CHAPTER ONE: INTRODUCTION

Notable quote
“Without a strategy, an organization is like a ship without a rudder, going around in a circle”
—Joel Ross and Michael Kami

1.1 Overview of strategy

The term ‘strategy’ is derived from the Greek word strategos, which means generalship – the
actual direction of military force, as directed from the policy governing its deployment. Strategy
was originally a term applied to warfare; it was defined as ‘the art of planning and directing
larger military movements and the operations of war.’ The term was first used around 360 BC,
when the Chinese military strategist Sun Tzu wrote The Art of War, a work which is said to have
influenced the thinking of many modern Japanese businesses, and has led to a number of
thoughts about how the ‘art’ can be applied to modern business.
1.2. Definition of Strategy?
What is strategy? Is it a plan? Does it refer to how we will obtain the ends we seek? Is it a
position taken? Just as military forces might take the high ground prior to engaging the enemy;
might a business take the position of low-cost provider? Or does strategy refer to perspective, to
the view one takes of matters, and to the purposes, directions, decisions and actions stemming
from this view? Strategy is all these—it is perspective, position and a plan.

Dictionary definition-A strategy is a general plan or set of plans intended to achieve

something, especially over a long period.
Michael Porter (1996) argues that strategy is about competitive position, about differentiating
yourself in the eyes of the customer, about adding value through a mix of activities different
from those used by competitors.
According to Charles W. and Gareth L a strategy is a set of related actions that managers take
to increase their company’s performance.
Alfred D Chandler, defined strategy as: “the determination of basic long-term goals and
objectives of an enterprise and the adoption of the courses of action and the allocation of
resources necessary for carrying out these goals”.
William F. Glueck defines strategy as: “a unified, comprehensive, integrated plan… designed
to ensure that the basic objectives of the enterprise are achieved”.

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 Hill and Jones define strategy as it is ‘a specific pattern of decisions and actions that
managers take to achieve superior organizational performance’.
Definition of strategic management
Fred R. David defined strategic management, as the art and science of formulating,
implementing, and evaluating cross-functional decisions that enable an organization to achieve
its objectives. As this definition implies, strategic management focuses on integrating
management, marketing, finance/accounting, production/operations, research and development,
and information systems to achieve organizational success.

According to David Hunger and Thomas, Strategic management is that set of managerial
decisions and actions that determines the long-run performance of a corporation. It includes
environmental scanning (both external and internal), strategy formulation (strategic planning),
strategy implementation, and evaluation and control. The study of strategic management
therefore, emphasizes the monitoring and evaluating of external opportunities and threats in light
of a corporation’s strengths and weaknesses in order to generate and implement a new strategic
direction for an organization
1.2 Stages of Strategic Management

The strategic-management process consists of three stages: strategy formulation, strategy

implementation, and strategy evaluation.
1. Strategy formulation

Strategy Formulation is the process of developing strategy and the process by which an
organization chooses the most appropriate courses of action to achieve its defined goals.
Strategy formulation is the task of selecting strategies, This process is essential to an
organization’s success, because it provides a framework for the actions that lead to the
anticipated results. Strategy formulation includes
 Developing a vision and mission  Establishing long-term objectives
 Identifying an organization’s  Generating alternative strategies, and
external opportunities and threats  Choosing particular strategies to
 Determining internal strengths and pursue
weaknesses
Strategy-formulation issues include deciding what new businesses to enter, what businesses to abandon, how to
allocate resources, whether to expand operations or diversify, whether to enter international markets. Because

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no organization has unlimited resources, strategists must decide which alternative strategies will benefit the firm
most. Strategy-formulation decisions commit an organization to specific products, markets, resources, and
technologies over an extended period of time. Strategies determine long-term competitive advantages. For
better or worse, strategic decisions have major multifunctional consequences and enduring effects on an
organization. Top managers have the best perspective to understand fully the ramifications of strategy-
formulation decisions; they have the authority to commit the resources necessary for implementation.
2. Strategy implementation

Developing a strategy is only effective if it is put into practice. Strategy implementation is the process by which
strategies and policies are put into action through the development of programs, budgets and procedures.
Strategy implementation is the task of putting strategies into action, which includes designing, delivering, and
supporting products; improving the efficiency and effectiveness of operations; and designing a company’s
organization structure, control systems, and culture. Paraphrasing the well-known saying that “success is 10%
inspiration and 90% perspiration,” in the strategic management arena we might say that “success is 10%
formulation and 90% implementation.” The task of selecting strategies is relatively easy (but requires good
analysis and some inspiration); the hard part is putting those strategies into effect. This process might involve
changes within the overall culture, structure and/or management system of the entire organization.

Strategy implementation requires a firm to establish annual objectives, devise policies, motivate employees, and
allocate resources so that formulated strategies can be executed. Strategy implementation includes developing a
strategy-supportive culture, creating an effective organizational structure, redirecting marketing efforts,
preparing budgets, developing and utilizing information systems, and linking employee compensation to
organizational performance. Strategy implementation often is called the “action stage” of strategic management.
Implementing strategy means mobilizing employees and managers to put formulated strategies into action.
Often considered to be the most difficult stage in strategic management, strategy implementation requires
personal discipline, commitment, and sacrifice. Successful strategy implementation hinges upon managers’
ability to motivate employees, which is more an art than a science. Strategies formulated but not implemented
serve no useful purpose.
Interpersonal skills are especially critical for successful strategy implementation. Strategy-implementation
activities affect all employees and managers in an organization. Every division and department must decide on
answers to questions, such as “What must we do to implement our part of the organization’s strategy?” and
“How best can we get the job done?” The challenge of implementation is to stimulate managers and employees
throughout an organization to work with pride and enthusiasm toward achieving stated objectives.
3. Strategy evaluation and control

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Strategy evaluation and control is the final stage in strategic management. It is the process in which corporate
activities and performance results are monitored so that actual performance can be compared with desired
performance. Managers at all levels use the resulting information to take corrective action and resolve
problems.

Managers desperately need to know when particular strategies are not working well; strategy evaluation is the
primary means for obtaining this information. All strategies are subject to future modification because external
and internal factors are constantly changing. Three fundamental strategy-evaluation activities are (1) reviewing
external and internal factors that are the bases for current strategies, (2) measuring performance, and (3) taking
corrective actions. Strategy evaluation is needed because success today is no guarantee of success tomorrow!
Success always creates new and different problems; complacent organizations experience demise. Strategy
formulation, implementation, and evaluation activities occur at three hierarchical levels in a large organization:
corporate, divisional, or strategic business unit, and functional.
By fostering communication and interaction among managers and employees across hierarchical levels,
strategic management helps a firm function as a competitive team.
1.3 Key Terms in Strategic Management

Before we further discuss strategic management, we should define nine key terms: competitive advantage,
strategists, vision and mission statements, external opportunities and threats, internal strengths and weaknesses,
long-term objectives, strategies, annual objectives, and policies.
1. Competitive Advantage

Strategic management is all about gaining and maintaining competitive advantage. This term can be defined as
“anything that a firm does especially well compare to rival firm”.’ When a firm can do something that rival
firms cannot do, or owns something that rival firm’s desire, that can represent a competitive advantage.
Eg. For example, in a global economic recession, simply having ample cash on the firm’s balance sheet can
provide a major competitive advantage. Having less fixed assets than rival firms also can provide major
competitive advantages in a global recession
Getting and keeping competitive advantage is essential for long-term success in an organization. Pursuit of
competitive advantage leads to organizational success or failure. Normally, a firm can sustain a competitive
advantage for only a certain period due to rival firms imitating and undermining that advantage. Thus, it is not
adequate to simply obtaining competitive advantage. A firm must strive to achieve sustained competitive
advantage
1) By continually adapting to changes in external trends and events and internal capabilities,
competencies, and resources; and

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 2) By effectively formulating, implementing, and evaluating strategies that capitalizes upon those factors.
Sustainable competitive advantage is an advantage over competitors that cannot easily be imitated.

2. Strategists

Strategists are the individuals who are most responsible for the success or failure of an organization. Strategists
have various job titles, such as chief executive officer, president, and owner, chair of the board, executive
director, chancellor, dean, or entrepreneur. Writers on organizational behavior say, “All strategists have to be
chief learning officers. We are in an extended period of change. If our leaders aren’t highly adaptive and great
models during this period, then our companies won’t adapt either, because ultimately leadership is about being a
role model”
Strategists help an organization gather, analyze, and organize information. They track industry and competitive
trends, develop forecasting models and scenario analyses, evaluate corporate and divisional performance, spot
emerging market opportunities, identify business threats, and develop creative action plans. Strategic planners
usually serve in a support or staff role. Usually found in higher levels of management, they typically have
considerable authority for decision making in the firm.
The CEO is the most visible and critical strategic manager. Any manager who has responsibility for a unit or
division, responsible for profit and loss outcomes, or direct authority over a major piece of the business is a
strategic manager (strategist). Strategists differ as much as the organizations themselves and these differences
must be considered in the formulation, implementation, and evaluation of strategies. Some strategists will not
consider any types of strategies because of their personal philosophies. Strategists differ in their attitudes,
values, ethics, willingness to take risks, concern for social responsibility, concern for profitability, concern for
short-run versus long-run aims, and management style.
3. Vision and Mission Statements

A vision statement answers the question, “What do we want to become?” Vision can be defined as ‘a mental
image of a possible and desirable future state of the organization’.
A company’s mission describes what the company does. Mission statements are “enduring statements of
purpose that distinguish one business from other similar firms. A mission statement identifies the scope of a
firm’s operations in product and market term.” It addresses the basic question that faces all strategies: “What is
our business?”
4. External Opportunities and Threats

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Opportunity is a combination of circumstances, time, and place which if accompanied by a certain course of
action on the part of the organization, is likely to produce significant benefits. Threat is reasonably probable
events which if it were to occur, would produce significant damage to the organization.
External opportunities and external threats refer to economic, social, cultural, demographic, environmental,
political, legal, governmental, technological, and competitive trends and events that could significantly benefit
or harm an organization in the future. Opportunities and threats are largely beyond the control of a single
organization-thus the external word. The population shifts, changing work values and attitudes, space
exploration, recyclable packages, and increased competition from foreign companies are examples of
opportunities or threats for companies. These types of changes are creating a different type of consumer and
consequently a need for different types of products, services, and strategies. Many companies in many
industries face the severe external threat of online sales, capturing increasing market share in their industry.
Other opportunities and threats may include the passage of a law, the introduction of a new product by a
competitor, a national catastrophe. A competitor’s strength could be a threat. Unrest in the Middle East, rising
energy costs, or the war against terrorism could represent an opportunity or a threat. A basic tenet or principle
of strategic management is that firms need to formulate strategies to take advantage of external opportunities
and to reduce the impact of external threats. For this reason, identifying, monitoring, and evaluating external
opportunities and threats is essential for success. This process of conducting research and gathering and
assimilating external information is sometimes called environmental scanning or industry analysis.
5. Internal Strengths and Weaknesses

Strengths are internal competencies possessed by the organization in comparison with the competitors. These
include structure and policies of the organization, location, and financial soundness, knowledge of personnel,
qualities of facilities, ownership of natural resources or a historic reputation for quality and so on.
Weaknesses are attributes of the organization which tend to decrease its competence in comparison to its
competitors.
Internal strengths and internal weaknesses are an organization’s controllable action that is performed especially
well or poorly. They arise in the management, marketing, finance/accounting, production/operations, research
and development, and management information systems activities of a business. Identifying and evaluating
organizational strengths and weaknesses in the functional areas of a business is an essential strategic-
management activity. Organizations strive to pursue strategies that capitalize on internal strengths and eliminate
internal weaknesses.
Strengths and weaknesses are determined relative to competitors. Relative deficiency or superiority is important
information. Strengths and weaknesses may be determined relative to a firm’s own objective.

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Internal factors can be determined in a number of ways, including computing ratios, measuring performance,
and comparing to past periods and industry averages. Various types of surveys also can be developed and
administered to examine internal factors such as employee morale, production efficiency, advertising
effectiveness, and customer loyalty.
6. Long-term Objectives

Objectives can be defined as specific results that an organization seeks to achieve in pursuing its mission.
Objectives are for organizational success because they state direction; aid in the evaluation; create synergy;
reveal priorities; focus, coordination; and provide a basis for effective planning, organizing, motivating, and
controlling activities. Objectives should be challenging, measurable, consistent, reasonable, and clear. In a
multidimensional firm, objectives should be established for the overall company and for each division.
7. Strategies

Strategies are the means by which long-term objectives will be achieved. Business strategies may include
geographic expansion, diversification, acquisition, product development, market penetration, retrenchment,
divestiture, liquidation, and joint venture. Strategies are potential actions that require top management decisions
and large amounts of the firm’s resources. In addition, strategies affect an organization’s long-term prosperity,
typically for at least five years, and thus are future-oriented. Strategies have multifunctional or multidivisional
consequences and require consideration of both the external and internal factors facing the firm.
8. Annual Objectives

Annual objectives are short-term milestones that organizations must achieve to reach long-term objectives. Like
long-term objectives, annual objectives should be measurable, quantitative, challenging, realistic, consistent,
and prioritized. They should be established at the corporate, divisional, and functional levels in a large
organization. Annual objectives should be stated in terms of management, marketing, finance/accounting,
production/operations, research and development, and management information systems (MIS)
accomplishments. A set of annual objectives is needed for each long-term objective. Annual objectives are
especially important in strategy implementation, whereas long-term objectives are particularly important in
strategy formulation. Annual objectives represent the basis for allocating resources.

9. Policies

Policies are the means by which annual objectives will be achieved. Policies include guidelines established to
support efforts to achieve stated objectives. Policies are guides to decision making and address repetitive or
recurring situations. Most policies are often stated in terms of management, marketing, finance/ accounting,

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production/operations, research and development, and computer information systems activities. Policies can be
established at the corporate level and apply to an entire organization at the divisional level and apply to a single
division or at the functional level and apply to particular operational activities or departments. Policies, like
annual objectives, are especially important in strategy implementation because they outline an organization’s
expectations of its employees and managers. Policies allow consistency and coordination within and between
organizational departments.
1.4 Overview of types of strategy

Strategy making is not just a task for top executives; middle and lower-level managers too must be involved in
the strategic-planning process to the extent possible. Strategies could be formulated at different levels of
management. The typical business firm usually considers three types of strategy: corporate, business, and
functional. First, a firm may choose a corporate strategy and then the business level strategy. Finally, it may
work on the details of the functional level strategies in each of its businesses. Below, the strategies that could be
adopted at the three levels will be discussed one by one.
1. Corporate level strategies

A corporate level strategy specifies actions a firm takes to gain a competitive advantage by selecting and
managing a group of different businesses competing in different product markets. Corporate strategy describes a
company’s overall direction in terms of its general attitude toward growth and the management of its various
businesses and product lines. Corporate strategies typically fit within the three main categories of stability,
growth, and retrenchment. Corporate level strategies are basically about the choice of direction that a firm adopt
in order to achieve its objectives. At the general corporate or headquarters level, basic decisions need to be
taken over what business the company is in or should be [Link] EFFORT (Endowment Fund For
Rehabilitation of Tigray) is committed to contribute to the sustainable development efforts in the region. In
light of the changing business environment along with changes and development of the country's social,
political and economic aspects as well as the global trends EFFORT has clearly stipulated its mission, vision
and core values to be strictly adhered and committed by all its shareholders, management and employees.
EFFORT is engaging in different business at different product markets for instance Sheba Tannery P.L.C,
Almeda Textile Factory P.L.C, Trans Ethiopia P.L.C., Messebo Building Materials Production P.L.C, Addis
Pharmaceutical Factory (APF), Mesfin Industrial Engineering and …etc.
2. Business Level Strategies

A business-level strategy is an integrated and coordinated set of commitments and actions the firm uses to gain
a competitive advantage by exploiting core competencies in specific product markets. This type of strategy
usually occurs at the business unit or product level, and it emphasizes the improvement of the competitive

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position of a corporation’s products or services in the specific industry or market segment served by that
business unit. For instance, Mesfin Industrial Engineering can be considered as one business unit for the
EFFORT business group. Michael E. Porter is credited with extensive pioneering work in the area of business
strategies or what he calls, competitive strategies. Companies pursue a business- level strategy to gain a
competitive advantage that enables them to outperform rivals and achieve above- average returns. They can
choose from three basic generic competitive approaches: cost leadership, differentiation, and focus, although, as
we will see, these can be combined in different ways. These strategies are called generic because all businesses
or industries can pursue them, regardless of whether they are manufacturing, service, or nonprofit enterprises.
3. Functional Level Strategies

This is the approach taken by 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. Functional level strategies are strategies,
which are designed by different functions of a company; Finance, Accounting, Research and Development,
Personnel, Marketing and Production. For example, Mesfin Industrial Engineering has strategies concerning
with the aforementioned functional areas to support its business level strategies as well as EFFORT’s corporate
level strategies.
One-business firms use all three types of strategy simultaneously like EFFORT. A hierarchy of strategy is a
grouping of strategy tips by level in the organization. Hierarchy of strategy is a nesting of one strategy within
another so that they complement and support one another. Functional strategies support business strategies,
which, in turn, support the corporate strategy (ies).

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1.5 The strategic management approach/Models of Above-Average Return

Strategic management is the full set of commitments, decisions, and actions required for a firm to create value
and earn above average returns. Average returns is returns that are equal to those an investor expects to earn
from other investments with a similar amount of risk. Above-Average Returns is returns that are in excess of
what an investor expects to earn from other investments with a similar amount of risk. There are different
approaches in strategic management that explain how firms can earn above-average returns. But now we will
focus only on the resource based view and the industrial organization view.
1. The Resource-Based View (RBV)

The resource-based model assumes that each organization is a collection of unique resources and capabilities.
The uniqueness of its resources and capabilities is the basis for a firm’s strategy and its ability to earn above-
average returns. The Resource-Based model suggests that above-average returns for any firm are largely
determined by characteristics inside the firm. This model focuses on developing or obtaining valuable resources
and capabilities which are difficult or impossible for rivals to imitate.
Resource-based theories concentrate on the chief resources of the organization as the principal source of
successful corporate strategy. Resources are input into a firm’s production process. The source of competitive
advantage lies in the organization’s resources. The Resource-Based View (RBV) approach to competitive
advantage argue that internal resources are more important for a firm than external factors in achieving and
sustaining competitive advantage. Proponents of the RBV view contend that internal resources that can be
grouped into three all-encompassing categories will primarily determine organizational performance: physical
resources, human resources, and organizational resources. Physical resources include all plant and equipment,
location, technology, raw materials, machines; human resources include all employees, training, experience,
intelligence, knowledge, skills, abilities; and organizational resources include firm structure, planning
processes, information systems, patents, trademarks, copyrights, databases, and so on. RBV theory asserts that
resources are actually what help a firm exploit opportunities and neutralize threats.
The basic premise of the RBV is that the mix, type, amount, and nature of a firm’s internal resources should be
considered first and foremost in devising strategies that can lead to sustainable competitive advantage.
Managing strategically according to the RBV involves developing and exploiting a firm’s unique resources and
capabilities, and continually maintaining and strengthening those resources. The theory asserts that it is
advantageous for a firm to pursue a strategy that is not currently being implemented by any competing firm.
When other firms are unable to duplicate a particular strategy, then the focal firm has a sustainable competitive
advantage, according to RBV theorists.
Steps in resource based model

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1. Identify the firm’s resources strengths and weaknesses compared with competitors
2. Determine the firm’s capabilities--what it can do better than its competitors. Capability: capacity of an
integrated set of resources to perform a task or activity in an integrative manner.
3. Determine the potential of the firm’s resources and capabilities in terms of a competitive advantage
4. Locate an attractive industry: an industry with opportunities that can be exploited by the firm’s resources and
capabilities
5. Select a strategy that best allows the firm to utilize its resources and capabilities relative to opportunities in
the external environment
2. The Industrial Organization (I/O) View

The model specifies that the industry in which a company chooses to compete has a stronger influence on
performance than do the choices managers make inside their organizations. The Industrial Organization (I/O)
approach to competitive advantage advocates that external (industry) factors are more important than internal
factors in a firm achieving competitive advantage. The Industrial Organization model suggests that above-
average returns for any firm are largely determined by characteristics outside the firm.
The I/O model has four underlying assumptions.
 First, the external environment is assumed to impose pressures and constraints that determine the strategies
that would result in above-average returns.
 Second, most firms competing within an industry or within a segment of that industry are assumed to
control similar strategically relevant resources and to pursue similar strategies in light of those resources.
 Third, resources used to implement strategies are assumed to be highly mobile across firms, so any resource
differences that might develop between firms will be short-lived.
 Fourth, organizational decision makers are assumed to be rational and committed to acting in the firm’s
best interests, as shown by their profit-maximizing behaviors.
The I/O model suggests that above-average returns are earned when firms are able to effectively study the
external environment as the foundation for identifying an attractive industry and implementing the appropriate
strategy. Companies that develop or acquire the internal skills needed to implement strategies required by the
external environment are likely to succeed, while those that do not are likely to fail. Hence, this model suggests
that returns are determined primarily by external characteristics rather than by the firm’s unique internal
resources and capabilities.
Proponents of the I/O view which focuses on analyzing external forces and industry variables as a basis for
getting and keeping competitive advantage. I/O theorists contend that external factors in general and the
industry in which a firm chooses to compete has a stronger influence on the firm’s performance than do the

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internal functional decisions managers make in marketing, finance, and the like. Firm performance, they
contend, is primarily based more on industrial properties, such as economies of scale, barriers to market entry,
product differentiation, the economy, and level of competitiveness than on internal resources, capabilities,
structure, and operations.
Steps in industrial organization model
1. Study the external environment, especially the industry environment
2. Locate an industry with high potential for above average returns.
3. Identify the strategy called for by the attractive industry to earn above average returns.
4. Develop or acquire assets and skills needed to implement the strategy.
5. Use the firm’s strengths (its developed or acquired assets and skills) to implement the strategy.
1.6 Benefits of Strategic management

Strategic management allows an organization to be more proactive than reactive in shaping its own future; it
allows an organization to initiate and influence (rather than just respond to) activities and thus to exert control
over its own destiny. The principal benefit of strategic management is to help organizations formulate better
strategies through the use of a more systematic, logical, and rational approach to strategic choice.
a) Financial Benefits of Strategic Management

Research indicates that organizations using strategic-management concepts are more profitable and successful
than those that do not.
 Improvement in sales, profitability, and productivity compared to firms without systematic planning
activities. High-performing firms tend to do systematic planning to prepare for future fluctuations in
their external and internal environments.
b) Nonfinancial Benefits

Besides helping firms avoid financial demise, strategic management offers other tangible benefits, such as
 An enhanced awareness of external threats, an improved understanding of competitors’ strategies,
 Reduced resistance to change, and a clearer understanding of performance–reward relationships.
 Strategic management enhances the problem-prevention capabilities of organizations because
 It promotes interaction among managers’ at all divisional and functional levels.
 Strategic management often brings order and discipline to an otherwise floundering firm.
 It can be the beginning of an efficient and an effective management system.
1.7 Business Ethics and Strategic Management

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Introduction

Business ethics is concerned with good and bad or right and wrong behavior and practices that take place in
business. Business ethics is the application of ethical values to business behaviour. It concerns how you do all
aspects of your business. A branch of philosophical ethics that reflect in what ways do the practices and
decisions made within business promote or undermine human well-being?

