Case A – Walton Art Center?In a narrative format, discuss the key facts and critical issues presented in the case. 2. Conside

Key Terms

Chapter Outline: 2-1 The Strategic Managment Process

2-2 Theories of Strategy

2-3 Strategy at the Corporate Level

2-4 Strategy at the Business Level

2-5 Strategy at the Functional Level

Summary Review Questions Glossary Endnotes

2Organizational Strategy & Performance

business-level strategy business unit competitive advantage contingency theory core competencies corporate profile corporate restructuring corporate-level strategy differentiation strategy

distinctive competence divestment downsizing external growth first-mover advantages focus functional strategies generic strategies growth strategy

industrial organization (IO) industry intended strategy internal growth liquidation low-cost strategy low-cost–differentiation realized strategy related diversification

retrenchment strategy stability strategy strategic alliances strategic group strategic mgmt. process strategy synergy turnaround

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Organizational Theory 2-2

strategy top management’s plans to attain outcomes consistent with the organization’s mission and goals

strategic management process the continuous process of determining the mission and goals of an organization within the context of its external environment and its internal strengths and weaknesses; formulating and implementing strategies; and exerting strategic control to ensure that the organization’s strategies are successful in attaining its goals

Organizations are most likely to succeed when their activities are integrated toward a common purpose. But this does not occur automatically; it requires substantial forethought and planning. In other words, it requires a strategy. This chapter discusses the strategic planning process, as well as strategic alternatives available for each organization. Although the concepts presented herein have been developed with profit-seeking firms in mind, they can be equally applicable to public and private not-for-profit organizations that must compete in some way with other organizations or agencies.

The concept of an organizational strategy encapsulates the notion of planning for success. Specifically, a strategy refers to top management’s plans to develop and sustain competitive advantage so that the organization’s mission is fulfilled. A strategy provides direction for the organization and can be identified by examining a pattern of decisions made by an organization’s top managers. It is most likely to be effective when it is compatible with the organization’s structure and culture, concepts that will be developed later in the text. Although strategy is discussed before structure and culture, all three dimensions are tightly intertwined.

A successful strategy is marked by four key distinctions. First, it does not simply emerge, but rather is developed after top managers systematically evaluate both the organization’s resources and external factors that can affect performance. Second, it is long-term and future-oriented—usually several years to a decade or longer—but built on knowledge about the past and present. Third, it is distinctively opportunistic, always seeking to take advantage of favorable situations that occur outside the organization. Finally, strategic thinking involves choices. “Win-win” strategic decisions are often possible, but most involve some degree of trade-off between alternatives, at least in the short run.

2-1 The Strategic Management Process Ideally, a strategy is developed as part of a conscious activity led by an organization’s top managers. The strategic management process also includes top management’s analysis of the environment in which the organization operates prior to formulating a strategy, as well as the plan for implementation and control of the strategy. This process can be summarized in six steps:1

1. External Analysis: Analyze the opportunities and threats or constraints that exist in the organization’s external environment.

2. Internal Analysis: Analyze the organization’s strengths and weaknesses in its internal environment.

3. Mission and Direction: Reassess the organization’s mission and its goals in light of the external and internal analyses.

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Organizational Theory 2-3

intended strategy the original strategy top management plans and intends to implement

realized strategy the strategy top management actually implements

4. Strategy Formulation: Formulate strategies that build and sustain competitive advantage by matching the organization’s strengths and weaknesses with the environment’s opportunities and threats. Consider the fit between the strategy and other organizational dimensions, such as the structure and the prevailing culture.

5. Strategy Implementation: Implement the strategies that have been developed. Make adjustments to the organizational structure, if feasible and relevant.

6. Strategic Control: Evaluate organizational effectiveness and engage in strategic control activities when the strategies are not producing the desired outcomes.

Although this process is simple and straightforward, complexities in the environment complicate the process, especially between the time a strategy is formulated and the time it is actually implemented. Henry Mintzberg introduced two terms to help clarify the shift that often occurs during this period. An intended strategy reflects what management originally planned and may be realized just as it was proposed , but the intended strategy and the realized strategy, what management actually implements usually differ.2 Hence, the original strategy may be realized with desirable or undesirable results, or it may be modified as changes in the firm or the environment become known.

