Concepts in Strategic Management and Business Policy Globalization, Innovation and Sustainability, 1

Concepts in Strategic Management and Business Policy Globalization, Innovation and Sustainability, 15th Edition By Thomas L Wheelen

Email: Richard@qwconsultancy.com

PART A SUGGESTIONS FOR TEACHING STRATEGIC MANAGEMENT

SUGGESTIONS FOR TEACHING STRATEGIC MANAGEMENT Strategic management ... Business policy ... Strategy. Whatever its name, it’s typically considered a “capstone” course in most business schools. Its primary job is to examine a business firm as a whole and to integrate the various functional disciplines. It generally includes industry analysis and competitive strategy with a healthy dose of SWOT analysis. It may also include corporate governance and/or social responsibility and ethics, depending upon the instructor. The course is generally expected to take a practical view of how business corporations actually function “in the real world.” Nevertheless, there are many ways to teach strategic management. Some people are strong proponents of “the case method.” Others argue that simulations are the best method of giving students a “hands-on” understanding of strategic decision making. A number of instructors also use experiential exercises, group projects, and audio-visual presentations. Very few, if any, argue for a straight lecture/discussion type of strategy course at the undergraduate and master’s level. Each approach, however, has its strengths and weaknesses.

Lecture/discussion, for example, is a good way to communicate a lot of information and to critically analyze theoretical concepts. In a strategy course, however, the emphasis is typically on developing integrative and problemsolving skills. This is a weakness of the lecture/discussion approach.

The simulation, in contrast, is an excellent method to develop these skills and to put learning in the hands of the student rather than in the hands of the instructor. It also emphasizes strategy implementation, an aspect of strategic management often receiving little emphasis in most strategy courses. Its weaknesses include turning the instructor from a teacher into an administrator. If teams are used, there is a strong tendency for students to let the “computer geeks” take charge of decision making as the objective turns from strategy making to “playing the game.”

The Case Method The most popular as well as the most perceived effective approach to teaching strategic management is the case method. Its strengths include a real-world orientation (believed to generate student involvement) and the ability to focus on developing decision-making skills by taking an integrative and conceptual, yet action-oriented approach.

This method may not go well, however, if the instructor is inexperienced in the use of cases and/or the students are not motivated to do more than a superficial reading of the cases. A capable case instructor must be able to force the typical student to go beyond satisficing at a very low level (e.g., “In my opinion, they ought to fire the CEO.”).

If given a free rein, the average undergraduate tends to “Monday morning quarterback” the case. For example, if everyone knows that Hershey Foods successfully developed and marketed a new type of sugar-free candy this year, there is a strong tendency to recommend this solution rather than other alternative courses of action. As a result, an instructor new to the case method must ensure that students truly understand that the best solution to any case problem is not (a) the one the instructor mentions, (b) what the company actually did, or (c) the most obvious solution. The best solution comes from the best analysis. This means that the instructor must work hard to ensure that students don’t take the easy route by merely stating the symptoms as if they were underlying problems and going immediately to their desired solution without regard for other alternatives.

Possible Course Syllabus and Outlines A number of policy instructors, including us, have a strong bias in favor of 75-minute classes meeting twice a week.

Open class discussion or oral presentations of complex strategy cases usually require at least an hour’s worth of time. Given the usual rigmarole involved in starting and ending a class, it is very difficult to handle a case well in a 50-minute period unless the case is analyzed over two class sessions. The course outlines you see below have been developed with generic activities. Instructors should explore MyManagementLab to review all possible activities in which students can participate.

One other variable, which complicates the development of a course outline, is the decision concerning the timing of the lectures on strategic management. Some instructors choose to spend the first part of their course lecturing over the book while the students quickly read the chapters. Others attempt to intersperse lectures with case discussions or presentations. The key question seems to be: How much information do students need before they can competently

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analyze their first comprehensive strategic management case? This is completely up to the instructor. We believe that a use of the strategic audit will help students to competently analyze their first comprehensive case even if they have not gone beyond corporate strategy in Chapter 7. We have found this point to be a good time to begin oral presentations, for example. The first case should, however, emphasize strategy formulation over implementation and be reasonably easy to analyze with each following case increasing in difficulty.

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SAMPLE COURSE SYLLABUS COURSE TITLE: STRATEGIC MANAGEMENT ———————————————————————————————————— Class Times & Location: Course Web Site: Instructor Information: Office & Office Hours: ————————————————————————————————————

COURSE DESCRIPTION: This course serves as a cohesive map for strategic management. It is designed to integrate the accepted theories in the area with real-world applications to provide students with the basic knowledge and skills needed for strategic management. Lecture and class assignments given in the course are intended to help students understand the needs of modern public and private organizations, including emerging national and international trends.

COURSE OBJECTIVES By the end of the course, students should be able to understand the basic elements of planning and implementing strategy.

RESOURCES TEXTBOOK: Strategic Management and Business Policy: Globalization, Innovation, and Sustainability, 15th Edition by T. Wheelen, J. Hunger, A. Hoffman, and C. Bamford.

