Strategy Formulation (Encyclopedia of Management)
Stated simply, strategy is a road map or guide by which an organization moves from a current state of affairs to a future desired state. It is not only a template by which daily decisions are made, but also a tool with which long-range future plans and courses of action are constructed. Strategy allows a company to position itself effectively within its environment to reach its maximum potential, while constantly monitoring that environment for changes that can affect it so as to make changes in its strategic plan accordingly. In short, strategy defines where you are, where you are going, and how you are going to get there.
Strategic planning, as a formalized business process, has been in practice for almost 40 years. However, it is commonplace to find that a grand majority of organizations have no clear concept of how to effectively conduct the planning process. As a result, most strategic plans are poorly conceived and do nothing more than sit on a bookshelf; no real impact is ever made on the company and its activities. Fortunately, within the past decade or so, there have been attempts made to clarify the major components and processes of strategic planning. In this respect, it has become easier for ordinary an organization to effectively create and implement a first rate strategic plan.
Basic strategic planning is comprised of several components that build upon the previous piece of the plan, and operates much like a flow chart. However, prior to embarking on this process, it is important to consider the players involved. There must be a commitment from the highest office in the organizational hierarchy. Without buy-in from the head of a company, it is unlikely that other members will be supportive in the planning and eventual implementation process, thereby dooming the plan before it ever takes shape. Commitment and support of the strategic-planning initiative must spread from the president and/or CEO all the way down through the ranks to the line worker on the factory floor.
Just as importantly, the strategic-planning team should be composed of top-level managers who are capable of representing the interests, concerns, and opinions of all members of the organization. As well, organizational theory dictates that there should be no more than twelve members of the team. This allows group dynamics to function at their optimal level.
The components of the strategic-planning process read much like a laundry list, with one exception: each piece of the process must be kept in its sequential order since each part builds upon the previous one. This is where the similarity to a flow chart is most evident, as can be seen in the following illustration.
The only exceptions to this are environmental scanning and continuous implementation, which are continuous processes throughout. This article will now focus on the discussion of each component of the formulation process: environmental scanning, continuous implementation, values assessment, vision and mission formulation, strategy design, performance audit analysis, gap analysis, action-plan development, contingency planning, and final implementation. After that, this article will discuss a Japanese variation to Strategy Formulation, Hoshin Planning, which has become very popular.
This element of strategy formulation is one of the two continuous processes. Consistently scanning its surroundings serves the distinct purpose of allowing a company to survey a variety of constituents that affect its performance, and which are necessary in order to conduct subsequent pieces of the planning process. There are several specific areas that should be considered, including the overall environment, the specific industry itself, competition, and the internal environment of the firm. The resulting consequence of regular inspection of the environment is that an organization readily notes changes and is able to adapt its strategy accordingly. This leads to the development of a real advantage in the form of accurate responses to internal
The idea behind this continual process is that each step of the planning process requires some degree of implementation before the next stage can begin. This naturally dictates that all implementation cannot be postponed until completion of the plan, but must be initiated along the way. Implementation procedures specific to each phase of planning must be completed during that phase in order for the next stage to be started.
All business decisions are fundamentally based on some set of values, whether they are personal or organizational values. The implication here is that since the strategic plan is to be used as a guide for daily decision making, the plan itself should be aligned with those personal and organizational values. To delve even further, a values assessment should include an in-depth analysis of several elements: personal values, organizational values, operating philosophy, organization culture, and stakeholders. This allows the planning team to take a macro look at the organization and how it functions as a whole.
Strategic planning that does not integrate a values assessment into the process is sure to encounter severe implementation and functionality problems if not outright failure. Briefly put, form follows function; the form of the strategic plan must follow the functionality of the organization, which is a direct result of organizational values and culture. If any party feels that his or her values have been neglected, he or she will not adopt the plan into daily work procedures and the benefits will not be obtained.
VISION AND MISSION FORMULATION
This step of the planning process is critical in that is serves as the foundation upon which the remainder of the plan is built. A vision is a statement that identifies where an organization wants to be at some point in the future. It functions to provide a company with directionality, stress management, justification and quantification of resources, enhancement of professional growth, motivation, standards, and succession planning. Porrus and Collins (1996) point out that a well-conceived vision consists of two major components: a core ideology and the envisioned future.
A core ideology is the enduring character of an organization; it provides the glue that holds an organization together. It itself is composed of core values and a core purpose. The core purpose is the organization's entire reason for being. The envisioned future involves a conception of the organization at a specified future date inclusive of its aspirations and ambitions. It includes the BHAG (big, hairy, audacious goal), which a company typically reaches only 50 to 70 percent of the time. This envisioned future gives vividly describes specific goals for the organization to reach.