The gap between the intended and realized strategies usually results from unforeseen environmental or organizational events, better information that was not available when the strategy was formulated, an improvement in top management’s ability to assess its environment, or strategic responses from competitors. As such, this gap can be minimized if top managers assimilate and process information about the organization’s environment more effectively. It is not uncommon for such a gap to exist, creating the need for constant strategic action if a firm is to stay on course. Instead of resisting modest strategic changes when new information is discovered, managers should search for new information and be willing to make such changes when necessary.

A thorough discussion of each step of the strategic management process is beyond the scope of this text. However, many of the concepts presented in the text relate to one or more of these phases. The remainder of this chapter is concerned primarily with the theories that influence the process and the content of corporate and competitive strategies available to organizations.

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industrial organization (IO) a view based in microecomonic theory that states that a firm’s profitability is most closely associated with industry structure

industry a group of competitors that produces similar products or services

resource-based theory a view that states that a firm’s performance is tied to the resources it acquires and utilizes.

2-2 Theories of Strategy The strategic management process has been influenced by a number of theories and perspectives, three of which are summarized in the table 2-1 and discussed below.

Industrial organization (IO) economics, a branch of microeconomics, emphasizes the influence of the industry environment upon the organization. IO emphasizes that an organization must adapt to influences exerted by its industry— the collection of competitors that offer similar products or services—to survive and prosper. Following this logic, organizational performance is primarily determined by the structure of the industry in which it competes. Industries with “favorable structures” offer the greatest opportunity for high organizational performance.

IO logic can be seen in Michael Porter’s frequently cited “five forces” model, discussed in greater detail in the following chapter. Porter’s model identifies five structural elements that influence industry profitability: Existing rivalry, threat of substitutes, threat of new entrants, bargaining power of buyers, and bargaining power of suppliers.3 These factors collectively determine the potential for profits in a particular industry. It assumes that organizations are likely to perform well when they operate in industries with attractive structures.

The concept of adaptation is central to the IO perspective. In essence, an organization’s performance and ultimate survival depend on its ability to adapt to external forces rather than attempt to influence or control them. Strategies, resources, and competencies are assumed to be fairly similar among competitors within a given industry. If one organization deviates from the industry norm and implements a new, successful strategy, others will rapidly mimic the higher- performing organization by purchasing the resources, competencies, or management talent that have made the leading firm so profitable. Hence, strategic managers should seek to understand the nature of the industry and formulate strategies that feed off the industry’s characteristics.4

In contrast to the IO perspective, resource-based theory views performance primarily as a function of an organization’s ability to acquire and utilize its resources.5 Although environmental opportunities and threats are important, an

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distinctive competence unique resources, skills, and capabilities that enable an organization to distinguish itself from its competitors and create a competitive advantage

contingency theory a perspective that suggests that the most profitable firms are likely to be the ones that develop the best fit with their environments

organization’s unique resources comprise the key variables that allow it to develop a distinctive competence, distinguishing itself from its rivals, and creating competitive advantage. “Resources” include all of a firm’s tangible and intangible assets, such as capital, equipment, employees, knowledge, and information.6 In many respects, an organization’s resources define its capabilities, as an organization with strong research and development may also possess the capability to develop successful new products. Ultimately, this can create value and lead to greater performance.

All resources are not equally valuable. If resources are to be used for sustainable competitive advantage—a organization’s ability to enjoy strategic benefits and outperform the industry norm over an extended period of time—those resources must be valuable, rare (i.e., not easily obtained by rivals), not easily imitated, and without strategically relevant substitutes.7 In other words, the most desirable resources on ones that utilized by an organization in a way that competitors cannot easily match. Valuable resources contribute significantly to the organization’s effectiveness and efficiency, rare resources are possessed by only a few competitors, and imperfectly imitable resources cannot be fully duplicated by rivals.