SOFTWARE: MyManagementLab (This is an optional resource, see www.mymanagementlab.com for more information.)

LIBRARY & INTERNET RESOURCES: Students are encouraged to use the university library and the Internet for research and to complete assignments when necessary.

COURSE COMPONENTS EXAMS: A designated number of exams and a final exam will test students’ understanding of the materials discussed in class and in the assigned readings.

CASE ASSIGNMENTS: Students will answer discussion questions from case applications assigned in the text. The goal is for students to apply the information discussed to these real-world situations to the concepts and principles presented in the course.

IN-CLASS EXERCISES: Throughout the semester, students are expected to be prepared to discuss issues relevant to the course and to participate in team exercises. For these exercises, students will be required to be actively involved to receive credit—for example, making substantive comments, answering questions, and preparing short presentations. Points will be awarded by the instructor based on individual and group participation. Students should bring their textbook to class as part of their participation grade. Material for in-class assignments can be found at the conclusion of each chapter—–see Ethical Dilemmas and Team Exercises.

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GRADING Percentage In-Class Exercises/Participation 10% Case Assignments (4 at 25 points each) 20% Exam(s) 50% Final Exam 20% TOTAL POINTS NOTE: • • •

Points 50 100 250 100 500

Class attendance and participation in class discussion is expected and absences will affect your final grade.

The due dates for assignments are non-negotiable and late work will be penalized.

All assignments are to be professional in appearance and typed to receive full credit.

COURSE POLICIES CLASSROOM BEHAVIOR: Classroom behavior that interferes with either the instructor’s ability to conduct the class or the ability of students to benefit from the instruction is not acceptable.

Students engaging in improper classroom behavior may have points deducted from their total points in the course, or if the situation warrants, be reprimanded to the university’s committee on student discipline.

ACADEMIC HONESTY AND APPEALS: Students are expected to maintain the highest standards of academic integrity. Behavior that violates these standards is not acceptable. Examples are the use of unauthorized material, communication with fellow students during an examination, attempting to benefit from the work of another student, and similar behavior that defeats the intent of an examination or other class work. Cheating on exams, plagiarism, improper acknowledgement of sources in essays, and the use of a single essay or paper in more than one course without permission are considered very serious offences and shall be grounds for disciplinary action as outlined in the current General Catalogue.

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COURSE OUTLINE 16-WEEK COURSE: SEMESTER Week Assigned Reading

1 2 3 4 5 6

Generic Activities—see MyManagementLab for actual activities that correspond with this text In-class discussion: Strategy (Chapter 1)

Chapter 1 Basic Concepts of Strategic Management Module Management Strategy Chapter 2 Corporate Governance Chapter 3 Social Responsibility and Ethics in Strategic Management Chapter 4 Environmental Scanning and Industry Analysis Chapter 5 Organizational Analysis and Competitive Advantage Chapter 6 Strategy Formulation and Business Strategy

7 8 9 10 11 12 13

14 15

Chapter 7 Strategy Formulation: Corporate Strategy Chapter 8 Strategy Formulation: Functional Strategy and Strategic Choice Chapter 9 Strategy Implementation: Global Strategy Chapter 10 Strategy Implementation: Organizing and Structure Chapter 11 Strategy Implementation: Staffing and Directing Chapter 12 Evaluation and Control

Chapter 13 Suggestions for Case Analysis Putting It All Together Final Exam

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In-class exercise: Building Constraints (Chapter 2) Case #1 (Chapter 3) In-class discussion: Scanning (Chapter 4) In-class discussion: Working with Apple Case #2 (Chapter 6) Exam 1 In-class discussion: Corporations Need Direction (Chapter 7) Case #1 (Chapter 8) In-class discussion: Successful Expatriates In-class exercise: Team Building (Chapter 10) Case #2: Hiring Decisions (Chapter 11) In-class exercise: Evaluating the Evaluation (Chapter 12) In-class discussion: Using Financials (Chapter 13) Case Presentation

COURSE OUTLINE 12-WEEK COURSE: SEMESTER Week Assigned Reading

1 2 3 4 5 6 7 8

9

10 11 12

Generic Activities—see MyManagementLab for actual activities that correspond with this text In-class discussion: Strategy (Chapter 1)

Chapter 1 Basic Concepts of Strategic Management Module Management Strategy Chapter 2 Corporate Governance Chapter 3 Social Responsibility and Ethics in Strategic Management Chapter 4 Environmental Scanning and Industry Analysis Chapter 5 Organizational Analysis and Competitive Advantage Chapter 6 Strategy Formulation and Business Strategy Chapter 7 Strategy Formulation: Corporate Strategy Chapter 8 Strategy Formulation: Functional Strategy and Strategic Choice Chapter 9 Strategy Implementation: Global Strategy Chapter 10 Strategy Implementation: Organizing and Structure Chapter 11 Strategy Implementation: Staffing and Directing Chapter 12 Evaluation and Control Chapter 13 Suggestions for Case Analysis Final Exam

