.
 Dogs having reached the end of their useful life are generally best put to sleep unless they
are still performing a useful function –not merely making a contribution to overheads.
 The portfolio must be balanced –when there are sufficient cash cows, stars and question
marks.

2. The General Electric (GE)Approach

Another portfolio planning approach that helps a business determine whether to invest in
opportunities is the General Electric (GE) approach. A portfolio planning approach that
examines a business’ strengths and the attractiveness of industries.. The GE approach examines a
business’s strengths and the attractiveness of the industry in which it competes. As we have
indicated, a business’ strengths are factors internal to the company, including strong human
resources capabilities (talented personnel), strong technical capabilities, and the fact that the firm
holds a large share of the market. The attractiveness of an industry can include aspects such as
whether or not there is a great deal of growth in the industry, whether the profits earned by the
firms competing within it are high or low, and whether or not it is difficult to enter the market.
For example, the automobile industry is not attractive in times of economic downturn such as the
recession in 2009, so many automobile manufacturers don’t want to invest more in production.
They want to cut or stop spending as much as possible to improve their profitability. Hotels and
airlines face similar situations.

Companies evaluate their strengths and the attractiveness of industries as high, medium, and low.
The firms then determine their investment strategies based on how well the two correlate with
one another. As figure below, “The General Electric (GE) Approach” shows, the investment
options outlined in the GE approach can be compared to a traffic light. For example, if a
company feels that it does not have the business strengths to compete in an industry and that the
industry is not attractive; this will result in a low rating, which is comparable to a red light. In
that case, the company should harvest the business (slowly reduce the investments made in it),
divest the business (drop or sell it), or stop investing in it, which is what happened with many
automotive manufacturers.

The General Electric (GE) Approach

Although many people may think a yellow light means “speed up,” it actually means caution.
Companies with a medium rating on industry attractiveness and business strengths should be
cautious when investing and attempt to hold the market share they have. If a company rates itself
high on business strengths and the industry is very attractive (also rated high), this is comparable
to a green light. In this case, the firm should invest in the business and build market share.
During bad economic times, many industries are not attractive. However, when the economy
improves businesses must reevaluate opportunities.

3.2 Business level strategies

Business level strategy focuses on improving the competitive position of a company’s or
business unit’s products or services within the specific industry or market segment that the
company or business unit serves. Business strategy can be competitive (battling against all
competitors for advantage) and /or cooperative (working with one or more competitors to gain
advantage against other competitors). Just as corporate strategy asks what industry (ies) the
company should be in, business strategy asks how the company or its units should compete or
cooperate in each industry.
Routes to building competitive advantage
Competitive strategies must be based on some sources of competitive advantage to be successful.
Companies build competitive advantages when they take steps that enable them to gain an edge
over their rivals in attracting buyers. These steps vary: for example, making the highest –
quality , product, providing the best customer service, producing at eh lowest cost, or focusing
resources on a specific segment or niche of the industry regardless of which avenue to building
competitive advantage the firm selects, customers should receive superior value than that
offered by rival firms. Recall that business level strategy focuses on how to compete in a given
business or industry with its different types of competitors aiming to sell to the same or similar
group of customer. In practice, competitors within an industry may be companies with no other
lines of business (single business firms) or business units belonging to larger, diversified
companies that operate across many industries.
Competitive strategy may arise from the following questions:
 Should we compete on the basis of low cost (and thus price), or should we differentiate
our products or services on some basis other that cost, such as quality or service?
 Should we compete head to head with our major competitors for the biggest but most
sought-after share of the market, or should we focus on a niche in which we can satisfy a
less sought-after but also profitable segment of the market?
Although there are as many different competitive strategies as there are firms competing, three
underlying approaches to building competitive advantage appear to exist at the broadest level.
They are (1) low-cost leaders hip strategies (2) differentiation. Strategies and (3) focus strategies.
These three broad types of competitive strategies have also been labeled generic strategies. Let
us now examine how each genetic type of competitive strategy can build competitive advantage.