The strategic results of a well formulated vision include the survival of the organization, the focus on productive effort, vitality through the alignment of the individual employees and the organization as a whole, and, finally, success. Once an agreed-upon vision is implemented, it is time to move on to the creation of a mission statement.
An explicit mission statement ensures the unanimity of purpose, provides the basis for resource allocation, guides organizational climate and culture, establishes organizational boundaries, facilitates accountability, and facilitates control of cost, time, and performance. When formulating a mission statement, it is vital that it specifies six specific elements, including the basic product or service, employee orientation, primary market(s), customer orientation, principle technologies, and standards of quality. With all of these elements incorporated, a mission statement should still remain short and memorable. For example, the mission statement of the American Red Cross, reads:
"The mission of the American Red Cross is to improve the quality of human life; to enhance self-reliance and concern for others; and to help people avoid, prepare for, and cope with emergencies."
Other functions of a mission statement include setting the bounds for development of company philosophy, values, aspirations, and priorities (policy); establishing a positive public image; justifying business operations; and providing a corporate identity for internal and external stakeholders.
This section of strategy formulation involves the preliminary layout of the detailed paths by which the company plans to fulfill its mission and vision. This step involves four major elements: identification of the major lines of business (LOBs), establishment of critical success indicators (CSIs), identification of strategic thrusts to pursue, and the determination of the necessary culture.
A line of business is an activity that produces either dramatically different products or services or that are geared towards very different markets. When considering the addition of a new line of business, it should be based on existing core competencies of the organization, its potential contribution to the bottom line, and its fit with the firm's value system.
The establishment of critical success factors must be completed for the organization as a whole as well as for each line of business. A critical success indicator is a gauge by which to measure the progress toward achieving the company's mission. In order to serve as a motivational tool, critical success indicators must be accompanied by a target year (i.e. 1999, 1999002, etc.). This also allows for easy tracking of the indicated targets. These indicators are typically a mixture of financial figures and ratios (i.e. return on investment, return on equity, profit margins, etc.) and softer indicators such as customer loyalty, employee retention/turnover, and so on.
Strategic thrusts are the most well-known methods for accomplishing the mission of an organization. Generally speaking, there are a handful of commonly used strategic thrusts, which have been so aptly named grand strategies. They include the concentration on existing products or services; market/product development; concentration on innovation/technology; vertical/horizontal integration; the development of joint ventures; diversification; retrenchment/turnaround (usually through cost reduction); and divestment/liquidation (known as the final solution).
Finally, in designing strategy, it is necessary to determine the necessary culture with which to support the achievement of the lines of business, critical success indicators, and strategic thrusts. Harrison and Stokes (1992) defined four major types of organizational cultures: power orientation, role orientation, achievement orientation, and support orientation. Power orientation is based on the inequality of access to resources, and leadership is based on strength from those individuals who control the organization from the top. Role orientation carefully defines the roles and duties of each member of the organization; it is a bureaucracy. The achievement orientation aligns people with a common vision or purpose. It uses the mission to attract and release the personal energy of organizational members in the pursuit of common goals. With a support orientation, the organizational climate is based on mutual trust between the individual and the organization. More emphasis is placed on people being valued more as human beings rather than employees. Typically an organization will choose some mixture of these or other predefined culture roles that it feels is suitable in helping it to achieve is mission and the other components of strategy design.
PERFORMANCE AUDIT ANALYSISConducting a performance audit allows the organization to take inventory of what its current state is. The main idea of this stage of planning is to take an
Developing a clear understanding of resource strengths and weaknesses, an organization's best opportunities, and its external threats allows the planning team to draw conclusions about how to best allocate resources in light of the firm's internal and external situation. This also produces strategic thinking about how to best strengthen the organization's resource base for the future.
Looking internally, there are several key areas that must be analyzed and addressed. This includes identifying the status of each existing line of business and unused resources for prospective additions; identifying the status of current tracking systems; defining the organization's strategic profile; listing the available resources for implementing the strategic thrusts that have been selected for achieving the newly defined mission; and an examining the current organizational culture. The external investigation should look closely at competitors, suppliers, markets and customers, economic trends, labor-market conditions, and governmental regulations. In conducting this query, the information gained and used must reflect a current state of affairs as well as directions for the future. The result of a performance audit should be the establishment of a performance gap, that is, the resultant gap between the current performance of the organization in relation to its performance targets. To close this gap, the planning team must conduct what is known as a gap analysis, the next step in the strategic planning process.
