Loading ...
Global Do...
News & Politics
11
0
Try Now
Log In
Pricing
Creating Value Successful business strategies Second edition Shiv S. Mathur and Alfred Kenyon OXFORD AUCKLAND BOSTON JOHANNESBURG MELBOURNE NEW DELHI Butterworth-Heinemann Linacre House, Jordan Hill, Oxford OX2 8DP 225 Wildwood Avenue, Woburn, MA 01801-2041 A division of Reed Educational and Professional Publishing Ltd A member of the Reed Elsevier plc group First published as Creating Value: Shaping tomorrow’s business 1997 Reprinted 1997 Paperback edition 1998 Second edition 2001 © Shiv S. Mathur and Alfred Kenyon 1997, 1998, 2001 All rights reserved. No part of this publication may be reproduced in any material form (including photocopying or storing in any medium by electronic means and whether or not transiently or incidentally to some other use of this publication) without the written permission of the copyright holder except in accordance with the provisions of the Copyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London, England W1P 0LP. Applications for the copyright holder’s written permission to reproduce any part of this publication should be addressed to the publishers British Library Cataloguing in Publication Data Mathur, Shiv Creating value: successful business strategies. – 2nd ed. 1. Strategic planning 2. Competition I. Title II. Kenyon, Alfred 658.4'012 ISBN 0 7506 5363 9 For information on all Butterworth-Heinemann publications visit our website at www.bh.com Composition by Genesis Typesetting, Laser Quay, Rochester, Kent Printed and bound in Great Britain Contents ......................................................... Preface to the first edition ............................ Preface to the second edition ...................... Outline: The framework in a nutshell .......... 1 Purpose, scope and basics ....................... Introduction: The purpose of this book ............. The objective: financial results from customer markets 5 ................................................ Organization- v customer-centred, supply v demand perspective 5 ............................................ Non-profit-making enterprises 7 ............................ Development of business strategy as a discipline 7 ............................................................... The role of this book 8 ............................................ Care with words 9 ................................................... Views of ˛business strategyÌ 10 ............................... MintzbergÌs ˛emergingÌ business strategies 10 ..... Strategy and ˛plan 12 .............................................. Business strategy: a working definition 13 ............ The macroeconomic environment 13 ...................... Addressing the manager 14 ..................................... Top management and its skills taken as given, not as a variable 15 ........................................ Should managers be thinkers? 15 ........................... What decisions are strategic? 16 ............................ Business strategy, culture, mission statements 17 ............................................................ Outline of the book 18 .............................................. How to read the book 19 ........................................... Notes 19 ..................................................................... Part 1: FUNDAMENTALS: THE FRAMEWORK AND ITS MAIN BUILDING BLOCKS ......................................................... 2 Objectives: what is business strategy for? .... Corporate success and the financial and commercial markets ............................................................................ The fundamental goal is financial: to earn more than the cost of capital 24 ............................................................. The cost of capital 24 ............................................................ Threats to independent survival 25 ....................................... Expected returns are the yardstick of value 25 ..................... Financial value and shareholder, owner or investor value 26 ................................................................................ The source of financial returns is commercial success 27 ... Pure dealing 28 ..................................................................... Short termism and the importance of time- frames 29 .......... Is a business an ethical agent? 30 ....................................... Ethical dilemmas and short and long time- frames 32 .......... Ethical conflicts of managers 33 ........................................... Collective and individual ethical values 35 ........................... The owner-manager 36 ........................................................ Summary of ethical issues 36 ............................................... Conclusion 37 ....................................................................... Notes 37 ............................................................................... 3 Competitive and corporate strategy - why centred on offerings? .......................................... Introduction ...................................................................... The individual offering...................................................... The importance of success in customer markets 41 ............ Identifying the single offering 41 ........................................... Inputs and outputs 42 ........................................................... The company 43 ................................................................... Tasks of competitive and corporate strategy 43 ................... Offerings are not management units 44 ............................... The case for a CC-strategy for each offering 45 ................... Decisions are often for more than one offering 49 ................ The offering as firmlet 49 ...................................................... The ˛firm 51 ......................................................................... How business strategy is structured 51 ................................ Redefining ˛business strategy 52 ........................................ Summary 53 ......................................................................... Introduction 57 ...................................................................... Exclusion 1: Tax-based changes in the operating profile of a group of companies 58 ....................................... Exclusion 2: Diversification or restructuring to improve financial leverage ( gearing) 59 ............................... Exclusion 3: Diversification to enhance financial clout 60 .... Summary 62 ......................................................................... Notes 62 ............................................................................... Part 2: UNDERSTANDING COMPETITIVE POSITIONING AND STRATEGY.................... 4 Differentiation creates private, not public markets ................................................................. Introduction ...................................................................... Differentiation: the key concept ....................................... Defining differentiation 68 ..................................................... The distancing of an offering from substitutes 69 ................. Competition for customers takes place in markets 70 .......... The key assumption 71 ......................................................... Industry analysis 71 .............................................................. Industries as markets 72 ....................................................... The public market 73 ............................................................ Illustrations of public markets 73 .......................................... An illustration from the tourist trade 74 ................................. Public and private markets 75 .............................................. The private market 77 ........................................................... The galaxy 78 ....................................................................... Which model best fits the real world? 79 .............................. Implications for the ˛industryÌ and ˛industry analysisÌ 81 ...... Using the model of the private market 82 ............................. Segmentation 83 ................................................................... Where the industry and public market models remain useful 83 ............................................................................... Summary and conclusion 84 ................................................ Customer and market segments 85 ...................................... Limitations of market segments as an analytical tool 86 ...... Using customer segments 86 ............................................... Segmentation 87 .................................................................. Summary 88 ......................................................................... Notes 88 ............................................................................... 5 Differentiation and its dimensions: classification of competitive strategies ............. Introduction ...................................................................... Classifying competitive strategies.................................... High and low differentiation and price sensitivity 92 ............. The four generic forms of differentiation 93 .......................... Subdimensions of differentiation 93 ...................................... Types of support differentiation 94 ....................................... Types of merchandise differentiation 96 ............................... Fuller classification of differentiation 99 ................................ The 16 permutations 101 ........................................................ The odder the better? 101 ...................................................... Advertising and differentiation 103 ......................................... Strategists need to think in terms of customers and output 104 ............................................................................... Fallacies prompted by an input language 105 ........................ The input - output distinction: conclusion 107 ......................... Summary 108 ......................................................................... Notes 108 ............................................................................... 6 Competitive positioning: differentiation and price ............................................................... Introduction ...................................................................... Differentiation: why and how? 111 .......................................... Distance and price sensitivity 111 .......................................... Single-scale and multidimensional differentiation 113 ............ Differentiation is indirect and uncertain 115 ............................ Differentiation seen as occurring along a quality scale 116 .... Very successful new offerings 118 ......................................... The cheaper and better offering 120 ...................................... The strategic role of price 121 ................................................ Summary 123 ......................................................................... Notes 124 ............................................................................... 7 Competitive positioning in imperfect markets with dominant sellers............................ Introduction ...................................................................... Market ’entry’ or ’encroachment’?.................................... Markets and profit margins: differentiation and circularity 127 .......................................................................... Monopoly 129 ......................................................................... Few dominant sellers: the circular or oligopoly case 129 ....... Circularity and the strategist 132 ............................................ Oligopoly and strategy implementation 134 ............................ The interrelation between circularity, differentiation and price 134 .......................................................................... Summary: differentiation, circularity and price 135 ................. Notes 136 ............................................................................... Part 3: COMPETITIVE STRATEGIES FOR PROFIT ........................................................... 