Good business ethics are a prerequisite for good strategic management; good ethics are just good business!
Managers and employees of firms must be careful not to become scapegoats blamed for company
environmental wrong doings. According to Watts et al (1998; 3 cited by Yakovleva, 2005; 12) “Corporate
Social Responsibility is the continuing commitment by business to behave ethically and contribute to economic
development while improving the quality of life of the workforce and their families as well of the local
community and society at large”.

Corporate Social Responsibility, thus, reflect the responsibility or accountability of organizations in pro not
only of its stakeholders but also of its surrounding environment, taking into consideration the various practices
that can affect those.

Harming the natural environment is unethical, illegal, and costly. A new wave of ethical issues related to
product safety, employee health, sexual harassment, smoking, affirmative action, waste disposal, foreign
business practices, conflicts of interest, employee privacy, security of company records, and layoffs has
accented the need for strategists to develop a clear code of business ethics. A code of business ethics can
provide a basis on which policies can be devised to guide daily behavior and decisions at the work site. To
ensure that the code is read, understood, believed, and remembered, organizations need to conduct periodic
ethics workshops to sensitize people to workplace circumstances in which ethical issues may arise. If employees
see examples of punishment for violating the code and rewards for upholding the code, this helps reinforce the
importance of a firm’s code of ethics.

Any organization, including non-profits, has to manage the ethical behaviour of employees and participants in
the overall operations of the organization. The ethical conduct of employees creates a culture of trust and
respect that makes a business productive. Business ethics is principles of conduct within organizations that
guide decision making and behaviour. Good business ethics –prerequisite for good strategic management; good
ethics is just good business! Bad ethics can derail/spoil even the best strategic plans.

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We define business ethics as the principles and standards that determine acceptable conduct in business
organizations. Personal ethics, on the other hand, relates to an individual’s values, principles, and standards of
conduct. The acceptability of behaviour in business is determined by not only the organization but also
stakeholders such as customers, competitors, government regulators, interest groups, and the public as well as
each individual’s personal principles and values.
Many experts agree that ethical leadership, ethical values, and compliance are important in creating good
business ethics. Many consumers and social advocates believe that businesses should not only make a profit but
also consider the social implications of their activities. We define social responsibility as a business’s obligation
to maximize its positive impact and minimize its negative impact on society. Business ethics relates to an
individual’s or a work group’s decisions that society evaluates as right or wrong, whereas social responsibility
is a broader concept that concerns the impact of the entire business’s activities on society.
Recognizing Ethical Issues in Business
Recognizing ethical issues is the most important step in understanding business ethics.
An ethical issue is an identifiable problem, situation, or opportunity that requires a person to choose from
among several actions that may be evaluated as right or wrong, ethical or unethical. In business, such a choice
often involves weighing monetary profit against what a person considers appropriate conduct.

Many business issues seem straightforward and easy to resolve on the surface but are in reality very complex. A
person often needs several years of experience in business to understand what is acceptable or ethical. For
example, it is considered improper to give or accept bribes, which are payments, gifts, or special favours
intended to influence the outcome of a decision. One of the principal causes of unethical behaviour in
organizations is overly aggressive financial or business objectives. Many of these issues relate to decisions and
concerns that managers have to deal with daily.
Many ethical issues in business can be categorized by the context of their relation with abusive and intimidating
behaviour, conflicts of interest, fairness and honesty, communications, misuse of company resources, and
business associations. Theft of time is the number one area of misconduct observed in the workplace. One
example of misusing time in the workplace is by engaging in activities that are not necessary for the job. It is
believed that the average employee steals 4.5 hours a week with late arrivals, leaving early, long lunch breaks,
inappropriate sick days. All of these activities add up to lost productivity and profits for the employers and
relate to ethical issues in the area of time theft.
Abusive and Intimidating Behaviour: Abusive and intimidating behaviour is the most common ethical
problem for employees. These concepts can mean anything from physical threats, false accusations, profanity,

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insults, yelling. Abusive behaviour can be placed on a continuum from a minor distraction to a disruption of the
workplace.
Misuse of Company Resources: Misuse of company resources has been identified as a leading issue in
observed misconduct in organizations. Issues might include spending an excessive amount of time on personal
e-mails, submitting personal expenses on company expenses reports, or using the company copier for personal
use.
Conflict of Interest: A conflict of interest, one of the most common ethical issues identified by employees,
exists when a person must choose whether to advance his or her own personal interests or those of others. To
avoid conflict of interest, employees must be able to separate their personal financial interests from their
business dealings.
Fairness and Honesty: Fairness and honesty are at the heart of business ethics and relate to the general values
of decision makers. Beyond obeying the law, businesspersons are expected not to harm customers, employees,
clients, or competitors. Honestly and fairness can relate to how the employees use the resources of the
organization. Fairness can be defined as being impartial and just, whereas honesty is defined as being truthful
and trustworthy. In contrast, dishonesty is usually associated with a lack of integrity, and lying.
Communications: Communications is another area in which ethical concerns may arise. False and misleading
advertising, as quell as deceptive personal-selling tactics, anger consumers and can lead to the failure of a
business. Truthfulness about product safety and quality are also important to consumers.
Business Relationships: The behaviour of businesspersons toward customers, suppliers, and others in their
workplace may also generate ethical concerns. Ethical behaviour within a business involves keeping company
secrets, meeting obligations and responsibilities, and avoiding undue pressure that may force others to act
unethically.
The Nature of Social Responsibility
Social responsibility refers to actions an organization takes beyond what is legally required to protect or
enhance the well-being of living things. Sustainability refers to the extent that an organization’s operations and
actions protect, mend, and preserve rather than harm or destroy the natural environment. Polluting the
environment, for example, is unethical, irresponsible, and in many cases illegal. Business ethics, social
responsibility, and sustainability issues therefore are interrelated and impact all areas of the comprehensive
strategic management.
The four dimensions of social responsibility are economic (being profitable), legal (obeying the law), ethical
(doing what is right, just, and fair), and voluntary (being a good corporate citizen).
Corporate citizenship is the extent to which businesses meet the legal, ethical, economic, and voluntary
responsibilities placed on them by their various stakeholders. It involves the activities and organizational

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processes adopted by businesses to meet their social responsibilities. Corporate citizenship involves action and
measurement of the extent to which a firm embraces the corporate citizenship philosophy and then follow
through by implementing citizenship and social responsibility initiatives.
One of the major corporate citizenship issues is the focus on preserving the environment. Consumers,
governments, and special interest groups are concerned about greenhouse gases and CO2 carbon emissions that
are contributing to global warming. Another example of a corporate citizenship issue might be animal rights.
In general, code of business ethics is essential. A code of business ethics is a document that provides
behavioural guidelines that cover daily activities and decisions within an organization. A new wave of ethics
issues related to product safety, employee health, sexual harassment, AIDS in the workplace, smoking, acid
rain, affirmative action, waste disposal, foreign business practices, cover-ups, takeover tactics, conflicts of
interest, employee privacy, inappropriate gifts, and security of company records has accentuated/highlighted
the need for strategists to develop a clear code of business ethics. Merely having a code of ethics, however, is
not sufficient to ensure ethical business behaviour. A code of ethics can be viewed as a public relations
gimmick, a set of platitudes, or window dressing. To ensure that the code is read, understood, believed, and
remembered, periodic ethics workshops are needed to sensitize people to workplace circumstances in which
ethics issues may arise. If employees see examples of punishment for violating the code as well as rewards for
upholding the code, this reinforces the importance of a firm’s code of ethics.
Thus, business practices always considered unethical –
 Misleading advertising
 Misleading labelling
 Harm to the environment
 Dumping flawed products on foreign markets
 Poor product or service safety
 not providing equal opportunities for women and minorities,
 overpricing,
 Moving jobs overseas and sexual harassment.
Thus, all strategy formulation, implementation, and evaluation decisions have ethical ramifications.
Social Responsibility Issues
As with ethics, managers consider social responsibility on a daily basis. Among the many social issues that
managers must consider are their firm’s relations with owners and stockholders, employees, consumers, the
environment, and the community.
Social responsibility is a dynamic area with issues changing constantly in response to society’s demands. There
is much evidence that social responsibility is associated with improved business performance.

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Relations with Owners and Stockholders: Businesses must first be responsible to their owners, who are
primly concerned with earning a profit or a return on their investment in a company. In a small business, their
responsibility is fairly easy to fulfil because the owner(s) personally manages the business or knows the
manager as well. In larger businesses, ensuring responsibility becomes a more difficult task.
A business’s obligations to its owners and investors, as well as to the financial community at large, include
maintaining proper accounting procedures, providing all relevant information to investors about the current and
protected performing of the firm, and protecting the owners’ rights and investments. In short, the business must
maximize the owner’s investments in the firm.
Employee Relations: Another issue of importance to a business is its responsibilities to employees. Without
employees, a business cannot carry out its goals. Employees expect businesses to provide a safe workplace, pay
them adequately for their work, and keep them informed of what is happening in their company. They want
employers to listen to their grievances and treat them fairly. A major social responsibility for business is
providing equal opportunities for all employees regardless of their sex, age, race, religion, or nationality.
Consumer Relations: A critical issue in business today is business’s responsibility to customers, who look to
business to provide them with satisfying, safe products and to respect their rights as consumers. The activities
that independent individuals, groups, and organizations undertake to protect their rights as consumers are
known as consumerism. To achieve their objectives, consumers and their advocate write letters to companies,
lobby government agencies, make public service announcements, and boycott companies whose activities they
deem irresponsible.
Sustainability Issues: We define sustainability as conducting activities in such a way as to provide for the long
term well-being of the natural environment, including all biological entities. Sustainability involves the
interaction among nature and individuals, organizations, and business strategies and includes the assessment
and improvement of business strategies, economic sectors, work practices, technologies, and lifestyle so that
they maintain the health of the natural environment.
A major issue in the area of environmental responsibility is pollution. Water pollution results from dumping
toxic chemicals and raw sewage into rivers and oceans, oil spills, and the burial of industrial waste in the
ground where it may filter into underground water-supplies. Air pollution is usually the result of smoke and
other pollutants emitted by manufacturing facilities, as well as carbon monoxide and hydrocarbons emitted by
motor vehicles. For example, when some chemical compounds emitted by manufacturing facilities react with air
and rain, acid rain results. Acid rain has contributed to the deaths of many forest and lakes in North America as
well as in Europe. Air pollution may also contribute to global warming. Land pollution is tied directly to water
pollution because many of the chemicals and toxic wastes that are dumped on the land eventually work their

17
way into the water supply. Effects of these pollutants on humans and wildlife are uncertain, but there is some
evidence to suggest that fish and other water-dwellers are starting to suffer serious effects.
Community Relations: A final, yet very significant, issue for businesses concerns their responsibilities to the
general welfare of the communities and societies in which they operate. Many business simply want to make
their communities better places for everyone to live and work. The most common way that businesses exercise
their community responsibility is through donations to local and national charitable organizations.

CHAPTER TWO

STRATEGY FORMULATION

(THE BUSINESS VISION, MISSION, AND VALUES)

“Notable Quotes”

"A business is not defined by its name, statutes, or articles of incorporation. The business mission defines it. Only
a clear definition of the mission and purpose of the organization makes possible clear and realistic business
objectives."—Peter Drucker
"A corporate vision can focus, direct, motivate, unify, and even excite a business into superior performance. The
job of a strategist is to identify and project a clear vision."—John Keane
"Where there is no vision, the people perish."—Proverbs 29:18

Strategy formulation is the development of long-range plans for the effective management of environmental opportunities
and threats, in light of corporate strengths and weaknesses. This chapter focuses on the concepts and tools needed to
evaluate and write a business vision and mission statements. A practical framework for developing mission statements is
provided. Actual mission statements from large and small organizations and for-profit work for and nonprofit enterprises
are presented and critically examined. The process of creating a vision and mission statement is discussed.

Vision statement
Developing a vision statement is often considered the first step in strategic planning, preceding even the development of a
mission statement.

 The vision of a company is the desired future state of a company.

 Vision is a picture of what the firm wants to be and, in broad terms, what it wants to ultimately achieve.
 The vision statement answers the question “What do we want to become?”
 A vision statement articulates the ideal description of an organization and gives shape to its intended future.
 Vision statement; is a statement about a company’s long-term direction; hope for the reality to be; keeps an
organization moving forward
Vision delineates management’s aspirations for the business, providing a panoramic view of the “where we are going”
and a convincing rationale for why this makes good business sense for the company. A strategic vision thus points an
organization in a particular direction, charts a strategic path for it to follow in preparing for the future, and molds
organizational identity. A clearly articulated strategic vision communicates management’s aspirations to stakeholders and
helps steer the energies of company personnel in a common direction.

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A clear vision provides the foundation for developing a comprehensive mission statement. A vision statement may apply
to an entire company or to a single division of that company. Whether for all or part of an organization, the vision
statement answers the question, “Where do we want to go?” Vision statement also answers the question “What do we
want to become?” What you are doing when creating a vision statement is articulating your dreams and hopes for your
business. It reminds you of what you are trying to build. While a vision statement does not tell you how you are going to
get there, it does set the direction for your business planning. That is why it is important when constructing a vision
statement to let your imagination go and dare to dream – and why it is important that a vision statement capture your
passion.

The vision statement should be short, preferably one sentence, and as many managers as possible should have input into
developing the statement. Vision must be compelling, inspiring and make people want to join the organization. It is the
banner, around which the organization rallies, since it is the driving force that keeps the organization move towards a
feasible by inspired future conditions. If vision is vivid and meaningful enough, people can do outstanding things to bring
to realization. However, if it is lacking, no amount of resources will induce people to move forward. Vision Statement is a
statement of the future ideal you are working towards. It outlines what the organization wants to be, or how it wants the
world in which it operates to be. It provides inspiration and the basis for all the organization is planning. It concentrates
on the future and provides clear decision-making criteria.

Features of an effective vision statement include

 Clarity and lack of ambiguity
 Vivid and clear picture
 Description of a bright future
 Memorable and engaging wording
 Realistic aspirations
 Alignment with organizational values and culture
To become effective, an organizational vision statement must become assimilated into the organization's culture. Leaders
have the responsibility of communicating the vision regularly; creating narratives that illustrate the vision; acting as role
models by embodying the vision; creating short-term objectives compatible with the vision; and encouraging others to
construct their own personal vision compatible with the organization's overall vision.
Purpose of Vision

 Shared vision is an initial force that brings people together.

 Clearly articulated vision can provide energy and strengths to individuals.
 It inspires stakeholders.
 It helps to see what you are working towards.
Some examples of vision statements
Bahir dar University
“BDU aspires to be one of the leading research-intensive universities in Africa and the first choice in Ethiopia
by 2030”.
National Bank of Ethiopia
To be one of the strongest and most reputable central banks in Africa.
The General Motors’ vision is to be the world leader in transportation products and related services.
Dell’s vision is to create a company culture where environmental excellence is second nature.
The Tyson Foods’ vision is to be the world’s first choice for protein solutions while maximizing shareholder value.

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2.2 Mission statement
An important first step in the process of formulating a mission is to come up with a definition of the organization’s
business. Essentially, the definition answers these questions: “What is our business? What will it be? What should it be?”
The responses guide the formulation of the mission. To answer the question, “What is our business?” a company should
define its business in terms of three dimensions: who is being satisfied (what customer groups), what is being satisfied
(what customer needs), and how customers’ needs are being satisfied (by what skills, knowledge, or distinctive
competencies).

This approach stresses the need for a customer-oriented rather than a product oriented business definition. A product-
oriented business definition focuses on the characteristics of the products sold and the markets served, not on which kinds
of customer needs the products are satisfying. Such an approach obscures the company’s true mission because a product is
only the physical manifestation of applying a particular skill to satisfy a particular need for a particular customer group. In
practice, that need may be served in many different ways, and a broad customer-oriented business definition that identifies
these ways can safeguard companies from being caught unaware by major shifts in demand.

Historically mission is associated with Christian religious groups; indeed, for many years, a missionary was assumed a
person on a specifically religious mission. The word "mission" dates from 1598, originally of Jesuits sending "missio",
Latin for "act of sending" members abroad.

Mission statement-is an enduring statement of purpose distinguishes one firm from another in the same business. It is a
declaration of a firm’s reason for existence. The mission statement is a declaration of an organization’s “reason for
being. ”Mission is a well convincible statement included fundamental and unique purpose, which makes it different from
other organization. It identifies the scope of its operation in terms of product offered and market served. The mission also
means what we are and what we do. Mission statements sometimes called a creed statement, a statement of purpose, a
statement of philosophy, a statement of beliefs, a statement of business principles, or a statement “defining our business.
All organizations have a reason for being, even if strategists have not consciously transformed this reason into writing.
Mission statements are essential for effectively establishing objectives and formulating strategies.

Mission statements often contain the purpose and aim of the organization; the organization's primary stakeholders;
products and services offered. A mission statement is like a flag the organization can hold up that gives the essence of
what it is about. Some mission statements are complex, long, and very broad; whereas some mission statements are simple
and direct.

Characteristics of a good mission statement

In order to be effective, a mission statement should possess the following characteristics. The mission statement should
be:

Broad in scope: It usually is broad in scope for at least two major reasons. First, a good mission statement allows for the
generation and consideration of a range of feasible alternative objectives and strategies without unduly stifling
management creativity. Excess specificity would limit the potential of creative growth for the organization. However, an
overly general statement that does not exclude any strategy alternatives could be dysfunctional. Do not include monetary
amounts, numbers, percentages, ratios, or objective. An effective mission statement should not be too lengthy;
recommended length is less than 250 words. Second, a mission statement needs to be broad to reconcile differences
effectively among, and appeal to, an organization’s diverse stakeholders, the individuals and groups of individuals who
have a special stake or claim on the company. Thus, a mission statement should be reconciliatory.

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Inspiring: an effective mission statement should arouse positive feelings and emotions about an organization; it should be
inspiring in the sense that it motivates readers to action. It should be motivating members of the organization or being its
customers.

A customer orientation: a good mission statement describes an organization’s purpose, customers, products or services,
markets, philosophy, and basic technology. A good mission statement reflects the anticipations of customers. Rather than
developing a product and then trying to find a market, the operating philosophy of organizations should be to identify
customers’ needs and then provide a product or service to fulfill those needs

Feasible: a mission should always aim high, but it should not be an impossible statement. In addition, it should be
realistic and achievable. Its followers must find it to be credible. However, feasibility depends on the resources available
to work towards a mission.

Precise: should not be so narrow to restrict the organization’s activities, nor should it be too broad to make itself
meaningless. It should be clear enough to lead to action

Include nine components: customers, products or services, markets, technology, concern for survival/growth/profits,
philosophy, self-concept, concern for public image, concern for employees

A mission statement should be enduring.

Components of a mission statement

Mission statements can and do vary in length, content, format, and specificity. Most practitioners and academicians of
strategic management consider an effective statement to exhibit nine characteristics or components. Because a mission
statement is often the most visible and public part of the strategic management process, it is important, that it includes all
of these essential components. Components and corresponding questions that a mission statement should answer are given
here.

Customer: Who are the firm’s customers?

Products or services: What are the firm’s major products or services?

Markets: Geographically, where does the firm compete?

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Technology: Is the firm technologically current?

Concern for survival, growth, and profitability: Is the firm committed to growth and financial soundness?

Philosophy: What are the basic beliefs, values, aspirations, and ethical priorities of the firm?

Self-concept: What is the firm’s distinctive competence or a major competitive advantage?

Concern for public image: Is the firm, responsive to social, community, and environmental concerns?

Concern for employees: Are employees a valuable asset of the firm?

Examples:

The mission of Woldia University is to produce competent and innovative professionals who are well built in
knowledge, ethics, and skills who can contribute to the nations people development, conduct problem-solving
researches and transfer them to the community service through the active participation of stakeholders
 We aspire to make PepsiCo the world’s premier consumer Products Company, focused on convenient foods and
beverages. We seek to produce healthy financial rewards for investors as we provide opportunities for growth and
enrichment to our employees, our business partners and the communities in which we operate. Moreover, in
everything we do, we strive to act with honesty, openness, fairness and integrity. Evaluate, using the elements of
the mission statement.
Importance of mission statements

King and Cleland recommended that organizations carefully develop a written mission statement in order to reap the
following benefits:

 To ensure unanimity of purpose within the organization

 To provide a basis, or standard, for allocating organizational resources
 To establish a general tone or organizational climate
 To serve as a focal point for individuals to identify with the organization’s purpose and direction, and to deter
those who cannot from participating further in the organization’s activities
 To facilitate the translation of objectives into a work structure involving the assignment of tasks to responsible
elements within the organization
 To specify organizational purposes and then to translate these purposes into objectives in such a way that cost,
time, and performance parameters can be assessed and controlled
Strategic vision Vs mission

A strategic vision concerns A mission statement focuses on

 A firms fnuture business path  Current business activity

 Where are we going?  Who we are & what we do.
 Market to be pursued  Current product & service offerings
 Future technology-product-customer focused  Customer needs being served
 Kind of company that management is trying to  Technological & business capabilities
create
The Process of Developing Vision and Mission Statements

As indicated in the strategic-management model chapter one, clear vision and mission statements are needed before
alternative strategies can be formulated and implemented. As many managers as possible should be involved in the

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process of developing these statements because, through involvement, people become committed to an organization. A
widely used approach to developing a vision and mission statement is

 First to select several articles about these statements and ask all managers to read these as background
information.
 Then ask managers themselves to prepare a vision and mission statement for the organization.
 A facilitator or committee of top managers should then merge these statements into a single document and
distribute the draft statements to all managers.
 A request for modifications, additions, and deletions is needed next, along with a meeting to revise the document
To the extent that all managers have input into and support the final documents, organizations can more easily obtain
managers’ support for other strategy formulation, implementation, and evaluation activities. Thus, the process of
developing a vision and mission statement represents a great opportunity for strategists to obtain needed support from all
managers in the firm.

During the process of developing vision and mission statements, some organizations use discussion groups of managers to
develop and modify existing statements. Some organizations hire an outside consultant or facilitator to manage the
process and help draft the language.

Business values
Business values are beliefs that the organization’s members hold in common and endeavor/try or attempt/ to put into
practice. The values of a company state how managers and employees should conduct themselves, how they should do
business, and what kind of organization they should build to help a company achieve its mission. Insofar as they help
drive and shape behavior within a company, values are commonly seen as the foundation of a company’s organizational
culture: the set of norms, and standards that control how employees work to achieve an organization’s mission and goals.
An organization’s culture is often seen as an important source of its competitive advantage.

 Values guide your organization’s members in performing their work.

 They answer the question --“What are the basic beliefs that we share as an organization?”
 Values fosters individual and organizational integrity
Core values are the principles and standards at the very center of our character, and from which we will not budge or
stray. Core values are extremely stable and change only very slowly over long periods. Core values form the basis for our
beliefs about life, us, and those around us, and the human potential of others and ourselves.