A gap analysis is a simple tool by which the planning team can identify methods with which to close the identified performance gap(s). All too often, however, planning teams make the mistake of making this step much more difficult than need be. Simply, the planning team must look at the current state of affairs
ACTION PLAN DEVELOPMENT
This phase of planning ties everything together. First, an action plan must be developed for each line of business, both existing and proposed. It is here that the goals and objectives for the organization are developed.
Goals are statements of desired future end-states. They are derived from the vision and mission statements and are consistent with organizational culture, ethics, and the law. Goals are action oriented, measurable, standard setting, and time bounded. In strategic planning, it is essential to concentrate on only two or three goals rather than a great many. The idea is that a planning team can do a better job on a few rather than on many. There should never be more than seven goals. Ideally, the team should set one, well-defined goal for each line of business.
Writing goals statements is often a tricky task. By following an easy-to-use formula, goals will include all vital components.
- Accomplishment/target (e.g., to be number one in sales on the East Coast by 2005)
- A measure (e.g., sales on the East Coast)
- Standards (e.g., number one)
- Time frame (e.g., long-term)
Objectives are near-term goals that link each long-term goal with functional areas, such as operations, human resources, finance, etc., and to key processes such as information, leadership, etc. Specifically, each objective statement must indicate what is to be done, what will be measured, the expected standards for the measure, and a time frame less than one year (usually tied to the budget cycle). Objectives are dynamic in that they can and do change if the measurements indicate that progress toward the accomplishment of the goal at hand is deficient in any manner. Simply, objectives spell out the step-by-step sequences of actions necessary to achieve the related goals.
With a thorough understanding of how these particular elements fit and work together, an action plan is developed. If carefully and exactingly completed, it will serve as the implementation tool for each established goal and its corresponding objectives as well as a gauge for the standards of their completion.
The key to contingency planning is to establish a reactionary plan for high impact events that cannot necessarily be anticipated. Contingency plans should identify a number of key indicators that will create awareness of the need to reevaluate the applicability and effectiveness of the strategy currently being followed. When a red flag is raised, there should either be a higher level of monitoring established or immediate action should be taken.
Implementation of the strategic plan is the final step for putting it to work for an organization. To be successful, the strategic plan must have the support of every member of the firm. As mentioned in the beginning, this is why the top office must be involved from the beginning. A company's leader is its most influential member. Positive reception and implementation of the strategic plan into daily activities by this office greatly increases the likelihood that others will do the same.
Advertising is key to successful implementation of the strategic plan. The more often employees hear about the plan, its elements, and ways to measure its success, the greater the possibility that they will undertake it as part of their daily work lives. It is especially important that employees are aware of the measurement systems and that significant achievements be rewarded and celebrated. This positive reinforcement increases support of the plan and belief in its possibilities.
Hoshin planning, or "hoshin kanri" in Japanese, is a planning method developed in Japan during the 1970s and adopted by some U.S. firms starting in the 1980s. Also known in the United States as policy deployment, management by policy, and hoshin management, it is a careful and deliberate process by which the few most important organizational goals are deployed throughout the organization. It consists of five major steps:
- Development at the executive level of a long-term vision.
- Selection of a small number of annual targets that will move the organization toward the vision.
- Development of plans at all levels of the organization that will together achieve the annual targets.
- Execution of the plans.
- Regular audits of the plans. Among U.S. companies that utilize this method are Hewlett-Packard and Xerox.
HISTORY OF HOSHIN PLANNING
The literal meaning of "hoshin kanri" is helpful in understanding its use "hoshin" is made up of two characters that mean "needle" and "pointing direction," together meaning something like a compass "kanri" also is made up of two characters that mean "control" or "channeling" and "reason" or "logic." Together they mean managing the direction of the company, which is vitally important especially in times of rapid change.
Hoshin management was developed in Japan as part of the overall refinement of quality programs in that country after World War II. At one time, "made in Japan" was synonymous with shoddy quality, but with the encouragement of the American occupation force, the Japanese Union of Scientists and Engineers (JUSE) made great efforts to improve Japanese manufacturing. An important element of the JUSE program between 1950 and 1960 was inviting W. Edwards Deming and Joseph M. Juran to train managers and scholars in statistical process control (SPC) and quality management. So significant were these visits, especially Deming's, that the highest Japanese award for quality is called the Deming Prize. Each company developed its own planning methodology, but the Deming Prize system involves the sharing of best practices, and common themes developed. In 1965 Bridgestone Tire published a report described the planning techniques used by Deming Prize winners, which were given the name hoshin kanri. By 1975 hoshin planning was widely accepted in Japan.