8 Competitive strategy: what makes it profitable?............................................................. Introduction: strategies are selected for their financial value ................................................................................ Accounting profits versus financial value......................... Differences between the accounting and financial frameworks 142 ...................................................................... The impact of competitive strategy on profitability: targeting profitable customers 143 ......................................... Competitive positioning is for tomorrow 144 ........................... The time-frame 145 ................................................................ The forgotten truism: the source of profits 146 ....................... Competitive strategy and the determinants of profit 146 ........ Effect of competitive strategy: differentiation and circularity 147 .......................................................................... The effect of differentiation on volume 148 ............................. Durability of margins and threats to durability 148 .................. Competitive threats 148 .......................................................... Autonomous, non-competitive threats 149 ............................. Responses to competitive threats 149 .................................... When is a commodity-buy strategy profitable? 149 ................ Volume and scale economies 150 .......................................... Market share and its benefits 150 ........................................... How a strategy aimed at raising market share can generate financial value 152 ................................................... How valid is market share as an intermediate goal? 153 ....... Summary 154 ......................................................................... Notes 157 ............................................................................... 9 Competitive strategy: dynamics of positioning............................................................ Introduction ...................................................................... The generic offering......................................................... The transaction life cycle 160 ................................................. The model of the rearranger 163 ............................................ Differentiation and the rearranger 164 .................................... Price competition and the rearranger 164 .............................. The model of the transformer 165 .......................................... Summary 167 ......................................................................... Notes 167 ............................................................................... Part 4: RESOURCES AND BUSINESS STRATEGY..................................................... 10 The theory of winning resources (the resource-based view) .......................................... Introduction ...................................................................... Different perspectives of ˛sustainedÌ 172 ............................... The resource-based view and its success criterion 173 ......... Success-aping pressures 173 ................................................ Where does sustained value-building occur Ò in the offering or in the company? 174 ............................................. Sustained value-building in customer markets: the resource- based view 174 ....................................................... Resources, their types and classification: winning resources 175 ......................................................................... Peterafs four cornerstones 176 ............................................. Heterogeneous (distinctive) 177 ............................................. Ex ante limits to competition (bargain) 178 ............................. Ex post limits to competition (matchless) 179 ......................... Imperfect mobility (inseparable) 180 ....................................... How the framework fits together 183 ...................................... Sustained value creation: for how long? 183 .......................... Using the resource-based framework 184 .............................. Why no customer market failure? 184 .................................... Sustained value-building by companies, through corporate strategy 185 ............................................................ Does the company encounter a success-aping process? 186 .......................................................................... The evidence and the logic 188 .............................................. Higher-level resources 188 ..................................................... Pure management resources 189 .......................................... The resource-based framework and corporate strategy 190 ............................................................................ Summary and conclusion 191 ................................................ Notes 192 ............................................................................... 11 Winning resources for the manager.............. Introduction ...................................................................... The cost of capital as the benchmark 197 .............................. Satisfying the benchmark 198 ................................................ Earning the cost of capital is a benchmark, not a cut- off point 199 ............................................................................ Practical benefits of the resource-based view 199 ................. Must they always be winning resources? 199 ........................ The role of the cornerstones: me-tooism is not enough 201 ............................................................................. Illustration: the jersey knitters 201 .......................................... Protective armour 203 ............................................................ The serial innovation case 204 ............................................... The rapid payback case 204 ................................................... External impediments to encroachment 205 .......................... Resources suitable to protect duration 206 ............................ Corporate competences 207 .................................................. Discriminating among winning resources 209 ........................ Limitations of the resource-based approach 212 .................... Value-building through corporate strategy 213 ....................... A special case: the capital of a financial institution 214 .......... Summary 215 ......................................................................... Notes 216 ............................................................................... 12 The ’scissors’ process for choosing a competitive strategy ............................................ Introduction ...................................................................... The big asymmetry 219 .......................................................... The two options 220 ............................................................... The choice process 221 .......................................................... An inventory of winning resources? 221 ................................. A short cut 223 ........................................................................ The two selection routes: which comes first? 223 .................. The steps in the process 225 .................................................. How sustainable must the value-building process be? 226 .... Back to the great asymmetry 226 ........................................... Summary of the scissors process 227 .................................... Summary of Part Four 227 ..................................................... Notes 228 ............................................................................... Part 5: CORPORATE STRATEGY FOR CLUSTERS OF OFFERINGS ......................... 13 Corporate strategy’s task is to build financial value ...................................................... Back to first principles...................................................... Corporate strategy is a function of the head office 232 .......... Managing the cluster 233 ....................................................... The primacy of financial markets: agency conflict 235 ........... Corporate and competitive strategy distinguished 238 ........... Summary 238 ......................................................................... Introduction 239 ...................................................................... The stockmarket as a cause 240 ............................................ Concentration of institutional shareholdings 243 .................... The short-termist incentive 243 .............................................. Managerial reaction 245 ......................................................... Summary 246 ......................................................................... Notes 246 ............................................................................... 14 False and valid tests of corporate strategy ................................................................. The diversification binge.................................................. The first false god: risk diversification 250 .............................. The second false god: size 252 .............................................. The importance of internal diversification 254 ........................ The costs of diversified operation 254 .................................... The natural bias towards overdiversification 255 .................... The decision criteria 256 ......................................................... The better-off test 256 ............................................................ The contractual alternative filter 258 ....................................... The best-owner filter 260 ........................................................ The robustness filter 260 ........................................................ The rationale of the three filters 260 ....................................... The arithmetic of the criteria 264 ............................................ Applying the test and filters 265 .............................................. Summary 265 ......................................................................... Notes 266 ............................................................................... 15 The corporate raider or catalyst .................... Introduction: pure dealers ................................................ Dealers in corporate control: corporate catalysts 269 ............ The ˛relatednessÌ issue 270 ................................................... Earnings per share growth of corporate catalysts 271 ........... Should corporate catalysts count as conglomerates? 272 ..... The culture of the corporate catalyst 272 ............................... Corporate catalysts and corporate strategy 274 ..................... Corporate catalysts retained clusters 274 ............................. Assessing the performance of corporate catalysts 275 .......... The corporate catalysts distinctive talents 276 ...................... Summary and conclusion 276 ................................................ Notes 277 ............................................................................... 16 Valuable clusters of offerings: relatedness ........................................................... Introduction ...................................................................... The six value-generating links 279 ......................................... Strategic planning and the core cluster 286 ........................... Do all firmlets need a head office? 287 .................................. Top management skills as a constraint: the ’dominant logic’ 288 ................................................................................. The need to understand the offerings 290 .............................. Value from related diversification 291 ..................................... The links and the filters 291 .................................................... How necessary is relatedness? 291 ....................................... Creative, defensive and other corporate strategies 292 ......... Summary: value generated by the head office 293 ................ Notes 297 ............................................................................... 17 How do managers develop successful corporate strategies? .......................................... Introduction: managing the cluster is not glamorous ....... Interdependent offerings 301 .................................................. Analysing proposals for additions 301 .................................... Analysing whether to retain or divest offering F 302 ............... Restructuring acquisitions 304 ................................................ Summary: corporate strategy 305 .......................................... Notes 306 ............................................................................... Part 6: OTHER IMPLICATIONS OF THE FRAMEWORK ................................................ 18 Where in the world to sell and operate ......... Plus ca change . . . .......................................................... Globalization 313 .................................................................... The Internet 314 ..................................................................... The geographical span of markets 315 .................................. Distance and frontiers 316 ...................................................... Geographical distance as a dimension of differentiation 317 ................................................................... A strategists view of markets 318 .......................................... The trade-off between local preferences and price 318 ......... Is location a strategic choice? 319 .......................................... Export or operate locally? 320 ................................................ Location, distance and strategy 321 ....................................... Implications of international business for management structure 323 ..................................................... Political influences 323 ........................................................... What local activities? 324 ....................................................... Summary 325 ......................................................................... Notes 326 ............................................................................... 19 Operating and organizational aspects of this framework...................................................... Introduction ...................................................................... Is the company’s inter-unit structure a prime strategic issue? 329 .............................................................................. The assumptions 331 ............................................................. Strategies and ’plans 334 ..................................................... The unit of strategy 335 .......................................................... Who formulates a competitive strategy? The need for a sponsor 336 ......................................................................... Who approves a competitive strategy? 337 ............................ Complex structures: one offering, several profit centres 339 ............................................................................. Summary: formulating competitive strategy 341 ..................... Managing and structuring corporate strategy: the principles and the complexities 342 ........................................ Making the corporate strategy task manageable 343 ............. When a new competitive strategy has been adopted 343 ...... Internal monitoring of the implementation of a new competitive strategy 344 ......................................................... Implementation of adopted corporate strategies 345 ............. Companies with a multitude of offerings 346 .......................... Roles of general managers and staff 346 ............................... Summary: structuring for strategy 347 .................................... Notes 348 ............................................................................... Endpiece: Business strategy for a new century .................................................................. What this book has tried to do ......................................... The directions of change 350 ................................................. The challenge may become more global 350 ......................... The culture will be different 351 .............................................. For whom are we working? 351 .............................................. The rise of corporate strategy 352 .......................................... The shrinking world 353 .......................................................... Glossary ......................................................... References ..................................................... Index ............................................................... Preface to the first edition Business strategy is receiving more and more attention, because competi- tion is becoming more intense. Two questions have received most attention. First, what are the management skills and qualities that make businesses successful? Secondly, how can we best describe the competitive process, and the key to success in that process? The present work attempts the second of these questions. The attempt began in the early 1980s with Shiv Mathur’s work on competitive positioning. That work has been developed over the years and is now presented mainly in Chapter 5. From that central insight, the present framework has been constructed. Its focus is how competitive positioning builds sustained profit or financial value. That task includes the critical topic of the distinctive resources of a business. A central thesis is that strategy must shape what customers choose to buy: offerings. In maintaining a close focus on the offering, and on how customers choose it, the framework departs from many other accounts of competitive strategy. This view of competitive strategy leads to a new perception of corporate strategy. Corporate strategy decides what cluster of offerings, not of profit centres, factories or subsidiaries, makes a company profitable. Ultimately business strategy chooses what profitable customers we want to win. We have had fun developing this framework, but we have had enormous support from many friends and colleagues. It is a real pleasure to acknowledge this here. Preface to the first edition Pride of place must go to those stalwarts who have read through an entire earlier draft, and given us invaluable advice: Shelagh Heffernan, Alec Chrystal, Sudi Sudarsanam, Archie Donaldson, Charles Baden-Fuller and Peter McKiernan. Some helpful friends have given us the benefit of their expertise on particular, more technical, parts of the text. Here again, Shelagh Heffernan has contributed Appendix 6.1. The other stalwarts are Geoffrey Barnett, Andrew Campbell, Chong Ju Choi, John Chown, Rob Grant and Robin Wensley. We are also greatly indebted to colleagues who had not met us personally, but helped us with advice in response to letters: Jay Barney, David Collis and Frederic Scherer. Some other colleagues have helped us enormously with their moral and personal support, and especially by using and testing our framework in class. We must single out Hugh Murray and Axel Johne, but we also owe much gratitude to Humphrey Bourne, Ann Brown, Paul Raimond and Gordon Wright. We are delighted to pay tribute to those who have attended executive seminars and to the many students who have received this framework and given us invaluable feedback. Especially helpful were first of all those who attended an elective on corporate strategy. Secondly there were some dozens of students who used this framework for their MBA projects. Lynn Carter Smith, Peter Cowap, Tim Kent-Phillips and Robert Sullebarger deserve special mention among our project students. Finally, we have had a lot of logistic and practical help from Shobha, Rittu and Tarun Mathur. Tarun has helped particularly by verifying some facts and the realism of some illustrations. With so much help, the mistakes are all our own! Shiv S. Mathur Alfred Kenyon viii Preface to the second edition We prepared the first hardback edition (Creating Value: Shaping Tomorrow’s Business) some 3 years ago. The book has since then been used by many lecturers and students in a number of countries, and has also been read by and presented to many practitioners in businesses in several countries. We have been pleasantly surprised by the sustained flow of useful comments and suggestions received from such different groups of readers. It has been comforting to note that the framework is not in any way outdated by the considerable changes that have occurred in IT and communications, or by the rapidly shrinking world. All these useful comments have prompted us to revise the book for a second edition. In this we have pursued four main objectives: to clarify what readers found difficult or ambiguous, to reduce the theory content and to focus more on managerial issues, to update examples and illustrations where this was helpful, to update a few references to the literature. The main changes are: a new section in Chapter 3 to set out a fuller case for our controversial adoption of the individual offering as the strategic unit, a clearer presentation of the resource-based view in Part Four, with less theory, a briefer account in a single Chapter 18 of the international dimension, which does however argue more clearly why this dimension is not an issue in its own right. Preface to the second edition Three terms in the account of resource-based theory in Part Four have been replaced in an effort to make their meanings clearer. The first edition’s ‘key’ resources are now described as ‘winning’ resources, the ‘diverse’ cornerstone as ‘distinctive’, and the ‘felicitous’ cornerstone as ‘bargain’. In each case the replaced terms had caused some misunderstandings. The authors wish to acknowledge their debt to all those who have helped with their very constructive and encouraging comments. Shiv S. Mathur Alfred Kenyon x Outline: The framework in a nutshell This book presents a framework of strategy for all businesses, large and small. This outline of that framework may be helpful, but a mere outline cannot do justice to the reasoning behind the framework, nor present all its elements. Figures in brackets refer to chapters, e.g. (3) = Chapter 3. Business strategy in this framework consists of (3): (a) competitive strategy, which positions a single competitive offering in relation to customers and competing substitutes, (b) corporate strategy, which manages a company’s cluster of offerings, by deciding what offerings to add, retain or divest. Only an individual offering competes in the sense of being chosen by customers. Each competitive strategy therefore concerns one offering (3). Both competitive and corporate strategy have a financial goal: making the company more valuable to its owners in the long term. This is true of the smallest one-person business as well as of the giant corporation. If the business does not at least earn its cost of capital, it cannot survive independently (2). Competitive strategy picks profitable, or more strictly, value-building offerings (8). An offering builds value, i.e. earns more than its cost of capital, if it simultaneously exploits (12): (a) a favourable market opportunity, by addressing a set of customers willing to pay prices (6) at which the offering can meet the financial objective, Creating Value (b) the company’s own distinctive resources which (i) give it an edge over competitors and (ii) provide armour against market forces which seek to erode or blunt that edge (10–12). These two conditions are like the two blades of a pair of scissors, which can only cut together (12). Favourable market opportunities arise from the way an offering is positioned, which is done either: (a) by differentiating the offering, i.e. distancing it from competing substitutes in order to make customers willing to pay value- building prices (5–6), or (b) by competing on price, with a low degree (if any) of differentiation, and a very competitive unit cost (5–6, 8). Differentiation is a matter of how customers see the offering. What customers see of an offering are its outputs, those features that customers take into account when choosing (4–6). Differentiation