Low Cost leadership Strategies

Low cost leadership strategies are based on a firm’s ability to provide a product or service at a
lower cost than its rivals. The basic operating assumption behind a low-cost leadership strategy
is to acquire a substantial cost advantages over other competitors that can be passed in to the
consumers to gain a large market share. A low –cost strategy then produces a competitive
advantage when the firm can earn a higher profit margin that result from selling products at
current market prices. In many cases, firms attempting to execute low-cost strategies aim to sell a
product that appeal to an “average” customer in a broad target market. Often times, these product
or service are highly standardized and not customized to an individual customer’s tastes, needs,
or desires.
Building a low –cost advantage
The low-cost leadership strategy is based on locating and leveraging every possible basic of cost
advantage in a firm’s value chain of activities. Building a cost-based advantage thus requires the
firm to find and exploit all the potential cost drivers that allow for greater efficiency in each
value- adding activity.
A cost driver is an economic or technological factor that determines the cost of performing
some activity. Important cost drivers that shape the low-cost leadership strategy include (1)
economies of scale (2) experience or leaning curve effects (3) degree of vertical integrations and
even (4) location of activity performance.
BENEFITS OF A COST LEADERSHIP STRATEGY

 The business can earn higher profits by charging a price equal to, or even below, that of
competitors because its costs are lower;
 It allows the business the possibility to increase both sales and market share by reducing
price below that charged by competitors (assuming that the product’s demand is price elastic
in nature);
 It allows the business the possibility to enter a new market by charging a lower price than
competitors;
 It can be particularly valuable in market where consumers are price sensitive;
 It creates an additional barrier to entry for organizations wishing to enter the industry.

2) Differentiation strategies

Another strategic approach to building competitive advantage is that of pursuing differentiation

strategies. Differentiation strategies are based on providing buyers with something that is
different or unique, that makes the company’s product or service district from that of its rivals.
The key assumption behind a differentiation strategy is that customers willing to pay a higher
price for a product that is distinct (or at least perceived as such) in some important way. Superior
value is created because the product is of higher quality, is technically superior in some way,
comes with superior service, or has a special appeal in some perceive way. In effect,
differentiation builds competitive advantage by making customers more loyal- and less price-
sensitive-to a given firm’s product.
Building a differentiation – based advantage
Firm’s practicing differentiation seek to design and produce highly distinctive or unique product
or service attributes that create high value for their customers. An important strategic
consideration managers must recognize is that differentiation does not mean the firm can neglect
its cost structure .While low unit cost is less important than distinctive product features to firms
practicing differentiations, the firm’s total cost structure is still important.
In almost all differentiation strategies, attention to product quality and services represents the
dominant routes for firms to build competitive advantage.
Advantage of differentiation
 it allows firms to insulate themselves partially from competitive rivalry in the industry.
 Customers of differentiated products are less sensitive to price. In practice, this attitude
means that firms may be able to pass along price increases to their customers.
 Strategies based on high quality may, up to a point, actually increase the potential market
share that a firm can gain.
 Differentiation poses substantial loyalty barriers that firms contemplating entry must
overcome.
Disadvantages of differentiation
 other firms may attempt to “out differentiate” firms that already have distinctive products
by providing similar or better product
 Price premiums become difficult to justify as customers gain more knowledge about the
product.
 Firms face a risk of over doing differentiation that may overtax or overextend their
resources.
3) Focus strategies
Focus strategies are designed to help a firm target a specific niche within an industry. These
niches could be a particular buyer group, a narrow segment of a given product line, a geographic
or regional market, or a niche with distinctive, special taste and preference. The basic idea
behind a focus strategy is to specialize the firm’s activities in ways that other broader-line firms
can’t perform as well.
Building a focus based advantage
Firms can build a focus in one of two ways. They can adopt a cost- based focus in serving a
particular niche or segment of the market, or they can adopt a differentiation based focus. Within
a particular targeted market or niche, however, a focused firm can pursue many of the same
characteristics as the broader low-cost or differentiation approaches to building competitive
advantage. Thus many of the source of competitive advantage discussed earlier for cost and
differentiation also apply to focus strategies at the niche or segment level.