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In-class exercise: Building Constraints (Chapter 2) Case #1 (Chapter 3) In-class discussion: Scanning (Chapter 4) In-class discussion: Working with Apple Case #2 (Chapter 6) Exam 1 In-class exercise: Developing Synergy (Chapter 8) Case #1 (Chapter 10)

In-class exercise: Team Building (Chapter 11) Case #2: Developing Controls (Chapter 12) Putting It All Together

PART C Additional Instructor Resources

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HANDOUT: UNDERSTANDING FINANCIAL STATEMENTS The following pages contain a paper by Maryanne Rouse of the University of South Florida. It can be very useful to those students who need to improve their knowledge of financial analysis, ratios, and so on. You are free to make copies of this paper to give your students. It is also available online at www.pearsonhighered.com/wheelen. The students may download the paper to read at their convenience at no cost to the instructor.

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UNDERSTANDING FINANCIAL STATEMENTS Maryanne M. Rouse University of South Florida Financial statements serve as both milestones and signposts. As milestones, financial statements help the reader assess the past financial performance and current financial condition of a proprietorship, partnership, or corporation.

As signposts, financial statements provide information about the past and present that is useful in predicting future financial performance and condition.

The three most frequently encountered and most widely used financial statements are the Balance Sheet, the Income Statement, and the Statement of Cash Flows. These three general-purpose financial statements are intended to provide information to shareholders, creditors, and other stakeholders about the financial position, operating results, and investing/financing activities of an organization.

Financial statements reflect only past transactions and events. A transaction typically involves an exchange of resources between the business and other parties. Purchase of goods held for resale, either on open account or for cash, is an example of a transaction.

BASES OF ACCOUNTING Although there are hybrid systems that combine elements of both, the two most widely used bases of accounting are the cash basis and the accrual basis.

Cash Basis—Under the cash basis of accounting, revenue is recognized when cash is received and expenses are recognized when cash is disbursed. Many small businesses and most individuals use the cash basis of accounting when preparing financial statements and tax returns. A key reason for its popularity is that it is simple: any cash coming in is treated as revenue while any cash going out is treated as expense. The cash basis also allows individuals to shift (legally!) receipts and payments from one period to another to reduce taxable income.

Because the timing of receipts and disbursements will influence reported profit (or taxable income), the cash basis doesn’t reflect true results of operations for a period of time or true financial position at a point in time.

And, since timing of receipts and disbursements can distort reported information, many small businesses as well as large corporations use the accrual basis of accounting.

Accrual Basis—Under the accrual basis of accounting, revenues are recognized when they are realized and expenses are matched against revenue.

Realized—Revenue is realized when the earning process is virtually complete and the amount that will be collected is measurable and reasonably assured.

Recognized—Revenue is recognized by making an entry in the financial records.

Matching—Insures that expenses are recognized in the same period as the revenue they helped generate.

___________________________ This note, prepared by Maryanne M. Rouse, University of South Florida, may be reproduced by faculty who adopt Strategic Management and Business Policy by Wheelen and Hunger for distribution to students. Copyright © 2000 Maryanne M. Rouse.

Reprinted by permission.

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Important measurement assumptions and concepts that underlie the preparation and interpretation of financial statements include the following.

Entity Assumption—Regardless of its form (corporation, partnership, proprietorship), a business enterprise exists separate and apart from its owners.

Monetary Assumption—Only those transactions that can be valued in monetary terms are recorded in the financial records.

Going Concern Assumption—In the absence of evidence to the contrary, the business is expected to continue into the future: it will be able to use its investment in assets to generate adequate income and cash to satisfy current and potential liabilities.

Time Period Assumption—Economic activities can be divided into artificial time periods such as a month, quarter, or year. (The shorter the time period, the more difficult it becomes to accurately measure elements of economic activity.)

Historical Cost—Amounts in the financial records and statements represent exchange value at the date of acquisition, not current value or replacement cost.

Conservatism—When there is doubt concerning which accounting choice is appropriate, conservatism indicates the firm should use the approach that is least likely to overstate income or assets.

Consistency—Similar transactions should be treated the same way from year to year so that statements can be compared over time.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES Generally Accepted Accounting Principles (GAAP) is a set of “ground rules” for valuing, recording, presenting, and disclosing financial information. The principles set forth in GAAP are intended to (1) help ensure consistency in the financial statements of a given firm from period to period and (2) provide some assurance that the financial statements of one firm can be compared to those of another.

Because there are choices within GAAP (e.g., methods of depreciation, inventory valuation methods, etc.), firms disclose which alternatives they chose in the first footnote to the financial statements, the Summary of Significant Accounting Policies. Other important information about how individual items are handled by the company is provided parenthetically in the statements themselves or in additional footnotes.

AUDITED, REVIEWED, COMPILED A firm’s management is responsible for the content and preparation of financial statements; however, the involvement of independent accountants enhances the credibility of management-prepared statements.

When a CPA is involved in compiling management-provided financial data in the form of a financial report but performs no other procedures, she/he will provide a Compilation Report. A Compilation Report informs the reader that the accountant expresses no opinion on the statements and provides no assurances about the financial information presented.

