The Strategic Planning Process

In the 1970's, many large firms adopted a formalized top-down strategic planning model. Under this model, strategic planning became a deliberate process in which top executives periodically would formulate the firm's strategy, then communicate it down the organization for implementation. The following is a flowchart model of this process:

The Strategic Planning Process

Mission

V

Objectives

V

Situation Analysis

V

Strategy Formulation

V

Implementation

V

Control

This process is most applicable to strategic management at the business unit level of the organization. For large corporations, strategy at the corporate level is more concerned with managing a portfolio of businesses. For example, corporate level strategy involves decisions about which business units to grow, resource allocation among the business units, taking advantage of synergies among the business units, and mergers and acquisitions. In the process outlined here, "company" or "firm" will be used to denote a single-business firm or a single business unit of a diversified firm.

Mission

A company's mission is its reason for being. The mission often is expressed in the form of a mission statement, which conveys a sense of purpose to employees and projects a company image to customers. In the strategy formulation process, the mission statement sets the mood of where the company should go.

Objectives

Objectives are concrete goals that the organization seeks to reach, for example, an earnings growth target. The objectives should be challenging but achievable. They also should be measurable so that the company can monitor its progress and make corrections as needed.

Situation Analysis

Once the firm has specified its objectives, it begins with its current situation to devise a strategic plan to reach those objectives. Changes in the external environment often present new opportunities and new ways to reach the objectives. An environmental scan is performed to identify the available opportunities. The firm also must know its own capabilities and limitations in order to select the opportunities that it can pursue with a higher probability of success. The situation analysis therefore involves an analysis of both the external and internal environment.

The external environment has two aspects: the macro-environment that affects all firms and a micro-environment that affects only the firms in a particular industry. The macro-environmental analysis includes political, economic, social, and technological factors and sometimes is referred to as a PEST analysis.

An important aspect of the micro-environmental analysis is the industry in which the firm operates or is considering operating. Michael Porter devised a five forces framework that is useful for industry analysis. Porter's 5 forces include barriers to entry, customers, suppliers, substitute products, and rivalry among competing firms.

The internal analysis considers the situation within the firm itself, such as:

• Company culture
• Company image
• Organizational structure
• Key staff
• Access to natural resources
• Position on the experience curve
• Operational efficiency
• Operational capacity
• Brand awareness
• Market share
• Financial resources
• Exclusive contracts
• Patents and trade secrets

A situation analysis can generate a large amount of information, much of which is not particularly relevant to strategy formulation. To make the information more manageable, it sometimes is useful to categorize the internal factors of the firm as strengths and weaknesses, and the external environmental factors as opportunities and threats. Such an analysis often is referred to as a SWOT analysis.

Strategy Formulation

Once a clear picture of the firm and its environment is in hand, specific strategic alternatives can be developed. While different firms have different alternatives depending on their situation, there also exist generic strategies that can be applied across a wide range of firms. Michael Porter identified cost leadership, differentiation, and focus as three generic strategies that may be considered when defining strategic alternatives. Porter advised against implementing a combination of these strategies for a given product; rather, he argued that only one of the generic strategy alternatives should be pursued.

Implementation

The strategy likely will be expressed in high-level conceptual terms and priorities. For effective implementation, it needs to be translated into more detailed policies that can be understood at the functional level of the organization. The expression of the strategy in terms of functional policies also serves to highlight any practical issues that might not have been visible at a higher level. The strategy should be translated into specific policies for functional areas such as:

• Marketing
• Research and development
• Procurement
• Production
• Human resources
• Information systems

In addition to developing functional policies, the implementation phase involves identifying the required resources and putting into place the necessary organizational changes.

Control

Once implemented, the results of the strategy need to be measured and evaluated, with changes made as required to keep the plan on track. Control systems should be developed and implemented to facilitate this monitoring. Standards of performance are set, the actual performance measured, and appropriate action taken to ensure success.

Dynamic and Continuous Process

The strategic management process is dynamic and continuous. A change in one component can necessitate a change in the entire strategy. As such, the process must be repeated frequently in order to adapt the strategy to environmental changes. Throughout the process the firm may need to cycle back to a previous stage and make adjustments.

Drawbacks of this Process

The strategic planning process outlined above is only one approach to strategic management. It is best suited for stable environments. A drawback of this top-down approach is that it may not be responsive enough for rapidly changing competitive environments. In times of change, some of the more successful strategies emerge informally from lower levels of the organization, where managers are closer to customers on a day-to-day basis.

Another drawback is that this strategic planning model assumes fairly accurate forecasting and does not take into account unexpected events. In an uncertain world, long-term forecasts cannot be relied upon with a high level of confidence. In this respect, many firms have turned to scenario planning as a tool for dealing with multiple contingencies.

