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|Pt. I||The Logic of Strategic Analysis||1|
|Ch. 1||What Is Strategy?||1|
|Ch. 2||What Is Performance?||25|
|Ch. 3||Evaluating Environmental Threats||74|
|Ch. 4||Evaluating Environmental Opportunities||109|
|Ch. 5||Evaluating Firm Strengths and Weaknesses: The Resource-based View||149|
|Pt. II||Business Strategies||193|
|Ch. 6||Vertical Integration||193|
|Ch. 7||Cost Leadership||233|
|Ch. 8||Product Differentiation||264|
|Ch. 10||Tacit Collusion||339|
|Pt. III||Corporate Strategies||368|
|Ch. 11||Strategic Alliances||368|
|Ch. 12||Corporate Diversification||404|
|Ch. 13||Organizing to Implement Corporate Diversification||445|
|Ch. 14||Mergers and Acquisitions||482|
|Ch. 15||International Strategies||516|
So—why do we need another book on business policy and strategic management? What does this book bring to its readers that other books don't? To answer these questions, it is important to understand (1.) how business school education has evolved in business schools, and (2.) strategic management's disciplinary status in colleges of business.
In 1959, two evaluations of the status of undergraduate and graduate business education were published. The first, sponsored by the Carnegie Foundation, concluded that "the central problem facing this branch of higher education is that academic standards need to be materially increased." The second, funded by the Ford Foundation, described in more detail what these academic standards should be by arguing that "business educators in increasing numbers are recognizing that it is insufficient to transmit and apply present knowledge. It is the function of higher education to advance the state of knowledge as well. A professional school of business that aspires to full academic status must meet this test."
These evaluations of business education in the 1950s have had a profound impact on the structure and function of business schools. Before the Carnegie and Ford studies, business school professors were often retired managers, and business school classes consisted primarily of discussions about and applications of various informal rules of thumb for managing different business functions. Today, most business school professors have Ph.D.s in either a business discipline or a related nonbusiness discipline, and business school classes focus on discussions about andapplications of various models, concepts, and theories that have been developed by academic research. Where previously the discussion of business practices was not well connected to any base academic disciplines, now teaching and research in business draws directly from, and often contributes to, these base disciplines—including economics, psychology, sociology, and mathematics.
Of all the functional areas in the business school, none began making the transition to a theory-grounded, research-based discipline earlier than organizational behavior and finance. As early as the 1930s, organizational behavior researchers were attempting to apply rigorous research methodologies derived from social psychology to study the behavior of individuals and groups in organizations. The now famous studies of the Western Electric plant in Hawthorne, New Jersey, demonstrated not only that social science research methods could be applied in an organizational context, but that they could be used to describe complex social phenomena inside firms. In finance, Modigliani and Miller's work on capital structure and the cost of capital, and Markowitz's and Tobin's work on portfolio selection, led the way in the application of economic theory to financial decision making in firms. Since this early work, finance has become, in a real sense, a subfield of microeconomics. Moreover, theoretical and empirical work in finance has had a significant impact on the field of microeconomics more generally.
Many of the other disciplines in business schools have gone through similar evolutions. Where marketing used to be taught by retired marketing executives, and marketing classes focused on the experiences of these managers, now marketing classes are typically taught by faculty with Ph.D.s in marketing or related disciplines, and marketing classes focus on understanding and applying models and concepts derived from economics, psychology, and statistics. Where operations management used to have an uncertain discipline grounding, it now has become an arena where psychological, sociological, mathematical, and statistical models are applied in managing quality, plant location, logistics, and other critical operational activities in firms. Finally, where accounting used to focus solely on generally accepted accounting rules, accounting research now draws more broadly on economics, psychology, and computer science to develop those accounting rules and to anticipate their implications for firms.
Some have been concerned that this increased emphasis on rigorous business research has reduced the quality of a business education. These observers have argued that although we now have much more rigorous methods for analyzing a firm's business situation, we have lost the human touch that is required to manage real firms—a human touch that used to be communicated to students by retired executives in the classroom. Of course, there is a great deal of truth in this criticism. It is certainly the case that if all a manager did was to apply these research-derived models in a firm, the firm would probably not perform very well. The management of a real organization is not something that can easily be reduced to a computer algorithm. Discipline-based faculty must strive to expose their students to this human touch. This is one reason for the continued popularity of case-based teaching in business schools. Not only do cases provide students opportunities to apply the theoretical models they are learning, they also simulate the socially complex context within which the application of these models must actually occur.
