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Written for business executives and MBA students, Kellogg on Strategy is a practical guide to choosing the right strategy for your business and applying it correctly. Rather than covering the basics of strategy, this expert guide shows you how to use strategy effectively so your business can succeed. You'll learn to analyze your current competitive position, develop the perfect strategy to match your goals, and apply that strategy thoughtfully and effectively. Inside, you'll find expert guidance on:
In the early 1990s, the Allegheny Hospital Education and Research Foundation (AHERF) launched a strategy to become a large integrated health care delivery system. AHERF was not the only health care provider pursuing this strategy. In fact, this was the dominant strategic direction proposed by industry analysts and managers alike. Within a few years, AHERF was one of the largest integrated health care providers in the United States and its CEO was hailed as a visionary. By 1998, AHERF was also bankrupt.
In the early 2000s, Samsung Corporation launched a strategy to revitalize its consumer video electronics business. Long regarded as a low-quality brand, it sought a quality leadership position in the fledgling market for digital home entertainment, including high definition television (HDTV). Samsung embraced digital light processing (DLP) technology. Cheaper and fatter than plasma, more expensive and thinner than traditional rear projection televisions (RPTVs), Samsung's DLP televisions offered a picture quality that equaled or beat either alternative.
Samsung's first generation DLP sets garnered rave reviews from specialty magazines and web sites. The technology appealed to critical early HDTV adopters who did their research and ignored the brand reputation. In fact, Samsung's reputation has improved since the launch of DLP. It has successfully entered the market for high-end DVD players and is poised to compete in the high-end plasma market.
It takes little imagination to come up with a strategy. In fact, almost all managers can easily identify any number of strategic options for their firms. Here are a few popular business strategies, with examples of firms that have pursued them:
Grow larger (General Electric, AHERF).
Downsize (Avon, Sara Lee).
Diversify into new markets (Wal-Mart, PepsiCo).
Dominate a niche (Starbucks, Jiffy Lube).
Outsource the production process (Nike, IKEA).
Integrate the production process (Armani, Tiffany).
Become the cost leader, even if quality is sacrificed (Kia, Motel 6).
Become the quality leader, even if costs increase (BMW, Four Seasons Hotels, Samsung).
Drive rivals from the market (Philip Morris, Microsoft).
Cooperate with rivals (Philip Morris, Sony).
Be an innovator (Intel, Philips Electronics).
Be an imitator (Microsoft, Dell Computer).
While it may be easy to come up with a strategy, it is much more difficult to select the appropriate one. For every Samsung, there is an AHERF. Some consultants may offer compelling arguments in favor of one strategy; others may recommend the diametrically opposite strategy. To make things more confusing, what works for one firm may not work for another firm in the same industry. So while it may take little imagination to come up with a strategy, it may take a lot of hard work to come up with the optimal strategy.
In brief, you are describing a strategy when you do both of the following:
1. Describe in what respect your firm's output is truly unique (what is the product market in which your firm has a monopoly, if you will) or the process by which you achieve inimitable efficiency.
2. Describe how you plan to defend this unique product or process from competition, entry, and imitation.
This book presents analyses that help you clearly identify your current or intended "monopoly" position.
This book is about the process of developing and analyzing strategies. It presents the principles, tools, and templates necessary for choosing among strategic alternatives. The goal of this process (often called strategic analysis or strategy evaluation) is to answer the following two principal questions (the PQs):
1. Does the firm possess advantages that will translate into profits?
To answer this question, we need to identify what the firm brings to the market that enables it to outperform its rivals. The firm may have a superior quality product that the market deems worthy of a price premium. Or the firm may have a superior production process that gives it a cost advantage.
2. Does the firm's business environment permit these advantages to turn into profits?
High quality and low costs are no guarantee of profits. It is essential to identify characteristics of the firm's environment that enable it to prosper from its advantages. Through an understanding of the business environment, we can answer questions such as how competition might erode profits, what firms can do about rivalry, and how the firm can sustain its profits over the long haul.
There are several reasons why the PQs are the right questions to ask when analyzing strategic alternatives:
1. Answering the PQs gives managers a more thorough understanding of the process by which their firm creates wealth and the conditions upon which that process depends.
2. This deep understanding is necessary to insure that managers do not change strategic direction for the sake of change, rather than in response to genuine problems and challenges.
3. By answering the PQs, managers can better determine whether a chosen strategy directly addresses the problems at hand. Willy-nilly selection of a strategy, whether because it sounds good or because it has become the latest fad, is not likely to bear fruit. Evaluating and making strategic choices on the basis of how they resolve the PQs will lead to enduring profits.