PEST Analysis

A PEST analysis is an analysis of the external macro-environment that affects all firms. P.E.S.T. is an acronym for the Political, Economic, Social, and Technological factors of the external macro-environment. Such external factors usually are beyond the firm's control and sometimes present themselves as threats. For this reason, some say that "pest" is an appropriate term for these factors. However, changes in the external environment also create new opportunities and the letters sometimes are rearranged to construct the more optimistic term of STEP analysis.

Many macro-environmental factors are country-specific and a PEST analysis will need to be performed for all countries of interest. The following are examples of some of the factors that might be considered in a PEST analysis.

Political Analysis

• Political stability
• Risk of military invasion
• Legal framework for contract enforcement
• Intellectual property protection
• Trade regulations & tariffs
• Favored trading partners
• Anti-trust laws
• Pricing regulations
• Taxation - tax rates and incentives
• Wage legislation - minimum wage and overtime
• Work week
• Mandatory employee benefits
• Industrial safety regulations
• Product labeling requirements

Economic Analysis

• Type of economic system in countries of operation
• Government intervention in the free market
• Comparative advantages of host country
• Exchange rates & stability of host country currency
• Efficiency of financial markets
• Infrastructure quality
• Skill level of workforce
• Labor costs
• Business cycle stage (e.g. prosperity, recession, recovery)
• Economic growth rate
• Discretionary income
• Unemployment rate
• Inflation rate
• Interest rates

Social Analysis

• Demographics
• Class structure
• Education
• Culture (gender roles, etc.)
• Entrepreneurial spirit
• Attitudes (health, environmental consciousness, etc.)
• Leisure interests

Technological Analysis

• Recent technological developments
• Technology's impact on product offering
• Impact on cost structure
• Impact on value chain structure
• Rate of technological diffusion

The number of macro-environmental factors is virtually unlimited. In practice, the firm must prioritize and monitor those factors that influence its industry. Even so, it may be difficult to forecast future trends with an acceptable level of accuracy. In this regard, the firm may turn to scenario planning techniques to deal with high levels of uncertainty in important macro-environmental variables.

SWOT Analysis

SWOT analysis is a simple framework for generating strategic alternatives from a situation analysis. It is applicable to either the corporate level or the business unit level and frequently appears in marketing plans. SWOT (sometimes referred to as TOWS) stands for Strengths, Weaknesses, Opportunities, and Threats. The SWOT framework was described in the late 1960's by Edmund P. Learned, C. Roland Christiansen, Kenneth Andrews, and William D. Guth in Business Policy, Text and Cases (Homewood, IL: Irwin, 1969). The General Electric Growth Council used this form of analysis in the 1980's. Because it concentrates on the issues that potentially have the most impact, the SWOT analysis is useful when a very limited amount of time is available to address a complex strategic situation.

The following diagram shows how a SWOT analysis fits into a strategic situation analysis.

Situation Analysis
/	\
Internal Analysis	External Analysis
/ \	/ \
Strengths Weaknesses	Opportunities Threats
SWOT Profile

The internal and external situation analysis can produce a large amount of information, much of which may not be highly relevant. The SWOT analysis can serve as an interpretative filter to reduce the information to a manageable quantity of key issues. The SWOT analysis classifies the internal aspects of the company as strengths or weaknesses and the external situational factors as opportunities or threats. Strengths can serve as a foundation for building a competitive advantage, and weaknesses may hinder it. By understanding these four aspects of its situation, a firm can better leverage its strengths, correct its weaknesses, capitalize on golden opportunities, and deter potentially devastating threats.

Internal Analysis

The internal analysis is a comprehensive evaluation of the internal environment's potential strengths and weaknesses. Factors should be evaluated across the organization in areas such as:

• Company culture
• Company image
• Organizational structure
• Key staff
• Access to natural resources
• Position on the experience curve
• Operational efficiency
• Operational capacity
• Brand awareness
• Market share
• Financial resources
• Exclusive contracts
• Patents and trade secrets

The SWOT analysis summarizes the internal factors of the firm as a list of strengths and weaknesses.

External Analysis

An opportunity is the chance to introduce a new product or service that can generate superior returns. Opportunities can arise when changes occur in the external environment. Many of these changes can be perceived as threats to the market position of existing products and may necessitate a change in product specifications or the development of new products in order for the firm to remain competitive. Changes in the external environment may be related to:

• Customers
• Competitors
• Market trends
• Suppliers
• Partners
• Social changes
• New technology
• Economic environment
• Political and regulatory environment

The last four items in the above list are macro-environmental variables, and are addressed in a PEST analysis.