In the early 1980s hoshin planning began to gain acceptance in the United States, first in companies that had divisions or subsidiaries in Japan which won the Deming Prize: Yokagawa Hewlett-Packard, Fuji Xerox, and Texas Instruments' Oita plant. Florida Power and Light, the only company outside Japan to win the Deming Prize, was an early adopter. During the 1990s the practice spread. In 1994 Noriaki Kano, professor of management science at the University of Tokyo and member of the Deming Prize Committee, gave a presentation on the topic at the meeting of the American Society of Quality Control (now the American Society for Quality).
THE CONTEXT FOR HOSHIN PLANNING
Hoshin planning should be seen in the context of total quality management (TQM). Several elements of TQM are especially important for the effectiveness of hoshin planning. Most basic is a customer-driven master plan that encapsulates the company's overall vision and direction. Hoshin planning also assumes an effective system of daily management that keeps the company moving on course, including an appropriate business structure and the use of quality tools such as SPC. A third important element of TQM is the presence of cross-functional teams. Experience in problem solving and communications across and between levels of the organization are vital for hoshin planning.
A number of general principles underlie this method. Of utmost importance is participation by all managers in defining the vision for the company as well as in implementing the plans developed to reach the vision. Related to this is what the Japanese call "catchball," which means a process of lateral and vertical communication that continues until understanding and agreement is assured. Another principle is individual initiative and responsibility. Each manager sets his own monthly and yearly targets and then integrates them with others. Related to this principle is a focus on the process rather than strictly on reaching the target and a dedication to root cause analysis. A final principle that is applied in Japan-but apparently not in the United States-is that when applying hoshin planning, there is no tie to performance reviews or other personnel measures.
STEPS OF POLICY DEPLOYMENT
In its simplest form, hoshin planning consists of a plan, execution, and audit. In a more elaborated form it includes a long-range plan (five to ten years), a detailed one-year plan, deployment to departments, execution, and regular diagnostic audits, including an annual audit by the CEO.
FIVE- TO TEN-YEAR VISION.
The long-range vision begins with the top executive and his staff, but is modified with input from all managers. The purpose is to determine where the company wants to be at that future point in time, given its current position, its strengths and weaknesses, the voice of the customer, and other aspects of the business environment in which it operates. Beyond stating the goal, this long-range plan also identifies the steps that must be taken to reach it. It focuses on the vital few strategic gaps that must be closed over the time period being planned.
Once the plan has been drafted, it is sent to all managers for their review and critique. The object is to get many perspectives on the plan. The review process also has the effect of increasing buy-in to the final plan. This process is easier in Japanese companies than in most U.S. firms because most Japanese companies have only four layers of management.
Once the long-range vision is in place, the annual plan is created. The vital few areas for change that were identified in the vision are translated into steps to be taken this year. Again, this process involves lateral and vertical communication among managers. The targets are selected using criteria such as feasibility and contribution to the long-term goals. The targets are stated in simple terms with clearly measurable goals. Some companies and authors refer to such an annual target as a hoshin. Most companies set no more than three such targets, but others establish as many as eight. Not all departments are necessarily involved in every hoshin during a given year. The targets are chosen for the sake of the long-term goals, not for involvement for its own sake.
DEPLOYMENT TO LOWER LEVELS.
Once the targets, including the basic metrics for each, are established, the plan is deployed throughout the company. This is the heart of hoshin planning. Each hoshin has some sort of measurable target. Top-level managers, having discussed it with their subordinates earlier in the process, commit to a specific contribution to that target, and then their subordinates develop their own plans to reach that contribution, including appropriate metrics. Plans are deployed to lower levels in the same way (see Figure 1). An important principle here is that those who have to implement the plan design the plan. In addition to the lower level targets, the means and resources required are determined. Catchball plays an important role here. A key element of the hoshin discipline is the horizontal and vertical alignment of the many separate plans that are developed. All ambiguities are clarified, and conflicting targets or means are negotiated.
The final step in deploying the hoshin is rolling up the separate plans and targets to ensure that they are sufficient to reach the company-wide target. If not, more work is done to reconcile the difference.
The best-laid plans can come to naught if they are not properly executed. In terms of TQM, the execution phase is where hoshin management hands responsibility over to daily management. The strategies identified in the plan become part of the daily operation of the company. If the process has been done properly, all employees know what has to be done at their level to reach the top-level goals and thereby move the company toward the future described in the long-term vision.
AUDITING THE PLAN.