is a matter of degree. The more differentiated an offering appears to be to customers, the less do their choices depend on price (6). Differentiation can be in several dimensions and subdimensions, which represent a number of generic competitive strategies. Chapter 5 describes and classifies a rich variety of them. They represent different ways in which offerings can be positioned in customers’ eyes (5). What customers compare and choose are competing offerings. They do not choose ‘firms’ (3), nor are their choices bounded by ‘industries’ or by discrete markets, with publicly visible boundaries. The real world of the advanced economies is one in which most offerings are differ- entiated to some degree. That means that each offering has a unique set of competitors, not wholly and exactly shared with any one of those competitors. Each offering thus has its own ‘private’ market (4). Businesses normally have to be organized into profit or cost centres with separate accountability. Hence they cannot normally be organized into individual offerings, which may even cut across such centres. Each offering therefore needs an internal sponsor, who sponsors not only its planning and selection, but also monitors its implementation. Sponsors will often be shared by a number of offerings (19). Markets are not equally competitive. Differentiation makes a market less competitive. So can oligopoly, a market condition in which there are only a few competitors, or at any rate only a few dominant competitors. In such markets it is harder to predict the outcome of the competitive process (7). Oligopolistic markets contain both the threat and the opportunity of price leadership (7). Value-building must be sustained until the cost of capital is recovered. That need can be met in two different ways (10–12): 2 Outline: The framework in a nutshell (a) in competitive strategy, by deploying distinctive resources which are specific to the seller and armoured against imitators and other assailants to the necessary extent, (b) in corporate strategy, by a flair for successfully picking winners and by skill and judgement in timing additions and divestments of offerings. Corporate strategy manages the cluster of offerings owned by any one company. There is evidence that in the period 1960–1980 company managers had an excessive urge to make their companies bigger, by adding offerings to their clusters: a diversification spree. Since 1980 managements have become more self-critical. There has been much divestment, which has made many companies more valuable. Com- panies should expand, provided that the nature of their business and skills requires expansion to build value. There is much scope for such growth, but none for the dash for size that characterized earlier decades (13–17). Strong safeguards are needed against over-expansion. These consist of the better-off test and some filters, applied to every decision to add or retain an offering. The test measures whether the company is more valuable with or without the offering. The filters guard against uncompetitive feather-bedding, against over-optimism, inertia and the reluctance to change course. Together these requirements and the next apply a stringent value-centred discipline (14). The better-off test cannot be passed by an unrelated diversification. The offering needs to be related to the rest of the cluster by one of six specified links. The most important of them is ‘synergy’: the sharing of resources and other efforts with other members of the cluster. Relatedness does not consist of belonging to the same ‘industry’ as other parts of the cluster (16). Corporate strategy’s task of managing the cluster includes the manage- ment and strategic allocation of the company’s resources, which tend to be shared among offerings (10, 16, 17, 19). The framework applies equally to domestic and international business, a distinction which is becoming less important. In international business it is helpful not to overestimate the significance of political states; for example, it is often wrong to regard one state like Singapore or Venezuela as one separate ‘market’ (18). 3 C h a p t e r 1 Purpose, scope and basics Introduction: The purpose of this book This book is about business strategy, meaning strategy in business. The task of business strategy is to make the business more valuable by a specific route: that of targeting profitable customers. If this book helps managers to see how they can best do that, it will have achieved its purpose. The book therefore makes two fundamental assumptions. The first is that business exists to satisfy its financial funding markets. This assumption is discussed in Chapter 2. The second is that a business can only achieve this financial aim in its customer markets, by successfully targeting profitable customers. Customers are profitable if the business can sell to them at margins which yield returns at least equal to the cost of capital. The focus of this book is on the strategic issues of competitive business. Its distinctive feature is its concentration on how customers choose what they buy. In normal conditions it is the customer who decides whether and what to buy. Purpose, scope and basics Much of the literature on business strategy is implicitly focused on the issues facing large and complex companies. That is natural, because vexing management problems of the who-should-do-what-and-at-what- level kind do not arise to anything like the same extent in very small businesses. However, the competitive issues of strategy are just as critical for even the one-person business, and we hope that such businesses will find this book just as relevant and helpful as the mammoths. The objective: financial results from customer markets The primary focus of this framework is therefore on financial results and customer markets. This emphasis is not of course unique. Many have said that the purpose of business is to produce financial results, and very few writers would deny that financial results are mainly achieved by success in customer markets. However, that central insight is not always followed through. Much writing and much managerial practice gives one of two extreme impressions. One is that financial results depend entirely on operating efficiencies. At the other extreme the object of business strategy is seen as maximum sales volume and market share, meeting customer preferences as if that alone were enough to produce acceptable levels of performance. The first focuses exclusively on costs, the second ignores them. Organization- v customer-centred, supply v demand perspective Writers commonly treat competitive strategy as determining how the whole company or perhaps part of the company such as a strategic business unit (SBU) relates to its customers and competitors. For example whether it competes by differentiation or on price. These writers seem to focus on the general stance of the company, and to imply that this strategic decision will effectively determine what kind of offerings the company will market; they will all be tarred with the same brush. For example, the offerings will all be differentiated or all undifferentiated, but low-priced. We might call that an organization-centred (OC) strategy, because its concern is with the company’s own resources, skills, outlook, culture and ethos. This book acknowledges the need for such OC-strategies in many, if perhaps not all companies. Our focus however is on customer-centred 5 Creating Value (CC) strategies, strategies entirely concerned with what offerings the company is to sell in the future, and on how customers will see those offerings in comparison with their competing substitutes. Chapter 3 will come back to this distinction between OC- and CC-strategies. However, a CC-strategy is not just a matter of taking care of the demand side. A successful CC-strategy will only sustain the building of financial value if its offering simultaneously both: occupies a favourable market position in relation to customers and competitors, discussed in Part Two, and exploits the company’s distinctive winning resources, discussed in Part Four. Both conditions must be met. In economic terms, the first condition covers the demand, and the last the supply side of the task. In the context of strategy, the demand and supply sides confront managers with very different challenges. Conse- quently strategy must deal with each of these issues separately before bringing them together. This book will therefore not get properly to grips with supply side issues until Part Three and especially Part Four. Chapter 12 will finally bring the two sides together. We deal with the demand side first, not because we regard it as more important, but because it should make the presentation easier to follow. Winning resources on the supply side are no less important to success than competitive positioning on the demand side. By the same token positioning is not simply a sub-issue of winning resources, as some proponents of the resource-based view appear to believe.1 Customer preferences are often shaped by the actions of sellers, but they are certainly also affected by social and economic changes over which suppliers have no influence. The demand side needs to be analysed in its own right. In any case we shall argue that even if all the company’s offerings were differentiated, their competitors and competitive positions would vary greatly. The resource-based view (RBV) was originally designed to explain why some companies persistently performed better than others. This could not occur in conditions of pure competition. The RBV’s explanation was that companies had different resource endowments. Our question in this book on the other hand is how our company can persistently outperform others. Our answer is that this requires full attention to both issues: resources and competitive position. 6 Purpose, scope and basics Non-profit-making enterprises Business strategy is concerned with the challenges of creating financial value in competitive markets. Some departments of state and some public agencies and corporations, as well as private charities, handle similar tasks. In fact, governments have recently tried to simulate market conditions2 in their business or near-business operations. The aim is to become more responsive to the varying needs of their customers or clients. The framework outlined in this book may be of some value to those who manage such enterprises. On the other hand, there will also be fundamental differences. A state health service will seek to look after the needs of those most in need, such as the poor and the old, who may be the least profitable customers in financial terms. A private healthcare business, on the other hand, may not be able to afford to serve them. The ultimate goal of the activity must affect its strategy. Development of business strategy as a discipline As a distinctive topic business strategy dates from around 1960. Some important ideas are older than that, but had developed as part of some other discipline like economics. Strategy has made great strides, especially in the hands of economists like Rumelt and Porter, since the 1970s. There is never- theless little agreement about its meaning, its purpose and its structure.3 In the 1960s strategy was first thought of as a formal, largely financial, planning process. The unquestioned goal of strategy was growth. Companies had learned the art of preparing budgets for the current year. Planning often just extended the process into years 2–5. By the mid-1970s the Boston Consulting Group’s portfolio management concept, founded on the growth/share matrix, became very influential with managers.4 This came in response to the problems faced by companies which had by then become larger and more diversified, in a more hostile economic climate. Porter’s Competitive Strategy (1980) was a landmark. It (a) placed competitive strategy within the industry as the competitive arena, (b) focused on the key dichotomy between differentiation and cost leadership, but (c) applied that distinction to position the firm itself within its industry. His competitive strategy was thus an OC-strategy.5 Practitioners and some strategic marketing writers had for some time treated the CC- strategic choice of future offerings6 as the central issue. 