The SWOT analysis summarizes the external environmental factors as a list of opportunities and threats.

SWOT Profile

When the analysis has been completed, a SWOT profile can be generated and used as the basis of goal setting, strategy formulation, and implementation. The completed SWOT profile sometimes is arranged as follows:

Strengths	Weaknesses
1. 2. 3. . . .	1. 2. 3. . . .
Opportunities	Threats
1. 2. 3. . . .	1. 2. 3. . . .

When formulating strategy, the interaction of the quadrants in the SWOT profile becomes important. For example, the strengths can be leveraged to pursue opportunities and to avoid threats, and managers can be alerted to weaknesses that might need to be overcome in order to successfully pursue opportunities.

Multiple Perspectives Needed

The method used to acquire the inputs to the SWOT matrix will affect the quality of the analysis. If the information is obtained hastily during a quick interview with the CEO, even though this one person may have a broad view of the company and industry, the information would represent a single viewpoint. The quality of the analysis will be improved greatly if interviews are held with a spectrum of stakeholders such as employees, suppliers, customers, strategic partners, etc.

SWOT Analysis Limitations

While useful for reducing a large quantity of situational factors into a more manageable profile, the SWOT framework has a tendency to oversimplify the situation by classifying the firm's environmental factors into categories in which they may not always fit. The classification of some factors as strengths or weaknesses, or as opportunities or threats is somewhat arbitrary. For example, a particular company culture can be either a strength or a weakness. A technological change can be a either a threat or an opportunity. Perhaps what is more important than the superficial classification of these factors is the firm's awareness of them and its development of a strategic plan to use them to its advantage.

Competitor Analysis

In formulating business strategy, managers must consider the strategies of the firm's competitors. While in highly fragmented commodity industries the moves of any single competitor may be less important, in concentrated industries competitor analysis becomes a vital part of strategic planning.

Competitor analysis has two primary activities, 1) obtaining information about important competitors, and 2) using that information to predict competitor behavior. The goal of competitor analysis is to understand:

• with which competitors to compete,
• competitors' strategies and planned actions,
• how competitors might react to a firm's actions,
• how to influence competitor behavior to the firm's own advantage.

Casual knowledge about competitors usually is insufficient in competitor analysis. Rather, competitors should be analyzed systematically, using organized competitor intelligence-gathering to compile a wide array of information so that well informed strategy decisions can be made.

Competitor Analysis Framework

Michael Porter presented a framework for analyzing competitors. This framework is based on the following four key aspects of a competitor:

• Competitor's objectives
• Competitor's assumptions
• Competitor's strategy
• Competitor's capabilities

Objectives and assumptions are what drive the competitor, and strategy and capabilities are what the competitor is doing or is capable of doing. These components can be depicted as shown in the following diagram:

Competitor Analysis Components

What drives the competitor What the competitor is doing or is capable of doing Objectives Strategy Competitor Response Profile Assumptions Resources & Capabilities

Adapted from Michael E. Porter, Competitive Strategy, 1980, p. 49.

A competitor analysis should include the more important existing competitors as well as potential competitors such as those firms that might enter the industry, for example, by extending their present strategy or by vertically integrating.

Competitor's Current Strategy

The two main sources of information about a competitor's strategy is what the competitor says and what it does. What a competitor is saying about its strategy is revealed in:

• annual shareholder reports
• 10K reports
• interviews with analysts
• statements by managers
• press releases

However, this stated strategy often differs from what the competitor actually is doing. What the competitor is doing is evident in where its cash flow is directed, such as in the following tangible actions:

• hiring activity
• R & D projects
• capital investments
• promotional campaigns
• strategic partnerships
• mergers and acquisitions

Competitor's Objectives

Knowledge of a competitor's objectives facilitates a better prediction of the competitor's reaction to different competitive moves. For example, a competitor that is focused on reaching short-term financial goals might not be willing to spend much money responding to a competitive attack. Rather, such a competitor might favor focusing on the products that hold positions that better can be defended. On the other hand, a company that has no short term profitability objectives might be willing to participate in destructive price competition in which neither firm earns a profit.

Competitor objectives may be financial or other types. Some examples include growth rate, market share, and technology leadership. Goals may be associated with each hierarchical level of strategy - corporate, business unit, and functional level.

The competitor's organizational structure provides clues as to which functions of the company are deemed to be the more important. For example, those functions that report directly to the chief executive officer are likely to be given priority over those that report to a senior vice president.

Other aspects of the competitor that serve as indicators of its objectives include risk tolerance, management incentives, backgrounds of the executives, composition of the board of directors, legal or contractual restrictions, and any additional corporate-level goals that may influence the competing business unit.