If information underlying the financial statements is reviewed by the CPA but not subjected to the extensive procedures of an audit, he/she may issue a Review Report, which provides limited assurances to the users of the statements.

An audit consists of a much more extensive examination of evidence supporting the financial statements as well as an intensive review of the audited firm’s internal control system. Because of the overwhelming volume of

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information/evidence, auditors use statistical sampling to select transactions for review and perform tests as the basis for drawing inferences about the reasonableness of the financial statements. Audit opinions are of three types: unqualified, qualified, and adverse. The auditor can also decline to express an opinion.

ELEMENTS OF FINANCIAL POSITION: THE BALANCE SHEET The balance sheet provides a “snapshot” of a firm’s financial position. Prepared at a point in time, the balance sheet shows what the firm owns (assets) and owes (liabilities owed to outsiders plus the residual interest owed to shareholder/owners).

Assets. An asset is something the firm owns that has future economic benefit. An item cannot be recorded as an asset unless the company owns it. Equipment leased under a short-term operating lease or a building that is rented would, therefore, not be considered an asset. However, ownership is not enough: the item, whether tangible (you can stub your toe on it) or intangible (no physical substance), must have future economic benefit. An example of something a company owns that has no future economic benefit is obsolete inventory.

In most financial statements, assets are divided into at least two categories: current and non-current. Current assets comprise those that are expected to be converted into cash or used up within one year or the operating cycle. Noncurrent assets include property, plant and equipment (PP&E), intangible assets, and deferred charges. PP&E and other non-current assets are not acquired with the intent to resell them; rather, they provide the productive capacity to earn revenue (i.e., going concern, historical cost).

Liabilities. Liabilities are obligations to pay or convey assets in the future based on past transactions. Liabilities are divided into current and non-current. Current liabilities are those obligations that will be satisfied within one year or the operating cycle; non-current liabilities are debts due after one year. Regardless of their classification as current or non-current, liabilities represent a claim, not an ownership interest.

Shareholders’ Equity. Shareholders’ equity is the ownership interest of those who have invested in the company through the purchase of capital stock. Shareholders’ equity account classifications include capital stock, additional paid in capital, and retained earnings. A corporation may have several different classes of stock, each having slightly different characteristics. The two general classes are preferred stock and common stock. Preferred stock will have a stated dividend rate or amount and will usually have preferences as to payment of dividends or distribution of assets in the event of liquidation. Corporations are under no obligation to declare dividends; however, if dividends are declared, the holders of stock with preferences must receive dividends before dividend payments can be made to the holders of common stock. The holders of common stock have no guarantees: they are the risk-takers who will benefit the most if a company is successful but who will lose the most (often their entire investment) if the company fails.

The Accounting Equation. Assets will always equal liabilities plus shareholders’ equity. This is not sleight of hand but the result of recognizing that each transaction has two sides. Another way of stating this duality is to note that the items listed on the right side of the balance sheet, liabilities plus shareholders’ equity, can be viewed as the sources of the assets listed on the left side of the balance sheet or as claims against those assets.

A CLOSER LOOK AT THE BALANCE SHEET ASSETS Current Assets Cash—Cash and cash equivalents including currency, bank deposits, and various marketable securities that can be converted into cash on short notice. Only securities that are purchased within 90 days of their maturity dates may be classified as cash.

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Marketable Securities—Short-term equity and debt investments that are readily marketable and which the company intends to convert into cash. Generally shown at fair market value, marketable securities represent an investment of idle cash.

Accounts Receivable—Amounts due from customers that have not yet been collected. Accounts receivable should “turn over” or be collected within the firm’s normal collection period, usually 30 to 60 days. An increase in the collection period may signal either a customer’s inability to pay or the company’s inability to collect. Managers and readers of financial statements are interested in the estimated cash that will be generated from collection of accounts.

Because some customers may fail to pay amounts due, an allowance for doubtful accounts is deducted from accounts receivable to derive the net amount of cash that the company believes will be collected.

Inventories—Represent items that have been manufactured or purchased for resale to customers. The generally accepted method of valuation for inventories is the lower of cost or market. Market, in this case, is the cost to replace the item. “Writing down” inventory to no more than the amount that can be realized through its sale provides a conservative estimate.

Prepaid Expenses/Other Current Assets—Usually minor elements of the balance sheet, “prepaids” represent payments made in advance, the benefits of which have not yet been used up. Examples include insurance and advertising contracts.

Non-Current Assets Property, Plant & Equipment—Also referred to as “fixed assets,” PP&E generally includes such long-lived elements as land, buildings, machinery, equipment, furniture, automobiles, and trucks. PP&E is recorded at historical cost and shown at that cost less accumulated depreciation. With the exception of land, because these long-lived assets are expected to gradually lose their economic usefulness over time, a portion of the total cost is allocated to current expense via depreciation. (Depreciation expense “matches” a portion of the asset’s cost to the revenue it helped generate in a given period.) Accumulated depreciation represents all depreciation expense to date for each depreciable asset included in PP&E. Intangibles—Assets with no physical substance but which often have great economic value. Only those intangibles that have been purchased are shown as assets. Patents, copyrights, and trademarks are examples of intangibles.