It is also the case that much of this rigorous business research is irrelevant to real business managers. In any given issue of a research journal, maybe only one or two articles actually have the potential to be applied in real organizations. The rest of this work is basic research. It is designed to address theoretical problems, problems that often have limited application potential. However, this basic research is often necessary before the applied work can be done. Moreover, when rigorous business research can be applied in real firms, its implications can be staggering. For example, there is little doubt that the way that firms are managed today is fundamentally different from how they were managed thirty years ago and that much of this change is traceable to work done in organizational behavior and related business disciplines. There is also little doubt that theoretical advances in finance have had an enormous impact on the structure and function of the modern economy. Leveraged buy-outs, futures markets, derivatives, and capital budgeting are all examples of economic phenomena that have been fundamentally altered by work in financial economics. Also, there is little doubt that the quality movement that swept the world through the 1980s and early 1990s found its intellectual roots, and many of its management tools, in the work done by operations management researchers. Indeed, there really isn't anything quite as practical as a good theory.
Where does the discipline of strategic management stand in this evolutionary process? It is probably safe to say that strategic management is one of the least developed and the least mature of all the disciplines in the business school. Finance and organizational behavior were well on their way to becoming rigorous discipline-based fields by the 1950s, and marketing, accounting, and operations were well on their way to this same status by the 1960s. But it was not until the late 1970s and early 1980s that work on a theoretically rigorous underpinning for the field of strategic management was begun. Before this tines period, strategic management was often taught by retired managers, and course content focused primarily on describing the activities and decisions of general managers in organizations.
In many ways, the delayed maturity of the field of strategic management is quite understandable. Strategic management is an inherently integrative activity in a firm—forcing managers to bring the skills and expertise of different business functions together to conceive of and implement a strategy. Thus research on strategic management is an inherently multidisciplinary task. To fully mature as an academic discipline, each of the specialties on which strategic management scholars rely must also mature. Therefore it is not surprising that the evolution of the field of strategic management was delayed until other business functions had matured from their pre-academic state to become more discipline-based, research-oriented specialties. However, although the maturing of strategic management has been delayed, it is certainly occurring.
Two events signaled the beginning of the evolution of the field of strategic management from its preacademic stage to a modern, discipline-based research field: the publication (in 1980) of Michael Porter's book Competitive Strategy and the publication (in 1974) of Richard Rumelt's book Strategy, Structure, and Economic Performance. As is described in Chapters 3 and 4, Porter adapted concepts from industrial organization economics to the analysis of threats and opportunities in a firm's competitive environment. Before Porter, the analysis of a firm's competitive environment was not well structured and involved generating long idiosyncratic lists of threats and opportunities facing a firm. After Porter, the critical threats in a firm's environment, as derived from IO economics, could be described and opportunities facing a firm could be deduced from the structure of a firm's industry. Porter had begun to provide a theoretical structure for analyzing one critical component of the business-level strategy formulation problem.
As I indicate in Chapter 12, Rumelt took ideas that had been explored by business historians and business scholars to develop a theory explaining the conditions under which corporate diversification strategies could add economic value to a firm, as well as a model describing the organizational structure firms would need to realize the potential value of a diversification effort. Before Rumelt, discussions of corporate strategy were mired in not very rigorous discussions of synergy and the appropriate level of centralization and decentralization. After Rumelt, the kind of product relatedness needed to achieve economies of scope was described, and the specific organizational structure needed to realize these economies was detailed. Rumelt had begun to provide a theoretical structure for analyzing some critical components of the corporate-level strategy formulation and implementation problem.