3.3. Functional Level Strategy

Functional strategy is the approach taken in a functional area to achieve corporate and business
unit objectives and strategies by maximizing resource productivity. It is concerned with
developing and nurturing a distinctive competence to provide a company or business unit with a
competitive advantage. For example, just as a multidivisional corporation has several business
units, each with its own business strategy, each business unit has its own set of departments, each
with its own functional strategy. The orientation of the functional strategy is dictated by its
parent business unit’s strategy. For example, a business unit following a competitive strategy of
differentiation through high quality needs a manufacturing strategy that emphasizes expensive,
quality assurance processes over cheaper, high-volume production; a human resource functional
strategy that emphasizes the hiring and training of a highly skilled, but costly, workforce; and a
marketing functional strategy that emphasizes distribution channel “pull” using advertising to
increase consumer demand over “push” using promotional allowances to retailers. If a business
unit were to follow a low-cost competitive strategy, however, a different set of functional
strategies would be needed to support the business strategy.
3.3.1 Marketing strategy
Marketing consists of those activities intended to move products or service form the producer to
the consumer or market. Marketing strategy deals with pricing, and distributing a product. Using
a market development strategy, a company or business unit can (1) capture a larger share of an
existing market for current products through market saturation and market penetration or (2)
develop new markets for current products.

Using the product development strategy, a company or unit, can (1) develop new products for
existing markets or (2) develop new products for new markets.
Using a successful brand name to market other products is called brand extension and is a good
way to appeal to a company's current customers.
There are numerous other marketing strategies. For advertising and promotion, for example, a
company or business unit can choose between a "push" and a "pull" marketing strategy.

3.3.2. Financial strategy

Financial strategy examines the financial implications of corporate and business level strategic
options and identifies the best financial course of action. It can also competitive advantage
through a lower cost of funds and a flexible ability to raise capital to support a business strategy.

3.3.3. Research and development (R&D) strategy

R&D strategy deals with product and process innovation and improvement. It also deals with the
appropriate mix of different types of R&D (basic, product, or process) and with the question of
how new technology should be accessed internal development, external acquisition, or through
strategic alliances.

One of the R&D choices is to be either a technological leader in which one pioneers an
innovation or a technological follower in which one imitates the products of competitors. Porter
suggests that deciding to become a technological leader or follower can b e a way of achieving
either overall low cost or differentiation.

3.3.4. Operations strategy

Operations strategy determines how and where a product or service is to be manufactured, the
level of vertical integration in the production process, and the deployment of physical resources.
It should also deal with the optimum level of technology the firm should use in its operations
processes.

The concept of a product's life cycle eventually leading to one size fits all mass production is
being increasingly challenged by the new concept of mass customization. A appropriate for an
ever changing environment, mass customization requires that people, processes, units and
technology reconfigure themselves to give customers exactly what they want, when they want it.
In contrast to continuous improvement, mass customization requires flexibility and quick
responsiveness. Managers coordinate independent, capable individuals. An efficient linkage
system is crucial. The result is low cost, high quality, customized goods and services mass
customization is having a significant impact on product development. Under a true mass
customization system, no one knows exactly what the next customer will want

3.3.5. Purchasing strategy

Purchasing strategy deals with obtaining the raw materials, parts, and supplies needed to perform
the operations function. The basic purchasing choices are multiple, sole, and parallel sourcing.
Under multiple sourcing, the purchasing company orders a particular part from several vendors.
Multiple sourcing has traditionally been considered superior to other purchasing approaches
because (1) it forces suppliers to compete for the business of an important buyer, thus reducing
purchasing costs; and (2) if one supplier could not deliver, another usually could, thus
guaranteeing that parts and supplies would always be on hand when needed.