Whether the competitor is meeting its objectives provides an indication of how likely it is to change its strategy.

Competitor's Assumptions

The assumptions that a competitor's managers hold about their firm and their industry help to define the moves that they will consider. For example, if in the past the industry introduced a new type of product that failed, the industry executives may assume that there is no market for the product. Such assumptions are not always accurate and if incorrect may present opportunities. For example, new entrants may have the opportunity to introduce a product similar to a previously unsuccessful one without retaliation because incumbant firms may not take their threat seriously. Honda was able to enter the U.S. motorcycle market with a small motorbike because U.S. manufacturers had assumed that there was no market for small bikes based on their past experience.

A competitor's assumptions may be based on a number of factors, including any of the following:

• beliefs about its competitive position
• past experience with a product
• regional factors
• industry trends
• rules of thumb

A thorough competitor analysis also would include assumptions that a competitor makes about its own competitors, and whether that assessment is accurate.

Competitor's Resources and Capabilities

Knowledge of the competitor's assumptions, objectives, and current strategy is useful in understanding how the competitor might want to respond to a competitive attack. However, its resources and capabilities determine its ability to respond effectively.

A competitor's capabilities can be analyzed according to its strengths and weaknesses in various functional areas, as is done in a SWOT analysis. The competitor's strengths define its capabilities. The analysis can be taken further to evaluate the competitor's ability to increase its capabilities in certain areas. A financial analysis can be performed to reveal its sustainable growth rate.

Finally, since the competitive environment is dynamic, the competitor's ability to react swiftly to change should be evaluated. Some firms have heavy momentum and may continue for many years in the same direction before adapting. Others are able to mobilize and adapt very quickly. Factors that slow a company down include low cash reserves, large investments in fixed assets, and an organizational structure that hinders quick action.

Competitor Response Profile

Information from an analysis of the competitor's objectives, assumptions, strategy, and capabilities can be compiled into a response profile of possible moves that might be made by the competitor. This profile includes both potential offensive and defensive moves. The specific moves and their expected strength can be estimated using information gleaned from the analysis.

The result of the competitor analysis should be an improved ability to predict the competitor's behavior and even to influence that behavior to the firm's advantage.

The Experience Curve

In the 1960's, management consultants at The Boston Consulting Group observed a consistent relationship between the cost of production and the cumulative production quantity (total quantity produced from the first unit to the last). Data revealed that the real value-added production cost declined by 20 to 30 percent for each doubling of cumulative production quantity:

The Experience Curve

The vertical axis of this logarithmic graph is the real unit cost of adding value, adjusted for inflation. It includes the cost that the firm incurs to add value to the starting materials, but excludes the cost of those materials themselves, which are subject the experience curves of their suppliers.

Note that the experience curve differs from the learning curve. The learning curve describes the observed reduction in the number of required direct labor hours as workers learn their jobs. The experience curve by contrast applies not only to labor intensive situations, but also to process oriented ones.

The experience curve relationship holds over a wide range industries. In fact, its absence would be considered by some to be a sign of possible mismanagement. Cases in which the experience curve is not observed sometimes involve the withholding of capital investment, for example, to increase short-term ROI. The experience curve can be explained by a combination of learning (the learning curve), specialization, scale, and investment.

Implications for Strategy

The experience curve has important strategic implications. If a firm is able to gain market share over its competitors, it can develop a cost advantage. Penetration pricing strategies and a significant investment in advertising, sales personnel, production capacity, etc. can be justified to increase market share and gain a competitive advantage.

When evaluating strategies based on the experience curve, a firm must consider the reaction of competitors who also understand the concept. Some potential pitfalls include:

• The fallacy of composition holds: if all other firms equally pursue the strategy, then none will increase market share and will suffer losses from over-capacity and low prices. The more competitors that pursue the strategy, the higher the cost of gaining a given market share and the lower the return on investment.

• Competing firms may be able to discover the leading firm's proprietary methods and replicate the cost reductions without having made the large investment to gain experience.

• New technologies may create a new experience curve. Entrants building new plants may be able to take advantage of the latest technologies that offer a cost advantage over the older plants of the leading firm.

The Value Chain

To better understand the activities through which a firm develops a competitive advantage and creates shareholder value, it is useful to separate the business system into a series of value-generating activities referred to as the value chain. In his 1985 book Competitive Advantage, Michael Porter introduced a generic value chain model that comprises a sequence of activities found to be common to a wide range of firms. Porter identified primary and support activities as shown in the following diagram:

Porter's Generic Value Chain

Inbound Logistics	>	Operations	>	Outbound Logistics	>	Marketing & Sales	>	Service	>	M A R G I N
Firm Infrastructure HR Management Technology Development Procurement

The goal of these activities is to offer the customer a level of value that exceeds the cost of the activities, thereby resulting in a profit margin.