Example: Woldia University is guided by the following core values/principles.

 Quality  Commitment  Democratic leadership

 Care for the community  Team sprit style
 Equity  Creativity  Unity with diversity
2.4 Strategic issues
Oxford English Dictionary defines an issue in a general sense as “a matter the decision of which involves important
consequences”. In relation to issue management, Dutton and Duncan (1987: 103) define strategic issues as
”developments, events and trends having the potential to impact an organization’s strategy”.

“Issues are events, developments, and trends that an organization’s members collectively recognize as having some
consequence to the organization.” Ansoff (1980) calls the collection of key issues that the company at a given time has as
the key strategic issue list. There are two types of strategic issues; external and internal. External strategic issues arise due
to factors beyond your control.

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Internal strategic issues are ones that your organization faces because of internal factors. Simply put, internal strategic
issues are the “big problems” your organization faces that you have direct influence and impact on the performance of the
organization..

2.5. Setting Goals and Objectives

Objectives: Objectives are organizations performance targets, the results and outcomes it wants to achieve. They function
as a yardstick for tracking an organization’s performance and progress. Objectives are the end results of planned activity.
They should be stated as action verbs and tell what is to be accomplished by when and quantified if possible. The
achievement of corporate objectives should result in the fulfillment of a corporation’s mission. In effect, this is what
society gives back to the corporation when the corporation does a good job of fulfilling its mission.

The term goal is often used interchangeably with the term objective. We prefer to differentiate the two terms. In contrast
to an objective, we consider a goal as qualitative statement of what one wants to accomplish, with no quantification of
what is to be achieved. For example, a simple statement of “increased profitability” is thus a goal, not an objective,
because it does not state how much profit the firm wants to make the next year. A good objective should be action-
oriented and begin with the word to. An example of an objective is “to increase the firm’s profitability in 2015 by 10%
over 2014.”

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

 Profitability (net profits)  Contributions to society (taxes paid,

 Efficiency (low costs, etc.) participation in charities, providing a needed
 Growth (increase in total assets, sales, etc.) product or service)
 Shareholder wealth (dividends plus stock price  Market leadership (market share)
appreciation)  Technological leadership (innovations,
 Utilization of resources (ROE or ROI) creativity)
 Reputation (being considered a “top” firm)  Survival (avoiding bankruptcy)
 Contributions to employees (employment
security, wages, diversity)
Long-Term Objectives: Long-term objectives represent the results expected from pursuing certain strategies. Strategies
represent the actions to be taken to accomplish long-term objectives. The nature of long-term objectives: Objectives
should be quantitative, measurable, realistic, understandable, challenging, hierarchical, obtainable, and congruent among
organizational units. Each objective should also be associated with a timeline. Objectives are commonly stated in terms
such as growth in assets, growth in sales, profitability, market share, degree and nature of diversification, degree and
nature of vertical integration, earnings per share, and social responsibility.

Objectives provide a basis for consistent decision making by managers whose values and attitudes differ. Objectives serve
as standards by which individuals, groups, departments, divisions, and entire organizations can be evaluated. Long-term
objectives are needed at the corporate, divisional, and functional levels of an organization. They are an important measure
of managerial performance. Without long-term objectives, an organization would drift aimlessly toward some unknown
end. It is hard to imagine an organization or individual being successful without clear objectives. Success only rarely
occurs by accident; rather, it is the result of hard work directed toward achieving certain objectives.

The Benefits of Having Clear Objectives

Provide direction by revealing expectations Reduce uncertainty

Allow synergy Minimize conflicts
Aid in evaluation by serving as standards Stimulate exertion
Establish priorities Aid in allocation of resources
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 Aid in design of jobs Provide a basis for consistent decision making

CHAPTER THREE
EXTERNAL ENVIRONMENTAL ANALYSIS
3.1 Introduction
For any organization, the environment consists of the set of external conditions and forces that have the
potential to influence the organization. Understanding the environment that surrounds an organization is
important. There are several reasons for this. First, the environment provides resources that an
organization needs in order to create goods and services. In the seventeenth century, British poet John
Donne famously noted, “no man is an island.” Similarly, it is accurate to say that no organization is self-
sufficient. As the human body must consume oxygen, food, and water, an organization needs to take in
resources such as labor, money, and raw materials from outside its boundaries.
Second, the environment is a source of opportunities and threats to an organization. Opportunities are
events and trends that create chances to improve an organization’s performance level. Threats are events
and trends that may undermine an organization’s performance. Executives must also realize that virtually
any environmental trend or event is likely to create opportunities for some organizations and threats for
others. This is true even in extreme cases. In addition to horrible human death and suffering, the March
2011 earthquake and tsunami in Japan devastated many organizations, ranging from small businesses that
were simply wiped out to corporate giants such as Toyota whose manufacturing capabilities were
undermined. As odd, as it may seem, however, these tragic events also opened up significant
opportunities for other organizations. The rebuilding of infrastructure and dwellings requires concrete,
steel, and other materials. Japanese concrete manufacturers, steelmakers, and construction companies are
likely to be very busy in the years ahead.
Third, the environment shapes the various strategic decisions that executives make as they attempt to
lead their organizations to success. The environment often places important constraints on an
organization’s goals, for example. A firm that set a goal of increasing annual sales by 50 percent might
struggle to achieve this goal during an economic recession or if several new competitors enter its
business. Environmental conditions also need to be taken into account when examining whether to start
doing business in a new country, whether to acquire another company, and whether to launch an
innovative product, to name just a few.
Characteristics of Environment
Some of the important, and obvious, characteristics are briefly described here.
1. Environment is complex. The environment consists of a number of factors, events, conditions, and
influences arising from different sources. All these do not exist in isolation, but interact with each
other to create entirely new sets of influences. It is difficult to comprehend at once what factors
constitute a given environment. Generally, environment is a complex phenomenon relatively easier to
understand in parts but difficult to grasp in its totality.
2. Environment is dynamic. The environment is constantly changing in nature. Due to the many and
varied influence operating, there is dynamism in the environment, causing it to change its shape and
character continuously.
3. Environment is multifaceted. What shape and character an environment will assume depends on the
perception of the observer. A particular change in the environment, or a new development, may be
viewed differently by different observers.
4. Environment has a far-reaching impact. An occurrence in the environment now may have an
impact that will stay for long time. The growth and profitability of an organization depend critically
on the environment in which it exists.
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3.2 The Nature of External Audit
The purpose of an external audit is to develop a finite list of opportunities that could benefit a firm and
threats that should be minimized. As the term finite suggests, the external audit is not aimed at developing
an exhaustive list of every possible factor that could influence the business; rather, it is aimed at
identifying key variables that offer actionable responses. Firms should be able to respond either
offensively or defensively to the factors by formulating strategies that take advantage of external
opportunities or that minimize the impact of potential threats. Most firms face external environments that
are highly turbulent, complex, and global conditions that make interpreting them increasingly difficult. To
cope with what are often ambiguous and incomplete environmental data and to increase their
understanding of the general environment, firms engage in a process called external environmental
analysis.
Components of the External Environment Analysis
Scanning: Identifying early signals of environmental changes and trends. Scanning entails the study of all
segments in the general environment. Through scanning, firms identify early signals of potential changes
in the general environment and detect changes that are already under way. When scanning, the firm often
deals with ambiguous, incomplete, or unconnected data and information. Environmental scanning is
critically important for firms competing in highly volatile environments. In addition, scanning activities
must be aligned with the organizational context; a scanning system designed for a volatile environment is
inappropriate for a firm in a stable environment.
Monitoring: Detecting meaning through ongoing observations of environmental changes and trends.
When monitoring, analysts observe environmental changes to see if an important trend is emerging from
among those spotted by scanning. Critical to successful monitoring is the firm’s ability to detect meaning
in different environmental events and trends. By monitoring trends, firms can be prepared to introduce
new goods and services at the appropriate time to take advantage of the opportunities identified trends
provides. Effective monitoring requires the firm to identify important stakeholders. Because the
importance of different stakeholders can vary over a firm’s life cycle, careful attention must be given to
the firm’s needs and its stakeholder groups across time. Scanning and monitoring is particularly important
when a firm competes in an industry with high technological uncertainty. Scanning and monitoring not
only can provide the firm with information; they also serve as a means of importing new knowledge about
markets and about how to successfully commercialize new technologies that the firm has developed.
Forecasting: Developing projections of anticipated outcomes based on monitored changes and trends.
Scanning and monitoring is concerned with events and trends in the general environment at a point in
time. When forecasting, analysts develop feasible projections of what might happen, and how quickly, as
a result of the changes and trends detected through scanning and monitoring.
Assessing: Determining the timing and importance of environmental changes and trends for firms’
strategies and their management. The objective of assessing is to determine the timing and significance of
the effects of environmental changes and trends in the strategic management of the firm. Through
scanning, monitoring, and forecasting, analysts are able to understand the general environment. Going a
step further, the intent of the assessment is to specify the implications of that understanding for the
organization. Without assessment, the firm is left with data that may be interesting but are of unknown
competitive relevance.
3.3 The Process of Performing an External Audit
The process of performing an external audit must involve as many managers and employees as possible.
As emphasized in earlier chapter, involvement in the strategic-management process can lead to
understanding and commitment from organizational members. Individuals appreciate having the

26
opportunity to contribute ideas and to gain a better understanding of their firms’ industry, competitors,
and markets. To perform an external audit companies may follow the following steps
1. Gather competitive intelligence and information: a company gathers competitive intelligence and
information about economic, social, cultural, demographic, environmental, political, governmental,
legal, and technological trends. Individuals can be asked to monitor various sources of information,
such as key magazines, trade journals, and newspapers. These persons can submit periodic scanning
reports to a committee of managers charged with performing the external audit. This approach
provides a continuous stream of timely strategic information and involves many individuals in the
external-audit process. Internet provides another source for gathering strategic information, as do
corporate, university, and public libraries. Suppliers, distributors, salespersons, customers, and
competitors represent other sources of vital information.
2. Assimilation and evaluation: Once information is gathered, it should be assimilated and evaluated.
A meeting or series of meetings of managers is needed to collectively identify the most important
opportunities and threats facing the firm. These key external factors should be listed on flip charts or
a chalkboard. A prioritized list of these factors could be obtained by requesting that all managers rank
the factors identified, from the most important opportunity/threat to the least important
opportunity/threat. These key external factors can vary over time and by industry. These key external
factors should be (a) important to achieving long-term and annual objectives, (b) measurable, (c)
applicable to all competing firms, and (d) hierarchical in the sense that some will pertain to the
overall company and others will be more narrowly focused on functional or divisional areas.
3. Communicate and distribute key external factors: A final list of the most important key external
factors should be communicated and distributed widely in the organization. Both opportunities and
threats can be key external factors.
3.4 Analysis of Key External Factors
An integrated understanding of the external and internal environments is essential for firms to understand
the present and predict the future. Firm’s external environment is divided into three major areas: the
general, industry, and competitor environments. An important objective of studying the external
environment is identifying opportunities and threats.
Figure 3.1Three Major Areas External Environment

Economic

Socio-cultural

Industry Environment
Legal
1) Threat of New Entrants
2) Power of Suppliers
3) Power of Buyers
4) Product Substitutes
5) Intensity of Rivalry
Environmental
Political
Competitor Environment

Technological

27
 I.
II.
III. General external factors
The general environment is composed of dimensions in the broader society that influence an industry and
the firms within it. It aim is to identifying opportunities and threats. An opportunity is a condition in the
general environment that, if exploited, helps a company achieves strategic competitiveness. Firms cannot
directly control the general environment’s segments and elements. Accordingly, successful companies
gather the information required to understand each segment and its implications for the selection and
implementation of the appropriate strategies.
Segments of the general environment
The general environment is composed of segments that are external to the firm. Although the degree of
impact varies, these environmental segments affect each industry and its firms. The challenge to the firm
is to scan, monitor, forecast, and assess those elements in each segment that are of the greatest
importance. These efforts should result in recognition of environmental changes, trends, opportunities,
and threats. PESTEL analysis is one important tool that executives can rely on to organizes factors within
the general environment and to identify how these factors influence industries and the firms. PESTEL is
an anagram, meaning it is a word that created by using parts of other words. In particular, PESTEL
reflects the names of the six segments of the general environment: (1) political, (2) economic, (3) social,
(4) technological, (5) environmental, and (6) legal.
1. Political segment
The political segment centers on the role of governments in shaping business. This segment includes
elements such as tax policies, changes in trade restrictions and tariffs, the stability of governments and
immigration policy. Immigration policy is an aspect of the political segment of the general environment
that offers important implications for many different organizations.
2. The Economic Segment
The health of a nation’s economy affects individual firms and industries. Because of this, companies
study the economic environment to identify changes, trends, and their strategic implications. The
economic environment refers to the nature and direction of the economy in which a firm competes or
may compete. Because nations are interconnected as a result of the global economy, firms must scan,
monitor, forecast, and assess the health of economies outside their host nation. For example, many nations
throughout the world are affected by the U.S. economy. The economic segment centers on the economic
conditions within which organizations operate. It includes elements such as: interest rates, inflation rates,
gross domestic product, unemployment rates, levels of disposable income, trade deficits or surpluses,
monetary policies , fiscal policies the general growth or decline of the economy. Rising unemployment
discouraged consumers from purchasing expensive, nonessential goods such as automobiles and
television sets. Bank failures during the economic crisis led to a dramatic tightening of credit markets.
This dealt a huge blow to homebuilders, for example, who saw demand for new houses plummet because
mortgages were extremely difficult to obtain.
3. Socio-cultural segment
The socio-cultural environment consists of factors related to human relationship within a society; the
development, forms and functions of such a relationship; and the learnt and shared behavior of groups of
human beings, which have a bearing on the business of an organization. Some of the important elements
are demographic characteristics includes population size, ethnic mix, age structure, income distribution,
geographic distribution. Socio-cultural attitudes and values: social customs, beliefs, rituals and practices,
changing lifestyle patterns and materialism; women in the workforce, concerns about the environment,

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workforce diversity , shifts in work and career preferences, attitudes about the quality and shifts in
preferences regarding product and service characteristics
4. Technological segment
The technological environment consists of those factors that are related to the knowledge applied and the
materials and machines used in the production of goods and services, which have an impact on the
business of an organization. The Internet has changed the nature of opportunities and threats by altering
the life cycles of products, increasing the speed of distribution, creating new products and services,
erasing limitations of traditional geographic markets, and changing the historical trade-off between
production standardization and flexibility. The Internet has lowered entry barriers and redefined the
relationship between industries and various suppliers, creditors, customers, and competitors. The
technological segment centers on improvements in products and services that are provided by science.
Relevant factors include changes in the rate of new product development, increases in automation,
product innovations, focus of private and government, applications of knowledge, advancements in
service industry delivery.
5. Environmental segment
The environmental segment involves the physical conditions within which organizations operate. It
includes factors such as: natural disasters, pollution levels, weather patterns, climate change. The threat
of pollution, for example, has forced municipalities to treat water supplies with chemicals. These
chemicals increase the safety of the water but detract from its taste. This has created opportunities for
businesses that provide better-tasting water. Rather than consume cheap but bad-tasting tap water, many
consumers purchase bottled water. Changes in temperature can affect many industries including farming,
tourism and insurance. With major climate changes, occurring due to global warming and with greater
environmental awareness this external factor is becoming a significant issue for firms to consider. The
growing desire to protect the environment is having an impact on many industries such as the travel and
transportation industries (for example, more taxes being placed on air travel and the success of hybrid
cars) and the general move towards more environmentally friendly products and processes is affecting
demand patterns and creating business opportunities.
6. Legal segment
These are related to the legal environment in which firms operate. The legal segment centers on how the
legal issues influence business activity. Business Organizations prefer to operate in a country where there
is a sound legal system. Examples of important legal factors include employment laws; health and safety
regulations, discrimination laws, antitrust laws. Intellectual property rights are a particularly daunting
aspect of the legal segment for many organizations. When a studio such as Adica produces a movie, a
software firm such as Adobe revises a program, or a video game company such as Activision devises a
new game, these firms are creating intellectual property. Such firms attempt to make profits by selling
copies of their movies, programs, and games to individuals. Piracy of intellectual property—a process
wherein illegal copies are made and sold by others—poses a serious threat to such profits. Law
enforcement agencies and courts in many countries, including the United States, provide organizations
with the necessary legal mechanisms to protect their intellectual property from piracy.
The introduction of age discrimination and disability discrimination legislation, an increase in the
minimum wage and greater requirements for firms to recycle are examples of relatively recent laws that
affect an organization’s actions. Legal changes can affect a firm's costs (e.g. if new systems and
procedures have to be developed) and demand (e.g. if the law affects the likelihood of customers buying
the good or using the service).
IV. Industry analysis

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Wayne Calloway said: “Nothing focuses the mind better than the constant sight of a competitor that wants
to wipe you off the map.” An industry is a group of firms producing products that are close substitutes
such as soft drinks or financial services. Industry analysis (popularized by Michael Porter) refers to an in-
depth examination of key factors within a corporation’s task environment. In the course of competition,
these firms influence one another.

Figure 3.2 The Porter’s “Five-Force” competition Model: - A key Analytical Tool

Typically, industries include a rich mix of competitive strategies that companies use in pursuing strategic
competitiveness and above-average returns. In part, these strategies are chosen because of the influence of
an industry’s characteristics. According to porter the intensity of industry competition and an industry’s
profit potential are functions of five forces of competition: the threats posed by new entrants, the power of
suppliers, and the power of buyers, product substitutes, and the intensity of rivalry among competitors.
1. The Threat of New Entrants to the Industry
A new entrant into industry represents a competitive threat to existing firms. It adds new production
capacity and potential to erode the market share of the existing industry. New entrants into the industry
are potential competitors. Potential competitors are organizations that currently are not competing in an
industry but have the capability to do so if they choose. Existing (established) organizations try to
discourage potential competitors from entering, since the more organizations enter an industry, the more
difficult it becomes for established organizations to hold their share of the market and to generate success.
Thus, a high risk of entry by potential competitors represents a threat to the profitability of established
organizations. On the other hand, if the risk of new entry is low, established organizations could take
advantage of this opportunity to raise prices and earn greater returns. The strength of the competitive
forces of potential rivals is largely a function of the height of barriers to entry. The concept of barriers to
entry implies that there are significant costs in joining an industry.
The greater the costs that potential competitors must bear, the greater are the barriers to entry. High entry
barriers keep potential competitors out of an industry even when industry returns are high. Barriers to
entry are unique industry characteristics that define the industry. Barriers reduce the rate of entry of new
firms, thus maintaining a level of profits for those already in the industry. From a strategic perspective,
barriers can be created or exploited to enhance a firm's competitive advantage. The principal sources of
barriers to entry are:
 Economies of scale: Economies of scale are derived from incremental efficiency improvements
through experience, as a firm gets larger. Therefore, as the quantity of a product produced during a

30
 given period increases the cost of manufacturing each unit declines. Economies of scale can be
developed in most business functions, such as marketing, manufacturing, research and development,
and purchasing. Increasing economies of scale enhances a firm’s flexibility.
 Product Differentiation: Over time, customers may come to believe that a firm’s product is unique.
This belief can result from the firm’s service to the customer, effective advertising campaigns, or
being the first to market a good or service. Companies such as Coca-Cola, Pepsi Cola, and the
world’s automobile manufacturers spend a great deal of money on advertising to convince potential
customers of their products’ distinctiveness. Customers valuing a product’s uniqueness tend to
become loyal to both the product and the company producing it. Typically, new entrants must allocate
many resources over time to overcome existing customer loyalties. To combat the perception of
uniqueness, new entrants frequently offer products at lower prices. This decision, however, may result
in lower profits or even losses.
 Capital Requirements: Competing in a new industry requires a firm to have resources to invest. In
addition to physical facilities, capital is needed for inventories, marketing activities, and other critical
business functions. Even when competing in a new industry is attractive, the capital required for
successful market entry may not be available to pursue an apparent market opportunity.
 Switching Costs: Switching costs are the one-time costs customers incur when they buy from a
different supplier. In some cases, switching costs are low, such as when the consumer switches to a
different soft drink. Switching costs can vary as a function of time. For example, a decision made by
manufacturers to produce a new, innovative product creates high switching costs for the final
consumer. Customer loyalty programs, such as airlines’ frequent flier miles, are intended to increase
the customer’s switching costs. If switching costs are high, a new entrant must offer either a
substantially lower price or a much better product to attract buyers. Usually, the more established the
relationship between parties, the greater is the cost incurred to switch to an alternative offering.
 Access to Distribution Channels: Over time, industry participants typically develop effective means
of distributing products. Once a relationship with its distributors has been developed, a firm will
nurture it to create switching costs for the distributors. Access to distribution channels can be a strong
entry barrier for new entrants, particularly in consumer nondurable goods industries (for example, in
grocery stores where shelf space is limited) and in international markets. New entrants have to
persuade distributors to carry their products, either in addition to or in place of those currently
distributed. Price breaks and cooperative advertising allowances may be used for this purpose;
however, those practices reduce the new entrant’s profit potential.
 Government Policy. Through licensing and permit requirements, governments can also control entry
into an industry. Liquor retailing, radio and TV broadcasting, banking, and trucking are examples of
industries in which government decisions and actions affect entry possibilities. In addition,
governments often restrict entry into some industries because of the need to provide quality service or
the need to protect jobs. Some of the most publicized government actions are those involving antitrust
 Retaliation by established producer: Firms seeking to enter an industry also anticipate the reactions
of firms in the industry. An expectation of swift and vigorous competitive responses reduces the
likelihood of entry. Vigorous retaliation can be expected when the existing firm has a major stake in
the industry (for example, it has fixed assets with few, if any, alternative uses), when it has substantial
resources, and when industry growth is slow or constrained. For example, any firm attempting to
enter the auto industry at the current time can expect significant retaliation from existing competitors
due to the overcapacity.
2. Rivalry among Established/Existing Firms
It describes the intensity of rivalry among competitors or established organizations within in the industry.
Because an industry’s firms are mutually dependent, actions taken by one company usually invite
31
competitive responses. In many industries, firms actively compete against one another. Competitive
rivalry intensifies when a firm is challenged by a competitor’s actions or when a company recognizes an
opportunity to improve its market position. Some industries appear “sleepy” because of a low level of
rivalry among competitors. On the other hand, some industries are characterized by a high level of
competitive activity (example, the brewing industry has many competitors who battle fiercely with each
other over market share). If this competitive force is weak, organizations have an opportunity to raise
prices and earn grater profits. However, if it is strong, significant price competition, including price wars,
may result from the intense rivalry. Price competition limits profitability by reducing the margins that can
be earned on sales. Generally, the factors that tend to precipitate intense rivalries in an industry are:
Numerous or equally balanced competitors: Intense rivalries are common in industries with many
companies. With multiple competitors, it is common for a few firms to believe that they can act without
eliciting a response. However, evidence suggests that other firms generally are aware of competitors’
actions, often choosing to respond to them. At the other extreme, industries with only a few firms of
equivalent size and power also tend to have strong rivalries. The large and often similar-sized resource
bases of these firms permit vigorous actions and responses.
Rate of industry growth: When a market is growing, firms try to effectively use resources to serve an
expanding customer base. Growing markets reduce the pressure to take customers from competitors.
However, rivalry in no-growth or slow-growth markets becomes more intense as firms battle to increase
their market shares by attracting competitors’ customers.
Lack of differentiation or low switching costs: When buyers find a differentiated product that satisfies
their needs, they frequently purchase the product loyally over time. Industries with many companies that
have successfully differentiated their products have less rivalry, resulting in lower competition for
individual firms. Firms that develop and sustain a differentiated product that cannot be easily imitated by
competitors often earn higher returns. However, when buyers view products as commodities (that is, as
products with few differentiated features or capabilities), rivalry intensifies. In these instances, buyers’
purchasing decisions are based primarily on price and, to a lesser degree, service.
The effect of switching costs is identical to the effect of differentiated products. The lower the buyers’
switch costs, the easier it is for competitors to attract buyers through pricing and service offerings. High
switching costs at least partially insulate the firm from rivals’ efforts to attract customers. Interestingly,
the switching costs such as pilot and mechanic training—are high in aircraft purchases, yet the rivalry
between Boeing and Airbus remains intense because the stakes for both are extremely high.