Contingency theory emphasizes the interaction between the organization and its environment. Within this perspective, the fit between organization and environment is the central concern. In other words, a strategy is most likely to be successful when it is consistent with the organization’s mission, its competitive environment, and its resources. In effect, contingency theory represents a middle ground perspective that views organizational performance as the joint outcome of environmental forces and the firm’s strategic actions. On the one hand, firms can become proactive by choosing to operate in environments where opportunities and threats match the firms’ strengths and weaknesses.8 On the other hand, should the industry environment change in a way that is unfavorable to the firm, its top managers should consider leaving that industry and reallocating its resources to other, more favorable industries.

Contingency theory is applied when a strategy is formulated. Strategic managers consider internal resources in light of external opportunities and threats and develop strategies that reflect a fit between the two. Hence, an effective strategy is not merely a “good idea,” but one that capitalizes on the particular resources controlled by an organization and the environment in which it operates. In other words, an effective strategy “fits” the organization.

As has been demonstrated, each of these three perspectives has merit and has been incorporated into the strategic management process. The industrial organization view is prominent within the industry analysis phase, resource-based theory applies directly to the internal analysis phase, and contingency theory is seen in the strategy formulation phase. Hence, multiple perspectives are critical to a holistic understanding of an organization’s strategy and its relationship with performance.9

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Organizational Theory 2-6

corporate-level strategy the broad strategy that top managment formulates for the overall organization

business-level stragegy a strategy formulated for a business unit that identifies how it will compete with other businesses within its industry

business unit an organizational entity with its own unique mission, set of competitors, and industry

competitive advantage a state whereby a business unit’s successful strategies cannot be easily duplicated by its competitors

functional strategies strategies created at functional levels (e.g., marketing, finance, production, etc.) to support the business and corporate strategies

corporate profile identification of the industry(ies) in which a firm operates

related diversification a process whereby an organization acquires one or more businesses not related to its core domain

synergy when the combination of two organizations results in higher efficiency and effectiveness that would otherwise be achieved by the two organizations separately

2-3 Strategy at the Corporate Level The complex notion of organizational strategy can be examined from three perspectives: firm (also called corporate), business (also called competitive), and functional. The corporate strategy reflects the broad strategic approach top management formulates for the organization. The business-level strategy outlines the competitive pattern for a business unit, an organizational entity with its own mission, set of competitors, and industry. Top managers craft competitive strategies for each business (unit) to attain and sustain competitive advantage, a state whereby its successful strategies cannot be easily duplicated by its competitors.10 Functional strategies are created at each functional level (i.e., marketing, finance, production, etc.) to support the business and corporate strategies.

There are two steps involved in developing the corporate strategy. The first step is to assess the markets or industries in which the firm operates. At the corporate level, top management defines the corporate profile by identifying the specific industry(s) in which the organization will operate. Three basic profiles are possible: operate in a single industry, operate in multiple related industries, or operate in multiple, unrelated industries.

An organization that operates in a single industry can benefit from the specialized knowledge that it develops from concentrating its efforts on one business area. This knowledge can help the firm improve product or service quality and become more efficient in its operations. McDonald’s, for instance, constantly changes its product line, while maintaining a low per-unit cost of operations by concentrating exclusively on fast food. Wal-Mart benefits from expertise derived from concentration in the retailing industry. Although involved in other businesses as well, Anheuser Busch limits its scope of operations primarily to brewing, from which it derives more than 80 percent of its revenues and profits.11 Firms operating in a single industry are more susceptible to sharp downturns in business cycles, however.

An organization may operate in multiple related industries to reduce the uncertainty and risk associated with operating in a single industry. An organization may diversify by developing a new line of business, or an organization with large, successful businesses may acquire smaller competitors with complementary product or service lines, a process known as related diversification. In some instances, however, a smaller firm may acquire a larger one, as was the case when Kmart acquired Sears in 2004. Size, of course, can be defined in a number of ways, including total revenues, number of employees or locations, or the physical size of facilities.

The key to successful related diversification is the development of synergy among the related business units. Synergy occurs when the two previously separate organizations join to generate higher effectiveness and efficiency than would have

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Organizational Theory 2-7

unrelated diversification process whereby an organization acquires businesses unrelated to its core domain

growth strategy corporate-level strategy designed to increase profits, sales, and/or market share

internal growth growth strategy in which a firm expands by internally increasing its size and sales rather than by acquiring other companies

external growth growth strategy whereby a firm acquires other companies

been generated by them separately. When there are similarities in product or service lines, relationships in the distribution channels, or complementary managerial or technical expertise across business units, synergy is most likely to result.