Just as Porter and Rumelt were completing their work, research in other disciplines began to be published that was destined to have a significant impact on the evolution of the field of strategic management. In organizational behavior, Ouchi's work on Japanese management systems significantly opened up the strategic implementation problem. In economics, transactions cost economics and the evolutionary theory of the firm provided some powerful tools for analyzing a firm's competitive position. In organization theory, population ecology theory was beginning to provide insights to the competitive process facing firms. In finance and accounting, agency theory and positive accounting were providing insights into the economics of organizational structure and organizational processes. Many of these theoretical developments were described in a book I published with Bill Ouchi in 1986 titled Organizational Economics.
The result of these theoretical breakthroughs in the field of strategic management and related disciplines has been a rapid growth in the intellectual maturity of strategic management. The number of people studying strategic phenomena in organizations has increased dramatically over the last several years. Currently, the Business Policy and Strategy Division of the Academy of Management is the largest of all Academy divisions. Scholars with a wide variety of disciplinary backgrounds, from finance to organizational behavior, are publishing in the strategic management literature. New ideas are constantly being developed and tested.
Moreover, this growth in interest in strategic management phenomena has not been limited to just business school academics. Much of the best of this work has had important implications for how real firms are managed. Porter's books, including Competitive Strategy and Competitive Advantage, have been read and applied by many practicing managers. C. K. Prahalad and Gary Hammel's Harvard Business Review article on core competencies—an article solidly grounded in strategic management academic research—is the all-time best-selling reprint at HBR. Like earlier work in finance, OB, and operations, research in strategic management has had, and continues to have, a profound impact on management practice.
Unfortunately, many students of strategic management, whether they axe full-time students, part-time students, or practicing managers, have found it difficult to get their minds around this rapidly evolving field. Individual articles or books generally push only a single point of view and do not provide the overall integrative framework necessary to apply strategic management concepts in real organizations. With a couple of exceptions, most text books do not include information on the most up-to-date research in strategic management, nor do they provide guidance to students or practitioners about how this research might be applied. The purpose of this book is to summarize and integrate the latest research in strategic management and related disciplines in a way that is accessible to students and practitioners and in a way that facilitates its application.
I have taken several actions to ensure the realization of this purpose.
One of my purposes is to present an integrated view of the field of strategic management. To facilitate this integration, the first five chapters of the book develop a framework (summarized in Chapter 5) that is then used as an organizing framework for the rest of the chapters. Moreover, this framework recognizes that understanding threats and opportunities in a firm's competitive environment and understanding the competitive implications of a firm's organizational strengths and weaknesses are both important in strategy formulation and implementation.
Thus, unlike Porter and others, this book is not organized around different types of competitive environments that firms might face. Such a structure unduly emphasizes environmental determinants of firm performance over organizational determinants of performance. Instead, after the organizing framework is developed, chapters focus on specific strategic options that firms may choose to gain competitive advantages. At the business level, these options include vertical integration (Chapter 6), cost leadership (Chapter 7), product differentiation (Chapter 8), flexibility (Chapter 9), and tacit collusion (Chapter 10). At the corporate level, these options include strategic alliances (Chapter 11), diversification (Chapters 12 and 13), mergers and acquisitions (Chapter 14), and international strategies (Chapter 15). How these strategic options help neutralize environmental threats and exploit environmental opportunities is discussed in each of these chapters, in connection with a discussion of how organizational strengths and weaknesses affect the ability of firms pursuing these strategies to gain sustained competitive advantages.
Another way in which the integration of the field of strategic management is facilitated is that strategy formulation and strategy implementation are not discussed in separate parts of the book. Many books and articles seem to adopt the fiction that it is possible to study strategy formulation and strategy implementation independently. This is obviously incorrect. It would clearly be a mistake for firms to formulate their strategies without considering how they were going to implement those strategies. Moreover, it is not possible to evaluate the quality of a firm's strategy implementation efforts independent of the strategy that a firm is trying to implement. Yet many strategy scholars focus either on strategy formulation or on strategy implementation, and many strategy texts address these topics separately, in different parts of the book.