The primary value chain activities are:

• Inbound Logistics: the receiving and warehousing of raw materials, and their distribution to manufacturing as they are required.

• Operations: the processes of transforming inputs into finished products and services.

• Outbound Logistics: the warehousing and distribution of finished goods.

• Marketing & Sales: the identification of customer needs and the generation of sales.

• Service: the support of customers after the products and services are sold to them.

These primary activities are supported by:

• The infrastructure of the firm: organizational structure, control systems, company culture, etc.

• Human resource management: employee recruiting, hiring, training, development, and compensation.

• Technology development: technologies to support value-creating activities.

• Procurement: purchasing inputs such as materials, supplies, and equipment.

The firm's margin or profit then depends on its effectiveness in performing these activities efficiently, so that the amount that the customer is willing to pay for the products exceeds the cost of the activities in the value chain. It is in these activities that a firm has the opportunity to generate superior value. A competitive advantage may be achieved by reconfiguring the value chain to provide lower cost or better differentiation.

The value chain model is a useful analysis tool for defining a firm's core competencies and the activities in which it can pursue a competitive advantage as follows:

• Cost advantage: by better understanding costs and squeezing them out of the value-adding activities.

• Differentiation: by focusing on those activities associated with core competencies and capabilities in order to perform them better than do competitors.

Cost Advantage and the Value Chain

A firm may create a cost advantage either by reducing the cost of individual value chain activities or by reconfiguring the value chain.

Once the value chain is defined, a cost analysis can be performed by assigning costs to the value chain activities. The costs obtained from the accounting report may need to be modified in order to allocate them properly to the value creating activities.

Porter identified 10 cost drivers related to value chain activities:

• Economies of scale
• Learning
• Capacity utilization
• Linkages among activities
• Interrelationships among business units
• Degree of vertical integration
• Timing of market entry
• Firm's policy of cost or differentiation
• Geographic location
• Institutional factors (regulation, union activity, taxes, etc.)

A firm develops a cost advantage by controlling these drivers better than do the competitors.

A cost advantage also can be pursued by reconfiguring the value chain. Reconfiguration means structural changes such a new production process, new distribution channels, or a different sales approach. For example, FedEx structurally redefined express freight service by acquiring its own planes and implementing a hub and spoke system.

Differentiation and the Value Chain

A differentiation advantage can arise from any part of the value chain. For example, procurement of inputs that are unique and not widely available to competitors can create differentiation, as can distribution channels that offer high service levels.

Differentiation stems from uniqueness. A differentiation advantage may be achieved either by changing individual value chain activities to increase uniqueness in the final product or by reconfiguring the value chain.

Porter identified several drivers of uniqueness:

• Policies and decisions
• Linkages among activities
• Timing
• Location
• Interrelationships
• Learning
• Integration
• Scale (e.g. better service as a result of large scale)
• Institutional factors

Many of these also serve as cost drivers. Differentiation often results in greater costs, resulting in tradeoffs between cost and differentiation.

There are several ways in which a firm can reconfigure its value chain in order to create uniqueness. It can forward integrate in order to perform functions that once were performed by its customers. It can backward integrate in order to have more control over its inputs. It may implement new process technologies or utilize new distribution channels. Ultimately, the firm may need to be creative in order to develop a novel value chain configuration that increases product differentiation.

Technology and the Value Chain

Because technology is employed to some degree in every value creating activity, changes in technology can impact competitive advantage by incrementally changing the activities themselves or by making possible new configurations of the value chain.

Various technologies are used in both primary value activities and support activities:

• Inbound Logistics Technologies
  • Transportation
  • Material handling
  • Material storage
  • Communications
  • Testing
  • Information systems
    
    
• Operations Technologies
  • Process
  • Materials
  • Machine tools
  • Material handling
  • Packaging
  • Maintenance
  • Testing
  • Building design & operation
  • Information systems
    
    
• Outbound Logistics Technologies
  • Transportation
  • Material handling
  • Packaging
  • Communications
  • Information systems
    
    
• Marketing & Sales Technologies
  • Media
  • Audio/video
  • Communications
  • Information systems
    
    
• Service Technologies
  • Testing
  • Communications
  • Information systems
    
    

Note that many of these technologies are used across the value chain. For example, information systems are seen in every activity. Similar technologies are used in support activities. In addition, technologies related to training, computer-aided design, and software development frequently are employed in support activities.

To the extent that these technologies affect cost drivers or uniqueness, they can lead to a competitive advantage.

Linkages Between Value Chain Activities

Value chain activities are not isolated from one another. Rather, one value chain activity often affects the cost or performance of other ones. Linkages may exist between primary activities and also between primary and support activities.