7 Creating Value Since then academics have mainly focused on three areas. The resource-based view explained varied performance from company to company. The second area is whether industries and strategic groups7 within industries are in practice appropriate units for analysing perform- ance.8 A third one, stimulated by a major contribution from Porter9 himself, is the distinction between competitive and corporate strategy. Kay10 has synthesized many of these ideas and also stressed the objective of adding financial value. This book focuses on CC-strategy. It asks what this company should sell tomorrow in order to become more profitable.11 One sub-issue asks how future offerings will be positioned vis-à-vis customers and competitors. However, as already mentioned, this customer-centred strategy is seen as requiring equal attention to the demand and supply side, to competitive positioning and to winning resources. Our model solves for the offering, not for price/volume. This reverses the traditional microeconomics model, which treats the offering as given, and solves for its optimum price and volume12 under various market conditions. Whereas the main concern of microeconomics is the perfor- mance of the economy, business strategy focuses on the prosperity of the business itself. The role of this book This book puts forward an integrated framework which builds on all these more recent ideas. Its dual focus is on the customer who chooses between competing offerings and on the special endowments which help a business to excel at serving specific groups of customers. The intense focus on customers yields the insight that the unit of competitive strategy has to be the individual competitive offering and its positioning in relation to customers and competing substitutes. Corporate strategy is seen as managing the company’s cluster of offerings. It too therefore concerns what the company should sell. In developing these concepts, the book probes deeply into the nature of differentiation and into the kind of markets in which differentiated offerings compete. What is thus presented, is a coherent framework of: what business strategy is, what it helps managers to achieve, and its subdivision into competitive and corporate strategy, and 8 Purpose, scope and basics how these two categories illuminate all the other dimensions of strategy like time-frames and geographical span, the demand and supply sides, formulation and implementation. One disclaimer is needed. Although this is an attempt at a comprehensive treatment of the topics just listed, there is no systematic coverage here of the important behavioural and organizational aspects of business strategy. Behavioural issues are given their due priority where they arise, but are not covered systematically, or as a sub-topic in their own right. As mentioned at the beginning, it is hoped that managers will find this framework both insightful and useful. Care with words A theme which will run through this book is the need to take care in the use of words. Business strategy uses terms like industry, firm, market, competition, differentiation, resource, competitive advantage, and con- glomerate. They all trip off the tongue quite easily, but they mean very different things to different people. Unfortunately their meanings matter. Misunderstandings about them can cause mischief of any degree, from trivial to catastrophic. If key words cause ambiguity between managers, they can cause even more of it between managers and business academics. Up to a point the two sides have learned to understand each other better. A rising proportion of managers have MBA or similar degrees, and therefore know what academics are writing and saying. Many others are exposed to articles, seminars or in-house exchanges with those who use academic concepts, frameworks and models. Nevertheless, there is a gulf between the two worlds. If academics rigorously define ‘industry’ as a group of competing substitutes, how many managers in the real world are conscious that the model does not apply to, say, the steel industry, with its combination of ‘products’, like castings, pipes, sheet metal, guns and cutlery, which are not particularly close substitutes? Its common feature is that it makes, processes or uses a single material. Academics can use such models without getting confused about their meaning, but is it fair to expect managers to have or to keep them in mind whenever they use an academic framework for thinking through their problems? The steel manager who attended a meeting of the trade association yesterday may be forgiven for not automatically associating an ‘industry’ with just competing substitutes. 9 Creating Value Language is not a glamorous topic. This is because well used words are inconspicuous. The trouble is that bad, ambiguous language, like any other bad tools, can wreak so much havoc, as we shall see. Views of ‘business strategy’ The first object lesson of the need to take care with words is the expression ‘business strategy’ and its exact meaning. A managing director known to the authors, when asked what the company’s strategy was, said ‘to move the factory’ some miles from where it then was. Another company might say its strategy is to restructure its European operations to come under a single headquarters instead of separate headquarters in each European country. A third company in the UK might say its strategy is to make an acquisition in the United States. Others might answer ‘to become a world class manufacturing company’, or ‘to become the industry leader’, or ‘to globalize’, or ‘to double earnings per share over 5 years’ or ‘to reduce the company’s debt equity ratio to 80 per cent’. All these examples are taken from real life. They illustrate how little uniformity there is in people’s concepts of ‘business strategy’. Mintzberg’s ‘emerging’ business strategies The need to take care with this expression has been greatly reinforced by the very influential Henry Mintzberg and his school. Mintzberg’s most controversial contribution is his acceptance that the term ‘strategy’ can mean any of ‘plan, ploy, pattern, position and perspective’, and that a strategy ‘may appear without preconception’.13 This formulation includes in the term ‘strategy’ ploys or even patterns which can ‘emerge’ from the managers’ actual past conduct. The formulation is therefore not confined to deliberate and conscious decisions.14 Mintzberg is reacting against the formal planning school which treated a plan and a strategy as interchangeable terms, and treated both as an extension of the financial budget into years 2–5. In rejecting this, Mintzberg must surely be supported. Formal plans of that type have little chance of helping businesses to become more profitable, because there was a great deal wrong with the concept: Plans did not focus on the competitive markets and offerings of the business. 10 Purpose, scope and basics They centred on accounting numbers, not on earning or beating the cost of capital of each of the offerings, adjusted for their different risks. Consequently they did not even make financial sense. Numbers produced by formal plans were not usable as control figures; consequently, there was little link with subsequent actual performance. They were neither a forecast, nor a management commitment. They were not a useful management tool. Mintzberg rejected formal plans mainly for their rigidity, their lack of an implementation stage, and their tendency to favour a top-down procedure. Mintzberg’s case against formal planning systems is persuasive and widely supported.15 Where he fails to convince, is in his extension of the concept of ‘strategy’ to: tactical and trivial meanings like ‘ploy’, undeliberate, ‘emergent’ processes. It is self-evident that ploys are a necessary and healthy part of the manager’s armoury. It is equally self-evident that a business frequently finds that it has drifted into a beneficial change of direction by a series of instinctive reactions to changing circumstances or information. These are all part of good management, but that does not justify the label ‘strategies’. Managers need a word that signifies a conscious decision to adopt a major direction-setting objective together with its implementation path. Only that can usefully be called a strategy. Such a strategy can and should be flexible and responsive to changes in the news or in managers’ understanding of the environment. If these adaptations and responses are conscious and deliberate, they are within a useful meaning of ‘strategy’. If they are a process of drift, they are not.16 ‘Deliberate’ adoption need not mean formal or written adoption. Again, a decision process is better when it includes contributions from the coal face, but the word ‘strategy’ does not lose its practical usefulness when it describes a decision taken just in the chief executive’s mind. It does however lose that usefulness if it covers too wide a range of meanings. That happens if it can also refer to something: minor or trivial, or never consciously articulated even in thought, or discovered not by thinking forward, but by merely contemplating and rationalizing past conduct. These meanings need to be excluded not from the concept of good management, only from the word ‘strategy’, if it is to remain a useful 11 Creating Value word. The list of ‘plan, ploy, pattern, position and perspective’ is too wide- ranging, not just too alliterative, to describe a serious concept. When the single label ‘strategy’ is stretched to include opposites like ‘plans’ and non-plans, it must snap. Mintzberg17 also rightly stresses that opportunistic action must often override plans or strategies, and that opportunistic actions may be more rewarding than rigid plans. That is clearly correct, but it does not make a case for calling such actions strategic. Special scrutiny is needed for one of the many arguments used by the ‘emergent’ school: the appeal to how managers actually use the word ‘strategy’. Managers are usually under pressure to cut corners and to stop short of perfection. Under pressure it is not always easy or even possible to maintain the prudence or the discipline to think ahead. Not unnaturally however in such conditions managers would still like to dignify all their decisions or unplanned actions, however trivial, with the status symbol of a ‘strategy’. They may in other words be tempted to use what they see as the language of perfection to describe imperfect practice. We might caricature them as saying: ‘If we do not have time to think long-term, let us call our expedients ‘strategies’: the in-word may make up for our omissions. Better still, let ‘strategy’ describe not what we set out to do, but what we have found our actual practice to be’. The process is a comforting one. If any managerial conduct qualifies for the grand word ‘strategy’, no one is left out in the cold. Sadly, such debased use of the word serves to disguise, not to inform. Worse still, the deception is often self-deception. To summarize, Mintzberg, like other writers, seems to be on firm ground in doubting whether formal planning systems serve much strategic purpose. Reservations about his views are purely linguistic. To include in the word ‘strategy’ unplanned, undeliberate and unconscious processes, or intentions which can only be articulated with hindsight, is to empty that word of much of its usefulness. Managers should not be deflected from thinking forward. ‘Strategy’ and ‘plan’ A strategy could be accurately described as one kind of ‘plan’ in the dictionary sense of ‘project’, consisting of a goal and an explicit method of attaining it. In that sense every strategy must be a ‘plan’. We nevertheless avoid this usage of ‘plan’, so as to avoid the ambiguities or associations to which the Mintzberg school has rightly drawn attention. 