Multiple sourcing was one way a purchasing firm could control the relationship with its
suppliers. So long as suppliers could provide evidence that they could meet the product
specifications, they were kept on the purchaser's list of acceptable vendors for specific parts and
supplies. Unfortunately the common practice of accepting the lowest bid often compromised
quality.

3.3.6. Logistics strategy

Logistics strategy deals with the flow of products into and out of the manufacturing process.
Three trends are evident: centralization, outsourcing, and the use of the Internet. To gain
logistical synergies across business units, corporations began centralizing logistics in the head
quarter's group. This centralized logistics group usually contains specialists with expertise in
different transportation modes such as rail or trucking. They work to aggregate shipping volumes
across the entire corporation to gain better contracts with shippers.
Many companies have found that outsourcing of logistics reduces costs and improves delivery
time. Many companies are using the Internet to simplify their logistical system.

3.3.7. Human resource management (HRM) strategy

HRM strategy, among other things, addresses the issue of whether a company or business unit
should hire a large number of low skilled employees who receive low pay, perform repetitive
jobs, and most likely quit after a short time (the McDonald's restaurant strategy) or hire skilled
employees who receive relatively high pay and are cress trained to participate in self managing
work teams. As work increases in complexity, the more suited it is for teams, especially in the
case of innovative product development efforts. Multinational corporations are increasingly
using self-managing work teams in their foreign affiliates as well as in home country operations.
Researches indicate that the use of work teams leads to increased quality and productivity as well
as to higher employee satisfaction and commitment.

3.3.8. Strategies to avoid

Several strategies, which could be considered corporate, business, or functional, are very
dangerous. Managers who have made a poor analysis or lack creativity may be trapped into
considering some of the following strategies to avoid:
 Follow the leader: Imitating a leading competitor's strategy might seem to be a good idea,
but it ignores a firm's particular strengths and the possibility that the leader may be
wrong.
 Hit another home run: If a company is successful because it pioneered an extremely
successful product, it tends to search for another super product that will ensure growth
and prosperity. Like betting on long shots at the horse races, the horse races, the
probability of finding a second winner is slight.
 Arms Race: entering into a spirited battle with another firm for increased market share
might increase sales revenue, but that increase will probably be more than offset by
increases in advertising, promotion, R&D, and manufacturing costs.
  Do Everything: When faced with several interesting opportunities, management might
tend to leap at all of them,. At first, a corporation might have enough resources to
develop each idea into a project, but money, time, and energy are soon exhausted as the
many projects demand large infusions of resources.
 Losing Hand: A corporation might have invested so much in a particular strategy that top
management is unwilling to accept its failure. Believing that it has too much invested to
quit, the corporation continues to throw "good money after bad."

3 .4. STRATEGIC CHOICE: SELECTION OF THE BEST STRATEGY

After the pros and cons of the potential strategic alternatives have been identified and evaluated,
one must be selected for implementation. By now, many feasible alternatives probably will have
emerged. How is the best strategy determined?

Perhaps the most important criterion is the ability of the proposed strategy to deal with the
specific strategic factors developed earlier in the SWOT analysis. If the alternative
doesn’t take advantage of environmental opportunities and corporate strengths and lead
away from environmental threats and corporate weaknesses, it will probably fail.

Another important consideration in the selection of a strategy is the ability of each

alternative to satisfy agreed-on objectives with the least use of resources and with the
fewest negative side effects.
It is therefore important to develop a tentative implementation plan that addresses
management’s likely difficulties. This should be done in light of societal trends, the industry,
and the company’s situation based on the construction of scenarios.