Another important type of intangible asset is goodwill. Goodwill is a label used by accountants to denote the economic value of an acquired firm in excess of its net identifiable assets. In a process similar to depreciation, the cost of intangible assets is spread over multiple operating periods via amortization.

LIABILITIES Current Liabilities Accounts Payable—The amounts the company owes to regular business creditors from whom it has bought goods and services on open account. Often called “trade debt,” accounts payable represents the short-term, unsecured debt that arises in the normal course of trade or business.

Notes Payable—More “formal” liabilities because they are evidenced by a written promise to pay. A note is a legal document that a court can force a firm to satisfy.

Accrued Expenses—Represent liabilities for services received but unpaid at the date of the balance sheet. Accrued expenses show the total amount the company owes for such items as salaries, rent, utility bills, and other operating expenses.

Income Taxes Payable—Includes unpaid taxes due within one year. Many firms use the more general category Taxes Payable and include in the total amounts owed for payroll as well as other taxes.

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Other Current Liabilities—Might include warranty obligations and unearned revenue. If interest payable is a relatively insignificant amount, it may be included here. A firm will have unearned revenue if it has received cash in advance of providing goods or services. Unearned revenue is a liability because the firm must either provide the goods/services as promised or return the cash received.

Long-Term Liabilities Deferred Income Taxes—Created by using different accounting methods for financial and tax purposes. For example, a company may use accelerated depreciation for tax purposes and straight-line depreciation for financial accounting purposes. The higher (accelerated) depreciation expense results in a lower income tax due. However, because income tax expense for financial accounting purposes reflects the higher amount that would be due if straight-line depreciation were used, the company estimates the difference that will be owed in the future. This estimate is called deferred taxes.

Debentures—A major source of funds for large firms, also known as bonds payable. A bond is written evidence of a long-term loan. It is really a promissory note containing the firm’s promise to (1) pay periodic interest (usually semiannually) at a specified rate and (2) repay the amount originally borrowed (i.e., the principal). Debentures may be secured or unsecured. A mortgage bond is a type of secured debenture. The holders of unsecured bonds rely on the ability of the firm to generate sufficient cash flows to meet principal and interest payments as they come due.

Other Long-Term Liabilities—Any other amounts owed to creditors with a due date beyond one year.

SHAREHOLDERS’ EQUITY Preferred Stock—Capital stock with certain preferences as to dividends and distribution of assets in the event of liquidation. For Serendipity, the preferred stock is $5.83 cumulative $100 par value. Par value is a legal concept: it is the amount below which shareholders’ equity may not be reduced by the distribution of dividends. $5.83 is the amount of the annual dividend to be paid. Cumulative means that if in any year the dividend is not paid, it accumulates and the accumulated amount must be paid to holders of preferred stock before any dividend is paid to the holders of common stock. The holders of preferred stock generally may not vote and therefore have no voice in company affairs (unless the company fails to pay dividends at the promised date.)

Common Stock—Generally voting stock with no specified dividend payment; however, companies may have several classes of common stock, which may include non-voting common stock.

Additional Paid-In Capital—Results from selling preferred or common stock at more than its par value. For example, if 100 shares of $10 par value common stock were sold for $1,500, $1,000 would be shown as common stock and the excess received over par value, $500, would be shown as additional paid-in capital. If a stock has no par value, the total amount received is shown as stock; no portion is assigned to additional paid-in capital.

Retained Earnings—Historical record of earnings retained in the business. It’s important to remember that there is no cash in retained earnings. Rather, retained earnings represent a claim against the excess of assets over liabilities.

Retained earnings increases as the result of earning a profit; this account is decreased by incurring a loss.

Declaration of a dividend also results in a decrease in retained earnings because the company is distributing part of its earnings, in the form of cash or other assets, back to its shareholder-owners.

Other Items—Treasury stock is the company’s own stock that has been issued, is fully paid, and has been repurchased by the company. When a company repurchases its own stock with the intention of holding it temporarily (rather than canceling it), the cost of treasury stock is usually shown as a deduction from stockholders’ equity.

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Serendipity Manufacturing Company, Inc

CONSOLIDATED BALANCE SHEET

December 31, 2000 and 1999 (dollars in thousands) ASSETS

2000

1999

$ 20,000 40,000

$ 15,000 32,000

Current Assets Cash Marketable Securities at market value Accounts Receivable, less allowance for doubtful accounts: 19X9, $2,375 and 19X8, $3,000 Inventories, at lower of first in, first out cost or market Prepaid Expenses and Other Current Total Current Assets

156,000

145,000

180,000 4,000 $ 400,000

185,000 3,000 $ 380,000

Property, Plant & Equipment Land Buildings Machinery Leasehold Improvements Furniture, Fixtures, etc.