Consider the case in which the design of a product is changed in order to reduce manufacturing costs. Suppose that inadvertantly the new product design results in increased service costs; the cost reduction could be less than anticipated and even worse, there could be a net cost increase.

Sometimes however, the firm may be able to reduce cost in one activity and consequently enjoy a cost reduction in another, such as when a design change simultaneously reduces manufacturing costs and improves reliability so that the service costs also are reduced. Through such improvements the firm has the potential to develop a competitive advantage.

Analyzing Business Unit Interrelationships

Interrelationships among business units form the basis for a horizontal strategy. Such business unit interrelationships can be identified by a value chain analysis.

Tangible interrelationships offer direct opportunities to create a synergy among business units. For example, if multiple business units require a particular raw material, the procurement of that material can be shared among the business units. This sharing of the procurement activity can result in cost reduction. Such interrelationships may exist simultaneously in multiple value chain activities.

Unfortunately, attempts to achieve synergy from the interrelationships among different business units often fall short of expectations due to unanticipated drawbacks. The cost of coordination, the cost of reduced flexibility, and organizational practicalities should be analyzed when devising a strategy to reap the benefits of the synergies.

Outsourcing Value Chain Activities

A firm may specialize in one or more value chain activities and outsource the rest. The extent to which a firm performs upstream and downstream activities is described by its degree of vertical integration.

A thorough value chain analysis can illuminate the business system to facilitate outsourcing decisions. To decide which activities to outsource, managers must understand the firm's strengths and weaknesses in each activity, both in terms of cost and ability to differentiate. Managers may consider the following when selecting activities to outsource:

• Whether the activity can be performed cheaper or better by suppliers.

• Whether the activity is one of the firm's core competencies from which stems a cost advantage or product differentiation.

• The risk of performing the activity in-house. If the activity relies on fast-changing technology or the product is sold in a rapidly-changing market, it may be advantageous to outsource the activity in order to maintain flexibility and avoid the risk of investing in specialized assets.

• Whether the outsourcing of an activity can result in business process improvements such as reduced lead time, higher flexibility, reduced inventory, etc.

The Value Chain System

A firm's value chain is part of a larger system that includes the value chains of upstream suppliers and downstream channels and customers. Porter calls this series of value chains the value system, shown conceptually below:

The Value System

...

>

Supplier Value Chain

>

Firm Value Chain

>

Channel Value Chain

>

Buyer Value Chain

Linkages exist not only in a firm's value chain, but also between value chains. While a firm exhibiting a high degree of vertical integration is poised to better coordinate upstream and downstream activities, a firm having a lesser degree of vertical integration nonetheless can forge agreements with suppliers and channel partners to achieve better coordination. For example, an auto manufacturer may have its suppliers set up facilities in close proximity in order to minimize transport costs and reduce parts inventories. Clearly, a firm's success in developing and sustaining a competitive advantage depends not only on its own value chain, but on its ability to manage the value system of which it is a part.

The BCG Growth-Share Matrix

The BCG Growth-Share Matrix is a portfolio planning model developed by Bruce Henderson of the Boston Consulting Group in the early 1970's. It is based on the observation that a company's business units can be classified into four categories based on combinations of market growth and market share relative to the largest competitor, hence the name "growth-share". Market growth serves as a proxy for industry attractiveness, and relative market share serves as a proxy for competitive advantage. The growth-share matrix thus maps the business unit positions within these two important determinants of profitability.

BCG Growth-Share Matrix

This framework assumes that an increase in relative market share will result in an increase in the generation of cash. This assumption often is true because of the experience curve; increased relative market share implies that the firm is moving forward on the experience curve relative to its competitors, thus developing a cost advantage. A second assumption is that a growing market requires investment in assets to increase capacity and therefore results in the consumption of cash. Thus the position of a business on the growth-share matrix provides an indication of its cash generation and its cash consumption.

Henderson reasoned that the cash required by rapidly growing business units could be obtained from the firm's other business units that were at a more mature stage and generating significant cash. By investing to become the market share leader in a rapidly growing market, the business unit could move along the experience curve and develop a cost advantage. From this reasoning, the BCG Growth-Share Matrix was born.