APPLYING EVALUATION CRITERIA

When considering which course of action to pursue, it is normally the cause that a number of
options present themselves to an organization’s top management. In order to ensure that each
option is fairly and equally assessed, a number of criteria are applied.
For each option, four criteria are applied – questions to ask of each option. In order to ‘pass’, the
option must usually receive an affirmative answer to each one. The four criteria are:
1. Is the strategic option suitable?
2. Is the strategic option feasible?
3. Is the strategic option acceptable?
4. Will the strategic option enable the organization to achieve competitive advantage?
Suitability criterion
A strategic option is suitable if it will enable the organization to actually achieve its strategic
objectives. If it will in any way fall short of achieving these objectives, then there is no point in
pursuing it and the option should be discarded.
Similarly, if an organization’s objective is to spread market portfolio by gaining a presence in
foreign markets, then the option of increasing the company’s investment in its domestic home
would clearly be unsuitable.
Feasibility criterion
A strategic option is feasible if it is possible. When evaluating options using these criteria, it is
likely that the options will be feasible to varying degrees. Some will be completely unfeasible,
others ‘might be’, whilst yet others are definitely feasible.
The extent to which an option is suitable will depend in large part upon the resource base that the
organization has. A deficit in any of the key resource areas (physical resources, financial, human
and intellectual) will present a problem at this stage of evaluation. If an option requires capital
that is unavailable, human skills that are difficult to buy in, land or equipment that is equally
difficult to obtain or a scarce intellectual resource, then it is likely to fail the feasibility criterion.
Acceptability criterion
A strategic option is acceptable if those who must agree to the strategy accept the option. This
raises an obvious question – who are those who agree that the option is acceptable?
We encountered the concept of stakeholders in chapter one. The extent that stakeholders can
exert influence upon an organization’s strategic decision-making rests upon the two variable,
power and interest. Stakeholders that have the highest combination of both the ability to
influence (power) and the willingness to influence (interest) will have the most effective
influence. Where two or more stakeholder groups have comparable influence, the possibility of
conflict over acceptability will be heightened. In most cases, the board of directors will be the
most influential stakeholder.

Competitive advantage criterion

We learned in Chapter two that one of the key objectives in strategy is to create competitive
advantage. This criterion asks a simple question of any strategic option: ‘what is the point of
pursuing an option if it isn’t going to result in superior performance (compared with competitors)
or higher than average profitability?’ In other words, a strategic option would fail this test if it
was likely to result in the business being only ‘ordinary’ or average with regard to the industry
norm.
This is particularly important when considering product options. For example, if a new product
option is forecast to receive an uncertain reception from the market, we might well ask what the
point of the launch is at all. It would be unlikely to result in competitive advantage for the
business.