Total Property, Plant & Equipment Less: Accumulated Depreciation Net Property, Plant & Equipment

$ 30,000 125,000 200,000 15,000 15,000 $ 385,000 125,000 $ 260,000

$ 30,000 118,500 171,100 15,000 12,000 $ 346,600 97,000 $ 249,600

Intangible Assets less amortization

$

2,000

$ 2,000

TOTAL ASSETS

$ 662,000

$ 631,600

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Serendipity Manufacturing Company, Inc

December 31, 2000 and 1999 (dollars in thousands) LIABILITIES

2000

1999

Current Liabilities Accounts Payable Notes Payable Accrued Expenses Income Taxes Payable Other Current Liabilities Total Current Liabilities

$ 60,000 51,000 30,000 17,000 12,000 $ 170,000

$ 57,000 61,000 36,000 15,000 12,000 $ 181,000

Long-Term Liabilities Deferred Income Taxes 12.5% Unsecured Debentures Other Long-Term Debt

$ 16,000 130,000 -

$ 9,000 130,000 6,000

TOTAL LIABILITIES

$ 316,000

$ 326,000

$

6,000

$ 6,000

SHAREHOLDERS’ EQUITY Preferred Stock, $5.83 cumulative, $100 par value, Authorized, issued, and outstanding, 60,000 shares Common Stock, $5 par value, authorized 20,000,000 shares, 19X9 issued 15,000,000 shares, 19X8 14,500,000 shares Additional Paid-in Capital Retained Earnings Less: Treasury Stock at Cost 19X9, 19X8, 1,000 shares TOTAL SHAREHOLDERS’ EQUITY

75,000 20,000 250,000

72,500 13,500 218,600

(5,000) $ 346,000

(5,000) $ 305,600

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

$ 662,000

$ 631,600

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ANALYZING SERENDIPITY’S BALANCE SHEET Investors, creditors, and other users of financial statements often analyze relationships between or among balance sheet accounts using ratios. The three types of ratios used most often are liquidity ratios, leverage ratios, and activity ratios.

Liquidity Ratios Liquidity ratios focus on working capital accounts and provide information about a company’s ability to meet currently maturing liabilities from its current assets. Working capital is current assets minus current liabilities. For Serendipity, working capital was $230,000,000 in 2000 and $199,000,000 in 1999. However, relationships provide a great deal more information about liquidity than absolute amounts.

Current Ratio—Current assets divided by current liabilities. It tells how many dollars of current assets are available to cover each dollar of current liabilities. For Serendipity, the current ratio for 2000 was $400,000/$170,000 or 2.35 to 1. The current ratio in 1999 was $380,000/$181,000 or 2.10 to 1. Serendipity’s liquidity has increased: in 2000 the company had $2.35 in current assets for each $1.00 of current liabilities versus $2.10 in current assets for each $1.00 of current liabilities in 1999. Because inventories are usually insignificant for companies in service industries, the current ratio for firms in these industries is generally lower than for firms in merchandising or manufacturing industries.

Quick Ratio—“Quick” assets (current assets minus inventories, prepayments, and other current assets) divided by current liabilities. Also called the acid test ratio, the quick ratio shows how many dollars of assets quickly convertible into cash are available for each dollar of current liabilities. For Serendipity, the quick ratio for 2000 is $216,000/$170,000 or 1.27 to 1. For 1999, the quick ratio is $192,000/$181,000 or 1.06 to 1.

Cash Ratio—Cash divided by current liabilities. The cash ratio shows how much cash is available for each dollar of current liabilities. Serendipity’s cash ratio for 2000 was $20,000/$170,000 or .12/1: the company has $.12 of cash for each dollar of current liabilities. This was an improvement from 1999 when the cash ratio was $15,000/$181,000 or .08/1.

Leverage Ratios Leverage ratios provide information about the relationship between the financing provided by owners (shareholders’ equity) and that provided by creditors (current and non-current liabilities). Leverage ratios provide a means of assessing the risk associated with using borrowed funds.

Debt to Equity Ratio—Total liabilities divided by total shareholder’s equity. Serendipity’s debt to equity ratio for 2000 is $316,000/$346,000 or .91 to 1: Serendipity had $.91 in debt for each dollar of equity. The debt to equity ratio for 1999 was $326,000/$305,600 or 1.07 to 1. (A debt/equity ratio of 1 to 1 would indicate that a company had an equal amount of debt and equity.)

Long-Term Debt to Capital Structure—Long-term debt divided by long-term debt plus shareholders’ equity. It expresses long-term debt as a percentage of the sum of long-term debt and equity financing. For 2000, Serendipity’s long-term debt to capital structure ratio is $130,000/$476,000 or .27; for 1999 it was $136,000/$441,600 or .31. In 2000, 27% of the company’s long-term financing was provided by creditors, down from 31% in 1999.

Debt to Assets Ratio—Shows the percentage of total assets financed by creditors. It is computed by dividing total debt by total assets. For Serendipity, this measure is $316,000/$662,000 or .48 for 2000; it was $326,000/$631,600 or .52 for 1999. All three leverage ratios show that Serendipity’s financial leverage in 2000 decreased from the prior year.