The four categories are:

• Dogs - Dogs have low market share and a low growth rate and thus neither generate nor consume a large amount of cash. However, dogs are cash traps because of the money tied up in a business that has little potential. Such businesses are candidates for divestiture.
• Question marks - Question marks are growing rapidly and thus consume large amounts of cash, but because they have low market shares they do not generate much cash. The result is a large net cash consumption. A question mark (also known as a "problem child") has the potential to gain market share and become a star, and eventually a cash cow when the market growth slows. If the question mark does not succeed in becoming the market leader, then after perhaps years of cash consumption it will degenerate into a dog when the market growth declines. Question marks must be analyzed carefully in order to determine whether they are worth the investment required to grow market share.
• Stars - Stars generate large amounts of cash because of their strong relative market share, but also consume large amounts of cash because of their high growth rate; therefore the cash in each direction approximately nets out. If a star can maintain its large market share, it will become a cash cow when the market growth rate declines. The portfolio of a diversified company always should have stars that will become the next cash cows and ensure future cash generation.
• Cash cows - As leaders in a mature market, cash cows exhibit a return on assets that is greater than the market growth rate, and thus generate more cash than they consume. Such business units should be "milked", extracting the profits and investing as little cash as possible. Cash cows provide the cash required to turn question marks into market leaders, to cover the administrative costs of the company, to fund research and development, to service the corporate debt, and to pay dividends to shareholders. Because the cash cow generates a relatively stable cash flow, its value can be determined with reasonable accuracy by calculating the present value of its cash stream using a discounted cash flow analysis.

Under the growth-share matrix model, as an industry matures and its growth rate declines, a business unit will become either a cash cow or a dog, determined soley by whether it had become the market leader during the period of high growth.

While originally developed as a model for resource allocation among the various business units in a corporation, the growth-share matrix also can be used for resource allocation among products within a single business unit. Its simplicity is its strength - the relative positions of the firm's entire business portfolio can be displayed in a single diagram.

Limitations

The growth-share matrix once was used widely, but has since faded from popularity as more comprehensive models have been developed. Some of its weaknesses are:

• Market growth rate is only one factor in industry attractiveness, and relative market share is only one factor in competitive advantage. The growth-share matrix overlooks many other factors in these two important determinants of profitability.
• The framework assumes that each business unit is independent of the others. In some cases, a business unit that is a "dog" may be helping other business units gain a competitive advantage.
• The matrix depends heavily upon the breadth of the definition of the market. A business unit may dominate its small niche, but have very low market share in the overall industry. In such a case, the definition of the market can make the difference between a dog and a cash cow.

While its importance has diminished, the BCG matrix still can serve as a simple tool for viewing a corporation's business portfolio at a glance, and may serve as a starting point for discussing resource allocation among strategic business units.

Turnaround Management

Times of corporate distress present special strategic management challenges. In such situations, a firm may be in bankruptcy or nearing bankruptcy. Often turnaround consultants are brought into the company to devise and execute a plan of corporate renewal, assuming that the firm has enough potential to make it worth saving.

Before a viable turnaround strategy can be formulated, one must identify the root cause or causes of the crisis. Frequently encountered causes include:

• Revenue downturn caused by a weak economy
• Overly optimistic sales projections
• Poor strategic choices
• Poor execution of a good strategy
• High operating costs
• High fixed costs that decrease flexibility
• Insufficient resources
• Unsuccessful R&D projects
• Highly successful competitor
• Excessive debt burden
• Inadequate financial controls

While each case is unique, the turnaround process frequently involves the following stages:

1. Management change - consultants may be called in to manage the turnaround of the firm.

2. Situation analysis - a situation analysis is performed to evaluate the prospects of survival. Assuming the firm is worth turning around, depending on the root causes of the distress one or more of the following turnaround strategies may be selected and presented to the board:

   • Change of top management
   • Divestment of certain assets
   • Reformulation of strategy
   • Revenue increase
   • Cost reduction
   • Strategic acquisitions
   
   

3. Emergency action plan - achieve positive cash flow as soon as possible by eliminating departments, reducing staff, etc.

4. Business restructuring - once positive cash flow is achieved, the strategic plan is implemented, improving continuing operations, adjusting the product mix and repositioning products if necessary. The management team begins to focus on achieving sustained profitability.

5. Return to normalcy - the company becomes profitable and the changes are internalized. Employees regain confidence in the firm and emphasis is placed on growing the restructured business while maintaining a strong balance sheet.

Abandonment Strategy

In some cases the prospects of the firm may be too bleak to continue as an ongoing operation and an exit strategy may be appropriate. Different strategies may be pursued that vary in their immediacy. An immediate abandonment strategy exits the market by immediately liquidating or selling to another firm. In other situations, a harvest strategy is appropriate by which the firm plays the end-game, maximizing near-term cash flows at the expense of market position.

Scenario Planning

Traditional forecasting techniques often fail to predict significant changes in the firm's external environment, especially when the change is rapid and turbulent or when information is limited. Consequently, important opportunities and serious threats may be overlooked and the very survival of the firm may be at stake. Scenario planning is a tool specifically designed to deal with major, uncertain shifts in the firm's environment.