An organization may choose to operate in unrelated industries because its managers wish to reduce risk by spreading resources across several markets, thereby pursuing unrelated diversification by acquiring businesses not related to its core domain. Unlike related diversification, unrelated diversification is not about synergy. Unrelated diversification is pursued primarily to reduce risks that are associated with the organization that operates in only one area of business. Unrelated diversification, however, can make it more difficult for managers to stay abreast of market and technological changes in the various industries. In addition, they may unknowingly shift attention away from the organization’s primary business in favor of less critical ones.

The second step involved in developing the corporate strategy is associated with the extent to which an organization seeks to increase its size. Simply stated, an organization may attempt to increase its size significantly, remain about the same size, or become smaller. These three possibilities are seen in three corporate strategies—growth, stability, and retrenchment (i.e., become smaller)—each of which is discussed in greater detail.

2-3a Growth Strategies

The growth strategy seeks to significantly increase a organization’s revenues or market share. Growth may be attained in a variety of ways. Internal growth is accomplished when a firm increases revenues, production capacity, and its workforce, and can occur by growing a business or creating new ones. External growth is accomplished when an organization merges with or acquires another firm. Mergers are generally undertaken to share or transfer resources and/or improve competitiveness by combining resources.

The attractiveness of merging with or acquiring another organization may seem intuitively obvious: Two organizations join forces into a single one that possesses all the strengths of the individual firms. The key to successful mergers and acquisitions is often found in the ability to develop synergy. Some companies like G.E. are well known for their ability to acquire other companies and integrate them effectively. Opportunities for synergy are not always easy to identify, however. It is not uncommon for an organization to acquire a business and later discard it when the anticipated synergy is not attained.

When two organizations combine through a merger or acquisition to form a “new” organization, blending two distinct cultures can be difficult amidst the rumors of layoffs and restructuring that often accompany the transaction.12 This is especially true when organizations across borders are involved. Although carmakers Chrysler

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Organizational Theory 2-8

strategic alliances corporate-level growth strategy in which two or more firms agree to share the costs, risks, and benefits associated with pursuing existing or new business opportunities. Strategic alliances are often referred to as partnerships

stability strategy corporate-level strategy intended to maintain a firm’s present size and current lines of business

and Daimler Benz merged to form DaimlerChrysler in 1998, complete cooperation between members from the two original organizations has been slow to develop. During the first few years of the merger, Mercedes executives closely guarded their technology from Chrysler for fear of eroding the Mercedes mystique. In 2003, the two divisions began to cooperate more closely when it began building the Crossfire, a Chrysler design with Mercedes components.13

One alternative to pursuing a merger or acquisition is to form a close relationship with another organization without becoming part of the same firm. Strategic alliances—often called partnerships—occur when two or more firms agree to share the costs, risks, and benefits associated with pursuing existing or new business opportunities. Strategic alliances can be temporary, disbanding after the project is finished, or they can involve multiple projects over an extended period of time.14 A strategic alliance can be particularly attractive when a project may be so large that it would strain a single company’s resources or require complex technology that no single firm possesses. Hence, firms with complementary technologies may combine forces, or one firm may contribute its technological expertise while another contributes its managerial or other abilities.15 American carmakers General Motors and Ford have established strategic alliances with small manufacturers in emerging economies such as China and Russia. GM and Ford provide technological expertise to the alliance, whereas the producer in the host country provides access and distribution to the local market.

Strategic alliances have two major advantages over mergers and acquisitions. First, they minimize increases in bureaucratic, developmental, and coordination costs. Second, each company can share in the benefits of the alliance without bearing all the costs and risks itself. A key disadvantage of a strategic alliance, however, is that one partner in the alliance may offer less value to the project than other partners but may gain a disproportionate amount of critical know-how from the cooperation with its more progressive partners. In addition, the participating organizations may hesitate to share complete information and expertise with each other.