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Activity Ratios Activity ratios describe a relationship between an income statement and balance sheet element. Examples of activity ratios include inventory turnover, asset turnover, average collection period for accounts receivable, and days of cash.

Asset Turnover—Sales divided by total assets. It measures asset utilization: how many dollars of sales are generated by each dollar invested in assets. For Serendipity, asset turnover was $765,000/$662,000 = 1.16 for 2000 and $725,000/$631,600 = 1.15 for 1999.

Inventory Turnover—Cost of goods sold divided by average inventory. It measures the number of times inventory is “turned over” or sold during a year. Using cost of goods sold as the numerator excludes any element of gross profit.

Some published ratios, however, including many industry averages, use sales as the numerator. It’s important to understand the difference and to make comparisons carefully. Using cost of goods sold, Serendipity’s inventory turnover for 2000 was $535,000/$180,000 or 2.97. For 1999, inventory turnover was 2.79. A declining inventory turnover can be a warning signal that customers find company’s products less attractive; an extremely rapid inventory turnover may indicate an inability to meet customer demand. Inventory turnover ratios should be interpreted in light of a company’s inventory policy. For instance, if a company were attempting to implement a JIT strategy, inventory on hand would be expected to be quite low and turnover quite high. In periods of rising prices, LIFO will result in a higher inventory turnover than FIFO or average cost.

Average Collection Period—For average collection period, the numerator is accounts receivable while the denominator is average daily sales (sales divided by 365). Serendipity’s average daily sales for 2000 are $2,095,890.

The average collection period for Serendipity in 2000 would be calculated as $156,000,000/$2,095,890 = 74.3 days.

For 1999, the ratio would be $145,000,000/$1,986,301 = 73 days. It is taking Serendipity slightly longer to collect from customers who purchased merchandise on open account.

A CLOSER LOOK AT THE INCOME STATEMENT Because the income statement shows how much profit a company earned or the size of the loss it incurred, the income statement is often referred to as the profit and loss statement, or P&L. The income statement shows the results of operations for the time period specified: it shows revenue earned during the period and the expenses that were incurred to earn that revenue. A classified income statement, such as that prepared by Serendipity, separates sources of revenue and types of expenses.

Revenue—The first item on an income statement is the company’s principal source of revenue. For Serendipity, it is net sales (sales less returns and allowances), revenue earned through the sale of goods and services to customers.

Cost of Goods Sold (COGS)—For a merchandise firm, COGS is the acquisition cost of the merchandise sold plus the cost of freight-in. For a manufacturer, COGS will include the material, labor, and overhead costs associated with merchandise sold.

Gross Margin (Gross Profit)—Gross margin/profit is the excess of net sales over COGS. Gross margin is the amount available to cover operating and financing expenses and provide for a profit.

Depreciation and Amortization—Depreciation and amortization are means to spread the cost of long-lived assets over the periods they are expected to benefit. For example, if a company buys a heavy-duty truck with an economic (useful) life of 4 years for $50,000, straight-line depreciation (equal amounts each year) would allocate one fourth or $12,500 of expense to each year. For Year 1, depreciation expense would be $12,500; at the end of Year 1, accumulated depreciation would be $12,500; book value (cost less accumulated depreciation) would be $37,500. For Year 2, depreciation would once again be $12,500; at the end of Year 2, accumulated depreciation would be $25,000; book value would be $25,000.

Selling, General, and Administrative Expenses (SG&A)—This amount includes all usual and recurring operating expenses with the exception of COGS. Showing these amounts separately allows a comparison of gross margin to

11 .

SG&A and also allows the reader of financial statements to analyze increases/decreases in SG&A over time. SG&A expenses are sometimes referred to as below the line costs because they are deducted from gross margin.

Operating Income—This amount is the excess of operating revenues over operating expenses. Because it excludes the results of financing and investing activities as well as the impact of unusual and non-recurring items, it provides a basis for estimating or predicting future income from regular, continuing operations.

Dividend and Interest Income/Interest Expense—In a classified income statement, revenues generated by investing activities are shown separately from sales revenues. Similarly, financing expenses are shown separately from operating expenses.

Income Before Income Taxes and Extraordinary Items—This line shows pre-tax income from both operating and financing/investing activities. It takes into consideration all ordinary income (the plus factors) and ordinary costs (the minus factors).

Income Taxes—Income taxes are shown as the amount that would be due on income shown for financial accounting purposes. Because of timing differences (e.g., using accelerated depreciation for tax purposes and straight-line depreciation for financial accounting purposes), the amount of taxes actually owed often differs from the amount shown as expense on the income statement.

Income Before Extraordinary Items—This line shows after-tax income earned from ongoing operating and financing activities before taking into consideration gains or losses from unusual, non-recurring items.

Extraordinary Items—There are some years in which companies experience events that can be described as both unusual and infrequent. The effects of these items are shown separately on a net-of-tax (the dollar amount after deducting the tax effect) basis. Earnings per share amounts are also shown separately for extraordinary items. A knowledge of which income streams are expected to continue and which gains and losses are one-time events provides additional useful information to financial statement readers.