4. The very process of answering the PQs often generates strategic choices. Strategy may thus be thought of as an organic process, in which choices emerge during the analytic process. We will encounter numerous examples in which the correct strategic responses are revealed through the analysis of the PQs.
5. Correct analysis leads to effective tactical choices, effective because managers are more likely to choose actions that enhance and leverage the firm's true advantage while properly accounting for competitive responses.
A Homework Assignment
Since this book is, in effect, a course in strategy, we think it is helpful to pull from our Kellogg course syllabus, specifically the section describing the homework assignments:
The evaluation of a firm's strategy will not be satisfied by phrases such as "superior marketing," "superior inventory management," or "superior product variety." The answer to the two key strategy evaluation questions needs to be 7 to 10 single-spaced typewritten pages.
Not to worry; you won't owe us assignments. However, contrast the richness of a 7- to 10-page single-spaced strategic analysis to the platitudes that often follow when managers are asked, "What are this firm's advantages?" or "How competitive is the market?"
This chapter lays out a broad game plan for answering the PQs. The rest of the book fills in the details and offers numerous examples of strategy in action. Chapters 2 to 4 address primarily the first of the two questions; Chapters 5 to 8 turn to the second question. Chapter 9 concludes with two highly detailed strategy evaluations, one for Amazon.com and one for the Chicago hospital market. While these analyses are fairly thorough, we were limited to public information. A manager performing the analysis on his or her own firm could probe more deeply.
We offer a caveat before we proceed. We acknowledge that a one-size-fits-all framework for strategy evaluation is too much to promise. On the other hand, teaching strategy evaluation exclusively by example may leave the reader inspired but apprehensive about how to initiate his or her own analysis. Hence, we propose a set of general tools and frameworks, but remind the reader that they may need to be adapted to his or her own particular strategic situations.
One more caveat: The methods that we present can appear daunting in their richness. We offer detailed guidance on how to perform much of the analysis forthcoming, but not all of it. It would be impractical to incorporate all the tools needed to do strategy evaluation in one book. Furthermore, any text suggesting it has enough information to guide one through the entire process is likely to be overreaching. Many good sources exist for topics not fully developed in this book and where appropriate, we point you to them.
Step One: Organize the Information Required for Strategy Analysis
Strategy should be driven by facts: facts about the firm, facts about its rivals, and facts about consumers. No amount of economic theory or consulting templates can substitute for institutional knowledge. But "institutional knowledge" is a broad concept, seemingly without bounds. Moreover, that knowledge is often disorganized and scattered. With a little discipline, it is possible to organize this knowledge to greatly facilitate the process of developing strategy.
In thinking about organizing knowledge, remember that the goal of strategic analysis is to help a particular firm determine how best to generate revenues that exceed its costs, including its capital costs. In our experience, managers often begin their analysis with qualitative claims about their firm that cannot be substantiated by quantitative data about the firm's actual performance. Hence, a good way to start organizing knowledge is by examining actual financial performance, preferably as close to the business unit level as possible.
We believe that the best measures identify what is commonly known as economic profit. Figure 1.1 presents one version of how to measure economic profit, as well as a list of its common sources of economic profit. Professor David Besanko, one of the creators of the core strategy course at Kellogg, developed this schematic to introduce students to the topic of strategy. The top equation states that economic profit equals net operating profits after tax (NOPAT) minus a charge for the capital tied up in the weighted average cost of capital (WACC).The equation just below it divides these terms into their components, each of which can be thought of as a metric or financial footprint of superior economic profit.
The schematic shows that a firm cannot generate superior economic profits unless it can map its advantage into some metric or footprint (such as gross margin or SG&A/Sales) in which it outperforms the average of a firm in the same business. By knowing which driver(s) is the basis for the firm's superior performance, the firm is guided in protecting and leveraging its advantage. Begin your strategy process by computing your economic profit and then list the strategic drivers that contribute toward your success.
Calculating economic profits and identifying the footprints of economic advantage, by business unit if possible, is certainly not a trivial task. However, this is also essential to any meaningful strategy. We would be highly skeptical if a firm laid claim to a strategic advantage over its rivals but could not back up the claim with financial metrics or economic analysis. Strategy formulation that started with such a questionable premise of superiority would not hold water. Not all firms have the financial and accounting systems that permit convincing analyses along these lines, but the more that a firm relies on using financial measurement as a compass for strategic choices, the better it will become. Starting with poor information and developing the necessary systems over time surely beats ignoring the analysis altogether.