12 Purpose, scope and basics Business strategy: a working definition The full meaning of ‘business strategy’ will unfold in Chapters 2 and 3, with the distinction between its two subdivisions, competitive and corporate strategy. However, a brief preview may be useful at this point. Business strategy in this book concerns decisions deliberately taken to establish what offerings (goods or services) the business is to offer to what customers in the future and against what competition, so as to meet its financial objectives. Business strategy is subdivided in this book into competitive and corporate strategy. Competitive strategy profitably positions individual competitive offerings, corporate strategy profitably manages the company’s cluster of offerings. ‘Profitable’ is here used as short-hand for value-building. A mere determination of the company’s scope of markets and activities, of ‘what business we are in’, is not seen as an essential element of a strategy, because it does not directly aim at the financial objective. For reasons discussed in Chapter 16, it is helpful for a company to define its scope. That definition should not however be an absolute or unchanging constraint, nor does it justify all proposals that fall within it18, nor is that definition itself a strategy, as that term is used in this book. These broad formulations beg many questions, not least what is meant by a ‘company’ or ‘a business’ and its financial objectives, but they will be answered as we progress through Chapters 2 and 3. The macroeconomic environment Managers should of course conduct the usual financial analysis before deciding to adopt or retain a competitive offering. This means estimating the net present value of its future cash flows, discounted at its cost of capital. The process is briefly touched upon in several places in this book, such as Chapters 12, 17 and 19. The projections used in that financial analysis must naturally take account of expected macroeconomic trends, i.e. cyclical swings in demand. Offerings are not equally sensitive to cyclical swings. Most affected are: offerings with a short life-span, too short to average out over the business cycles, and offerings in cyclical trades like civil construction. 13 Creating Value This essential task of reconnoitring the macroeconomic background will not be specifically pursued in this book, which focuses on the competitive, i.e. microeconomic, environment. Addressing the manager This book is written for the manager. It seeks to refocus business strategy on the need to succeed in markets in which customers choose what they buy. It aims to give the manager a more systematic and more sharply defined account of how to map out future objectives and paths towards attaining them. It owes a huge debt to what others have written, but it draws above all on observation of particular businesses and their strategic problems. It does not seek to present any fresh empirical research. Instead it draws on a number of disciplines, especially marketing, microeconomics and financial theory, all of which enrich our understanding of business strategy. Strategy (as here defined) is practised by senior people in business, many of whom have heard, read or picked up ideas and concepts developed in business schools and elsewhere. They are not strangers to expressions like differentiation, strategic groups, corporate competences, demand elasticity, transnational corporations, or even emergent strategies. This book will therefore seek to set out the meaning and interrelatedness of some of these academic ideas wherever that may help the manager to understand the issues of strategy a little better. Some of the ideas and frameworks – like the one in this book – come from economics, and focus on the nature of the competitive process. Many others come from disciplines like human resources and psychology, and focus on the qualities that make good strategists, i.e. top managers. The two sets of ideas obviously cover overlapping issues. Managers, like academics, have different mental backgrounds, are trained in different disciplines, and are experienced in different special- isms. Some will be familiar with the language of economics, some unfamiliar. The same applies no doubt to the languages of marketing, accounting, finance, and many others. The book should be helpful to all who have an interest in strategy, but it may well be that some parts of it will make more sense to some readers than to others. This is inevitable in such a multidisciplinary topic. A recurrent theme is that customers vary in their preferences and predispositions; this is no doubt also true of readers. 14 Purpose, scope and basics The main task of this study is to set out just what a business strategy is and how it should be formulated. The framework that it presents is designed with a sharp eye on the practicalities of implementation. Implementation itself is only dealt with19 to the extent that strategy modifies the way a business needs to be run day by day. Top management and its skills taken as given, not as a variable There is now an influential school of writers on business strategy20 who examine those top management skills that will enable a company to manage a much wider spread of businesses successfully. The wider spread may concern businesses at the frontiers of technology, or complex global businesses, or conglomerates of unrelated businesses. In this book it is assumed that a given top management team’s directing skills can change only within limits. Any more radical change would call for substantial changes in the composition of the top team itself. A given team can, for example, update its command of the technologies in which the company is specialized. On the other hand, it probably cannot extend its skills to radically different areas. The influential writers present some most valuable insights into what strategies require what kind of top management skills. However, as much of the radical change in skills would require significant changes in the top team, this book will treat these issues as peripheral, not central to its own purpose. This book is addressed to managers who want to improve their grasp of how they themselves, not their successors, can formulate and implement strategies better in their present companies. It is assumed that they do not wish to be replaced. 15 Should managers be thinkers? Managers sometimes approach the topic of business strategy as an opportunity to show dynamic vigour. A caricature might portray an apocryphal manager almost determined to resist any temptation to think and reflect. It is as if such managers must above all avoid being caught in the act of thinking: it smacks of indecision. The upshot is a series of defensive strategy-substitutes, like a 57-page annual form-filling exercise, or bold, prophetic lists of targets (sometimes called ‘missions’) such as those in the box. Creating Value ‘Mission statement’ 1 We are in the business of leisure services. 2 Double EU market share from 22.5 per cent to 45 per cent in 5 years. 3 Earnings per share to grow 15 per cent p.a. 4 Debt equity ratio to fall from 80 per cent to 60 per cent. 5 Turnover per employee to rise from £180 to £200 at this month’s level of prices. There is of course a place for such a set of objectives. It motivates. It gives the company’s managers and workforce some uniformity of purpose, perhaps some shared values. However, can such a list be helpfully called a ‘business strategy’? First, the list is little more than a wish list of possible objectives. They are not systematically derived from what financial markets require of the business. Even less are they integrated into a coherent pattern of action in commercial markets. The book sets out to show that reflection helps strategy. Moreover, thoughtful strategy explicitly seeks to create positive value in the eyes of the financial markets, and more if possible. Without reflection the manager cannot form very clear ideas about the purpose of the business, about the criteria of success, how success can be achieved in various possible future environments, what changes are needed from the present commercial position and resources of the business, and how those changes might be attained. What decisions are strategic? Rumelt, Schendel and Teece21 take as their starting-point the fact that businesses have choices to make. Strategic choices (they say) include: goals, products and services to offer, policies for positioning themselves in product markets, the level of scope and diversity, organization structure, administrative systems used to define and coordinate work. 16 Purpose, scope and basics The approach via choices is a very practical one, but there is also a case for first defining business strategies themselves. It is generally hazardous to adopt particular strategies before forming a clear view of what business strategy is. If we launch directly into the task of finding a strategy to adopt and pursue, before we know what we mean by a strategy, the risk is that we might embark on a half-baked project that turns out not to be a proper business strategy. The two tasks are quite distinct. We may for example decide, like the managing director quoted earlier, that our strategy is to move the factory. It may be a few years down the road before it dawns on us that the factory move, however sound, was not in fact a business strategy, and that we are going bankrupt because we did not formulate a proper strategy, aimed at finding profitable customers. Business strategy, culture, mission statements Business strategy is sometimes assumed to encompass topics like corporate culture,22 mission statements, or statements about values adopted by the company. All these are matters that a business strategy must take account of, accommodate or comply with, not something which it creates or changes.23 Hofstede24 helpfully calls culture ‘the software of the mind’. Corporate culture is something more fundamental than what this book calls a strategy. On the other hand, lower level cultures like attitudes to customers are closely associated with the company’s winning and other resources,25 which should be largely, but not invariably, taken as given. These lower level cultures can be ancillary to a strategy. Values, objectives and mission statements stop well short of action plans. This can be illustrated from the corporate philosophy of the Bank of Credit and Commerce International (BCCI). It interestingly consisted of the following four pillars:26 submission to God service to humanity giving success. These kind of statements set broad objectives and contexts for a business strategy. They can also impose constraints on it. The strategist must take these as given; a competitive or corporate strategy can hardly be allowed 17 Creating Value or expected to change them. Yet they are not themselves strategies. A strategy targets a much more specific, though major objective: producing offerings to win profitable customers. Outline of the book Part One (Chapters 2 and 3) sets out the hierarchy of corporate objectives and the ethical foundations of business objectives. It classifies business strategy into competitive and corporate strategy, and describes how they interact. Part Two (Chapters 4–7) aims to give the reader a thorough under- standing of competitive markets and competitive strategy in those markets. It describes how a competitive offering is positioned in relation to its competing substitutes and customers. It defines, describes and classifies competitive strategies. It shows how the prices that sellers can charge depend on the key features of differentiation and the degree of oligopoly. Part Three (Chapters 8 and 9) relates the nature of competitive positioning to the financial raison d’être of the business. It examines the elements that build financial value in a competitive strategy. It sets out how concepts like differentiation, time-frames, duration of profitable margins, volume and market share interact in competitive strategy. It goes on to look at the dynamics of competitive positioning, and how a business can either exploit its markets as it finds them or destabilize and transform them to its own advantage. Part Four (Chapters 10–12) discusses the vital contribution of a company’s idiosyncratic resources or capabilities to profitability, and what enables some companies to be persistently successful in building financial value. It also puts forward excellence in corporate strategy as an alternative route to sustained value-building. Chapter 12 then outlines a practical framework, derived from the earlier argument, for selecting profitable competitive strategies and thus targeting profitable customers. Part Five (Chapters 13–17) moves from competitive to corporate strategy, i.e. from the single value-adding offering to the company’s cluster of offerings. It discusses the criteria of success, and how they can be passed only by related clusters of offerings. It presents a specific list of links that relate offerings in the required sense. It stresses the critical significance of divestments. 