FINANCIAL TOOLSF FOR EVALUATION

In the evaluation and selection stage, a number of ‘tools’ are available to managers that may
assist in deciding upon the most appropriate option. Not all of them will be appropriate in every
circumstance and some are more widely used than others. They are used to explore the
implications of the options so that the decisions that are made are based upon the best possible
information.
Accountants are usually very involved in strategic evaluation and selection because of their
expertise in understanding the financial implications of the possible courses of action. There are
two major areas of financial analysis: cash-flow forecasting and investment appraisal.
Cash – flow forecasting
One of the most straightforward financial tools is cash-flow analysis – some-times called funds-
flow analysis. Essentially, it involves a forecast of the expected income from an option, of the
costs that will be incurred and, from this, the forecast net cash inflows or outflows. For most
options, the forecast will be broken down into monthly ‘chunks’ and a profit and loss statement
will be constructed for each month. If the same procedure is carried out for each option, the most
favorable can be identifies.
Investment appraisal
An investment, at its simplest, is some money put up for a project in the expectation that it will
enable more money to be made in the future. The questions surrounding investment appraisal
concern how much will the organization make against each investment option.
There is a strong time element to investment appraisal techniques because the returns on the
investment may remain for several years or even decades. It is for this reason that a factor is
often built in to the calculation to account for inflation.
The first and most obvious thing that accountants want to know about any investment is the
payback period. This is the time taken to repay the investment – the shorter the better. If, for
example, an investment of $1000 is expected to increase profits by $100 a month, then the
payback period will be 10 months.
In practice, payback periods are rarely this short and it is this fact that makes investment
appraisal calculations a bit more complicated. When the effects of inflation are taken into
account, the returns on an investment can be eroded over time. Consequently, accountants
include a factor to account for the effects of inflation, usually on a ‘best-guess’ basis.
Other tools for evaluation
Financial evaluation of strategic options is very important, but for most organizations other tools
can also provide useful information. These may require financial information as an input and so
they should be seen not as ‘instead of’ financial analyses, but ‘as well as’. They enrich the
information, enabling management to select the best strategic option.
Cost – benefit analysis
Cost-benefit analysis applies to almost every area of life, not just strategic evaluation and
selection. Each option will have a cost associated with it and will be expected to return certain
benefits. If both of these can be quantified in financial terms, then the cost-benefit calculation
will be relatively straightforward. The problem is that this is rarely the case.
The costs of pursuing one particular option will have a number of elements. Any financial
investment costs will be easily quantifiable. Against this, the cost of not pursuing the next best
option needs to be taken into account – the opportunity cost. There may also be a number of
social and environmental costs which are much harder to attach a value to.
The same problems apply to the benefits. In addition to financial benefits, an organization may
also take into account social benefits and others such as improved reputation or improved
service. Intangible benefits are very difficult to attach a value to for a cost-benefit analysis as
they can take a long time to work through in increased financial performance.
Social costs and benefits
All organizations have an impact upon the societies that are in their locality or that are affected
by their products or activities. Although the term social is a bit nebulous, it is generally taken to
mean the effect on the condition of employment, social well-being, health, chemical emissions,
pollution, aesthetic appearance (e.g. ‘eyesores’), charitable societies, etc.
A strategic option will have an element of social cost and social benefit. We would describe a
social cost as a deterioration in any of the above an increase in unemployment, higher levels of
emissions, pollution, declining salaries, etc. Conversely, a social benefit will result in an
improvement in the condition of society – increasing employment, cleaner industry, better
working conditions, etc.
Impact analysis
When a strategic option may be reasonably expected to have far-reaching consequences in either
social or financial terms, an impact study may be appropriate. Essentially, this involves asking
the question, ‘If this option goes ahead, what will its impact be upon . . .
The thing that might be impacted upon will depend upon the particular circumstances of the
option. For a proposed development of a new nuclear power station, for example, the impact
study would typically take into account the development’s implications for local employment,
local tourism, health risk to employees and local residents, the reputation and appearance of the
town or region, local flora and fauna, among other things.
In many cases, an impact study will be an intrinsic part of the cost-benefit calculation, and it
suffers from the same limitations – that of evaluating the true value of each thing that may be
impacted.

‘WHAT IF?’ AND SENSITIVITY ANALYSIS

The uncertainties of the future, as we have seen, make any prediction inexact. Whilst an
organization can never be certain of any sequence of future events, ‘what if?’ analysis, and its
variant, sensitivity analysis, can give an idea of how the outcome would be affected by a number
of possible disruptions.
The development of computerized applications such as spreadsheets have made this activity
easier than it used to be. A financial model on a spreadsheet that makes a number of assumptions
such as revenue projections, cost forecasts, inflation rate, etc., can be modified to show instantly
the effect of, say, a 10 per cent increase in costs or a higher-than-expected rate of inflation. This
is designed to show how sensitive the cash flow is to its assumptions – hence the name.
Qualitative variables can also be analyzed. If an option has a high dependency upon the
availability of a key raw material or the oversight of a key manager, a ‘what if? Study will show
the effect that the loss or reduction in the key input would have.