High Exit Barriers: Sometimes companies continue competing in an industry even though the returns on
their invested capital are low or negative. Firms making this choice likely face high exit barriers, which
include economic, strategic, and emotional factors causing companies to remain in an industry when the
profitability of doing so is questionable. Exit barriers are especially high in the airline industry.
Common exit barriers are:
 Specialized assets (assets with values linked to a particular business or location).
 Fixed costs of exit (such as labor agreements).
 Strategic interrelationships (relationships of mutual dependence, such as those between one business
and other parts of a company’s operations, including shared facilities and access to financial markets).
 Emotional barriers (aversion to economically justified business decisions because of fear for one’s
own career, loyalty to employees, and so forth).
 Government and social restrictions (these restrictions often are based on government concerns for job
losses and regional economic effects).
3. The Bargaining Power of Buyers

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Firms seek to maximize the return on their invested capital. Alternatively, buyers (customers of an
industry or a firm) want to buy products at the lowest possible price the point at which the industry earns
the lowest acceptable rate of return on its invested capital. The bargaining power of buyers refers to the
ability of buyers to bargain down prices charged by companies in the industry or to raise the costs of
companies in the industry by demanding better product quality and service. To reduce their price, buyers
bargain for higher quality, greater levels of service, and lower prices. These outcomes are achieved by
encouraging competitive battles among the industry’s firms. Customers (buyer groups) are powerful
when:
 They purchase a large portion of an industry’s total output.
 The sales of the product being purchased account for a significant portion of the seller’s annual
revenues.
 They could switch to another product at little, if any, cost.
 The industry’s products are undifferentiated or standardized, and the buyers pose a credible threat
if they were to integrate backward into the sellers’ industry.
 The sellers’ product is not critical in one way or another to the buyer. If it is critical to the quality,
price, appeal, etc,, of an industrial buyer group’s finished product, for example, then the sellers
will have power over the buyers.
 When buyers can threaten to enter the industry and produce the product themselves and thus
supply their own needs, also a tactic for forcing down industry prices.
 When the supply industry depends on the buyers for a large percentage of its total orders.
Armed with greater amounts of information about the manufacturer’s costs and the power of the Internet
as a shopping and distribution alternative, consumers appear to be increasing their bargaining power in
many industries. One reason for this shift is that individual buyers incur virtually zero switching costs
when they decide to purchase from one manufacturer rather than another or from one dealer as opposed to
a second or third one.
4. The Bargaining Power of Suppliers
The fourth of Porter’s five competitive forces is the bargaining power of suppliers the organizations that
provide inputs into the industry, such as materials, services, and labor (which may be individuals,
organizations such as labor unions, or companies that supply contract labor). The bargaining power of
suppliers refers to the ability of suppliers to raise input prices, or to raise the costs of the industry in other
ways for example, by providing poor quality inputs or poor service. Powerful suppliers squeeze profits
out of an industry by raising the costs of companies in the industry. Thus, powerful suppliers are a threat.
Alternatively, if suppliers are weak, companies in the industry have the opportunity to force down input
prices and demand higher- quality inputs (e.g., more productive labor). Suppliers are most powerful in the
following situations:
 The product that suppliers sell has few substitutes and is vital to the companies in an industry.
 The profitability of suppliers is not significantly affected by the purchases of companies in a
particular industry, in other words, when the industry is not an important customer to the suppliers.
 Companies in an industry would experience significant switching costs if they moved to the product
of a different supplier because a particular supplier’s products are unique or different. In such cases,
the company depends on a particular supplier and cannot play suppliers off against each other to
reduce price.
 Suppliers can threaten to enter their customers’ industry and use their inputs to produce products that
would compete directly with those of companies already in the industry.
 Companies in the industry cannot threaten to enter their suppliers’ industry and make their own inputs
as a tactic for lowering the price of inputs.
 Suppliers’ product is differentiated
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5. The Threat of Substitute Products
Substitutes are offerings that differ from the goods and services provided by the competitors in an
industry but that fill similar needs to what the industry offer. How strong of a threat substitutes are
depends on how effective substitutes are in serving an industry’s customers. For example, companies in
the coffee industry compete indirectly with those in the tea and soft drink industries because all three
serve customer needs for nonalcoholic drinks. The existence of close substitutes is a strong competitive
threat because this limits the price that companies in one industry can charge for their product, and thus
industry profitability. If the price of coffee rises too much relative to that of tea or soft drinks, coffee
drinkers may switch to those substitutes.
If an industry’s products have few close substitutes, so that substitutes are a weak competitive force, then,
other things being equal, companies in the industry have the opportunity to raise prices and earn
additional profits. For example, there is no close substitute for microprocessors, which gives companies
like Intel and AMD the ability to charge higher. In general, product substitutes present a strong threat to a
firm when customers face few, if any, switching costs and when the substitute product’s price is lower or
its quality and performance capabilities are equal to or greater than those of the competing product.
Competitive Forces/Competitor’s analysis
An important part of an external audit is identifying rival firms and determining their strengths,
weaknesses, capabilities, opportunities, threats, objectives, and strategies. Collecting and evaluating
information on competitors is essential for successful strategy formulation. Identifying major competitors
is not always easy because many firms have divisions that compete in different industries. Many
multidivisional firms do not provide sales and profit information on a divisional basis for competitive
reasons. In addition, privately held firms do not publish any financial or marketing information.
Seven characteristics describe the most competitive companies:
1. Strive to continually increase market share.
2. Use the vision/mission as a guide for all decisions.
3. Realize that the old adage “if it’s not broke, don’t fix it” has been replaced by “whether it’s broke or
not, fix it;” in other words, continually strive to improve everything about the firm
4. Continually adapt, innovate, and improve – especially when the firm is successful.
5. Strive to grow through acquisition whenever possible
6. Hire and retain the best employees and managers possible
7. Strive to stay cost-competitive on a global basis
Competitor analysis focuses on each company against which a firm directly competes. For example, Coca
cola and Pepsi cola, Mesobo Cement, Muger cement and Derba cement, and Boeing and Airbus should be
keenly interested in understanding each other’s objectives, strategies, assumptions, and capabilities.
Furthermore, intense rivalry creates a strong need to understand competitors. In a competitor analysis, the
firm seeks to understand
 What drives the competitor, as shown by its future objectives
 What the competitor is doing and can do, as revealed by its current strategy.
 What the competitor believes about the industry, as shown by its assumptions.
 What competitor’s capabilities are, as shown by its strengths and weaknesses
Information about these four dimensions helps the firm prepare an anticipated response profile for each
competitor. The results of an effective competitor analysis help a firm understand, interpret, and predict
its competitors’ actions and responses. Understanding the actions of competitors clearly contributes to the
firm’s ability to compete successfully within the industry. Critical to an effective competitor analysis is
gathering data and information that can help the firm understand its competitors’ intentions and the
strategic implications resulting from them. Useful data and information combine to form competitor
intelligence: the set of data and information the firm gathers to better understand and better anticipate
34
competitors’ objectives, strategies, assumptions, and capabilities. The more information and knowledge a
firm can obtain about its competitors, the more likely it is that it can formulate and implement effective
strategies. Major competitors’ weaknesses can represent external opportunities; major competitors’
strengths may represent key threats.
3.4. Sources of external information
A wealth of strategic information is available to organizations from both published and unpublished
sources. Unpublished sources include customer surveys, market research, speeches at professional and
shareholders’ meetings, television programs, interviews, and conversations with stakeholders. Published
sources of strategic information include periodicals, journals, reports, government documents, abstracts,
books, directories, newspapers, and manuals. The Internet has made it easier for firms to gather,
assimilate, and evaluate information.

CHAPTER FOUR
INTERNAL ENVIRONMENT ASSESSMENT
4.1 The Nature of an Internal Audit

This chapter focuses on identifying and evaluating a firm’s strengths and

weaknesses in the functional areas of business, including management, marketing,
finance and production and operations, research and development (R&D), and
management accounting, information systems (MIS).This internal scanning, often
referred to as organizational analysis, is concerned with identifying and developing
an organization’s resources and competencies.

“Notable Quotes”
 "Like a product or service, the planning process itself must be managed and
shaped, if it is to serve executives as a vehicle for strategic decision-
making."—Robert Lenz
 "Weak leadership can wreck the soundest strategy."—Sun Tzu
 "The idea is to concentrate our strength against our competitor’s relative
weakness." —Bruce Henderson

4.2 The Nature of an Internal Audit

Internal environment provides an organization with the capability to capitalize on
the opportunities or protect itself from the threats that are present in the external
environment. Analysts must look within the corporation itself to identify internal
strategic factors critical strengths and weaknesses that are likely to determine
whether a firm will be able to take advantage of opportunities while avoiding

35
threats. Ultimately, the fit takes place between the external and the internal
environment that enable an organization to formulate its strategy.
Internal environmental analysis is all about identifying strength and weaknesses,
which the organization may have. All organizations have strengths and weaknesses
in the functional areas of business. No enterprise is equally strong or weak in all
areas. Internal strengths and weaknesses, coupled with external opportunities and
threats and clear vision and mission statements, provide the basis for establishing
objectives and strategies. Objectives and strategies are established with the
intention of capitalizing on internal strengths and overcoming weaknesses.

Key Terminology in Internal Environment Analysis

Resources, capabilities, and core competencies provide the foundation of
competitive advantage.
Resources: are an organization’s assets thus the basic building blocks of the
organization. Resources are the foundation for strategy and unique bundles of
resources generate competitive advantages leading to wealth creation. Resources
are bundled to create organizational capabilities. Resources are the source of
capabilities, some of which lead to the development of a firm’s core competencies
or its competitive advantages. Resources represent inputs into a firm’s production
process such as capital equipment, skills of employees, brand names, finances and
talented managers. Some of a firm’s resources are tangible while others are
intangible. Tangible resources are assets that can be seen and quantified. The four
types of tangible resources are financial, organizational, physical, and
technological
Financial Resources
 The firm’s borrowing capacity
 The firm’s ability to generate internal funds
Organizational Resources
 The firm’s formal reporting structure and its formal planning,
controlling, and coordinating systems
Physical Resources
 Sophistication and location of a firm’s plant and equipment
 Access to raw materials
Technological Resources
 Stock of technology, such as patents, trade-marks, copyrights, and trade secrets

Intangible resources are assets that cannot be seen and quantified. It includes
assets that typically are rooted deeply in the firm’s history and have accumulated
over time. Because they are embedded in unique patterns of routines, intangible

36
resources are relatively difficult for competitors to analyze and imitate. The three
types of intangible resources are human, innovation, and reputational. Human
resources: knowledge, trust, managerial capabilities, and organizational routines.
Innovation resources: ideas, capacity to innovate, scientific capabilities.
Reputational resources; reputation with customers, brand name, perceptions of
product quality, durability, and reliability, reputation with suppliers, for efficient,
effective, supportive, and mutually beneficial interactions and relationships
1. Capabilities: refer to a firm’s ability to exploit its resources. An organizational
capability refers to the ability of an organization to perform a coordinated set of
tasks, utilizing organizational resources, for the purpose of achieving a
particular end result”. In other words, capabilities are emerged by the
application of resources. Capabilities exist when resources have been purposely
integrated to achieve a specific task or set of tasks. These tasks range from
human resource selection to product marketing and research and development
activities. Critical to the building of competitive advantages, capabilities are
often based on developing, carrying, and exchanging information and
knowledge through the firm’s human capital.

The foundation of many capabilities lies in the unique skills and knowledge of a
firm’s employees and, often, their functional expertise. Hence, the value of
human capital in developing and using capabilities and, ultimately, core
competencies cannot be overstated. While resources exist on their own,
capabilities are implanted in organizational routines, practices and operational
procedures of an organization. Capabilities which are the building blocks of
core competencies include process and product design, product development,
operations, value chain integration, all aspects of marketing and customer
service, and organization design. A capability is functionally based and is
resident in a particular function. Thus, there are marketing capabilities,
manufacturing capabilities, and human resource management capabilities.
When these capabilities are constantly being changed and reconfigured to make
them more adaptive to an uncertain environment, they are called dynamic
capabilities.

37
2. Competency: is the ability of an individual to do a job properly. It is a cross-
functional integration and coordination of capabilities. For example, a
competency in new product development in one division of a corporation may
be the consequence of integrating management of information systems (MIS)
capabilities, marketing capabilities, R&D capabilities, and production
capabilities within the division.
3. Core competency: is a collection of competencies that crosses divisional
boundaries, is widespread within the corporation. Core competencies are
capabilities that serve as a source of competitive advantage for a firm over its
rivals. Core competencies distinguish a company competitively and reflect its
personality. Thus, new product development is a core competency if it goes
beyond one division. Three criteria that distinguishes a core competence from a
competence; a core competence must contribute significantly to customer
benefit from a product, a core competence should be competitively unique,
must be difficult for competitors to imitate and finally, a core competence
should provide potential access to a wide variety of markets. Capabilities are
formed by the integration of resources whereas core competencies are formed
by the integration of capabilities.
4. Distinctive competencies: A firm’s strengths that cannot be easily matched or
imitated by competitors are called distinctive competencies. Building
competitive advantages involves taking advantage of distinctive competencies.

38
 Strategies are designed in part to improve on a firm’s weaknesses, turning them
into strengths and maybe even into distinctive competencies. This means all
firms should continually strive to improve on their weaknesses, turning them
into strengths, and ultimately developing distinctive competencies that can
provide the firm with competitive advantages over rival firms.
5. Competitive Advantage
Four Criteria of Sustainable Competitive Advantage
Core competencies are sources of competitive advantage for the firm over its
rivals. Capabilities failing to satisfy the four criteria of sustainable competitive
advantage are not core competencies, meaning that although every core
competence is a capability, not every capability is a core competence. In slightly
different words, for a capability to be a core competence, it must be valuable and
unique, from a customer’s point of view. For the competitive advantage to be
sustainable, the core competence must be inimitable and non-substitutable, from a
competitor’s point of view. Sustained competitive advantage is achieved only
when competitors cannot duplicate the benefits of a firm’s strategy or when they
lack the resources to attempt imitation. For some period of time, the firm may earn
a competitive advantage by using capabilities that are, for example, valuable and
rare, but imitable. Sustainable competitive advantage results only when all four
criteria are satisfied.
1. Valuable: Valuable capabilities allow the firm to exploit opportunities or
neutralize threats in its external environment. By effectively using capabilities
to exploit opportunities, a firm creates value for customers.
2. Rare: Rare capabilities are capabilities that few competitors possess. A key
question to be answered when evaluating this criterion is, “How many rival
firms possess these valuable capabilities?” Capabilities possessed by many
rivals are unlikely to be sources of competitive advantage for any one of them.
Instead, valuable but common (i.e., not rare) resources and capabilities are
sources of competitive parity. Competitive advantage results only when firms
develop and exploit valuable capabilities that differ from those shared with
competitors.
3. Costly to Imitate: Costly-to-imitate capabilities are capabilities that other firms
cannot easily develop. Capabilities that are costly to imitate are created because
of one reason or a combination of three reasons.
 First, a firm sometimes is able to develop capabilities because of unique
historical conditions. “As firms evolve, they pick up skills, abilities and

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 resources that are unique to them, reflecting their particular path through
history.” A firm with a unique and valuable organizational culture that emerged
in the early stages of the company’s history “may have an imperfectly imitable
advantage over firms founded in another historical period” one in which less
valuable or less competitively useful values and beliefs strongly influenced the
development of the firm’s culture.
 A second condition of being costly to imitate occurs when the link between the
firm’s capabilities and its competitive advantage is causally ambiguous. In these
instances, competitors cannot clearly understand how a firm uses its capabilities
as the foundation for competitive advantage. As a result, firms are uncertain
about the capabilities they should develop to duplicate the benefits of a
competitor’s value-creating strategy.
 Social complexity is the third reason that capabilities can be costly to imitate.
Social complexity means that at least some, and frequently many, of the firm’s
capabilities are the product of complex social phenomena. Interpersonal
relationships, trust, friendships among managers and between managers and
employees, and a firm’s reputation with suppliers and customers are examples
of socially complex capabilities.
4. Non-substitutable: on-substitutable capabilities are capabilities that do not
have strategic equivalents. This final criterion for a capability to be a source of
competitive advantage “is that there must be no strategically equivalent
valuable resources that are themselves either not rare or imitable. Two valuable
firm resources (or two bundles of firm resources) are strategically equivalent
when they each can be separately exploited to implement the same strategies.”
In general, the strategic value of capabilities increases as they become more
difficult to substitute. The invisible capabilities are, the more difficult it is for
firms to find substitutes and the greater the challenge is to competitors trying to
imitate a firm’s value-creating strategy. Firm-specific knowledge and trust-
based working relationships between managers and non-managerial personnel
are examples of capabilities that are difficult to identify and for which finding a
substitute is challenging.

4.3 The Process of Performing an Internal Audit

The internal audit requires gathering and assimilating information about the firm's
management, marketing, finance/accounting, production/operations, research and
development (R&D), and computer information systems operations. To perform an
internal audit companies may follow the following steps
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4. Gather information on functional areas: Representative Managers and
employees from throughout the firm need to be involved in determining a
firm’s strengths and weaknesses. The internal audit requires gathering and
assimilating information about the firm's management, marketing,
finance/accounting, production/operations, research and development (R&D),
and information systems.
5. Assimilation and evaluation: Once information is gathered from different
functional areas in the organization, it should be assimilated and evaluated. A
meeting or series of meetings of functional managers is needed to collectively
identify the most important strength and weakness the firm have. Key factors
should be prioritized as so that the firm’s most important strengths and
weaknesses can be determined collectively
6. Communicate and distribute key internal strength and weakness: A final
list of the most important key strengths and weakness should be communicated
and distributed widely in the organization.
4.4 Relationship among the Functional Areas of Business
Functional Areas of Business
Strategic management is a highly interactive process that requires effective
coordination among management, marketing, finance and accounting, production
and operations, R&D, and MIS managers. It is not possible in a strategic-
management text to review in depth all the material presented in courses such as
marketing, finance, accounting, management, management information systems,
and production and operations; there are many subareas within these functions,
such as customer service, warranties, advertising, packaging, and pricing under
marketing. However, strategic planning must include a detailed assessment of how
the firm is doing in all internal areas. For different types of organizations, such as
hospitals, universities, and government agencies, the functional business areas, of
course, differ. In a hospital, for example, functional areas may include cardiology,
hematology, nursing, maintenance, physician support, and receivables. Functional
areas of a university can include athletic programs, placement services, housing,
fund-raising, academic research, counseling, and intramural programs. Within
large organizations, each division has certain strengths and weaknesses.
1) Management
The functions of management consist of five basic activities: planning, organizing,
staffing, leading, and controlling.

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Planning- Planning consists of all those managerial activities related to preparing
for the future. Specific tasks include forecasting, establishing objectives, devising
strategies, developing policies, and setting goals. Planning is most important at
strategy formulation stage of strategic-management process.
Organizing- Organizing includes all those managerial activities that result in a
structure of task and authority relationships. Organizing is most important at
strategy implementation stage of strategic-management process.
Staffing- Staffing activities are centered on personnel or human resource
management. Staffing is most important at strategy implementation stage of
strategic-management process
Leading –leading involves efforts directed toward shaping human behavior.
Leading is most important at strategy implementation stage of strategic-
management process
Controlling- Controlling refers to all those managerial activities directed toward
ensuring that actual results are consistent with planned results. Controlling is most
important at strategy evaluation stage of strategic-management process
2) Accounting / Finance
Financial condition is often considered the single best measure of a firm's
competitive position and overall attractiveness to investors. Determining an
organization's financial strengths and weaknesses is essential to formulating
strategies effectively. A firm's liquidity, leverage, working capital, profitability,
asset utilization, cash flow, and equity can eliminate some strategies as being
feasible alternatives. Financial factors often alter existing strategies and change
implementation plans. Financial ratio analysis is the most widely used method for
determining an organization's strengths and weaknesses in the investment,
financing, and dividend areas. This includes investment decision, capital
budgeting, the financing decision and dividend decisions
3) Production/Operations
The production/operations function of a business consists of all those activities that
transform inputs into goods and services. Production/operations management
deals with inputs, transformations, and outputs that vary across industries and
markets. A manufacturing operation transforms or converts inputs such as raw
materials, labor, capital, machines, and facilities into finished goods and services.
4) Marketing
Marketing can be described as the process of defining, anticipating, creating, and
fulfilling customers' needs and wants for products and services. There are seven

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basic functions of marketing: There are seven basic functions of marketing: (1)
customer analysis, (2) selling products/services, (3) product and service planning,
(4) pricing, (5) distribution, (6) marketing research, and (7) opportunity analysis.
Understanding these functions helps strategists identify and evaluate marketing
strengths and weaknesses.
5) Management Information Systems
Billions of bits of information are now “in the cloud.” Information ties all business
functions together and provides the basis for all managerial decisions. It is the
cornerstone of all organizations. Information represents a major source of
competitive management advantage or disadvantage. Assessing a firm’s internal
strengths and weaknesses in information systems is a critical dimension of
performing an internal audit. A MIS’s purpose is to improve the performance of an
enterprise by improving the quality of managerial decisions. An effective
information system thus collects, codes, stores, synthesizes, and presents
information in such a manner that it answers important operating and strategic
questions.
A management information system (MIS) receives raw material from both the
external and internal evaluation of an organization. It gathers data about marketing,
finance, production, and personnel matters internally, and social, cultural,
demographic, environmental, economic, political, governmental, legal,
technological, and competitive factors externally. Data are integrated in ways
needed to support managerial decision-making. Data becomes information only
when it is evaluated, filtered, condensed, analyzed, and organized for a specific
purpose, problem, individual, or time.
6) Research and Development
The fifth major area of internal operations that should be examined for specific
strengths and weaknesses is research and development (R&D). Many firms today
conduct no R&D, and yet many other companies depend on successful R&D
activities for survival. Firms pursuing a product development strategy especially
need to have a strong R&D orientation. The purpose of research and development
are as follows: Development of new products before competition, improving
product quality and improving manufacturing processes to reduce costs. Thus, a
key to organizational success is effective coordination and understanding among
managers from all functional business areas. Through involvement in performing
an internal strategic-management audit, managers from different departments and
divisions of the firm come to understand the nature and effect of decisions in other

43
functional business areas in their firm. Knowledge of these relationships is critical
for effectively establishing objectives and strategies.
7) Human resource management: Human resource management (HRM) is an
integrative general management that involves identifying the organization’s
demand for human resources with particular skills and abilities. As for the
introduction of the new products or services, it is necessary for HRM
department to know about it. Once the new products or services are introduced,
marketing has the responsibility to inform the HRM department punctually and
sufficiently. The information for HRM department should be concerned with
the new skills and experience needed for the new workers at present.
4.5 The Value Chain Analysis
Value is the extent to which a good or service is perceived by its customer to meet
his or her needs or wants, measured by a product’s performance characteristics and
by its attributes for which customers are willing to pay. Value is created by a
product’s low cost, by its highly differentiated features, or by a combination of low
cost and high differentiation, compared with competitors’ offerings.
Value=Benefits = Functional benefits + emotional
benefits_______________
Costs Monetary costs + time costs + energy costs + psychic
costs

It commonly depends more on the customer's perception of the worth of

the product than on its intrinsic value. Firms must provide value to a customer that
is superior to the value provided by competitors in order to create a competitive
advantage. Value chain analysis allows the firm to understand the parts of its
operations that create value and those that do not. Understanding these issues is
important because the firm earns above-average returns only when the value it
creates is greater than the costs incurred to create that value.
Value chain is the processes or activities a company performs to design, produce,
and market, deliver and support its product. The value chain analysis describes
the activities the organization performs and links them to the organizations
competitive [Link] chain analysis allows the firm to understand the parts
of its operations that create value and those that do not. Understanding these issues
is important because the firm earns above-average returns only when the value it
creates is greater than the costs incurred to create that value. According to Porter,
the business of a firm can best be described as a value chain, in which total

44
revenues minus total costs of all activities undertaken to develop and market a
product or service yields value
Value chain analysis (VCA) refers to the process whereby a firm determines the
costs associated with organizational activities from purchasing raw materials to
manufacturing product(s) to marketing those products
The value chain is a template that firms use to understand their cost position and to
identify the multiple means that might be used to facilitate implementation of a
chosen business-level strategy. As shown in Figure 4.1, a firm’s value chain is
segmented into primary and supportive activities.
Primary activities: are involved with a product’s physical creation, its sale and
distribution to buyers, and its service after the sale. Supportive activities: provide
the assistance necessary for the primary activities to take place. The value chain
shows how a product moves from the raw-material stage to the final customer. For
individual firms, the essential idea of the value chain is to create additional value
without incurring significant costs while doing so and to capture the value that has
been created. In a globally competitive economy, the most valuable links on the
chain are people who have knowledge about customers. This locus of value
creating possibilities applies just as strongly to retail and service firms as to
manufacturers.