18 Purpose, scope and basics Parts One to Five comprise the framework that is here put forward. Part Six (Chapters 18 and 19) looks back at the framework from two different perspectives. Chapter 18 takes the perspective of geographical distance and political frontiers, and discusses to what extent and how this geographical dimension fits into this framework of competitive and corporate strategy. Chapter 19 takes the perspective of organization structures and chains of command. Strategies have to be formulated and implemented; so how can our offering-based framework be made compatible with conventional organization structures? The Endpiece concludes with some reflections on where business strategy might be heading. How to read the book This book is intended to present a coherent and reasonably comprehensive framework of the issues of business strategy. It is intended as a seamless garment. It should therefore be read as a whole. Nevertheless a busy reader could omit the appendices and Chapter 18, as they do not affect the main structure of the framework. Chapter 15 is also outside the main structure, but should be of interest all the same. Chapter 19 is essential reading. It alone discusses implementation issues and how businesses can be structured for strategy formulation and implementation. Notes 1. Grant e.g. (1996b). 2. For instance, the ‘internal market’ in the UK National Health Service, and proposals in various countries to issue education vouchers to parents. 3. Whittington (1993). 4. Abell and Hammond (1979). 5. Porter and subsequent strategy writers do not explicitly distinguish between positioning the firm or the individual offering. It is as if they implied that a firm’s or sub-unit’s overall policy must charactererize that of each offering. The issue will be developed in Chapter 3. 6. O’Shaughnessy (1995). 7. See Chapter 4. 8. Rumelt (1991). The 1996 Annual Conference of the Strategic Management Society identified ‘the changing boundaries of “industry”’ as a theme for study. 9. Porter (1987). 10. Kay (1993). 11. Resource-based theory (Chapter 10) is not in effect a departure from this search for profitable offerings. It merely directs that search towards offerings for which the company has distinctive resources. Business strategy is of course here taken to look for 19 Creating Value where the company is going rather than for the qualities and structures required for successful direction. 12. Rumelt (1984) puts it: ‘The central concerns of business policy are the observed heterogeneity of firms and firms’ choice of product-market commitments. By contrast, the basic phenomena of interest in neoclassical theory is the functioning of the price system . . .’. ‘Business policy’ is now widely called ‘strategy’, and neoclassical theory is a development of industrial economics. 13. Mintzberg (1987b) p 13. 14. Mintzberg (1987a). For another critique of these issues see Kay (1993) Chapter 19. 15. Andrews (1981). 16. Mintzberg and Waters (1985). Kenyon and Mathur (1993) point out how the qualifying word ‘emergent’ has added to the difficulties by spanning both deliberate and undeliberate processes. 17. Mintzberg (1990). 18. Markides (2000). 19. Chapter 19. 20. Prahalad and Bettis (1986), Teece, Pisano and Shuen (1997), Eisenhardt and Martin (2000). 21. Rumelt, Schendel and Teece (1991). This important paper takes stock of what the discipline of business strategy has been trying to achieve, and where it might need to go. The authors regret (p.7) the lack of an agreed definition of ‘strategy’. 22. Corporate culture is here used to describe the collective mental climate in which a business arrives at its decisions, rather than how it implements them, e.g. by smiling and paying attention to customers. 23. Once again, the assumption is that any real change in corporate culture would require substantial changes in the composition of the top team. If so, the incumbent top team will only undertake strategies that require such minor incremental changes in culture as are within that existing team’s scope. 24. Hofstede (1991). 25. Chapter 10. 26. Lessem (1989) quotes some of these. 20 PART ONE FUNDAMENTALS: THE FRAMEWORK AND ITS MAIN BUILDING BLOCKS Chapter 2 looks at what business strategy aims to achieve, and sets it in its financial and ethical environment. Chapter 3 sets out and defines the main building bricks: competitive and corporate strategy, offering, competitive positioning, inputs and outputs, and how some of these concepts relate to management structures. It sets out the case for accepting the individual offering as the strategic unit. It completes the definition of business strategy. C h a p t e r 2 Objectives: what is business strategy for? Corporate success and the financial and commercial markets The box in Chapter 1 illustrates certain approaches to corporate objectives. Not the least of its shortcomings is how the list jumbles commercial and financial objectives. This chapter explores the ultimate goals of business and therefore of business strategy. It seeks to sort out to what extent ultimate goals are financial, commercial or ethical. Some would personalize that and ask whether a business exists for its investors, its stakeholders, or society at large. The chapter thus explores why strategies are needed. There are a number of answers, but they are not equally fundamental. The ultimate objective of a business has to be financial: to earn returns at least equal to the cost of capital. Capital is scarce, and financial markets determine its equilibrium price, which will vary with the risk of each venture. That rather formal statement about earning at least the cost of capital is probably the best way to define the purpose of a proposed new business. Most managers however work in an existing business, and experience the Creating Value ultimate supremacy of the financial markets in a different and threatening way. Satisfying those markets is also a condition of survival. If we do not earn the returns expected by the financial markets, the independent survival of our business is in jeopardy. The fundamental goal is financial: to earn more than the cost of capital A business is brought into being by the investment of funds in a risky commercial venture, in order to earn returns greater than the cost of those funds (next section below): this basic objective is financial. It is not, for example, worth investing money in a corner store if its expected returns are no better than the risk-free return on treasury bills or on a savings account. More formally, the fundamental purpose of a business is to build financial value. That means that its expected future cash flows, discounted at its cost of capital, result in a positive net present value. In that calculation the investment has to be quantified at the opportunity cost of the resources employed. The opportunity cost of resources is either their acquisition cost (if new) or their value in their best alternative employment inside the company, or their net disposal value. The resources here include not just the net assets covered by balance sheets, but also any intangibles excluded from that list, such as the skills of the management and workforce. Practical measurement steps are listed in Chapter 17 under the two headings ‘Analysing proposals for additions’ and ‘Analysing whether to retain or divest offering F’. The cash flows must for this purpose of course be calculated after deducting as a cost the market value of, for example, the owner’s own services to the shop. That value might be the best salary that the owner could alternatively earn, say by managing someone else’s shop or by managing a football team. The cost of capital The fundamental purpose of a business, therefore, is to earn returns that will at least amortize its risk-adjusted cost of capital. The cost of capital is a central concept of financial theory, derived from how the financial markets work. Whether a business is funded in the financial markets or not, those markets determine its cost of capital. I may invest my own inherited capital in my business. However, whether that investment makes sense for me depends on the opportunity cost of that capital – on 24 Objectives: what is business strategy for? what returns I might obtain from the best alternative investment open to me. That opportunity cost is what my business must beat. If I can earn better (risk-adjusted) returns in some other venture, then I should put it into that other venture, not into my own business. The best yardstick is ratios derived from published financial reports and share price informa- tion. Those ratios must for that purpose of course be adjusted for the lesser marketability and probably higher risk of my own business. The cost of capital of any investment is in this book defined as that investment’s weighted average cost of equity and debt, the latter after tax. A company can here be regarded as the sum of its investment projects. Each project or offering has its own degree of risk, and the greater the risk, the higher the cost of capital. The returns required from a given business must therefore cover the cost of its particular degree of risk. Risks are of many kinds, but the most fundamental category is competitive risk: the risk that another, more attractive shop will open close to our shop, or that consumer tastes will move away from the type of retail service that we are equipped to provide. Threats to independent survival The primacy of financial returns holds for a continuing as well as a new business. The independent survival of an established business is threat- ened if it fails to earn its cost of capital. This threat can take two forms: bankruptcy or hostile takeover. Those who are funding the business now may either withdraw their support or decline to finance any necessary growth or development, leaving the business unfinanceable. The threat of hostile takeover is at present a serious problem only for listed companies in certain countries: the USA, the UK, and others where hostile takeover is a common occurrence. If such a listed company fails to convince the stockmarket that its future cash flows will meet its cost of capital, it will see its share price drop, making a hostile takeover both feasible and tempting for any predator able to make better use of the assets. Whatever the threat, the yardstick of the independent survival of a business of any size is set by its financial markets. Expected returns are the yardstick of value Financial markets assess an investment in a business at the net present value of the expected future cash flows from that investment. If the market expects future returns to diverge from past returns, then the past level is 25 Creating Value irrelevant to financial value. Expectations are what matters. In practice, expectations are of course powerfully shaped by the past track record; if only because the past is known and the future is uncertain. The distinction is nevertheless important. Stockmarkets and other financial markets are very sensitive to expected changes of trend, and will value companies accordingly. Reported price earnings ratios, like those listed in the Financial Times and Wall Street Journal, show wide dispersions. This is largely because the reported ratios relate today’s share price to the last reported historical earnings per share. These are always significantly out of date. Share prices on the other hand incorporate the market’s current view of prospective earnings. If the financial press could reliably ascertain and list prospective earnings multiples, these would no doubt be less widely dispersed. Financial value and shareholder, owner or investor value The objective of business strategy, we have said, is to boost the net present value, but of precisely what? The answer is shareholder value, which Rappaport1 defines as corporate value less debt.2 In other words, he defines the combined value of the company to its shareholders and lenders as ‘corporate’ value. This book is concerned simply with shareholder value. The leverage of debt to equity is a matter of financial policy, which is outside the scope of this book. It will be tacitly assumed that this leverage will be optimized from the point of view of the owners of the equity. In fact, of course, a company may have a capital structure with more than one class of shares, such as preference shares and ordinary or common shares. To