In this book, strategy formulation and strategy implementation are discussed together for each of the strategic options facing firms. Thus, beginning with Chapter 6, the conditions under which pursuing a strategy will be economically valuable, along with the conditions under which pursuing a strategy will be a source of sustained competitive advantage, are discussed. Following this strategy formulation discussion, the actions that a firm must pursue to implement this strategy are also discussed. For all but one of the strategic options facing firms (corporate diversification), the strategy formulation and implementation discussions occur in the same chapter. For corporate diversification strategies, the formulation discussion is in one chapter (Chapter 12), and the implementation discussion is in the subsequent chapter (Chapter 13), because the diversification implementation literature is so large.
Another of my purposes is to summarize the latest research findings in strategic management and related disciplines. Several things have been done to accomplish this purpose. For example, within each chapter, current thinking and research—some of it not yet published—is incorporated in the discussion. In Chapter 2's discussion of firm performance, a variety of measures of firm performance that have only recently begun to appear in the strategy literature are discussed, including the Treynor index, Sharpe's measure, Jensen's alpha, and Tobin's q. Other popular measures of performance that have not been widely discussed in other strategy books are also introduced, including event study methodologies for analyzing firm performance. Also, Chapter 5's discussion of organizational strengths and weaknesses is a state-of-the-art summary of what has come to be known as the resource-based view of the firm. Chapter 10's discussion of tacit collusion draws on recent developments in game theory, and Chapter 11's discussion of trust in strategic alliances draws on some very recently published work. Chapter 12's discussion of corporate diversification strategies is well grounded in current work in strategic management and finance. Chapter 15's analysis of international strategies draws on some of the most recent developments in this rapidly growing literature.
Each chapter reflects the latest developments in strategic management research, and my choice of which strategies to focus on in Part II (business-level strategies) and Part III (corporate-level strategies) reflects currently important topics in the field.
Many books limit their discussion of business-level strategies to competitive strategies (including cost leadership and product differentiation), but this book includes discussions of vertical integration, flexibility (that is, strategic decision making under uncertainty), and cooperative business level strategies as well. Moreover, two classes of these cooperative strategies are discussed—tacit collusion and some strategic alliances. In an era of downsizing and outsourcing, decisions about what business functions to keep within the boundaries of a firm are extremely important. Chapter 6 presents the latest thinking about these and related vertical integration issues. Rapidly changing global markets increase the importance of strategic decision making under uncertainty, the topic of Chapter 9. Collusion strategies (Chapter 10) have been much in the business news lately and are important phenomena about which students and practitioners need to be aware. Strategic alliance strategies (Chapter 11)—including nonequity alliances, equity alliances, and joint ventures—are becoming increasingly more important for firms and especially for firms looking to expand their business opportunities in nondomestic markets.
At the corporate level, this, book includes a chapter on strategic alliances (Chapter 11). Moreover, although most strategy books have chapters on diversification and international strategies, fewer have discussions on merger and acquisitions strategies—even though mergers and acquisitions are often popular means of implementing diversification and global strategies. Chapter 14 presents the latest research on merger and acquisition strategies.
To ensure that this text includes the full range of the most recent work in strategic management and related disciplines, each article in each issue of the Strategic Management Journal, the Academy of Management Review, the Academy of Management Journal, the Academy of Management Executive, and the Rand Journal of Economics for the last ten years was read and summarized. Then, if it was determined that an article had a strategic focus, the article was classified as being germane to one or more of the chapters of this book. Not all of these articles are cited in the book, but I am quite confident that any current major research stream published in these journals is reflected in the content of my book. For example, I was able to relate every article published in SMJ to one of the chapters of this book with the exception of a few articles on strategic management in small firms.
If students and practitioners cannot read, understand, and apply all of this research, it will be of limited value to them. Thus it was not enough to include all the major research streams in strategic management and related disciplines; it was also important to make this work accessible and applicable. I have done several things to accomplish this. First, the book is full of examples. Most of these examples come from either Fortune or the Wall Street Journal. Indeed, each issue of Fortune for the last 10 years, and most editions of the Wall Street Journal over this same time period, have been read in search of examples of the phenomena discussed in this book. If no examples of a particular strategic phenomenon discussed in the research literature could be found, a discussion of this strategic phenomenon was usually omitted from the book. The logic here is straightforward: If we can't find examples of a phenomenon in the popular business literature, then the phenomenon, though perhaps theoretically interesting, is probably not practically important and thus can be omitted without loss.