Figure 4.1the value chain analysis

Moreover, for organizations in all sectors, the effects of e-commerce make it
increasingly necessary for companies to develop value-adding knowledge
processes to compensate for the value and margin that the Internet strips from
physical processes. Table 4.2 lists the items that can be evaluated to determine the
value-creating potential of primary activities. In Table 4.3, the items for evaluating

45
support activities are shown. All items in both tables should be evaluated relative
to competitors’ capabilities. To be a source of competitive advantage, a resource or
capability must allow the firm (1) to perform an activity in a manner that provides
value superior to that provided by competitors, or (2) to perform a value-creating
activity that competitors cannot complete. Only under these conditions does a firm
create value for customers and have opportunities to capture that value.
Table 4.2Examining the Value-Creating Potential of Primary Activities
Inbound Activities, such as materials handling, warehousing, and inventory
Logistics control, used to receive, store, and disseminate inputs to a product.
Operations Activities necessary to convert the inputs provided by inbound
logistics into final product form. Machining, packaging, assembly,
and equipment maintenance are examples of operations activities.
Outbound Activities involved with collecting, storing, and physically
Logistics distributing the final product to customers. Examples of these
activities include finished goods warehousing, materials handling,
and order processing.
Marketing Activities completed to provide means through which customers can
and Sales purchase products and to induce them to do so. To effectively market
and sell products, firms develop advertising and promotional
campaigns, select appropriate distribution channels, and select,
develop, and support their sales force.
Service Activities designed to enhance or maintain a product’s value. Firms
engage in a range of service-related activities, including installation,
repair, training, and adjustment. Each activity should be examined
relative to competitors’ abilities. Accordingly, firms rate each
activity as superior, equivalent, or inferior.
Each activity should be examined relative to competitors’ abilities.
Accordingly, firms rate each activity as superior, equivalent, or
inferior.

Table 4.3 Examining the Value-Creating Potential of Support Activities

Procurement Activities completed to purchase the inputs needed toproduce a firm’s
products. Purchased inputs include items fully consumed during the
manufacture of products (e.g., raw materials and supplies, as well as fixed
assets— machinery, laboratory equipment, office equipment, and buildings).
Technological Activities completed to improve a firm’s product and the processes used to
46
Development manufacture it. Technological development takes many forms, such as process
equipment, basic research and product design, and servicing procedures.
Human Resource Activities involved with recruiting, hiring, training, developing, and compensating
Management all personnel.
Firm Firm infrastructure includes activities such as general management, planning,
Infrastructure finance, accounting, legal support, and governmental relations that are required to
support the work of the entire value chain. Through its infrastructure, the firm
strives to effectively and consistently identify external opportunities and threats,
identify resources and capabilities, and support core competencies.
Each activity should be examined relative to competitors’ abilities. Accordingly, firms rate each
activity as superior, equivalent, or inferior.

Outsourcing
Outsourcing is the purchase of a value-creating activity from an external supplier.
Not for-profit agencies as well as for-profit organizations actively engage in
[Link] engaging in effective outsourcing increase their flexibility,
mitigate risks, and reduce their capital investments. In multiple global industries,
the trend toward outsourcing continues at a rapid pace. Moreover, in some
industries virtually all firms seek the value that can be captured through effective
outsourcing. The auto manufacturing industry and, more recently, the electronics
industry are examples of this situation. As with other strategic management
process decisions, careful study is required before the firm decides to engage in
outsourcing.
Outsourcing can be effective because few, if any, organizations possess the
resources and capabilities required to achieve competitive superiority in all
primary and support activities. For example, research suggests that few companies
can afford to develop internally all the technologies that might lead to competitive
advantage. By nurturing a smaller number of capabilities, a firm increases the
probability of developing a competitive advantage because it does not become
overextended. In addition, by outsourcing activities in which it lacks competence,
the firm can fully concentrate on those areas in which it can create value.
There are concerns about the consequences of outsourcing. For the most part, these
concerns revolve around the potential loss in firms’ innovative ability and the loss
of jobs within companies that decide to outsource some of their work activities to
others. Thus, innovation and technological uncertainty are two important issues to
consider in making outsourcing decisions. Companies should be aware of these
issues and be prepared to fully consider the concerns about outsourcing when
different stakeholders (e.g., employees) express them.
Outsourcing has several advantages for firms but also carries some important risks
as well. Outsourcing can potentially reduce costs and increase the quality of the
activities outsourced. In this way, it adds value to the product provided to
consumers. Thus, outsourcing can contribute to a firm’s competitive advantage and
its ability to create value for its stakeholders. Additionally, the risk of the
outsourcing partner’s learning the technology and becoming a competitor is

47
highlighted. Therefore, outsourcing decisions are critical and must be made with
strategic criteria in mind, including a thorough evaluation of potential partners and
selection of effective and reliable partners.
4.6 Internal Factor Evaluation (IFE) Matrix
A summary step in conducting an internal strategic-management audit is to
construct an Internal Factor Evaluation (IFE) Matrix. This strategy-formulation
tool summarizes and evaluates the major strengths and weaknesses in the
functional areas of a business, and it also provides a basis for identifying and
evaluating relationships among those areas. Intuitive judgments are required in
developing an IFE Matrix, so the appearance of a scientific approach should not be
interpreted to mean this is an all-powerful technique. An IFE Matrix can be
developed in five steps:
1) List key internal factors as identified in the internal-audit process. Use a total of
from 10 to 20 internal factors, including both strengths and weaknesses. List
strengths first and then weaknesses.
2) Assign a weight that ranges from 0.0 (not important) to 1.0 (all-important) to
each factor. Regardless of whether a key factor is an internal strength or
weakness, factors considered to have the greatest effect on organizational
performance should be assigned the highest weights. The sum of all weights
must equal 1.0.
3) Assign a 1-to-4 rating to each factor to indicate whether that factor
represents a major weakness (rating = 1), a minor weakness (rating = 2), a
minor strength (rating = 3), or a major strength (rating = 4). Note that strengths
must receive a 3 or 4 rating and weaknesses must receive a 1 or 2 rating.
Ratings are thus company-based, whereas the weights in step 2 are industry-
based.
4) Multiply each factor’s weight by its rating to determine a weighted score for
each variable.
5) Sum the weighted scores for each variable to determine the total weighted
score.
Regardless of how many factors are included in an IFE Matrix, the total weighted
score can range from a low of 1.0 to a high of 4.0, with the average score being
2.5.
Total weighted scores will below 2.5 characterize organizations that are weak
internally, whereas scores significantly above 2.5 indicate a strong internal
position. IFE Matrix should include from 10 to 20 key factors. The number of
factors has no effect upon the range of total weighted scores because the weights
always sum to 1.0. When a key internal factor is both strength and a weakness, the
factor should be included twice in the IFE Matrix, and a weight and rating should
be assigned to each statement.

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An example of an IFE Matrix is provided in Table 4.4 for a retail computer store.
Note that the two most important factors to be successful in the retail computer
store business are “revenues from repair/service in the store” and “location of the
store.” Also note that the store is doing best on “average customer purchase
amount” and “in-store technical support.” The store is having major problems with
its carpet, bathroom, paint, and checkout procedures. Note also that the matrix
contains substantial quantitative data rather than vague statements; this is excellent.
Overall, this store receives a 2.5 total weighted score, which on a 1-to-4 scale is
exactly average/halfway, indicating there is definitely room for improvement in
store operations, strategies, policies, and procedures.
The IFE Matrix provides important information for strategy formulation. For
example, this retail computer store might want to hire another checkout person and
repair its carpet, paint, and bathroom problems.
Table 4.4 a Sample Internal Factor Evaluation Matrix for a Retail Computer
Store
Key Internal Factors Weight Rating Weighted
Score
Internal Strengths
1. Inventory turnover increased from 5.8 to 6.7 .05 3 .15
2. Average customer purchase increased from $97 to $128 .07 4 .28
3. Employee morale is excellent .10 3 .30
4. In-store promotions resulted in 20 percent increase in sales .05 3 .15
5. Newspaper advertising expenditures increased 10 percent .02 3 .06
6. Revenues from repair/service segment of store up 16 percent .15 3 .45
7. In-store technical support personnel have MIS college degrees .05 4 .20
8. Store’s debt-to-total assets ratio declined to 34 percent .03 3 .09
9. Revenues per employee up 19 percent .02 3 .06
Internal Weaknesses
1. Revenues from software segment of store down 12 percent .10 2 .20
2. Location of store negatively impacted by new Highway 34 .15 2 .30
3. Carpet and paint in store somewhat in disrepair .02 1 .02
4. Bathroom in store needs refurbishing .02 1 .02
5. Revenues from businesses down 8 percent .04 1 .04
6. Store has no Web site .05 2 .10
7. Supplier on-time delivery increased to 2.4 days .03 1 .03
8. Often customers have to wait to check out .05 1 .05
TOTAL 1.00 2.50

At the conclusion of the internal analysis, firms must identify their strengths and
weaknesses in resources, capabilities, and core competencies. For example, if they
have weak capabilities or do not have core competencies in areas required to
49
achieve a competitive advantage, they must acquire those resources and build the
capabilities and competencies needed. Alternatively, they could decide to
outsource a function or activity where they are weak in order to improve the value
that they provide to customers. Therefore, firms need to have the appropriate
resources and capabilities to develop the desired strategy and create value for
customers and shareholders as well. Having many resources does not necessarily
lead to success. Firms must have the right ones and the capabilities needed to
produce superior value to customers. Undoubtedly, having the appropriate and
strong capabilities required for achieving a competitive advantage is a primary
responsibility of top-level managers. These important leaders must focus on both
the firm’s strengths and weaknesses.

CHAPTER FIVE
STRATEGY FORMULATION
STRATEGY ANALYSIS AND CHOICE

This chapter focuses on generating and evaluating alternative strategies, as well as selecting strategies to
pursue.

“Notable Quotes”
 "The early bird may get the worm, but the second mouse gets the cheese."
 "Tomorrow always arrives. It is always different. And even the mightiest company is in trouble if
it has not worked on the future. Being surprised by what happens is a risk that even the largest
and richest company cannot afford, and even the smallest business need not run." —Peter
Drucker

5.1 The Nature of Strategy Analysis and Choice

Increasingly important to firm success, strategy is concerned with making choices among two or more
alternatives. When choosing a strategy, the firm decides to pursue one course of action instead of others.
The choices made are influenced by opportunities and threats in the firm’s external environment as well
as the nature and quality of its internal resources, capabilities, and core competencies. The fundamental
objective of using any type of strategy is to gain strategic competitiveness and earn above-average
returns. Strategies are purposeful, precede the taking of actions to which they apply, and demonstrate a
shared under-standing of the firm’s vision and mission. Strategy analysis and choice seek to determine
alternative courses of action that could best enable the firm to achieve its mission and [Link]
choice is the decision to select from among the alternative strategies, which will best meet the enterprise’s
objectives Identifying and evaluating alternative strategies should involve many of the managers and
employees who earlier assembled the organizational vision and mission statements, performed the
external audit, and conducted the internal audit. Representatives from each department and division of the
firm should be included in this process, as was the case in previous strategy-formulation activities.
5.2 Types of strategy
Strategies can be divided in to three broad categories
1. Corporate strategy: 1) growth strategy, 2) stability strategy, 3) retrenchment strategy.

50
 2. Business unit strategy: 1) cost leadership, 2) differentiation, 3) focus cost leadership, 4) focus
differentiation,5) integrated cost leadership/ differentiation.
3. Functional strategy
5.2.1 Corporate level strategy
A corporate-level strategy specifies actions a firm takes to gain a competitive advantage by selecting and
managing a group of different businesses competing in different product markets. Corporate-level
strategy is concerned with key issues like: in what product markets and businesses the firm should
compete and how corporate headquarters should manage those businesses. Corporate strategy deals with
three key issues facing the corporation as a whole:
1. The firm’s overall orientation toward growth, stability, or retrenchment (directional strategy). This
includes question like; should we expand, cut back, or continue our operations unchanged, Should we
concentrate our activities within our current industry or should we diversify into other industries? If
we want to grow and expand, should we do so through internal development or through external
acquisitions, mergers, or strategic alliances?
2. The industries or markets in which the firm competes through its products and business units
3. The manner in which management coordinates activities, transfers resources, and cultivates
capabilities among product lines and business units

Corporate level strategies are basically about the choice of direction that a firm adopts in order to achieve
its objectives. Corporate-level strategies help companies’ select new strategic positions—positions that
are expected to increase the firm’s value. Corporate level strategies are about decisions related to
allocating resources among the different businesses of a firm, transferring resources from one set of
businesses to others, and managing and nurturing a portfolio of businesses in such a way that the overall
corporate objectives are achieved. An analysis based on business definition provides a set of strategic
alternatives that an organization can consider. Major corporate strategies are stability, growth &
retrenchment
1. Stability strategy
Stability strategies make no change to the company’s current activities. It is adopted by an organization
when it attempts to an incremental improvement of its functional performance by marginally changing
one or more of its businesses in terms of their respective customer groups, customer functions and
alternative technologies either singly or collectively.A corporation may choose stability over growth by
continuing its current activities without any significant change in [Link] 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.
 An organization that is large and dominates its market(s) may choose a stability strategy in an
effort to avoid government controls or penalties for monopolizing the industry.
 Another organization may find that further growth is too costly and could have detrimental effects
on profitability.
 Finally, an organization in a low- growth or no-growth industry that has no other viable options
may be forced to select a stability strategy.
a) 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.

51
b) 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. There are no obvious
opportunities or threats, nor is there much in the way of significant strengths or weaknesses. Few
aggressive new competitors are likely to enter such an industry.
c) 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. Management postpone investments and/or cuts expenses (such as R&D, maintenance,
and advertising) to stabilize profits during this period. It may even sell one of its product lines for the
cash-flow benefits.
The profit strategy is useful only to help a company get through a temporary difficulty. Unfortunately,
the strategy is seductive and if continued long enough it will lead to a serious deterioration in a
corporation’s competitive position. The profit strategy is typically top management’s passive, short-
term, and often self-serving response to a difficult situation. In such situations, it is often better to
face the problem directly by choosing a retrenchment strategy.
2. Growth/Expansion strategies
Growth strategies expand the company’s activities. By far the most widely pursued corporate strategies
are those designed to achieve growth in sales, assets, profits, or some combination. Companies that do
business in expanding industries must grow to survive. Continuing growth means increasing sales and a
chance to take advantage of the experience curve to reduce the per-unit cost of products sold, thereby
increasing profits.A corporation can grow internally by expanding its operations or it can grow externally
through mergers, acquisitions, and strategic [Link] two basic growth strategies are concentration
on the current product line(s) in one industry and diversification into other product lines in other
industries.
1. Concentration
If a company’s current product lines have real growth potential, concentration of resources on those
product lines makes sense as a strategy for growth. It is concentration on the current business. The two
basic concentration strategies are vertical growth and horizontal growth. Growing firms in a growing
industry tend to choose these strategies before they try diversification.
a) Vertical Growth. Vertical growth involves taking over a function previously provided by a supplier
or by a distributor. The company, in effect, grows by making its own supplies and/or by distributing
its own products. This may be done in order to reduce costs, gain control over a scarce resource,
guarantee quality of a key input, or obtain access to potential customers. This growth can be achieved
either internally by expanding current operations or externally through acquisitions. Vertical growth
can be backward integration or forward integration. Backward integration is a strategy of
seeking ownership or increased control of a firm’s suppliers.

Seven guidelines for when backward integration may be an especially effective strategy are:
• When an organization’s present suppliers are especially expensive, or unreliable, or incapable of
meeting the firm’s needs for parts, components, assemblies, or raw materials.
• When the number of suppliers is small and the number of competitors is large.
• When an organization competes in an industry that is growing rapidly; this is a factor because
integrative-type strategies (forward, backward, and horizontal) reduce an organization’s ability to
diversify in a declining industry.
• When an organization has both capital and human resources to manage the new business of
supplying its own raw materials.

52
 • When the advantages of stable prices are particularly important; this is a factor because an
organization can stabilize the cost of its raw materials and the associated price of its product(s)
through backward integration.
• When present supplies have high profit margins, which suggests that the business of supplying
products or services in the given industry is a worthwhile venture.
• When an organization needs to quickly acquire a needed resource.

Vertical growth results in vertical integration—the degree to which a firm operates vertically in multiple
locations on an industry’s value chain from extracting raw materials to manufacturing to retailing.
Forward integration involves gaining ownership or increased control over distributors or retailers.
This strategy can be especially appropriate
• When an organization’s present distributors are especially expensive, or unreliable, or incapable
of meeting the firm’s distribution needs.
• When the availability of quality distributors is so limited as to offer a competitive advantage to
those firms that integrate forward.
• When an organization has both the capital and human resources needed to manage the new
business of distributing its own products.
• When the advantages of stable production are particularly high; this is a consideration because an
organization can increase the predictability of the demand for its output through forward
integration.
• When present distributors or retailers have high profit margins; this situation suggests that a
company profitably could distribute its own products and price them more competitively by
integrating forward.
b) Horizontal Growth. Strategy of adding related or similar product/service lines to existing core
business, either through acquisition of competitors or through internal development of new
products/services Horizontal integration refers to a strategy of seeking ownership of or increased
control over a firm’s competitors. One of the most significant trends in strategic management today is
the increased use of horizontal integration as a growth strategy. Mergers, acquisitions, and takeovers
among competitors allow for increased economies of scale and enhanced transfer of resources and
competencies. Mergers between direct competitors are more likely to create efficiencies than mergers
between unrelated businesses, both because there is a greater potential for eliminating duplicate
facilities and because the management of the acquiring firm is more likely to understand the business
of the target
2. Diversification Strategies
According to strategist Richard Rumelt, companies begin thinking about diversification when their
growth has plateaued and opportunities for growth in the original business have been [Link] often
occurs when an industry consolidates, becomes mature, and most of the surviving firms have reached the
limits of growth using vertical and horizontal growth strategies. Unless the competitors are able to expand
internationally into less mature markets, they may have no choice but to diversify into different industries
if they want to continue growing. Diversification can be either related or unrelated. The key issue here is
if the operations of the firm in the new industry share some link in with the firm's existing value chain. Is
there some value adding activity that can be shared? For example, is there a production facility, a
distribution network, or a marketing competence that both can use?

A. Concentric (Related) Diversification. Growth through concentric diversification is expansion into a

related industry. Growth through concentric diversification into a related industry may be a very
appropriate corporate strategy when a firm has a strong competitive position but industry
attractiveness is [Link] indicates that the probability of succeeding by moving into a related
business is a function of a company’s position in its core business. For companies in leadership
positions, the chances for success are nearly three times higher than those for [Link] focusing

53
 on thecharacteristics that have given the company its distinctive competence; the company uses those
very strengths as its means of diversification. The firm attempts to secure strategic fit in a new
industry where the firm’s product knowledge, its manufacturing capabilities, and the marketing skills
it used so effectively in the original industry can be put to good [Link] corporation’s products or
processes are related in some way: they possess some common thread. The search is for synergy, the
concept that two businesses will generate more profits together than they could separately. The point
of commonality may be similar technology, customer usage, distribution, managerial skills, or
product similarity example, Johnson and Johnson engages in products for baby care, skin care,
oral care, wound c a r e , and women's health c a r e fields, as well as nutritional products.
B. Conglomerate (Unrelated) Diversification.
Conglomerate diversification is diversifying into an industry unrelated to its current one. Involves
diversifying into businesses with No strategic fit, No meaningful value chain relationships and No
unifying strategic theme
Rather than maintaining a common thread throughout their organization, strategic managers who adopt
this strategy are primarily concerned with financial considerations of cash flow or risk reduction. This is
also a good strategy for a firm that is able to transfer its own excellent management system into less-well-
managed acquired firms. Examples of unrelated diversification W. R. Grace engage in the production of
Chemicals, Coal Mining, Oil and Gas Extraction, Food Manufacturing, Paper Products and Health
S e r v i c e . General Electric and Berkshire Hathaway are examples of companies that have used
conglomerate diversification to grow successfully. General electric engaged in the production health care,
appliance, financial service, aviation and energy. The emphasis in conglomerate diversification is on
sound investment and value-oriented management rather than on the product-market synergy common to
concentric diversification.A cash-rich company with few opportunities for growth in its industry might,
for example, move into another industry where opportunities are great but cash is hard to find. Another
instance of conglomerate diversification might be when a company with a seasonal and,therefore, uneven
cash flow purchases a firm in an unrelated industry with complementingseasonal sales that will level out
the cash [Link] management considered the purchase of a natural gas transmission business (Texas
Gas Resources) by CSX Corporation (a railroad dominated transportation company) to be a good fit
because most of the gas transmission revenue was realized in the winter months—the lean period in the
railroad business.
3. Retrenchment strategies
Retrenchment strategies reduce the company’s level of activities. A company may pursue retrenchment
strategies when it has a weak competitive position in some or all of its product lines resulting in poor
performance—sales are down and profits are becoming losses. These strategies impose a great deal of
pressure to improve performance. In an attempt to eliminate the weaknesses that are, dragging the
company down, management may follow one of several retrenchment strategies, ranging from turnaround
or becoming a captive company to selling out, bankruptcy, or liquidation.