Essential to hoshin planning is the periodic diagnostic audit, most often done on a monthly basis. Each manager evaluates the progress made toward his own targets, and these reports are rolled up the organization to give feedback on the process to the highest levels. Successes and failures are examined at every level, and corrective action is taken as necessary. If it becomes apparent that something is seriously amiss in the execution, because of a significant change in the situation or perhaps a mistake in the planning phase, the plan may be adjusted and the change communicated up and down the organizational structure as necessary. The audit is a diagnostic review, an opportunity for mid-course corrections and not a time for marking up a scorecard. At the end of the year, the CEO makes an annual diagnostic review of the entire plan, focusing not only on the overall success or failure, but also on the entire process, including the planning phase. The results of this audit become part of the input for the next annual plan, along with the five-to-ten-year plan and changes in the internal or external business environment.
Although full implementation of hoshin planning in a large organization takes considerable effort, it is recognized as having many advantages over traditional business planning. The discipline of
Babich, Peter. Hoshin Handbook. 2nd ed. Poway, CA: Total Quality Engineering, Inc., 1996.
Bechtell, Michele L. The Management Compass: Steering the Corporation Using Hoshin Planning. New York: AMACOM, 1995.
. "Navigating Organizational Waters with Hoshin Planning." National Productivity Review, Spring 1996.
Collins, Brendan, and Ernest Huge. Management by Policy: How Companies Focus Their Total Quality Efforts to Achieve Competitive Advantage. Milwaukee: ASQC Quality Press, 1993.
Collins, James C., and Jerry I. Porras. "Building Your Company's Vision." Harvard Business Review, September-October 1996, 650.
Goldstein, Leonard D., Timothy M. Nolan, and J. William Pfeiffer. Applied Strategic Planning: How to Develop a Plan that Really Works. New York: McGraw-Hill, Inc., 1993.
Harrison, Roger, and Herb Stokes. Diagnosing Organizational Culture. San Francisco: Pfeiffer, 1992.
King, Bob. Hoshin Planning: the Developmental Approach. Methuen, MA: GOAL/QPC, 1989.
Mellum, Mara Minerva, and Casey Collett. Breakthrough Leadership: Achieving Organizational Alignment through Hoshin Planning. Chicago: American Hospital Publishers, Inc., 1995.
Plenert, Gerhard. The eManager: Value Chain Management in an eCommerce World. Dublin, Ireland: Blackhall Publishing, 2001.
. International Operations Management. Copenhagen, Denmark: Copenhagen Business School Press, 2002.
"Total Quality Engineering." Hoshin Planning. Poway, CA: Total Quality Engineering, Inc. Available from <<a href="http://www.tqe.com/hoshin.html">http://www.tqe.com/hoshin.html>.
Strategy Formulation (Encyclopedia of Business)
Strategy formulation is vital to the well-being of a company or organization. There are two major types of strategy: (1) corporate strategy, in which companies decide which line or lines of business to engage in; and (2) business or competitive strategy, which sets the framework for achieving success in a particular business. While business strategy often receives more attention than corporate strategy, both forms of strategy involve planning, industry/market analysis, goal setting, commitment of resources, and monitoring.
IMPORTANCE OF STRATEGY
The formulation of a sound strategy facilitates a number of actions and desired results that would be difficult otherwise. A strategic plan, when communicated to all members of an organization, provides employees with a clear vision of what the purposes and objectives of the firm are. The formulation of strategy forces organizations to examine the prospect of change in the foreseeable future and to prepare for change rather than to wait passively until market forces compel it. Strategic formulation allows the firm to plan its capital budgeting. Companies have limited funds to invest and must allocate capital funds where they will be most effective and derive the highest returns on their investments.
On the other hand, a firm without a clear strategic plan gives its decision makers no direction other than the maintenance of the status quo. The firm becomes purely reactive to external pressures and less effective at dealing with change. In highly competitive markets, a firm without a coherent strategy is likely to be outmaneuvered by its rivals and face declining market share or even declining sales.
The formulation of sound strategy may be seen as having six important steps:
- The company or organization must first choose the business or businesses in which it wishes to engagen other words, the corporate strategy.
- The company should then articulate a "mission statement" consistent with its business definition.
- The company must develop strategic objectives or goals and set performance objectives (e.g., at least 15 percent sales growth each year).
- Based on its overall objectives and an analysis of both internal and external factors, the company must create a specific business or competitive strategy that will fulfill its corporate goals (e.g., pursuing a market niche strategy, being a low-cost, high-volume producer).
- The company then implements the business strategy by taking specific steps (e.g., lowering prices, forging partnerships, entering new distribution channels).
- Finally, the company needs to review its strategy's effectiveness, measure its own performance, and possibly change its strategy by repeating some or all of the above steps.