In addition, each chapter ends with a chapter summary and review questions. The summary highlights the key issues discussed in the chapter, and the review questions force readers to go beyond what is written in a chapter, to try to understand its implications for managing real firms.
One characteristic that enhances the accessibility and applicability of many strategic management texts is missing in this book—cases. The lack of cases does not mean that cases are irrelevant in the teaching of strategic management. Indeed, I think that case teaching is a very important component of any strategic management class. However, to be most useful, cases should provide students and managers an opportunity to see how a set of ideas, a model, or a technique can actually be used to engage in a strategic analysis and make a strategic decision. In this book I focus on these ideas, models, and techniques, and I assume that teachers will choose their own cases in which these tools can be applied.
There are numerous sources for case material that can he used in conjunction with this book. Moreover, the structure of my text makes choosing cases relatively easy. Since much of the book is organized around specific strategic options facing firms, cases that focus on firms trying to decide whether to pursue a particular strategic option help demonstrate how the ideas and models in a chapter can be applied in a realistic setting. Thus, for example, to help the discussion of cost-leadership competitive business strategies to come alive, cases on Nucor Steel and Wal-Mart are good options, for these firms tend to focus on cost leadership. To help the discussion of strategic alliances to come alive, cases on General Motors, AT&T, and Corning are good options, for these firms have all been pursuing alliance strategies, albeit in very different ways and for very different reasons. The discussion of vertical integration can be greatly enhanced by cases that focus on firms going through outsourcing decisions and by cases that focus on firms that exist because of outsourcing (such as EDS).
Although the fundamental purpose of this book remains unchanged from the first edition, there are some important changes in the second edition. Some of these changes are cosmetic. For example, students have indicated that they prefer endnotes to in-text citations, and this approach to citations has been adopted in the second edition. This has also given me the opportunity to make substantive comments along with the citations. Other changes have been more substantive in nature.
For example, I was never satisfied with the definition of strategy in Chapter 1 of the first edition. Additional reading and a great deal of thought have led me to adopt a different definition of strategy in the second edition. This definition is logically consistent with the definition in the first edition, but I think it is more powerful and insightful.
In Chapter 2 of the first edition, I reviewed net present value techniques for evaluating the performance of a firm. While, technically speaking, these approaches are accurate, it is unusual to have the information necessary to apply them in conducting strategic analyses of real firms. Moreover, these techniques are adequately described elsewhere. In lieu of a review of these present value techniques, Chapter 2 in the second edition focuses on how to adjust a firm's accounting numbers to more accurately characterize its level of economic performance. To this end, Chapter 2 draws heavily on the work of Tom Copeland and his colleagues in a discussion of Return on Invested Capital (ROIC) and Economic Profit (EP). The Market Value Added,(MVA) approach to estimating a firm's performance is also discussed in Chapter 2.
The discussion of the impact of industry structure and firm performance in Chapter 3 is substantially enhanced in the second edition. More traditional approaches to defining industry structure (such as perfect competition, monopolistic competition, oligopoly, and monopoly) and their performance implications have been discussed. This provides a broader theoretical underpinning to Porter's five forces framework.
Opportunities in additional industrial contexts have been added to Chapter 4. These include opportunities in increasing returns or network industries, opportunities in hyper-competitive industries, and opportunities in empty core industries.
One of the most significant changes in the second edition of the book involves shifting the discussion of vertical integration strategies from Part III (Corporate Strategies) to Part 11 (Business Strategies). This was done because I have become convinced that determining a firm's boundaries—what business functions it will and will not operate in—logically precedes any business level strategic choices a firm may make. Thus, while it is still possible for a firm's vertical integration strategy to turn into a corporate diversification strategy, I have concluded that, on balance, it is important for the discussion of vertical integration to come before the discussion of other business level strategies.