2-3b Stability Strategy

Although growth is intuitively appealing, it is not always the most effective strategy. The stability strategy seeks to keep the organization at roughly the same size. Growth may occur naturally but is typically limited to the level of industry growth. Stability enables the organization to focus its efforts on enhancing current activities, while avoiding costs associated with internal or external growth. An organization may adopt a stability strategy in leaner times and shift to a growth strategy when economic conditions improve. Stability can also be an effective strategy for a high performing organization, but it is not necessarily a risk-averse strategy.

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Organizational Theory 2-9

retrenchment strategy corporate-level strategy designed to reduce the size of the firm

corporate restructuring corporate strategic approach that includes such actions as realigning divisions in the firm, reducing the amount of cash under the discretion of senior executives, and acquiring or divesting business units

turnaround corporate-level retrenchment strategy intended to transform the firm into a leaner and more effective business by reducing costs and rethinking the firm’s product lines and target markets

Stability may be pursued instead of growth under at least four sets of cir- cumstances:

1. Industry growth is slow or non-existent. In this situation, one firm’s growth must come at the expense of a rival. This can be particularly costly, especially when attacking an industry leader.16

2. Costs associated with growth do not exceed its benefits. During the “cola wars” of the 1980s, PepsiCo and Coca-Cola spent millions to lure consumers to their cola brands, only to realize that the costs associated with securing this market share severely reduce profits.

3. Growth may place great constraints on quality and customer service, especially in small organizations known for their personal service and attention to detail.

4. Large, dominant organizations may not wish to risk prosecution for monopolistic practices associated with growth. American firms, for example, may be prohibited from acquiring competitors if regulators believe their combined market shares will threaten competitiveness. Even internal growth can be problematic at times, as was the case in the late 1990s through 2001 with Microsoft’s costly defense against federal charges that the company unfairly dictated terms in the software industry.

2-3c Retrenchment Strategies

Growth strategies and the stability strategy are generally adopted by healthy organizations. But when performance is disappointing, a retrenchment strategy may be appropriate. Retrenchment takes one or a combination of three forms: turnaround, divestment, or liquidation. A retrenchment strategy is often accompanied by a reorganization process known as corporate restructuring. Corporate restructuring includes such actions as realigning divisions in the firm, reducing the amount of cash under the discretion of senior executives, and acquiring or divesting business units.17 Restructuring is not limited to organizations that perform poorly over an extended period of time. Even well-known, leading companies progress through product and economic cycles that require them to restructure on occasion. Fast-food giant McDonald’s, for example, posted a fourth quarter 2002 loss of $344 million, its first in 37 years. The firm responded with a restructuring plan that included opening fewer new stores, greater product and marketing emphasis on existing outlets, and a number of store closings in 2003 in the United States and Japan, its two largest markets.18

A turnaround seeks to transform the organization into a leaner, more effective firm and can include such actions as eliminating unprofitable outputs, reducing the size of the workforce, cutting costs of distribution, and reassessing product lines

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Organizational Theory 2-10

downsizing a means of organizational restructuring that eliminates one or more hierarchical levels from the organization and pushes decision making downward in the organization

divestment a corporate-level retrenchment strategy in which a firm sells one or more of its business units

and customer groups.19 Turnarounds are often accompanied by downsizing, the elimination of one or more hierarchical levels in an organization. Turnarounds are often preceded by changes in the external environment. In general, a turnaround is usually not as drastic a move as corporate restructuring, but the two terms are often used interchangeably in the business press.

Turnarounds involving layoffs are generally more difficult to implement than one might think. When layoffs are required, organizations must address their effects on both departing employees and those who remain with the organization, the “survivors.” Employees may be given opportunities to voluntarily leave—generally with an incentive—to make the process as congenial as possible. The problem with this approach, however, is that those departing are often the top performers who are most marketable, leaving the organization with a less competitive workforce. When layoffs are simply announced, less competitive workers can be eliminated more easily, but morale is likely to suffer more.20

When layoffs are necessary, however, several actions may palliate some of the negative effects. Top managers should communicate honestly and effectively with …