simplify, it will be assumed that there is only one class of shares, which fully carries the risk of fluctuating results. With these simplifying assumptions, we can use the expressions ‘financial value’, ‘shareholder value’, ‘investor value’ or ‘owner value’ as if they were interchangeable terms. It is helpful to have available some terms that do not presuppose a formal company or ownership structure. Managers’ guiding principle should be to create shareholder value, i.e. to manage the company in such a way as to improve its long-term value to shareholders. Shareholder value is measured in terms of a given investor’s or owner’s interest in the business.3 Financial value is close to, but not identical with, profitability. In most contexts the two are closely correlated. In other words, actions that boost 26 Objectives: what is business strategy for? the company’s accounting profitability, more often than not improve its financial value. The difference between them is due to the accounting definition of ‘profit’, a difference discussed in Chapter 8. Shareholder value must be sharply distinguished from financial size. A listed company’s financial size is its market capitalization. This can be increased not only by boosting its share price, but also by increasing the number of shares issued, perhaps to new shareholders. If so, the company’s financial value and its financial size do not necessarily rise or fall together. This will now be illustrated. The market capitalization of a company is the number of issued shares multiplied by the share price. If Holdings plc has issued 10 million shares, which have a market price of £2.00 each, the market capitalization is £20 million. This will rise to £24 million, if Holdings plc acquires Sellout plc by issuing a further two million Holdings shares to the owners of Sellout, and if Holdings’ share price remains at £2.00 per share. There are now 12 million Holdings shares at £2.00, giving £24 million. This however will not make any individual shareholder better off. His or her 300 shares are worth £600 before and after the acquisition of Sellout. The company’s financial size has gone up, but no change has occurred in its financial or shareholder value. The return to any such shareholder or investor is what managers should maximize. It is the sum for which the shareholder can sell the holding in the market, plus any cash paid to the shareholder by the company. For example, if the company were to buy back 10 per cent of its own shares for £2.00 per share, our shareholder would receive 30 × £2 = £60 cash. In addition, if the share price has remained steady at £2.00, the shareholder would retain 270 shares worth £2 each = £540. The shareholder’s total wealth would be £540 + £60 cash = £600: again no change. However, if as a result of either the acquisition of Sellout or the buy-back of shares the share price were to rise to £2.10, the shareholder would have gained: 10p × 300 = £30 in the first case and 10p × 270 = £27 in the second.4 What needs to be boosted is the value of what investors hold, together with any cash receipts brought about by the actions or decisions of the managers. The source of financial returns is commercial success However, though this financial objective of the business is fundamental, its attainment is primarily a matter of competitive success in winning 27 Creating Value profitable customers in commercial markets. The arbiter of whether a business survives is its financial market, but the means of survival, its returns, are decided by customers in its commercial markets. This is not just a good model of a business, illustrated in Figure 2.1. It is also echoed in financial theory. For example, the parameter in the capital asset pricing model for practical purposes measures the degree of cyclicality of the principal commercial market or markets5 in which the company is seen to be operating. Thus the ultimate reality of business is the need to satisfy financial markets by success in winning profitable customers in commercial markets. This is mirrored in the basic framework of business strategy. In the next chapter we shall classify business strategy into the two classes of: competitive strategy and corporate strategy. Competitive strategy operates in commercial markets only; corporate strategy is more closely concerned with financial markets, but again by selecting profitable customer markets. Pure dealing A classification of business strategy into competitive and corporate strategy excludes one type of business activity, which has no customers. Nor of course does it have competitors anxious to win the same customers’ buying preferences. We call this pure or ‘proprietary’ dealing. What are sometimes called market makers are one example of pure dealing. Market makers make profits in financial and commodity markets by buying and selling financial instruments, commodities, or derivatives 28 Figure 2.1 The fundamental business objective and its source Objectives: what is business strategy for? like options or futures. In the traditional pre-1986 London stockmarket, the smaller6 jobbers were pure dealers. Other pure dealers are more properly called ‘speculators’. Dealers’ sole source of profit is a nose for a price at which they can deal profitably. They deal impersonally; their profits depend on price, not on customers. Their dealing price is all they offer. They are described in more detail in Chapter 15. We exclude pure dealing from our definition of business strategy, not because that activity is not a business, but because this book is focused on selecting and successfully competing in customer markets. Pure dealer strategies require a very different kind of book. We do however in Chapter 15 discuss a particular form of pure dealing, that of the corporate ‘raider’ or catalyst, which happens to play an important part in discussions of corporate strategy. Short termism and the importance of time-frames One further fundamental concept must be introduced at this point: the time perspective. Objectives can be short- or long-term. Managers may have in mind value and performance for just the current financial year, or they may focus on a period ahead of (say) 7 years. In many businesses important investment decisions look forward to returns that cannot come in less than 3–7 years from now. When Eurotunnel first decided to go ahead with the construction of the Channel Tunnel, it knew it would earn no returns for at least 7 or 8 years. Years are also needed to implement investment projects like process plants, power stations, theme parks, mass transit systems, or the development of a new aircraft or aero engine. It can also take years to design, make and bring to the market a new mass- produced consumer durable. Managers of companies in some countries are nowadays widely thought to be ‘short termist’. This expression is not always sharply defined, but it usually implies an over-preoccupation with short-term financial results and liquidity, and inadequate attention to building the business up for a prosperous future. In many cases such neglect positively destroys long-term value. For example, a company fearing a takeover bid may dismantle its entire information technology overhead. Over the next few months the cash saved may improve reported results, but in the medium term it may impair the company’s ability to control its business and serve its customers. Short-termist managers appear to be fire-fighting, reacting to pressures, not creating opportunities. 29 Creating Value Appendix 13.1 will suggest that short termism may have a financial cause. Here we simply look at it as a managerial phenomenon. Where managers are said to be short termist, they are invariably believed to pay excessive attention to the financial markets, for example by giving undue priority to dividends and not enough to their commercial markets. Generally, short termism is induced by a belief that the company’s current financial performance is so poor as to expose it to hostile takeover or bankruptcy. It is in the commercial markets that a longer view is needed; for we cannot successfully compete for customer preferences today unless we planned and invested in a winning strategy some years ago. Strategy is by definition concerned with a longer term. Obviously not all major business decisions take as long to earn their first returns as the Channel Tunnel. In some fast-moving businesses a new competitive posture can be introduced in a matter of months. This might for example be because the critical new capital asset can be purchased off the shelf. In such a case the ‘longer term’ is relatively short. A new strategy means some major change of direction, and will take whatever time-span is dictated by the characteristics of the offering. Short-termist action is usually self-defeating. It may buy time, but probably very little time. If it averts immediate loss of independent survival, its consumption of the seed-corn tends to ensure recurrent threats. Once that consumption becomes apparent, the company’s credibility in the financial markets will be fatally impaired. To sum up, the fundamental objective of business, and therefore of business strategy, is to enhance long-term owner value.7 Is a business an ethical agent? At this point it is worth questioning some of the fundamental assumptions about the purpose of business activity. The contention that the funda- mental purpose of a business is to create long-term financial value may appear to conflict with an influential contemporary view which regards a business as having social responsibilities to a wider range of ‘stake- holders’, not just its investors. The other stakeholders include its employees, its customers and suppliers, the community or society affected by the operations of the business, and the environment. This view assigns to a business some non-financial objectives, such as social welfare and conservation. It thus disputes the monopoly of the financial objective. 30 Objectives: what is business strategy for? Strictly, therefore, the term ‘stakeholder’ includes the company’s investors as well as the other groups. Like many other writers, we shall however here and there adopt the convenient shorthand that restricts the term to non-investor groups, such as employees, customers and suppliers, and the community. The case for this stakeholder view can be stated as follows: Business is no different from other human activities. Human beings can have no single, exclusive loyalty that releases them from all other loyalties. Business managers’ special duties to the owners of the business do not entitle them to injure or ignore the interests of others. A long-serving employee may well have ‘invested’ a greater proportion of his or her economic worth in the company than many a shareholder. We all have conflicting loyalties and duties, and business managers must manage their dilemmas just like the rest of us.8 Put like that, the stakeholder view sounds very persuasive. Its weakness, however, is that it mistakes the essential nature of a business. A business is not a moral agent at all: it is an inanimate object. It is an investment project, brought into existence to earn in excess of its cost of capital. Its raison d’être is financial. The long-standing employee may well have a strong moral claim to a reciprocal commitment by those running the business, but any such commitment can only be honoured as long as the business continues to exist. Once it fails to meet its financial survival condition, the business is likely to cease, and with it any commitment to the employee. The stakeholder view misses the point when it debates only how the cake should be divided up between the owners and other stakeholder groups. That debate becomes pointless when there is no cake to divide: when the business has failed to survive. The fact that the condition of survival happens to favour the investors is, at this fundamental level, beside the point. It will now be clear that the stakeholder view in its extreme form fails to make four vital distinctions:9 Between the inanimate business and its human managers as the bearers of loyalty to anyone. Between the investors as people and the financial value of the business in which they have invested. The anti-stakeholder view, properly expressed, sees the financial success of the business, not that of its investors, as the object of an overriding loyalty. 31