A retrenchment strategy simply means falling back and regrouping. The term retrenchment is sometimes
defined rather broadly, similarly to decline strategies. These strategies impose a great deal of pressure to
improve performance. This strategy is followed when an organization aims at a contraction of its
activities through substantial reduction or the elimination of the scope of one or more of its businesses, in
terms of their respective customer groups, customer functions or alternative technologies either singly or
jointly in order to improve its overall [Link] types of defensive strategies:
Turnaround strategy- reverses the negative trend. Emphasizes the improvement of operational
efficiency and is probably most appropriate when a corporation’s problems are pervasive but not yet
critical. Research shows that poorly performing firms in mature industries have been able to improve their
performance by cutting costs and expenses and by selling off assets. Analogous to a weight reduction diet,
the two basic phases of a turnaround strategy are contraction and consolidation.

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A captive company strategy involves giving up independence in exchange for security. A company with
a weak competitive position may not be able to engage in a full-blown turnaround strategy. The industry
may not be sufficiently attractive to justify such an effort from either the current management or
investors. Nevertheless, a company in this situation faces poor sales and increasing losses unless it takes
some action. Management desperately searches for an “angel” by offering to be a captive company to one
of its larger customers in order to guarantee the company has continued existence with a long-term
contract.
Sell-Out/Divestment Strategy: If a corporation with a weak competitive position in an industry is unable
either to pull itself up by its bootstraps or to find a customer to which it can become a captive company, it
may have no choice but to sell out. The sell-out strategy makes sense if management can still obtain a
good price for its shareholders and the employees can keep their jobs by selling the entire company to
another firm. The hope is that another company will have the necessary resources and determination to
return the company to profitability.
Bankruptcy/Liquidation 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.
5.2.2 Business Level Strategies
Business level strategies are an integrated and coordinated set of commitments and actions the firm uses
to gain a competitive advantage by exploiting core competencies in specific product markets. In the
process, the firm uses its competencies to gain, sustain, and enhance its strategic or competitive
advantage. Business strategy can be competitive (battling against all competitors for advantage) and/or
cooperative (working with one or more companies to gain advantage against other competitors).
MichaelPorter is credited with extensive pioneering work in the area of business strategies or what he
calls, competitive strategies. Porter’s competitive strategies raise the following questions: Should we
compete on the basis of lower cost (and thus price), or should we differentiate our products or
services on some basis other than 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?

Michael Porter proposes two “generic” competitive strategies for outperforming other corporations in a
particular industry: lower cost and differentiation. These strategies are called generic because they can be
pursued by any type or size of business firm:
Porter further proposes that a firm’s competitive advantage in an industry is determined by its competitive
scope, that is, the breadth of the company’s or business unit’s target market.

Porter’s Generic Business Level Strategies

1. Cost leadership
2. Differentiation
3. Focused cost leadership
4. Focused differentiation
5. Integrated cost leadership/differentiation
1. Cost Leadership Business Strategy
A cost leadership strategy is based upon a business organizing and managing its value adding activities to
be the lowest cost producer of the product or service in an industry. Value chain analysis is central to

55
identifying where cost savings can be made at various stages in the value chain and its internal and
external linkages. A successful cost leadership strategy is likely to rest upon a number of organizational
features. Attainment of a position ofcost leadership depends on the arrangement of value chain activities
so as to:
 Reduce unit costs by copying rather than originating designs, using cheaper materials and other
cheaper resources, producing products with no frills, reducing labor costs and increasing labor
productivity.
 Achieving economies of scale by high-volume sales perhaps based on advertising and promotion,
allowing high fixed costs of investment in modern technology to be spread over a high volume of
output
 Using high volume purchasing to obtain discounts for bulk buying of materials
 Locating activities in areas where costs are low or government help is available
When the competitive advantage of a firm lies in a lower cost of products or services relative to what the
competitors have to offer, it is termed as cost leadership. Customers prefer a lower cost product
particularly if it offers the same utility to them as the comparable products available in the market offer.
When all firms offer products at comparable price, then the cost leader firm earns a higher profit owing to
the low cost of its products. Cost leadership offers a margin of flexibility to the firm to lower price if the
competition becomes stiff and yet earn more or less the same level of [Link] companies competing in a
price sensitive market, cost leadership is a strategy imperative of the entire organization.
Conditions under Which Cost Leadership is Used
Not every condition under which market operates is conducive to the use of the cost leadership strategy.
There are certain conditions that make such usage meaningful. Some of such conditions are mentioned
below:
 If the markets for the product/service is price based competition
 If the product/service is standardized and its competition takes place in such a way that
differentiation is superfluous
 If the buyers may be numerous and possess a significant bargaining power to negotiate a price
reduction from the supplying firm
 If there is lesser customer loyalty and the cost of switching from one seller to another is low.
 If there might be few ways available for differentiation to take place.
Table 5.1 Advantages and disadvantages of cost leadership Strategy
Advantage Disadvantage
 Defend market share  Competitors may imitate the strategy, thus driving overall
 Build entry barriers industry profits down
 Increase market share  Cost advantage is temporary
 Enter new markets  Cost leadership is obviously not a market friendly approach
 Reduce the cost of capital  Technological shifts are a greater threat to a cost leader as these
may change the ground rules on which an industry operates
2. Differentiation Business Strategy
It is a strategy of achieving a competitive advantage by creating a product that is perceived by customers
as unique in some important [Link] a differentiation strategy means that a firm is competing based
on uniqueness rather than price and is seeking to attract a broad market.A differentiation strategy is based
on persuading customers that a product is superior to that offered by competitors. Differentiation can be
based on premium product features or simply upon creating consumer perceptions that a product is
superior. A differentiation strategy is likely to necessitate emphasis on innovation, design, research and
development, awareness of particular customer needs and marketing. The firm outperforms its
competitors who are not able or willing to offer the special features that it can and does. Customers prefer
a differentiated product/service when it offers them a utility that they value, and are willing to pay more
for getting such a utility. Profits for the differentiation firm come from the difference in the premium

56
price charged and the additional cost incurred in providing the differentiation. To the extent the firm is
able to offer differentiation by maintaining a balance between its price and costs, it succeeds. However, it
may fail if the customers are no longer interested in the differentiated features, or not willing to pay extra
for such features.
Table 5.2 Advantages and disadvantages of Differentiation Strategy
Advantages Disadvantages
 lessening competitive rivalry  Price premiums to have a limit
 Reduce bargaining power of buyers  customers will not be willing to pay extra to
 Acts as a entry barrier to new entrants obtain the unique features
 Reduce substitutability  if it is not valued by the customers it will fail

3. Focused cost leadership

Focus business strategies essentially rely on either cost leadership or differentiation but cater to a narrow
segment of the total market. In terms of the market, therefore, focus strategies are niche strategies. The
more commonly used bases for identifying customer groups are the demographic characteristics (age,
gender, income, occupation etc), geographic segmentation (rural/urban), lifestyle (traditional/modern). A
focus strategy is aimed at a segment of the market for a product rather than at the whole market or many
markets. A particular group of customers is identified on the basis of age, income, life style, sex,
geographic location, some other distinguishing segmental characteristic or a combination of these. For the
identified market segment a focus firm uses either the lower cost or differentiation strategy.
Focused cost leadership is the first of two focus strategies. A focused cost leadership strategy requires
competing based on price to target a narrow market. A firm that follows this strategy does not necessarily
charge the lowest prices in the industry. Instead, it charges low prices relative to other firms that compete
within the target market.
4. Focused differentiation
Focused differentiation is the second of two focus strategies. A focused differentiation strategy requires
offering unique features that fulfill the demands of a narrow market. As with a focused low-cost strategy,
narrow markets are defined in different ways in different settings. Some firms using a focused
differentiation strategy concentrate their efforts on a particular sales channel, such as selling over the
Internet only. Others target particular demographic groups.
Conditions under which a focus strategies are used
1. When the target market niche is large, profitable, and growing.
2. When industry leaders do not consider the niche to be crucial to their own success.
3. When industry leaders consider it too costly or difficult to meet the specialized needs of the target
market niche while taking care of their mainstream customers.
4. When the industry has many different niches and segments, thereby allowing a focuser to pick a
competitively attractive niche suited to its own resources.
5. When few, if any, other rivals are attempting to specialize in the same target segment
6. When consumers have distinctive preferences or requirements and when rival firms are not
attempting to specialize in the same target segment.
7. When the focusing firm has the necessary skills and expertise to serve the niche segment
8. When the focusing firm can guard its territory from other predator firms based on customer
relations and the loyalty it has developed and its acknowledged superiority in serving the niche
segments.
Table 5.3 Advantage and disadvantage of focus strategy
Advantage Disadvantage
 It allows specialization and greater  Serving niche markets requires the
knowledge development of distinctive competencies to
 lower investment in resources serve those markets

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  It makes entry to a new market less costly  commitment to a narrow marker segment
and simpler  High cost

5. Integrated Cost Leadership/Differentiation Strategy

Most consumers have high expectations when purchasing a good or service. In general, it seems that most
consumers want to pay a low price for products with somewhat highly differentiated features. Because of
these customer expectations, a number of firms engage in primary and support activities that allow them
to simultaneously pursue low cost and differentiation. Firm seeking to do this use the integrated cost
leadership/differentiation [Link] objective of using this strategy is to efficiently produce products
with some differentiated [Link] production is the source of maintaining low costs while
differentiation is the source of creating unique [Link] that successfully use the integrated cost
leadership/differentiation strategy usually adapt quickly to new technologies and rapid changes in their
external environments.
Thisrisky of strategy is risky because firms find it difficult to perform primary and support activities in
ways that allow them to produce relatively inexpensive products with levels of differentiation that create
value for the target customer. Moreover, to properly use this strategy across time, firms must be able to
simultaneously reduce costs incurred to produce products (as required by the cost leadership strategy)
while increasing products’ differentiation (as required by the differentiation strategy).They may got the
problem of “stuck in the middle. Being stuck in the middle means that the firm’s cost structure is not low
enough to allow it to attractively price its products and that its products are not sufficiently differentiated
to create value for the target customer.
5.2.3. Functional Level Strategy (Reading Assignment)

5.3 A comprehensive strategy formulation framework

Important strategy-formulation techniques can be integrated into a three-stage decision-making
framework, (input stage, matching stage and the decision stage). The tools presented in this framework
are applicable to all sizes and types of organizations and can help strategists identify, evaluate, and select

Stage one (The Input Stage)

Input stage of the formulation framework consists of the external factors evaluation (EFE), internal
factors evaluation Matrix (IFE) and Competitive Profile Matrix (CPM). Stage 1 is called the Input
Stage; stage 1 summarizes the basic input information needed to formulate strategies.
The input tools require strategists to quantify subjectivity during early stages of the strategy-formulation
process. Making small decisions in the input matrices regarding the relative importance of external and
internal factors allows strategists to more effectively generate and evaluate alternative strategies. Good
intuitive judgment is always needed in determining appropriate weights and ratings. Let us see External
Factor Evaluation (EFE) Matrix and the competitive profile matrix (CPM). The internal factor
evaluation matrix discussed in chapter 4.

External Factor Evaluation (EFE) Matrix

An External Factor Evaluation (EFE) Matrix allows strategists to summarize and evaluate economic,
social, cultural, demographic, environmental, political, governmental, legal, technological, and
competitive information. The EFE Matrix can be developed in five steps:

1. List key external factors as identified in the external-audit process. Include a total of 15 to 20 factors,
including both opportunities and threats that affect the firm and its industry. List the opportunities

58
 first and then the threats. Be as specific as possible, using percentages, ratios, and comparative
numbers whenever possible.
2. Assign to each factor a weight that ranges from 0.0 (not important) to 1.0 (very important). The
weight indicates the relative importance of that factor to being successful in the firm’s industry.
Opportunities often receive higher weights than threats, but threats can receive high weights if they
are especially severe or threatening. Appropriate weights can be determined by comparing successful
with unsuccessful competitors or by discussing the factor and reaching a group consensus. The sum
of all weights assigned to the factors must equal 1.0.
3. Assign a rating between 1 and 4 to each key external factor to indicate how effectively the firm’s
current strategies respond to the factor, where 4 = the response is superior, 3 = the response is above
average, 2 = the response is average and 1 = the response is poor. Ratings are based on effectiveness
of the firm’s strategies. Ratings are thus company-based, whereas the weights in Step 2 are industry-
based. It is important to note that both threats and opportunities can receive a 1, 2, 3, or 4.
4. Multiply each factor’s weight by its rating to determine a weighted score.
5. Sum the weighted scores for each variable to determine the total weighted score for the organization.

Regardless of the number of key opportunities and threats included in an EFE Matrix, the highest possible
total weighted score for an organization is 4.0 and the lowest possible total weighted score is 1.0. The
average total weighted score is 2.5. A total weighted score of 4.0 indicates that an organization is
responding in an outstanding way to existing opportunities and threats in its industry. In other words, the
firm’s strategies effectively take advantage of existing opportunities and minimize the potential adverse
effects of external threats. A total score of 1.0 indicates that the firm’s strategies are not capitalizing on
opportunities or avoiding external threats.

Table 5.4 External Factor Evaluation (EFE) Matrix - Example

Factor Weight Rating Weighted
Score
Opportunities
1 High-end in-home entertainment sales are growing nationally 0.15 4 0.60
2 Forecast for continued growth of expensive housing in Dade & 0.16 4 0.64
Broward counties
3 Wealthy foreigners buy expensive entertainment equipment for their 0.07 3 0.21
homes in South Florida
4 Current customers refer new prospects with little prompting 0.12 3 0.36
5 Direct mailing lists are available by household income 0.06 3 0.18
Threats
1 Large chains could expand upward into their niche 0.13 1 0.13
2 New technologies such as satellite broadcast compete with current 0.10 1 0.10
technologies
3 Declining incomes in South Florida versus the U.S. 0.08 2 0.16
4 South Florida highly dependent on trade with Latin America 0.07 1 0.07
5 Economy depends on air transport, a volatile industry 0.06 2 0.12
Total 1.00 2.57
Note that the total weighted score of 2.57 is above the average (midpoint) of 2.5, so this cinema business
is doing pretty well, taking advantage of the external opportunities and avoiding the threats facing the
firm.

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The Competitive Profile Matrix (CPM)

The Competitive Profile Matrix (CPM) identifies a firm’s major competitors and its particular strengths
and weaknesses in relation to a sample firm’s strategic position. The weights and total weighted scores in
both a CPM and an EFE have the same meaning. However, critical success factors in a CPM include both
internal and external issues. In a CPM, the ratings and total weighted scores for rival firms can be
compared to the sample firm. This comparative analysis provides important internal strategic information.

The first step is to find the critical success factors for the company and attach weight to those factors
according to their relative importance. In the next step, company need to identify its major competitors and
rate each competitors including company itself on each of the critical success factors. critical success
factors include both internal and external issues and different ratings have been given from 1 to 4
considering their relative importance to the organization where 1 stands for major weakness, 2 stands for
minor weakness, 3 stands for minor strength, and 4 stands for major strength. Same method has been
applied when rating to the critical success factors of competitors. Lastly, company has to multiply the
weight by the rating for each factor to get a weighted score and then adds up each competitor’s weighted
scores to get a total weighted score.

Table 5.5. The Competitive Profile Matrix (CPM) example

Key Success Factors Weight

Company A Competitor 1 Competitor 2

Score Weighted Score Weighted Score Weighted

Score Score Score
Innovation 0.25 4 1.00 4 1.00 3 0.75
Advertising 0.20 2 0.40 3 0.60 4 0.80
Brand Name 0.20 1 0.20 4 0.80 2 0.40
Product Quality 0.15 4 0.60 2 0.30 2 0.30
Customer Service 0.10 3 0.30 2 0.20 1 0.10
Price Competitiveness 0.05 3 0.15 3 0.15 4 0.20
Technological 0.05 3 0.15 1 0.05 2 0.10
Competence

Total 1 2.80 3.10 2.65

This table portrays the competitive scenarios of the company and its competitors in the industry. From this
table, it is found that the company A scores better (strengths) in innovation and product quality, and
assumes minor strength in customer service, price competitiveness, and in technological competence.
Albeit, company has minor weakness in advertising and major weakness is in brand name. As a whole, its
total score is 2.80 and on the other hand, its competitor A’s and competitor B’s total scores are 3.10, and
2.65 respectively. From this competitive profile matrix, it is revealed that competitor 1 enjoys more
competitive advantages by 0.30 than the company itself while competitor 2 is lagging behind by 0.15.

Stage 2 (The Matching Stage)

Strategy is sometimes defined as the match an organization makes between its internal resources and
skills and the opportunities and risks created by its external factors. The matching stage of the strategy-
formulation framework consists of five techniques that can be used in any sequence: the Strengths-
Weaknesses-Opportunities-Threats (SWOT) Matrix, the Strategic Position and Action Evaluation

60
(SPACE) Matrix, the Boston Consulting Group (BCG) Matrix, the Internal-External (IE) Matrix, and the
Grand Strategy Matrix. These tools rely upon information derived from the input stage to match external
opportunities and threats with internal strengths and weaknesses. Matching external and internal critical
success factors is the key to effectively generating feasible alternative strategies.

The basic concept of matching is illustrated in Table 5-6. Any organization, whether military, product-
oriented, service-oriented, governmental, or even athletic, must develop and execute good strategies to
win. A good offense without a good defense, or vice versa, usually leads to defeat. Developing strategies
that use strengths to capitalize on opportunities could be considered an offense, whereas strategies
designed to improve upon weaknesses while avoiding threats could be termed defensive. Every
organization has some external opportunities threats and internal strengths and weaknesses that can be
aligned to formulate feasible alternative strategies.

Table 5.6 Matching Key External and Internal Factors to Formulate Alternative Strategies

Key Internal Factor Key External Factor Resultant Strategy

Excess working capital (an + 20 percent annual growth in Acquire Cellfone, Inc.
internal strength the cell phone industry (an
external opportunity)
Insufficient capacity (an internal + Exit of two major foreign Pursue horizontal integration by
weakness) competitors from the industry (an buying
external opportunity) competitors’ facilities
Strong R&D expertise (an + Decreasing numbers of Develop new products for older
internal strength) younger adults (an adults
external threat)
Poor employee morale (an + Rising healthcare costs (an Develop a new wellness program
internal weakness) external threat)

The Strengths-Weaknesses-Opportunities-Threats (SWOT) Matrix

The Strengths-Weaknesses-Opportunities-Threats (SWOT) Matrix is an important matching tool that
helps managers develop four types of strategies: SO (strengths-opportunities) Strategies,
WO (weaknesses-opportunities) Strategies, ST (strengths-threats) Strategies, and WT (weaknesses-
threats) Strategies.

Matching key external and internal factors is the most difficult part of developing a SWOT Matrix and
requires good judgment—and there is no one best set of matches. Note in Table 6-1 that the first, second,
third, and fourth strategies are SO, WO, ST, and WT strategies, respectively.
 SO Strategies use a firm’s internal strengths to take advantage of external opportunities. All
managers would like their organizations to be in a position in which internal strengths can be used to
take advantage of external trends and events. For example, a firm with excess working capital (an
internal strength) could take advantage of the cell phone industry’s 20 percent annual growth rate (an
external opportunity) by acquiring Cellfone, Inc., a firm in the cell phone industry. Organizations
generally will pursue WO, ST, or WT strategies to get into a situation in which they can apply SO
Strategies. When a firm has major weaknesses, it will strive to overcome them and make them
strengths. When an organization faces major threats, it will seek to avoid them to concentrate on
opportunities.
 WO Strategies aim at improving internal weaknesses by taking advantage of external opportunities.
Sometimes key external opportunities exist, but a firm has internal weaknesses that prevent it from
exploiting those opportunities. For example, there may be a high demand for electronic devices to
control the amount and timing of fuel injection in automobile engines (opportunity), but a certain auto
parts manufacturer may lack the technology required for producing these devices (weakness). One
possible WO Strategy would be to acquire this technology by forming a joint venture with a firm

61
 having competency in this area. An alternative WO Strategy would be to hire and train people with
the required technical capabilities.
 ST Strategies use a firm’s strengths to avoid or reduce the impact of external threats. This does not
mean that a strong organization should always meet threats in the external environment head-on.
 WT Strategies are defensive tactics directed at reducing internal weakness and avoiding external
threats. An organization faced with numerous external threats and internal weaknesses may indeed be
in a precarious position. In fact, such a firm may have to fight for its survival, merge, retrench,
declare bankruptcy, or choose liquidation.

The Strategic Position and Action Evaluation (SPACE) Matrix

The Strategic Position and Action Evaluation (SPACE) Matrix, another important Stage 2 matching tool.
Its four-quadrant framework indicates whether aggressive, conservative, defensive, or competitive
strategies are most appropriate for a given organization. The axes of the SPACE Matrix represent two
internal dimensions (financial position [FP] and competitive position [CP]) and two external dimensions
(stability position [SP] and industry position [IP]).

These four factors are perhaps the most important determinants of an organization’s overall strategic
position. Depending on the type of organization, numerous variables could make up each of the
dimensions represented on the axes of the SPACE Matrix. Factors that were included earlier in the firm’s
EFE and IFE Matrices should be considered in developing a SPACE
The steps required to develop a SPACE Matrix are as follows:
1. Select a set of variables to define financial position (FP), competitive position (CP), Stability
position (SP), and industry position (IP).
2. Assign a numerical value ranging from +1 (worst) to +7 (best) to each of the variables that make up
the FP and IP dimensions. Assign a numerical value ranging from -1 (best) to -7 (worst) to each of the
variables that make up the SP and CP dimensions. On the FP and CP axes, make comparison to
competitors. On the IP and SP axes, make comparison to other industries.
3. Compute an average score for FP, CP, IP, and SP by summing the values given to the variables of
each dimension and then by dividing by the number of variables included in the respective dimension.
4. Plot the average scores for FP, IP, SP, and CP on the appropriate axis in the SPACE Matrix.
5. Add the two scores on the x-axis and plot the resultant point on X. Add the two scores on the y-axis
and plot the resultant point on Y. Plot the intersection of the new xy point.
6. Draw a directional vector from the origin of the SPACE Matrix through the new intersection point.
This vector reveals the type of strategies recommended for the organization: aggressive, competitive,
defensive, or conservative.