The second exercise useful for organizing information is called a "firm map." A useful map depicts the firm's position in its industry, as shown in Figure 1.2. Each stage in the map represents an industry or a set of firms whose outputs are considered reasonably close substitutes by customers. In the vertical chain (from Stage 1 to Stage 4), the industries are ordered from least to most processed (i.e., from furthest to closest to the end customers), and the dots represent particular firms in the industry. Firms in each stage supply the firms in the next, while firms in the final stage sell to consumers. While the firms in any one stage may have multiple suppliers, this analysis should focus on the most critical suppliers. We have arbitrarily determined that our firm of interest is in Stage 3.We have circled one of the dots in Stage 3 to indicate the location of our firm. The firm map shows that our firm (and all others in Stage 3) obtains supplies from three industries (A, B, and C).
Along the vertical and horizontal axis of each box are the characteristics that consumers value most highly and use to distinguish among firms. In this example, we have chosen perceived value on the X-axis and product variety on the Y-axis of the box for Stage 3.We see that our firm is fairly high in value but low in variety. We could have incorporated a third dimension by varying the size of the dots used to identify each firm. The size of the dots might correlate to market share or annual sales. Quite frankly, the analyst can get as creative and colorful as the availability of data allows.
The remaining boxes depict industries whose outputs substitute for or are complementary to the output of our industry. When complete, the boxes capture all competitors, substitutes, and complements. For example, Hyatt Hotels and Sheraton Hotels are in the same industry box (hotels), campgrounds are a substitute, and the availability of rental cars is a complement.
Like our financial analysis, firm mapping requires a measure of diligence. It is possible to prepare a qualitative firm map based on institutional knowledge. We offer a number of tools for adding rigor to the mapping exercise: Chapter 4 shows how to quantify a firm's position in the market, and Chapter 5 discusses how to more precisely identify competitors. The marketing literature also offers guidance on a number of mapping issues.
Understanding the facts about your firm's position is an indispensable part of strategic formulation, and you should attempt to make a map even if you know it is imperfect. Like the analysis of economic profits, something is better than nothing. Do not neglect your obligation to organize essential institutional knowledge as a central component of strategy formulation and analysis. The lack of perfect information is no excuse.
Step Two: Define the Firm's Position
To enjoy superior economic profits, a firm must have either a superior position in an industry that generates average returns (e.g., Wal-Mart), or an average position in an industry that generates superior returns (e.g., Eli Lilly). Having a superior position in a superior industry (Microsoft) is rare and especially profitable. The next two steps in the strategy process involve examining the firm's position relative to its industry, and examining the overall industry profitability. We present positioning before industry analysis, but this choice is arbitrary.
The first step in positioning analysis is identifying the firm's customers. The firm mapping should provide this information. The next step is to determine the firm's value creation proposition, that is, how the firm creates benefits for consumers (B) above and beyond the cost of production (C). At a minimum, the firm needs to generate a positive B-C. If it cannot do so, it may as well shut down.
Chapter 2 develops the B-C framework thoroughly. In Chapter 2, we argue that it is not sufficient for a firm to produce a positive B-C. If the firm is to outperform its rivals, it must produce more B-C than they do. The chapter then uses B-C to explain a number of concepts that are fundamental to strategy, including generic strategies and disruptive technologies. Increasing B-C is not just a matter of what the firm does, but also about whom the firm chooses to serve. Finding the right customer means segmenting the marketing correctly. After discussing segmentation, the chapter closes by offering a variety of tactics for creating B-C and discussing how firms should set their prices to best exploit their B-C advantage.
Excerpted from Kellogg on Strategy by David Dranove Excerpted by permission.
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Chapter 1: Getting Ready to Do Strategy.
Chapter 2: B Minus C: Positioning Your Firm against the Competition.
Chapter 3: Affirming Your Competitive Advantage: The Resources and Capabilities Audit.
Chapter 4: Measuring Your Competitive Advantage: A Toolkit.
Chapter 5: The Cancer of Competition: How to Diagnose It.
Chapter 6: The Cancer of Competition: How to Cure It.
Chapter 7: The Threat of Entry and How to Combat It.
Chapter 8: How to Sustain Your Competitive Advantage.
Chapter 9: Two Examples of Strategy in Action: Southwest Airlines and the Chicago Hospital Market.
Posted March 16, 2007
This concise guide to strategy offers an excellent basic introduction to business strategy. David Dranove and Sonia Marciano not only outline their own benefits-minus-cost ('B ¿ C') approach to strategy they also usefully summarize the essentials of other widely accepted approaches, most notably that of Harvard Business School professor Michael E. Porter. They write lucidly, avoid academic jargon and stay focused on the essentials without burdening the reader with unnecessary detail. They illustrate their discussion with examples drawn from actual business successes and failures and two case studies, one from the airline industry and the other from the health-care industry. We recommend this book to beginning managers looking for a strategy primer. Experienced strategists can turn to it for a refresher course in fundamental business truths.Was this review helpful? Yes NoThank you for your feedback. Report this reviewThank you, this review has been flagged.