Scenario planning has its roots in military strategy studies. Herman Kahn was an early founder of scenario-based planning in his work related to the possible scenarios associated with thermonuclear war ("thinking the unthinkable"). Scenario planning was transformed into a business tool in the late 1960's and early 1970's, most notably by Pierre Wack who developed the scenario planning system used by Royal Dutch/Shell. As a result of these efforts, Shell was prepared to deal with the oil shock that occurred in late 1973 and greatly improved its competitive position in the industry during the oil crisis and the oil glut that followed.

Scenario planning is not about predicting the future. Rather, it attempts to describe what is possible. The result of a scenario analysis is a group of distinct futures, all of which are plausible. The challenge then is how to deal with each of the possible scenarios.

Scenario planning often takes place in a workshop setting of high level executives, technical experts, and industry leaders. The idea is to bring together a wide range of perspectives in order to consider scenarios other than the widely accepted forecasts. The scenario development process should include interviews with managers who later will formulate and implement strategies based on the scenario analysis - without their input the scenarios may leave out important details and not lead to action if they do not address issues important to those who will implement the strategy.

Some of the benefits of scenario planning include:

• Managers are forced to break out of their standard world view, exposing blind spots that might otherwise be overlooked in the generally accepted forecast.

• Decision-makers are better able to recognize a scenario in its early stages, should it actually be the one that unfolds.

• Managers are better able to understand the source of disagreements that often occur when they are envisioning different scenarios without realizing it.

The Scenario Planning Process

The following outlines the sequence of actions that may constitute the process of scenario planning.

1. Specify the scope of the planning and its time frame.

2. For the present situation, develop a clear understanding that will serve as the common departure point for each of the scenarios.

3. Identify predetermined elements that are virtually certain to occur and that will be driving forces.

4. Identify the critical uncertainties in the environmental variables. If the scope of the analysis is wide, these may be in the macro-environment, for example, political, economic, social, and technological factors (as in PEST).

5. Identify the more important drivers. One technique for doing so is as follows. Assign each environmental variable two numerical ratings: one rating for its range of variation and another for the strength of its impact on the firm. Multiply these ratings together to arrive at a number that specifies the significance of each environmental factor. For example, consider the extreme case in which a variable had a very large range such that it might be rated a 10 on a scale of 1 to 10 for variation, but in which the variable had very little impact on the firm so that the strength of impact rating would be a 1. Multiplying the two together would yield 10 out of a possible 100, revealing that the variable is not highly critical. After performing this calculation for all of the variables, identify the two having the highest significance.

6. Consider a few possible values for each variable, ranging between extremes while avoiding highly improbable values.

7. To analyze the interaction between the variables, develop a matrix of scenarios using the two most important variables and their possible values. Each cell in the matrix then represents a single scenario. For easy reference in later discussion it is worthwhile to give each scenario a descriptive name. If there are more than two critical factors, a multidimensional matrix can be created to handle them but would be difficult to visualize beyond 2 or 3 dimensions. Alternatively, factors can be taken in pairs to generate several two-dimensional matrices. A scenario matrix might look something like this:

   Scenario Matrix

   		VARIABLE 1
   		Outcome 1A | V	Outcome 1B | V
   V A R I A B L E 2	Outcome 2A -->	Scenario 1	Scenario 2
   	Outcome 2B -->	Scenario 3	Scenario 4

   
   One of these scenarios most likely will reflect the mainstream views of the future. The other scenarios will shed light on what else is possible.

8. At this point there is not any detail associated with these "first-generation" scenarios. They are simply high level descriptions of a combination of important environmental variables. Specifics can be generated by writing a story to develop each scenario starting from the present. The story should be internally consistent for the selected scenario so that it describes that particular future as realistically as possible. Experts in specific fields may be called upon to devlop each story, possibly with the use of computer simulation models. Game theory may be used to gain an understanding of how each actor pursuing its own self interest might respond in the scenario. The goal of the stories is to transform the analysis from a simple matrix of the obvious range of environmental factors into decision scenarios useful for strategic planning.

9. Quantify the impact of each scenario on the firm, and formulate appropriate strategies.

An additional step might be to assign a probability to each scenario. Opinions differ on whether one should attempt to assign probabilities when there may be little basis for determining them.

Business unit managers may not take scenarios seriously if they deviate too much from their preconceived view of the world. Many will prefer to rely on forecasts and their judgement, even if they realize that they may miss important changes in the firm's environment. To overcome this reluctance to broaden their thinking, it is useful to create "phantom" scenarios that show the adverse results if the firm were to base its decisions on the mainstream view while the reality turned out to be one of the other scenarios