Substantively, Chapter 6—the new vertical integration chapter-has been significantly modified. In the first edition, the only conceptual framework for doing vertical integration analysis included was transactions cost economics. In the new edition, this transactions cost discussion is augmented by a discussion of the impact of capabilities on vertical integration decisions (that is, a resource-based theory of vertical integration) and by a discussion of the impact of uncertainty on vertical integration decisions (that is, a real options theory of vertical integration). These three approaches to vertical integration can sometimes have contradictory management implications, and an approach to reconciling these differences is also discussed. This chapter also is used to present some of the key organizing issues associated with implementing any business level strategy. Thus, in this chapter, some of the critical dimensions of the U-form structure are discussed as are some of the most critical management controls and compensation policies that can be used to implement business level strategies. The description of the determinants of compensation, and the relationship between compensation and the implementation of business level strategies, has received particular attention in this chapter.
By introducing the basic organizing problems associated with implementing a business level strategy in Chapter 6, the discussion of implementing other business level strategies in subsequent chapters can focus on how these basic organizing principles can be adapted to implement other business strategies. Thus, the discussion of the particular organizing requirements for implementing cost leadership strategies, in Chapter 7, has been substantially increased. Chapter 8's discussion of implementing product differentiation strategies has also been more fully developed. In particular, this chapter now includes a discussion of some of the most recent research on managing innovation in firms, under the assumption that implementing product differentiation strategies almost always involves implementing a product innovation process. The process of managing innovation in firms was largely omitted in the first edition, an omission that is reversed in the second edition.
Chapter 9 is entirely new in the second edition. Since the publication of the first edition, there has been increasing interest—among scholars and managers—in decision making under uncertainty. The primary conceptual tool that has been proposed for guiding strategic decision making under these conditions is real options analysis. As described in Chapter 9, real options analysis builds on options theory, as developed in the field of finance. Chapter 9 describes why real options analysis is important, shows how real options analysis is related to options theory, and shows how real options analysis can be applied—both numerically and conceptually—to help firms make strategic choices under conditions of uncertainty. The key strategic option discussed in Chapter 9 is flexibility, and the conditions under which flexibility can be a source of competitive advantage and sustained competitive advantage are also discussed in this chapter.
The discussion of tacit collusion in Chapter 10 now incorporates some important work on competitive dynamics published in the game theory and strategic management literatures. After reading this chapter, you will never look at puppy dogs in exactly the same way.
Chapter 11's discussion of strategic alliances continues to incorporate the latest work in this area of research and practice. Moreover, by placing Chapter 11 in Part III of the book, the role that most strategic alliance strategies play in enabling a firm to pursue some form of diversification is recognized. Chapters 10 and 11, together, describe cooperative strategies that firms can pursue. Thus, rather than adopting the structure presented in the book as it currently stands (that is, Part 11 focuses on business level strategies and Part III focuses on corporate level strategies), it is also possible to use the following structure: Competitive Strategies (Chapters 6, 7, 8, and 9), Cooperative Strategies (Chapters 10 and 11), and Corporate Strategies (Chapters 12,13,14, and 15).
A major change in Chapter 12's discussion of corporate diversification focuses on the indirect effects that diversifying to reduce risk can have for equity holders. In the chapter, it is suggested that when firms diversify to reduce risk, other stakeholders in a firm (including employees, suppliers, and customers) may be more willing to make firm-specific investments in a firm. Since these firm-specific investments may be the source of economic profits for a firm, diversification that makes it more likely for other stake holders to make firm-specific investments may indirectly benefit a firm's equity holders. While it still follows, from this discussion, that related diversification will generally be preferred over unrelated diversification, the chapter now recognizes that there may be some indirect benefits of diversification that were not discussed in the first edition.
The discussions of organizing to implement corporate diversification (in Chapter 13) and of mergers and acquisitions (in Chapter 14) have been modified to reflect these indirect benefits.
Finally, Chapter 15 has been updated and modified. At one time, the plan was to integrate the content of Chapter 15 into the rest of the chapters, to include within each chapter a discussion of how a particular strategic option would operate in an international context. However, I concluded—after several chapters—that such an approach tended to confuse and complicate the description of the basic economic and organization logic associated with each strategic option in the book. Now, as in the first edition, international strategies are considered as a special case of corporate strategies, and the challenges that are unique to pursuing corporate strategies in an international context are the primary topic in Chapter 15.