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63
The Boston Consulting Group (BCG) Matrix
Autonomous (independent) divisions (or profit centers) of an organization make up what is called a
business portfolio. When a firm’s divisions compete in different industries, a separate strategy often must
be developed for each business. The Boston Consulting Group (BCG) Matrix designed specifically to
enhance a multidivisional firm’s efforts to formulate strategies (BCG is a private management-consulting
firm based in Boston).
The BCG Matrix graphically portrays differences among divisions in terms of relative market share
position and industry growth rate. The BCG Matrix allows a multidivisional organization to manage its
portfolio of businesses by examining the relative market share position and the industry growth rate of
each division relative to all other divisions in the organization. Relative market share position is defined
as the ratio of a division’s own market share (or revenues) in a particular industry to the market share (or
revenues) held by the largest rival firm in that industry.
Relative market share position is given on the x-axis of the BCG Matrix. The midpoint on the x-axis
usually is set at .50, corresponding to a division that has half the market share of the leading firm in the

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industry. The y-axis represents the industry growth rate in sales, measured in percentage terms. The
growth rate percentages on the y-axis could range from -20 to +20 percent, with 0.0 being the midpoint.
The average annual increase in revenues for several leading firms in the industry would be a good
estimate of the value.
Divisions located in Quadrant I of the BCG Matrix are called “Question Marks,” those located in
Quadrant II are called “Stars,” those located in Quadrant III are called “Cash Cows,” and those divisions
located in Quadrant IV are called “Dogs.”

1. Question Marks—Divisions in Quadrant I have a low relative market share position, yet they
compete in a high-growth industry. Generally, these firms’ cash needs are high and their cash
generation is low. These businesses are called Question Marks because the organization must decide
whether to strengthen them by pursuing an intensive strategy (market penetration, market
development, or product development) or to sell them.
2. Stars: Quadrant II businesses (Stars) represent the organization’s best long-run opportunities for
growth and profitability. Divisions with a high relative market share and a high industry growth rate
should receive substantial investment to maintain or strengthen their dominant positions. Forward,
backward and horizontal integration; market penetration; market development; and product
development are appropriate strategies for these divisions.
3. Cash Cows: Divisions positioned in Quadrant III have a high relative market share position but
compete in a low-growth industry. Called Cash Cows because they generate cash in excess of their
needs, they are often milked. Many of today’s Cash Cows were yesterday’s Stars. Cash Cow
divisions should be managed to maintain their strong position for as long as possible. Product
development or diversification may be attractive strategies for strong Cash Cows. However, as a Cash
Cow, division becomes weak, retrenchment or divestiture can become more appropriate.
4. Dogs: Quadrant IV divisions of the organization have a low relative market share position and
compete in a slow- or no-market-growth industry; they are Dogs in thefirm’s portfolio. Because of
their weak internal and external position, these businesses are often liquidated, divested, or trimmed
down through retrenchment. When a division first becomes a Dog, retrenchment can be the best

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 strategy to pursue because many Dogs have bounced back, after strenuous asset and cost reduction, to
become viable, profitable divisions.
The major benefit of the BCG Matrix is that it draws attention to the cash flow, investment
characteristics, and needs of an organization’s various divisions. The divisions of many firms evolve over
time: Dogs become Question Marks, Question Marks become Stars, Stars become Cash Cows, and Cash
Cows become Dogs in an ongoing counterclockwise motion. Less frequently, Stars become Question
Marks, Question Marks become Dogs, Dogs become Cash Cows, and Cash Cows become Stars (in a
clockwise motion). In some organizations, no cyclical motion is apparent. Over time, organizations
should strive to achieve a portfolio of divisions that are Stars.
Stage three (The decision stage)
Stage 3, called the decision stage, and involves a single technique, the Quantitative Strategic Planning
Matrix (QSPM). A QSPM uses input information from Stage 1 to objectively evaluate feasible alternative
strategies identified in Stage 2. A QSPM reveals the relative attractiveness of alternative strategies and
thus provides objective basis for selecting specific strategies. This technique objectively indicates which
alternative strategies are best. The QSPM uses input from Stage 1 analyses and matching results from
Stage 2 analyses to decide objectively among alternative strategies. That is, the EFE Matrix, IFE Matrix,
and Competitive Profile Matrix that make up Stage 1, coupled with the SWOT Matrix, SPACE Matrix,
BCG Matrix, IE Matrix, and Grand Strategy Matrix that make up Stage 2, provide the needed information
for setting up the QSPM (Stage 3). The QSPM is a tool that allows strategists to evaluate alternative
strategies objectively, based on previously identified external and internal critical success factors. Like
other strategy-formulation analytical tools, the QSPM requires good intuitive judgment. Six steps
required to develop a QSPM are discussed:
Step 1 Make a list of the firm’s key external opportunities/threats and internal
strengths/weaknesses in the left column of the QSPM. This information should be taken directly from
the EFE Matrix and IFE Matrix. A minimum of 10 external key success factors and 10 internal key
success factors should be included in the QSPM.
Step 2 Assign weights to each key external and internal factor. These weights are identical to those in
the EFE Matrix and the IFE Matrix. The weights are presented in a straight column just to the right of the
external and internal critical success factors.
Step 3 Examine the Stage 2 (matching) matrices, and identify alternative strategies that the
organization should consider implementing. Record these strategies in the top row of the QSPM.
Group the strategies into mutually exclusive sets if possible.
Step 4 Determine the Attractiveness Scores (AS) defined as numerical values that indicate the relative
attractiveness of each strategy in a given set of alternatives.
Attractiveness Scores (AS) are determined by examining each key external or internal factor, one at a
time, and asking the question “Does this factor affect the choice of strategies being made?” If the answer
to this question is yes, then the strategies should be compared relative to that key factor. Specifically,
Attractiveness Scores should be assigned to each strategy to indicate the relative attractiveness of one
strategy over others, considering the particular factor. The range for Attractiveness Scores is 1 = not
attractive, 2 = somewhat attractive, 3 = reasonably attractive, and 4 = highly attractive. By attractive, we
mean the extent that one strategy, compared to others, enables the firm to either capitalize on the strength,
improve on the weakness, exploit the opportunity, or avoid the threat. Work row by row in developing a
QSPM. If the answer to the previous question is no, indicating that the respective key factor has no effect
upon the specific choice being made, then do not assign Attractiveness Scores to the strategies in that set.
Use a dash to indicate that the key factor does not affect the choice being made. Note: If you assign an

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AS score to one strategy, then assign AS score(s) to the other. In other words, if one strategy receives a
dash, then all others must receive a dash in a given row.
Step 5 Compute the Total Attractiveness Scores. Total Attractiveness Scores (TAS) are defined as the
product of multiplying the weights (Step 2) by the Attractiveness Scores (Step 4) in each row. The Total
Attractiveness Scores indicate the relative attractiveness of each alternative strategy, considering only the
impact of the adjacent external or internal critical success factor. The higher the Total Attractiveness
Score, the more attractive the strategic alternative (considering only the adjacent critical success
factor).
Step 6 Compute the Sum Total Attractiveness Score. Add Total Attractiveness Scores in each strategy
column of the QSPM. The Sum Total Attractiveness Scores (STAS) reveal which strategy is most
attractive in each set of alternatives. Higher scores indicate more attractive strategies, considering all the
relevant external and internal factors that could affect the strategic decisions. The magnitude of the
difference between the Sum Total Attractiveness Scores in a given set of strategic alternatives indicates
the relative desirability of one strategy over another.

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In the above table, two alternative strategies (1) buy new land and build new larger store and (2) fully
renovate existing store are being considered by a computer retail store. Note by sum total attractiveness
scores of 4.63 versus 3.27 that the analysis indicates the business should buy new land and build a new
larger store.

5.6 The Balanced Scorecard (BSC)

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Traditional financial reporting systems provide an indication of how a firm has performed in the past, but
offer little information about how it might perform in the future. For example, a firm might reduce its
level of customer service in order to boost current earnings, but then future earnings might be negatively
impacted due to reduced customer satisfaction. To deal with this problem, Robert Kaplan and David
Norton developed the Balanced Scorecard, a performance measurement system that considers not only
financial measures, but also customer, business process, and learning measures. BSC provide a
“balance” between financial measures and other measures that are important for understanding
organizational activities that lead to sustained, long-term performance.
The balanced scorecard translates the organization's strategy into four perspectives, with a balance
between the following:
 Between internal and external measures
 Between objective measures and subjective measures
 Between performance results and the drivers of future results

Balanced Scorecard Perspectives

In the industrial age, most of the assets of a firm were in property, plant, and equipment and the financial
accounting system performed an adequate job of valuing those assets. In the information age, much of the
value of the firm is embedded in innovative processes, customer relationships, and human resources. The
financial accounting system is not so good at valuing such assets. The Balanced Scorecard goes beyond
standard financial measures to include the following additional perspectives: the customer perspective,
the internal process perspective, and the learning and growth perspective.

 Financial perspective - includes measures such as operating income, return on capital employed,
and economic value added.
 Customer perspective - includes measures such as customer satisfaction, customer retention, and
market share in target segments.
 Business process perspective - includes measures such as cost, throughput, and quality. These
are for business processes such as procurement, production, and order fulfillment.
 Learning & growth perspective - includes measures such as employee satisfaction, employee
retention, skill sets, etc.

These four realms are not simply a collection of independent perspectives. Rather, there is a logical
connection between them - learning and growth lead to better business processes, which in turn lead to
increased value to the customer, which finally leads to improved financial performance.

Balanced Scorecard as a Strategic Management System

The Balanced Scorecard originally was conceived as an improved performance measurement system.
However, it soon became evident that it could be used as a management system to implement strategy at
all levels of the organization by facilitating the following functions:

1. Clarifying strategy - the translation of strategic objectives into quantifiable measures clarifies
the management team's understanding of the strategy and helps to develop a coherent consensus.
2. Communicating strategic objectives - the Balanced Scorecard can serve to translate high level
objectives into operational objectives and communicate the strategy effectively throughout the
organization.
3. Planning, setting targets, and aligning strategic initiatives - ambitious but achievable targets
are set for each perspective and initiatives are developed to align efforts to reach the targets.
4. Strategic feedback and learning - executives receive feedback on whether the strategy
implementation is proceeding according to plan and on whether the strategy itself is successful
("double-loop learning").

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5.7 The 7‘S Model
How do you go about analyzing how well your organization is positioned to achieve its intended
objective? This is a question that has been asked for many years, and there are many different
[Link] approaches look at internal factors, others look at external ones, some combine these
perspectives, and others look for congruence between various aspects of the organization being studied.
Ultimately, the issue comes down to which factors to [Link] some models of organizational
effectiveness go in and out of fashion; one that has persisted is the McKinsey 7’s framework. Developed
in the early 1980s by Tom Peters and Robert Waterman, two consultants working at the McKinsey &
Company consulting firm, the basic premise of the model is that there are seven internal aspects of an
organization that need to be aligned if it is to be [Link] model can be applied to elements of a
team or a project as well. The alignment issues apply, regardless of how you decide to define the scope of
the areas you study.
The Seven S Elements
The McKinsey 7’s model involves seven interdependent factors which are categorized as either "hard" or
"soft" elements:
Hard Elements Soft Elements
Strategy Shared Values
Structure Skills
Systems Style
Staff

The Hard S’s

The hard elements (strategy, structure and system) are easier to define or identify and management can
directly influence them. They can be found in strategy statements, corporate plans, organizational charts
and other documentations.
 Strategy: Actions a company plans in response to or anticipation of changes in itsexternal
environment.
 Structure:Basis for specializationand co-ordination influenced primarily by strategy and by
organization size and diversity.
 Systems: Formal and informal procedures that support the strategy and structure. (Systems are more
powerful thanthey are given credit)

The Soft S’s

The four soft s’s however, are hardly feasible. They are difficult to describe since capabilities, values and
elements of corporate culture are continuously developing and changing. They are highly determined by
the people at work in the organization. Therefore, it is much more difficult to plan or to influence the
characteristics of the soft elements. Although the soft factors are below the surface, they can have a great
impact of the hard structures, strategies and systems of the organization.

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Style: Management Style; more a matter of what managers do than what they say; How do a
company’smanagers spend their time? What are they focusing attention on? Symbolism –the creation and
maintenance (or sometimes deconstruction) of meaning is a fundamental responsibility of managers.
Staff: The people/human resource management – processes used to develop managers, socialization
processes, ways of shaping basic values of management cadre, ways of introducing youngrecruits to the
company, ways of helping to manage the careers of employees.
Skills:The distinctive competences –what the company does best, ways ofexpanding or shifting
competences
Shared Values/Superordinate Goals:Guiding concepts, fundamental ideas around which a business is
built –must besimple, usually stated at abstract level, have great meaning inside the organization even
though outsiders may not see or understandthem.
How to Use the Model?
Now you know what the model covers, how can you use it?
The model is based on the theory that, for an organization to perform well, these seven elements need to
be aligned and mutually reinforcing. So, the model can be used to help identify what needs to be realigned
to improve performance, or to maintain alignment (and performance) during other types of change.
Whatever the type of change – restructuring, new processes, organizational merger, new systems, change
of leadership, and so on – the model can be used to understand how the organizational elements are
interrelated, and so ensure that the wider impact of changes made in one area is taken into consideration.

CHAPTER SIX
STRATEGY IMPLEMENTATION
(IMPLEMENTING STRATEGIES MANAGEMENT ISSUES)

“Notable Quotes”
"Objectives can be compared to a compass bearing by which a ship navigates. A compass bearing is firm,
but "in actual navigation, a ship may veer off its course for many miles. Without a compass bearing, a
ship would neither find its port nor be able to estimate the time required to get there."—Peter Drucker

6.1 Introduction
Strategy implementation is the sum total of the activities and choices required for the execution of a
strategic plan. It is the process by which objectives, strategies, and policies are put into action through the
development of programs, budgets, and procedures. Strategy formulation and strategy implementation
should thus be considered as two sides of the same coin. To begin the implementation process, strategy
makers must consider three questions:
• Who are the people who will carry out the strategic plan?
• What must be done?
• How are they going to do what is needed?
Management should have addressed these questions and similar ones initially when they analyzed the
pros and cons of strategic alternatives, but the questions must be addressed again before management can
make appropriate implementation plans. Unless top management can answer these basic questions
satisfactorily, even the best-planned strategy is unlikely to provide the desired outcome.
6.2 The nature of strategy implementation

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The strategic management process does not end when the firm decides what strategies to pursue. There
must be a translation of strategy thought into strategic action. Translation requires support of all managers
and employees of the business. Implementing strategy affects an organization from top to bottom; it
affects all the functional and divisional areas of a business. Successful strategy formulation does not
guarantee successful strategy implementation. The greatest strategy is doomed if it is implemented badly.
Strategy-formulation concepts and tools do not differ greatly for small, large, for-profit, or nonprofit
organizations. However, strategy implementation varies substantially among different types and sizes of
organizations. Implementing strategies requires such actions as altering sales territories, adding new
departments, closing facilities, hiring new employees, changing an organization’s pricing strategy,
developing financial budgets, developing new employee benefits, establishing cost-control procedures,
changing advertising strategies, building new facilities, training new employees, transferring managers
among divisions, and building a better management information system. These types of activities
obviously differ greatly between manufacturing, service, and governmental organizations.
It is always more difficult to do something (strategy implementation) than to say you are going to do it
(strategy formulation)! Although inextricably linked, strategy implementation is fundamentally different
from strategy formulation. Strategy formulation and implementation can be contrasted in the following
ways:
Strategy Formulation Strategy Implementation
 Is positioning forces before the action  Is managing forces during the action.
 Focuses on effectiveness.  Focuses on efficiency.
 Is primarily an intellectual process.  Is primarily an operational process.
 Requires good intuitive and analytical skills.  Requires special motivation and leadership
skills.
 Requires coordination among a few  Requires coordination among many
individuals. individuals.

6.3 Management Issues Central to Strategy Implementation

The management issues central to strategy implementation include establishing annual objectives,
devising policies, allocating resources, altering an existing organizational structure, restructuring and
reengineering, revising reward and incentive plans, minimizing resistance to change, matching managers
with strategy, developing a strategy supportive culture, adapting production/operations processes,
developing an effective human resources function, and, if necessary, downsizing.
1. Establishing Annual Objectives

Annual objectives are short-term milestones that organizations must achieve to reach long-term
objectives. Annual objectives should be stated in terms of functional areas. A set of annual objectives is
needed for each long-term objective. Annual objectives are essential for strategy implementation because
they (1) represent the basis for allocating resources; (2) are a primary mechanism for evaluating
managers; (3) are the major instrument for monitoring progress toward achieving long-term objectives;
and (4) establish organizational, divisional, and departmental priorities. Considerable time and effort
should be devoted to ensuring that annual objectives are well conceived, consistent with long-term
objectives, and supportive of strategies to be implemented. Annual objectives should be compatible with
employees’ and managers’ values and should be supported by clearly stated policies. Annual objectives
should be measurable, consistent, reasonable, challenging, clear, communicated throughout the
organization, characterized by an appropriate time dimension, and accompanied by commensurate

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rewards and sanctions. Annual objectives should be compatible with employees and managers’ values and
should be supported by clearly stated policies.
The purpose of annual objectives can be summarized as follows:
 Annual objectives serve as guidelines for action, directing and channeling efforts and activities of
organization members. They provide a source of legitimacy in an enterprise by justifying activities to
stakeholders. They serve as standards of performance.


LONG-TERM COMPANY OBJECTIVE

Double company revenues in two years through
market development and market penetration.
(Current revenues are $2 million.)

DIVISION I
DIVISION II DIVISION III
ANNUAL OBJECTIVE
Increase divisional ANNUAL OBJECTIVE ANNUAL OBJECTIVE
Increase divisional Increase divisional
revenues by 40% this
year and 40% next year. revenues by 40% this revenues by 50% this
(Current revenues are year and 40% next year. year and 50% next year.
(Current revenues are (Current revenues are
$1 million.)
$0.5 million.) $0.5 million.)

R&D Production Marketing Finance Personnel

annual annual annual objective annual annual
objective objective Increase the objective objective
Develop two new Increase number of Obtain long-term Reduce employee
products this year production salespeople by 40 Financing of absenteeism
that are Efficiency by 30% this year. $400,000 in the from 10% to
successfully this next six months 5% this year.
marketed. year.

Figure 6.1 hierarchy of objectives

2. Devise Policies
Policies facilitate solving recurring problems and guide the implementation of strategy. Broadly defined,
policy refers to specific guidelines, methods, procedures, rules, forms, and administrative practices
established to support and encourage work toward stated goals. Policies are instruments for strategy
implementation. Policies set boundaries, constraints, and limits on the kinds of administrative actions that
can be taken to reward and sanction behavior; they clarify what can and cannot be done in pursuit of an
organization’s objectives. Policies let both employees and managers know what is expected of them,
thereby increasing the likelihood that strategies will be implemented successfully. They provide a basis
for management control, allow coordination across organizational units, and reduce the amount of time
managers spend making decisions. Policies also clarify what work is to be done and by whom. They
promote delegation of decision making to appropriate managerial levels where various problems usually
arise. Many organizations have a policy manual that serves to guide and direct behavior.
Policies can apply to all divisions and departments (for example, “We are an equal opportunity
employer”). Some policies apply to a single department (“Employees in this department must take at least
one training and development course each year”). Whatever their scope and form, policies serve as a

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mechanism for implementing strategies and obtaining objectives. Policies should be stated in writing
whenever possible. They represent the means for carrying out strategic decisions.
3. Allocate Resource

Resource allocation is a central management activity that allows for strategy execution. In organizations
that do not use a strategic-management approach to decision making, resource allocation is often based on
political or personal factors. Strategic management enables resources to be allocated according to
priorities established by annual [Link] could be more detrimental to strategic management
and to organizational success than for resources to be allocated in ways not consistent with priorities
indicated by approved annual objectives.
All organizations have at least four types of resources that can be used to achieve desired objectives:
financial resources, physical resources, human resources, and technological resources. Allocating
resources to particular divisions and departments does not mean that strategies will be successfully
implemented. A number of factors commonly prohibit effective resource allocation including:
overprotection of resources, too great emphasis on short-run financial criteria, organizational politics,
vague strategy targets, reluctance to take risks and lack of sufficient knowledge.
4. Managing Conflict
Interdependency of objectives and competition for limited resources often leads to conflict. Conflict can
be defined as a disagreement between two or more parties on one or more issues. Establishing annual
objectives can lead to conflict because individuals have different expectations and perceptions, schedules
create pressure, personalities are incompatible, and misunderstandings between line managers (such as
production supervisors) and staff managers (such as human resource specialists) occur. For example, a
collection manager’s objective of reducing bad debts by 50 percent in a given year may conflict with a
divisional objective to increase sales by 20 percent.
Establishing objectives can lead to conflict because managers and strategists must make trade-offs, such
as whether to emphasize short-term profits or long-term growth, profit margin or market share, market
penetration or market development, growth or stability, high risk or low risk, and social responsiveness or
profit maximization. Trade-offs are necessary because no firm has sufficient resources pursue all
strategies to would benefit the firm.
Conflict is unavoidable in organizations, so it is important that conflict be managed and resolved before
dysfunctional consequences affect organizational performance. Conflict is not always bad. An absence of
conflict can signal indifference and apathy. Conflict can serve to energize opposing groups into action and
may help managers identify problems.
Various approaches for managing and resolving conflict can be classified into three categories:
1. Avoidance: includes such actions as ignoring the problem in hopes that the conflict will resolve itself
or physically separating the conflicting individuals (or groups).
2. Defusion: can include playing down differences between conflicting parties while emphasizing on
similarities and common interests, compromising so that there is neither a clear winner nor a loser,
resorting to majority rule, appealing to a higher authority, or redesigning present positions.
3. Confrontation: is exemplified by exchanging members of conflicting parties so that each can gain an
appreciation of the other’s point of view or holding a meeting at which conflicting parties present
their views and work through their differences.

4. Matching Structure with Strategy

Changes in strategy often require changes in the way an organization is structured for two major reasons:
First, structure largely dictates how objectives and policies will be established. For example, objectives
and policies established under a geographic organizational structure are couched in geographic terms.

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Objectives and policies are stated largely in terms of products in an organization whose structure is based
on product groups. The structural format for developing objectives and policies can significantly impact
all other strategy-implementation activities.
The second major reason why changes in strategy often require changes in structure is that structure
dictates how resources will be allocated. If an organization’s structure is based on customer groups, then
resources will be allocated in that manner. Similarly, if an organization’s structure is set up along
functional business lines, then resources are allocated by functional areas. Unless new or revised
strategies place emphasis in the same areas as old strategies, structural reorientation commonly becomes a
part of strategy implementation.
Changes in strategy lead to changes in organizational structure. Structure should be designed to facilitate
the strategic pursuit of a firm and, therefore, follow strategy. Without a strategy or reasons for being
(mission), companies find it difficult to design an effective structure.
Structure undeniably can and does influence strategy. Strategies formulated must be workable, so if a
certain new strategy required massive structural changes it would not be an attractive choice. In this way,
structure can shape the choice of strategies. But a more important concern is determining what types of
structural changes are needed to implement new strategies and how these changes can best be
accomplished.