DEFINING THE BUSINESS
While this would appear to be the easiest of the six steps listed above, the simplicity of this first step is deceptive. Businesses must be defined in terms of their customers. Without customers, there is no business. They are a firm's only real source of revenue and, hence, of power. Successful businesses are those that create profitable customers. With this in mind, it makes sense to define any business in terms of its customers. Some companies achieve success by concentrating on product development, product quality, efficient production, and other product related functions. However, it is important to remember that the success of these companies is entirely dependent upon customers valuing a firm's products above others, or appreciating the lower prices provided through the firm's abilities to produce at lower costs. One cannot assume that customers always want to pay less for their goods and services. In the markets for luxury goods like perfumes, for example, few companies have been successful in pursuing the strategy of being the low-cost supplier, whereas in other markets this is a highly coveted industry status.
INDUSTRY DEFINITION BY END BENEFIT.
Business scholars have long urged corporate leaders to define their businesses broadly and in terms of the end benefits their customers receive. Hence, oil companies should not view themselves as being in the "oil business," but in terms of the broader category of "energy," when attempting to market oil as a fuel. Automobile drivers don't necessarily have a strong preference for exactly what fuels their vehicle. If ethanol could power their vehicle as conveniently as gasoline, the consumer would have little preference between the two systems. If ethanol were more convenient and less expensive than gasoline, consumers would buy ethanol and not gasoline. Drivers aren't buying gasoline for its own sake when they visit a service station; rather, what they are buying is energy to facilitate transportation.
An example of an effectively broad industry definition comes from Charles Revson (1906-1975), founder of Revlon cosmetics, who often said he was in the business of selling "the promise of hope." This insightful business definition led Revson to concentrate his efforts on meticulously creating advertising depicting feminine images that were unrealistic to the vast majority of his customers, yet were perfectly consistent with their deepest hopes for themselves. Lotteries operate on the same principles. Few people expect to win, so the benefit is the hope of winning. Hope can be a very profitable business to be in even if it is difficult to imagine as an industry.
DEFINITION BY CUSTOMERS SERVED.
Many successful companies have defined themselves in terms of their customers. A general store in a remote area would do well to define its business as serving the customers in its trading area. While such a business definition might lead the firm in directions that would be at the whim of the local clientele, that business should remain profitable as long as customers are happy. An example of such a business is L.L. Bean, which was started when Leon L. Bean developed a superior hunting boot well suited for his native Maine and sold it through the mail to a mailing list of Maine residents who had purchased hunting licenses. The mail order company grew by first serving the needs of hunters and later by expanding the concept to all wilderness activities. While this might seem to be a definition based upon an activity, careful examination of L.L. Bean shows that the firm has identified a psychographic market segment to which it continually caters. Many of its buyers really don't care for wilderness sports as much as they simply identify with the targeted market segment and wish to buy products that conform to the segment's norms.
DEFINITION BY TECHNOLOGY.
Genentech Inc. is a firm engaged in the development of genetic research and biotechnology for pharmaceuticals: it has defined itself as being in the biotech business. Business definition by technology leads to a very tumultuous corporate existence, as the business enterprise turns direction every time there's a new invention.
The strategic mission of an organization embodies a long-term view of what sort of organization it wishes to become. The value to management of having a lucid mission statementhe second step in strategy formulationan be in rendering tangible the firm's long-term course and in guiding decisions toward a rational design. Among the elements that are key to a good mission statement are a statement of corporate values and philosophy, a statement of the scope and purpose of the business, an acknowledgement of special competencies, and an articulation of the corporate vision for its future.
Clearly stated strategic objectives, the third step of strategy formulation, outline the position in the marketplace that the firm seeks. Performance targets state the measurable milestones that the firm needs to reach or obtain to achieve its strategic objectives.
Some strategic objectives relate to the positioning of goods and services in the competitive marketplace while others concern the structure of the company itself and how it plans to produce goods or manage its operations. Typical strategic objectives involve profitability, market share, return on investment, technological achievement, customer service level, revenue size, and diversification.
In order to make strategic planning work, the goals, missions, objectives, performance targets, or other hopes of top management must somehow be made real by others in more distant locations down the organizational chart. Merely communicating to each member of the business the vision that top management has for the firm is not sufficient. Strategic objectives and performance targets should penetrate every corner of the organizational chart. There should be a hierarchy of strategic formulation starting with the highest levels of the firm, from which it is consistently translated from level to level so that each department knows what its contribution to the overall mission of the firm is to be. This process should end with each individual in the firm having strategic objectives and performance targets tailored to their specific role in the firm.
ORGANIZATION-WIDE STRATEGY LEVEL.
This is top management's plan for achieving its aims. These strategies are for the entire organization and should not concern the specific affairs of individual business units.
Organization-wide strategy requires schemes for overseeing the extent and combinations of companies' assorted actions in order to achieve a superior corporate performance. When numerous activities are being managed simultaneously, there are interactive effects in managing the group of activities as a whole. Such a group of activities is often referred to as the "business portfolio." Proper management of the business portfolio demands actions and decisions about how and when the firm should enter new ventures and what areas the firm needs to exit. Further, in all management, timing is crucial. Top management needs to set the timetable for business entry, exit, growth, and downsizing. Often a sound strategy goes awry when management attempts to move too quickly, too slowly, or just fails to set any timetable for action allowing for little temporal coordination of the firm's efforts. Further, organization-wide strategy should address the balance of resources across the firm's various activities. These resources need to be allocated to direct the company's activities toward the strategic objectives of the organization. Through these activities at the corporate-wide level, decisions about balancing business risks can maximize security for the firm.
The fourth step in strategy formulation requires developing the business or competitive strategy. Business strategy refers to the strategy used in directing one coherent business unit or product line. The most crucial question business strategy should address is how the unit plans to be competitive within its specific business market. Important logistical issues to consider include (1) what role each of the functional areas within the business unit will play in creating this competitive advantage in the marketplace; (2) what the potential responses are to prospective changes in marketplace; and (3) how to allocate the business unit's resources between its various divisions.
The overall competitive strategy should take into account three main factors: (1) the status, make-up, and prognosis of the industry as a whole and its market(s); (2) the firm's position relative to its competitors; and (3) internal factors at the firm, such as particular strengths and weaknesses.
An industry or market analysis should consider the structure of the industry, the forces compelling change within the industry, the cost and price economics of the industry, elements critical to success in the industry, and imminent problems and issues in the industry.
A review of the industry's structure should evaluate factors such as these:
- the size of the total market
- the growth rate of the market
- profitability of the firms in the industry
- whether the industry is producing at capacity or there is excess capacity already in place
- the entry barriers to the industry
- whether the industry's products are commodity goods or highly unique
Change in an industry may occur along several lines, and the direction of change often has major implications for the competitive strategy. In an obvious example, if a manufacturing industry is facing in the medium term a massive technological overhaul due to phase-in of environmental regulations, it would probably make little sense to bring a major new factory on line using the older technology, even if for the moment it is still more widely used. Other noteworthy industry changes to consider include what stage of development the industry and its market are at (developing, mature, declining), what technological advances could impact the industry, what regulatory changes are new or on the horizon, and whether there are major patents about to expire that will allow cheaper entry into the market.
It is also important to examine in detail the economics of doing business in a particular industry. One area of particular concern is the cost structure. For instance, industries characterized by a high percentage of fixed costs are subject to extreme price wars during competitive times in the market. Airlines are an example of a high-fixed-cost industry. Industries with high variable costs tend to have smaller swings in their pricing structure. Cost structure also has implications for capital and cash flow requirements, as well as for the overall entry barriers to participating in the industry.
Production costs tend to decline over time in proportion to the total quantity of goods produced. This is mainly due to two factors: learning and experience. Each has its own curve, the "learning curve" and the "experience curve." While each of these effects might be diagnosed separately, the end effect of both may be the same: the firm that produces the most goods in the industry tends to have the lowest cost of production in the long term. All things being equal, this will give that firm the long term cost advantage in the industry for the life of the product.
In a typical scenario, being the low-cost producer allows the firm to receive not only the greatest margin on its products when all firms in the market participate in an established price structure, but when price competition arises the low-cost producer can make a profit or break even on its goods, while its competitors lose money. This is a key strategic advantage. This is why many firms during the development of a new and potentially large long-term market will forgo a profitable, small, prestige niche strategy for a less profitable market penetration strategy that demands heavy investment and expansion of production. This second strategy can yield a long-term advantage in the industry by allowing the firm to gain from the learning and experience effects. Competitors later may not be able to catch up since they lack the cumulative production experience and assets of the pioneer in the industry.
One alternative to the low-cost strategy is a highvalue strategy, in which customers pay more but also expect to receive a product or service somehow better than that offered by the low-cost supplier. The improvement may be tangible in durability and features, or it may be an appeal to status, image, or lifestyle that makes the product or service more compelling to some consumers.
However, even industry leaders must guard against complacency; they might be on top in the traditional market paradigm, but there may be a new paradigm emerging that will make them obsolete if they fail to change. The accumulation of learning and experience does little good if these assets are directed at the wrong vision of the market. This has strategic implications not only for the market leader, but also its competitors, who may be able to benefit from the leader's slow rate of change. A real-life example was the rise of Wal-Mart Stores, Inc. from a regional discount chain to the world's largest retailer. Arguably its older competitors like Kmart had more experience, but they failed to adapt to the market changes, technologies, and aggressive management practices that helped propel Wal-Mart to market dominance. Wal-Mart embodied a new paradigm in general consumer merchandise retailing, a model that the former market leaders have since tried to emulate.