5. Restructuring and Reengineering

Restructuring
Restructuring—also called downsizing, rightsizing, or delayering—involves reducing the size of the firm
in terms of number of employees, number of divisions or units, and number of hierarchical levels in the
firm’s organizational structure. This reduction in size is intended to improve both efficiency and
effectiveness. Restructuring is concerned primarily with shareholder well-being rather than employee
well-being.
Firms often employ restructuring when various ratios appear out of line with competitors as determined
through benchmarking exercises. Recall that benchmarking simply involves comparing a firm against the
best firms in the industry on a wide variety of performance related criteria. Some benchmarking ratios
commonly used in rationalizing the need for restructuring are headcount-to-sales-volume, or corporate-
staff-to-operating-employees,or span-of-control figures. The primary benefit sought from restructuring is
cost reduction. For some highly bureaucratic firms, restructuring can actually rescue the firm from global
competition and demise. However, the downside of restructuring can be reduced employee commitment,
creativity, and innovation that accompanies the uncertainty and trauma associated with pending and actual
employee layoffs.
Reengineering
Reengineering—also called process management, process innovation, or process redesign—involves
reconfiguring or redesigning work, and processes for the purpose of improving cost, quality, service, and
speed. Reengineering is concerned more with employee and customer wellbeing than shareholder well-
being. Reengineering does not usually affect the organizational structure or chart, nor does it imply job
loss or employee layoffs. Whereas restructuring is concerned with eliminating or establishing, shrinking
or enlarging, and moving organizational departments and divisions, the focus of reengineering is
changing the way work is actually carried out.
In reengineering, a firm uses information technology to break down functional barriers and create a work
system based on business processes, products, or outputs rather than on functions or inputs.

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Cornerstones of reengineering are decentralization, reciprocal interdependence, and information sharing.
Reengineering is characterized by many tactical (short-term, business-function-specific) decisions,
whereas restructuring is characterized by strategic (long-term, affecting all business functions) decisions.
A benefit of reengineering is that it offers employees the opportunity to see more clearly how their
particular jobs affect the final product or service being marketed by the firm. However, reengineering can
also raise manager and employee anxiety, which, unless calmed, can lead to corporate trauma.
6. Minimize Resistance to Change
Resistance to change is refusal to accept changes that will be implemented in [Link]
organization or individual can escape from change. However, the thought of change raises anxieties
because people fear economic loss, inconvenience, uncertainty, and a break in normal social patterns.
Almost any change in structure, technology, people, or strategies has the potential to disrupt comfortable
interaction patterns. For this reason, people resist change. The strategic-management process itself can
impose major changes on individuals and processes. Reorienting an organization to get people to think
and act strategically is not an easy task.
Resistance to change can be considered the single greatest threat to successful strategy implementation.
Resistance regularly occurs in organizations in the form of sabotaging production machines, absenteeism,
filing unfounded grievances, and an unwillingness to cooperate. People often resist strategy
implementation because they do not understand what is happening or why changes are taking place. In
that case, employees may simply need accurate information. Successful strategy implementation hinges
upon managers’ ability to develop an organizational climate conducive to change. Change must be
viewed as an opportunity rather than as a threat by managers and employees. Because of diverse external
and internal forces, change is a fact of life in organizations. The rate, speed, magnitude, and direction of
changes vary over time by industry and organization.
Organizational change should be viewed today as a continuous process rather than as a project or event.
The most successful organizations today continuously adapt to changes in the competitive environment,
which themselves continue to change at an accelerating rate. It is not sufficient today to simply react to
change. Managers need to anticipate change and ideally be the creator of change. Viewing change as a
continuous process is in stark contrast to an old management doctrine regarding change, which was to
unfreeze behavior, change the behavior, and then refreeze the new behavior.

Resistance to change can emerge at any stage or level of the strategy-implementation process. Although
there are various approaches for implementing changes, three commonly used strategies are:
1. Force change strategy: involves giving orders and enforcing those orders; this strategy has the
advantage of being fast, but it is plagued by low commitment and high resistance.
2. Educative change strategy:is one that presents information to convince people of the need for
change; the disadvantage of an educative change strategy is that implementation becomes slow and
difficult. However, this type of strategy evokes greater commitment and less resistance than does the
force change strategy.
3. Rational or self-interest change strategy: is one that attempts to convince individuals that the
change is to their personal advantage. When this appeal is successful, strategy implementation can be
relatively easy. However, implementation changes are seldom to everyone’s [Link] rational
change strategy is the most desirable, so this approach is examined a bit further. Managers can
improve the likelihood of successfully implementing change by carefully designing change efforts.

7. Creating a Strategy-Supportive Culture

Strategists should strive to preserve, emphasize, and build upon aspects of an existing culture that support
proposed new strategies. Aspects of an existing culture that are antagonistic to a proposed strategy should

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be identified and changed. Changing a firm’s culture to fit a new strategy is usually more effective than
changing a strategy to fit an existing culture. Numerous techniques are available to alter an organization’s
culture, including recruitment, training, transfer, promotion, restructure of an organization’s design, role
modeling, positive reinforcement, and mentoring.
The following elements are most useful in linking culture to strategy:
 Formal statements of organizational philosophy, charters, creeds, materials used for recruitment
and selection, and socialization
 Designing of physical spaces, facades, buildings
 Deliberate role modeling, teaching, and coaching by leaders
 Explicit reward and status system, promotion criteria
 Stories, legends, myths, and parables about key people and events
 What leaders pay attention to, measure, and control?
 Leader reactions to critical incidents and organizational crises
 How the organization is designed and structured
 Organizational systems and procedures
 Criteria used for recruitment, selection, promotion, leveling off, retirement, and
“excommunication” of people
8. Linking performance and pay to strategies
How can an organization’s reward system be more closely linked to strategic performance? How can
decisions on salary increases, promotions, merit pay, and bonuses be more closely aligned to support the
long-term strategic objectives of the organization? There are no widely accepted answers to these
questions, but a dual bonus system based on both annual objectives and long-term objectives is becoming
common. The percentage of a manager’s annual bonus attributable to short-term versus long-term results
should vary by hierarchical level in the organization. A chief executive officer’s annual bonus could, for
example, be determined on a 75 percent shortterm and 25 percent long-term basis. It is important that
bonuses not be based solely on short-term results because such a system ignores long-term company
strategies and objectives.

9. Adapt Production/Operations processes

Production/operations capabilities, limitations, and policies can significantly enhance or inhibit the
attainment of objectives. Production processes typically constitute more than 70 percent of a firm’s total
assets. A major part of the strategy-implementation process takes place at the production site. Production-
related decisions on plant size, plant location, product design, choice of equipment, kind of tooling, size
of inventory, inventory control, quality control, cost control, use of standards, job specialization,
employee training, equipment and resource utilization, shipping and packaging, and technological
innovation can have a dramatic impact on the success or failure of strategy-implementation efforts.

10. Develop an Effective Human Resource Function

The job of human resource manager is changing rapidly as companies continue to downsize and
reorganize. Strategic responsibilities of the human resource manager include assessing the staffing needs
and costs for alternative strategies proposed during strategy formulation and developing a staffing plan for
effectively implementing strategies. This plan must consider how best to manage spiraling health care
insurance costs. The plan must also include how to motivate employees and managers during a time when
layoffs are common and workloads are high. Linking company and personal benefits is a major new
strategic responsibility of human resource managers. Other new responsibilities for human resource
managers may include establishing and administering an employee stock ownership plan (ESOP),
instituting an effective child-care policy, and providing leadership for managers and employees in a way
that allows them to balance work and family.

A well-designed strategic-management system can fail if insufficient attention is given to the human
resource dimension. Human resource problems that arise when businesses implement strategies can
usually be traced to one of three causes: (1) disruption of social and political structures, (2) failure to
match individuals’ aptitudes with implementation tasks, and (3) inadequate top management support for

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implementation activities. Strategy implementation poses a threat to many managers and employees in an
organization. New power and status relationships are anticipated and realized. New formal and informal
groups’ values, beliefs, and priorities may be largely unknown. Managers and employees may become
engaged in resistance behavior as their roles, prerogatives, and power in the firm change. Disruption of
social and political structures that accompany strategy execution must be anticipated and considered
during strategy formulation and managed during strategy implementation.
A concern in matching managers with strategy is that jobs have specific and relatively static
responsibilities, although people are dynamic in their personal development. Commonly used methods
that match managers with strategies to be implemented include transferring managers, developing
leadership workshops, offering career development activities, promotions, job enlargement, and job
enrichment.

Factors causing unsuccessful implementation of strategy

1. Unsuccessful coupling of the strategy to and actions: Unsuccessful coupling of strategy with the
actions necessary to implement it, both within the organization and in the external decision situations
with which it is concerned may cause unsuccessful implementation of strategy. This can be resulted
from a number of causes and conditions. For example, the unsatisfactory coupling of the new strategy
may be due to lack of explicit decoupling from previous strategy and commitment within the
organization itself. The decoupling may be caused by the existence of a sizable group of people in
the organization who are convinced that the new strategy is not practical and that the previous ways
and activities are best. Another factor for unsatisfactory coupling may be misperceptions by the
strategist of the impact of the newly proposed initiatives for the organization and its people. It is
sometimes assumed that the new initiative will be accepted by the organization with a minimum time
and effort from all those who are involved.
2. Insufficient attention- another major factor causing unsuccessful implementation of the strategy is
insufficient attention to the negotiation of outcomes in the external decision situation. It is the
tendency to assume once the strategy is formulated; that all is necessary to the success of the
organization is the aggressive pursuit of the strategy. However, the assumption holds well only as
long as there is no change in the decision situation. If these situations change, there should be a
corresponding change in the strategy also.
3. Defective strategy- Sometimes there may be a strategy, whichcannot be implemented within the
context of present and future organizational resources. The strategic choice should always be related
with organizational capability to implement it.

CHAPTER SEVEN
STRATEGY EVALUATION AND CONTROL

“Notable Quotes”
"Strategy evaluation must make it as easy as possible for managers to revise their plans and reach
quick agreement on the changes."—Dale McConkey

7.1The Nature of Strategy Evaluation

The best formulated and best implemented strategies become obsolete as a firm’s external and internal
environments change. It is essential, therefore, that strategists systematically review, evaluate, and control
the execution of strategies. The strategic-management process results in decisions that can have
significant, long-lasting consequences. Erroneous strategic decisions can cause severe penalties and can
be exceedingly difficult, if not impossible, to reverse. Most strategists agree, therefore, that strategy
evaluation is vital to an organization’s well-being; timely evaluations can alert management to problems

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or potential problems before a situation becomes critical. Strategy evaluation includes three basic
activities:
1) Examining the underlying bases of a firm’s strategy,
2) Comparing expected results with actual results,
3) Taking corrective actions to ensure that performance conforms to plans.
Adequate and timely feedback is the cornerstone of effective strategy evaluation. Strategy evaluation can
be no better than the information on which it is based. Too much pressure from top managers may result
in lower managers contriving numbers they think will be [Link] evaluation can be a
complex and sensitive undertaking. Too much emphasis on evaluating strategies may be expensive and
counterproductive. Strategy evaluation is essential to ensure that stated objectives are being achieved. In
many organizations, strategy evaluation is simply an appraisal of how well an organization has
performed. Have the firm’s assets increased? Has there been an increase in profitability? Have sales
increased? Have productivity levels increased? Have profit margin, return on investment, and
earnings-per-share ratios increased? Some firms argue that their strategy must have been correct if the
answers to these types of questions are affirmative. Well, the strategy or strategies may have been correct,
but this type of reasoning can be misleading because strategy evaluation must have both a long-run and
short-run focus. Strategies often do not affect short-term operating results until it is too late to make
needed changes. It is impossible to demonstrate conclusively that a particular strategy is optimal or even
to guarantee that it will work. One can, however, evaluate it for critical flaws.
Criteria for Evaluating Strategies
There are four criteria that could be used to evaluate a strategy: consistency, consonance, feasibility, and
advantage. Consonance and advantage are mostly based on a firm’s external assessment, whereas
consistency and feasibility are largely based on an internal assessment. Strategy evaluation is important
because organizations face dynamic environments in which key external and internal factors often change
quickly and dramatically. Success today is no guarantee of success tomorrow! An organization should
never be lulled into complacency with success.
Consistency
A strategy should not present inconsistent goals and policies. Organizational conflict and
interdepartmental bickering are often symptoms of managerial disorder, but these problems may also be a
sign of strategic inconsistency. Three guidelines help determine if organizational problems are due to
inconsistencies in strategy:
 If managerial problems continue despite changes in personnel and if they tend to be issue-based
rather than people-based, then strategies may be inconsistent.
 If success for one organizational department means, or is interpreted to mean, failure for another
department, then strategies may be inconsistent.
 If policy problems and issues continue to be brought to the top for resolution, then strategies may
be inconsistent.
Consonance
Consonance refers to the need for strategists to examine sets of trends, as well as individual trends, in
evaluating strategies. A strategy must represent an adaptive response to the external environment and to
the critical changes occurring within it. One difficulty in matching a firm’s key internal and external
factors in the formulation of strategy is that most trends are the result of interactions among other trends.
For example, the day-care explosion came about as a combined result of many trends that included a rise
in the average level of education, increased inflation, and an increase in women in the workforce.
Although single economic or demographic trends might appear steady for many years, there are waves of
change going on at the interaction level.

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Advantage
A strategy must provide for the creation and/or maintenance of a competitive advantage in a selected area
of activity. Competitive advantages normally are the result of superiority in one of three areas: (1)
resources, (2) skills, or (3) position. Positional advantage tends to be self-sustaining as long as the key
internal and environmental factors that underlie it remain stable. This is why entrenched firms can be
almost impossible to unseat, even if their raw skill levels are only average. Although not all positional
advantages are associated with size, it is true that larger organizations tend to operate in markets and use
procedures that turn their size into advantage, while smaller firms seek product/market positions that
exploit other types of advantage. The principal characteristic of good position is that it permits the firm to
obtain advantage from policies that would not similarly benefit rivals without the same position.
Therefore, in evaluating strategy, organizations should examine the nature of positional advantages
associated with a given strategy.
Feasibility
A strategy must neither overtax available resources nor create unsolvable sub problems. The final broad
test of strategy is its feasibility; that is, can the strategy be attempted within the physical, human, and
financial resources of the enterprise? The financial resources of a business are the easiest to quantify and
are normally the first limitation against which strategy is evaluated. In evaluating a strategy, it is
important to examine whether an organization has demonstrated in the past that it possesses the abilities,
competencies, skills, and talents needed to carry out a given strategy.

7.2 A strategy evaluation framework

Strategy-evaluation frameworkshows how the evaluation of strategy flows. The framework depicted
activates in terms of key questions that should be addressed, alternative answers to those questions, and
appropriate actions for an organization to take. Notice that corrective actions are almost always needed
except when (1) external and internal factors have not significantly changed and (2) the firm is
progressing satisfactorily toward achieving stated objectives. There are three basic activities to be
performed in evaluating strategy. These are:
I. Reviewing Bases of Strategy
Reviewing the underlying bases of an organization’s strategy could be approached by developing a
revised EFE Matrix and IFE Matrix. A revised IFE Matrix should focus on changes in the organization’s
management, marketing, finance/accounting,production/operations, R&D, and management information
systems strengths and weaknesses. A revised EFE Matrix should indicate how effective a firm’s strategies
have been in response to key opportunities and threats. This analysis could also address such questions as
the following.
 How have competitors reacted to our strategies?
 How have competitors' strategies changed?
 Have major competitor's strengths and weaknesses changed?
 Why are competitors making certain strategic changes?
 Why are some competitor's strategies more successful than others?
 How satisfied are our competitors with their present market positions and profitability?
 How far can our major competitors be pushed before retaliating?
 How could we more effectively cooperate with our competitors?
Numerous external and internal factors can prevent firms from achieving long-term and annual objectives.
Externally, actions by competitors, changes in demand, changes in technology, economic changes,
demographic shifts, and governmental actions may prevent objectives from being accomplished.
Internally, ineffective strategies may have been chosen or implementation activities may have been poor.

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Objectives may have been too optimistic. Thus, failure to achieve objectives may not be the result of
unsatisfactory work by managers and employees. All organizational members need to know this to
encourage their support for strategy-evaluation activities. Organizations desperately need to know as soon
as possible when their strategies are not effective.
External opportunities and threats and internal strengths and weaknesses that represent the bases of
current strategies should continually be monitored for change. It is not really a question of whether these
factors will change but rather when they will change and in [Link] are some key questions to
address in evaluating strategies:
 Are our internal strengths still strengths?
 Have we added other internal strengths? If so, what are they?
 Are our internal weaknesses still weaknesses.
 Do we now have other internal weaknesses? If so, what are they?
 Are our external opportunities still opportunities?
 Are there now other external opportunities? If so, what are they?
 Are our external threats still threats?
 Are there now other external threats? If so, what are they?
 Are we vulnerable to a hostile takeover?
Fig 7.1 A Strategy-Evaluation Framework
Activity
ACTIVITY ONE: one:
REVIEW review underlying
UNDERLYING bases
BASES OF STRATEGY of strategy
Prepare Revised Internal Prepare Revised External
Prepare Revised Internal Prepare Revised External
Factor Evaluation (IFE) MatrixFactor Evaluation (EFE) Matrix
Factor Evaluation (IFE) Matrix Factor Evaluation (EFE) Matrix
Compare Revised to Compare Revised to
Compare Revised
Existing Internal to
factor Compare Revised to
Existing External Factor
Existing Internal factor
Evaluation (IFE) Matrix Existing
Evaluation (EFE) Matrix External Factor
Evaluation (IFE) Matrix Evaluation (EFE) Matrix

Do Significant Differences Occur? Yes

NO

Activity Two: Measure Organizational Performance Activity Three:

Compare planned to actual progress toward meeting stated objective Take Corrective Action

Do Significant Differences Occur? Yes

No

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 Continue Present Course

7.3 Characteristics of An effective evaluation system

Strategy evaluation must meet several basic requirements to be effective. First, strategyevaluation
activities must be:
 Economical: too much information can be just as bad as too little information; and too many controls
can do more harm than good.
 Meaningful: They should specifically relate to a firm’s objectives.
 Provide useful information: They should provide managers with useful information about tasks over
which they have control and influence.
 Provide timely information: Strategy-evaluation activities should provide timely information; on
occasion and in some areas, managers may daily need information. For example, when a firm has
diversified by acquiring another firm, evaluative information may be needed frequently. However, in
an R&D department, daily or even weekly evaluative information could be dysfunctional.
Approximate information that is timely is generally more desirable s a basis for strategy evaluation
than accurate information that does not depict the present. Frequent measurement and rapid reporting
may frustrate control rather than give better control. The time dimension of control must coincide
with the time span of the event being measured.
 Provide a true picture of what is happening: Strategy evaluation should be designed to provide a
true picture of what is happening. For example, in a severe economic downturn, productivity and
profitability ratios may drop alarmingly; although employees and managers are actually working
[Link] evaluations should fairly portray this type of situation. Information derived from the
strategy-evaluation process should facilitate action and should be directed to those individuals in the
organization who need to take action based on it. Managers commonly ignore evaluative reports that
are provided only for informational purposes; not all managers need to receive all reports. Controls
need to be action-oriented rather than information-oriented.
 Should not dominate decisions: The strategy-evaluation process should not dominate decisions; it
should foster mutual understanding, trust, and common sense. No department should fail to cooperate
with another in evaluating strategies.
 Simple: Strategy evaluations should be simple, not too cumbersome, and not too restrictive. Complex
strategy-evaluation systems often confuse people and accomplish little. The test of an effective
evaluation system is its usefulness, not its complexity.

7.4. Strategic Control: Control Process

In strategic controlling we will follow certain steps. Hereare the five stage processes of control.
1. Determine what to measure: Top managers and operational managers need to specify what
implementation processes and results will be monitored and evaluated. The processes and results
must be capable of being measured in a reasonably objective and consistent manner. The focus should
be on the most significant elements in a process—the ones that account for the highest proportion of
expense or the greatest number of problems. Measurements must be found for all important areas,
regardless of difficulty.
2. Establish standards of performance: Standards used to measure performance are detailed
expressions of strategic objectives. They are measures of acceptable performance results. Each
standard usually includes a tolerance range, which defines acceptable deviations. Standards can be set
not only for final output but also for intermediate stages of production output.
3. Measure actual performance: Measurements must be made at predetermined times.
4. Compare actual performance with the standard: If actual performance results are within the
desired tolerance range, the measurement process stops here.
5. Take corrective action: If actual results fall outside the desired tolerance range, action must be taken
to correct the deviation. The following questions must be answered:
 Is the deviation only a chance fluctuation?

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  Are the processes being carried out incorrectly?
 Are the processes appropriate to the achievement of the desired standard? Action must be taken
that will not only correct the deviation but also prevent its happening again.
 Who is the best person to take corrective action?
Top management is often better at the first two steps of the control model than it is at the last two follow-
through steps. It tends to establish a control system and then delegate the implementation to others. This
can have unfortunate results. Nucor is unusual in its ability to deal with the entire evaluation and control
process.
Types of Control
Control can focus on events before, during, or after a process. For example, a local automobile dealer can
focus on activities before, during, or after sales of new cars. Careful inspection of new cars and cautious
selection of sales employees are ways to ensure high quality or profitable sales even before those sales
take place. Monitoring how salespeople act with customers is a control during the sales task. Counting the
number of new cars sold during the month and telephoning buyers about their satisfaction with sales
transactions are controls after sales have occurred. These types of controls are formally calledfeed
forward, concurrent, and feedback, respectively.
 Preventive /Preliminary / Input Control attempt to identify and prevent deviations in the standards
before they occur. Preventive controls focus on human, material, and financial resources within the
organization. These controls are evident in the selection and hiring of new employees. For example,
organizations attempt to improve the likelihood that employees will perform up to standards by identifying
the necessary job skills andby using tests and other screening devices to hire people with those skills.
 Concurrent controls: monitor ongoing employee activity to ensureconsistency with quality standards.
These controls rely on performance standards, rules, and regulations for guiding employee tasks and
behaviors. Their purpose is to ensure that work activities produce the desired results. As an example, many
manufacturing operations include devices that measure whether the items being produced meet quality
standards. Employees monitor the measurements; if they see that standards are not being met in some area,
they make a correction themselves or let a manager know that a problem is occurring.
 Feedback controls: involve reviewing information to determinewhether performance meets established
standards. For example, suppose that an organization establishes a goal of increasing its profit by 12
percent next year. To ensure that this goal is reached, the organization must monitor its profit on a monthly
basis. After three months, if profit has increased by 3 percent, management might assume that plans are
going according to schedule.

Control Techniques
Control techniques provide managers with the type and amount of information they need to measure and
monitor performance. The information from various controls must be tailoredto a specific management
level, department, unit, or operation.
To ensure complete and consistent information, organizations often use standardized documents such as
financial, status, and project reports. Each area within an organization, however, uses its own specific
control techniques:
 Financial controls
 Budget controls
 Marketing controls
 Human resource controls
 Computers and information controls

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