A fundamental part of developing a business strategy is to understand in detail who the main competitors are and where their strengths and weaknesses lie. Competitors can be analyzed by the type of goods they produce, their price, markets served, or channels of distribution used. Many industries have clear niching, with each firm or group of firms avoiding direct competition through some combiniation of product differentiation or market segmentation. Other industries are characterized by large-scale head-on competition. Coca-Cola and Pepsi, in the soft drink industry, are a highly visible example.
Not all future competition originates from present competitors, however. New market entrants are most often found lurking on the sidelines of the firm. For example, suppliers are often looking to forward integrate into an industry. Suppliers of the raw materials that go into a product may have a competitive cost advantage through such vertical integration. Suppliers are often motivated in such moves by the assurance of having a guaranteed market for their output.
On the flip side, customers may decide to backward integrate into business. Customers considering backward integration usually first attempt to establish their own "private labeled" product prior to integration. When customers put considerable time and effort into their private label version of a product, it may well be a sign of a growing intent to backward integrate. The notion of private label is most associated with retailing, where, for example, grocery stores have house labels, but may or may not actually manufacture the products bearing their labels. However, similar practices exist in many other lines of business.
Firms that produce either substitutes for a product or complementary goods to a product may also be a competitor. These firms have experience in the market, and a competitor's product niche in the market represents a simple product line extension for their firm. Often the threat of competitive retaliation into these firms' product areas is useful in deterring such moves.
Barriers to market entry are often responsible for setting the level of competition in an industry. Historically, retail has tended to be a competitive industry due to the relatively low costs of entry into the market (although this has changed somewhat as large chains consolidate and have significant price and marketing advantages over smaller competitors). But compared to manufacturing heavy industrial goods, retail still has relatively few barriers. American auto manufacturers probably worry very little about other American firms entering the market of passenger automobiles, because both the financial and regulatory barriers to entry are far too high. Not all barriers are financial. Drug firms enjoy oligopoly status due to their abilities to interface with the U.S. Food and Drug Administration in getting new drugs approved. New firms would have great difficulty in developing the same working relationships. Military suppliers also enjoy an oligopoly status due to political barriers to entering the market. Each firm must analyze what factors keep its competitors at bay when assessing the potential for others to want to share in their profits.
A strategy is of course only as good as its implementation. A company may have an impressive strategy for conquering the market, but if it fails to take the right steps the strategy is meaningless. The means of implementing strategies are called tactics. The tactical execution, while crucial to the success of any strategy, is not a traditional part of the formulation of that strategy. However, many firms have been successful in discovering successful tactics and building their strategies about "what works." The implementation experience, whether favorable or unfavorable, also directly informs the strategy revision process or any new strategies, as the company will take into account its successes and failures when choosing future paths.
MONITORING AND ASSESSMENT
Strategy formulation should be done on a regular basis, as often as required by changes in the industry. Firms need to track the company's progress, or lack thereof, on the key goals and objectives outlined in the strategic plan. The company must be objective and flexible enough to realize whether the strategy is no longer appropriate as it was first conceived, and whether it needs revision or replacement. In other cases, the strategy itself may be fine, but the communication of the strategy to employees has been inadequate or the specific steps to implementation haven't worked out as planned. This evaluation and feedback of the strategy formulation, the final step, provides the foundation for successful future strategy formulation.
Aspesi, Claudio, and Dev Vardhan. "Brilliant Strategy, But Can You Execute?" McKinsey Quarterly, winter 1999.
Bache, Alan, and Mike Freeman. "Is Our Vision Any Good?" Journal of Business Strategy, March-April 1999.
Bart, Christopher. "Mission Matters." CPA Journal, August 1998.
Faulkner, David, and Cliff Bowman. The Essence of Competitive Strategy. Hertfordshire, UK: Prentice Hall International, 1995.
Ghemawat, Pankaj. "Building Strategy on the Experience Curve." Harvard Business Review, March-April 1985, 143-49.
Peters, Thomas J., and Robert H. Waterman. In Search of Excellence: Lessons from America's Best-Run Companies. New York: Harper & Row, 1982.
Porter, Michael E. Competitive Strategy: Techniques for Analyzing Industries and Competitors. New York: Free Press, 1980.
. "How Competitive Forces Shape Strategy." Harvard Business Review, March-April 1979, 137-45.
Ulwick, Anthony W. Business Strategy Formulation: Theory, Process, and the Intellectual Revolution. Westport, CT: Quorum Books, 1999.