Net Income—This line shows the net after-tax effect once all revenues and all expenses for a period of time are considered.

Statement of Changes in Shareholders’ Equity—If there have been many complex transactions affecting ownership interests, a company may choose to summarize them in a separate statement called the Statement of Changes in Shareholders’ Equity. In other cases, the information may be presented in a footnote.

12 .

Serendipity Manufacturing Company, Inc

CONSOLIDATED INCOME STATEMENT 2000

1999

Net Sales Cost of Sales Gross Profit

$ 765,000 535,000 $ 230,000

$ 725,000 517,000 $ 208,000

Operating Expenses Depreciation and amortization Selling, general, and administrative expenses Operating Income

$ 28,000 100,929 $ 101,071

$ 25,000 109,500 $ 73,500

Other Income (Expense) Dividend and Interest Income Interest Expense Foreign Currency gains (losses) Income Before Income Taxes and Extraordinary Loss

$ 5,250 (12,125) 2,000 $ 96,196

$ 9,500 (16,250) (1,000) $ 65,750

41,446

26,250

$ 54,750

$ 39,500

Years ended December 31, 2000 and 1999 (in thousands)

Income Taxes Income Before Extraordinary Loss Extraordinary Loss (net of tax benefit of $750)

(5,000)

Net Income

$ 49,750

$ 39,500

Earnings per Common Share before Extraordinary Loss

$

3.32

$

2.72

Earnings per Common Share, Extraordinary Loss

$

(0.33)

Net Income (per Common Share)

$

2.99

$

2.77

13 .

ANALYZING SERENDIPITY’S INCOME STATEMENT Gross Profit Margin—Gross margin percentage expresses gross margin as a percentage of sales. Serendipity’s gross margin was 30.1% of sales in 2000 ($230,000/$765,000), an increase from 28.7% in 1999 ($208,000/$725,000). The increase in Serendipity’s gross margin percentage from 1999 to 2000 means that there was more of each sales dollar left over to cover below the line costs in 2000. Gross margin percentage can also be used to compare Serendipity with competitors and to industry averages.

Operating Margin of Profit—Operating margin of profit is computed by dividing operating profit by sales. For Serendipity, this measure shows that for each dollar of sales, Serendipity earned 13.2 cents in operating profit in 2000: $101,071/$765,000. Operating profit per sales dollar increased from 10.1% in 1999: $73,500/$725,000. The comparison reveals that not only did the business grow, but it also became more profitable. Analysts and other users of financial statements use operating margin of profit as a basis for comparing companies in the same industry as well as across industries.

Net Profit Ratio—Net profit divided by sales is another way to evaluate operating performance. For Serendipity, net profit as a percentage of sales, often referred to as return on sales, grew from 5.45% in 1999 ($39,500/$725,000) to 6.5% in 2000 ($49,750/$765,000).

Asset Turnover Ratio—As noted in the discussion of balance sheet analysis, this ratio shows how many dollars in sales were generated by each dollar invested in assets. For Serendipity, the asset turnover ratio in 2000 was 1.16/1: each dollar of assets generated $1.16 of sales. For 1999, the asset turnover ratio was 1.15/1. Another way to think about the relationship between sales and assets is the concept of investment intensity: the more dollars of assets required per dollar of sales, the higher the investment intensity.

Return on Assets—Return on assets is calculated by dividing net income by total assets. For Serendipity, 2000 ROA was $49,750/$662,000 or 7.52%. The 1999 ROA was $39,500/$631,600 or 6.25%. Serendipity’s change in ROA has been positive.

Return on Equity—Return on equity measures the rate of return on the book value of the shareholders’ total investment in the company. In 2000, ROE for Serendipity was $49,750/$346,000 or 14.38%. ROE for 1999 was $39,500/$305,600 or 12.93%.

Times Interest Earned—This measure indicates the ability of a company to meet its required interest payments on debt. It is computed by adding interest expense back to income before taxes and dividing the total by interest expense. For Serendipity, times interest earned in 2000 would be $96,196+$12,125/$12,125 or 8.93 times. For 1999, times interest earned would be 5.05 times.

14 .

A “common-size” income statement is an important analytical tool. Because a common-size statement expresses each income statement element as a percentage of sales, it highlights changes and trends in a company’s operating performance and provides a basis for comparison to industry averages:

Serendipity Manufacturing Company, Inc

CONSOLIDATED INCOME STATEMENT (Common Size) Years ended December 31, 2000 and 1999 (in thousands) Net Sales Cost of Sales Gross Profit

100.00% 69.93% 30.07%

100.00% 71.31% 28.69%

Operating Expenses Depreciation and amortization Selling, general, and administrative expenses Operating Income

3.66% 13.19% 13.21%

3.45% 15.10% 10.14%

Other Income (Expense) Dividend and Interest Income Interest Expense Foreign Currency gains (losses) Income Before Income Taxes and Extraordinary Loss

1.58% 0.26%

2.24% -0.14%

12.57%

9.07%

Income Taxes

5.42%

3.48%

Income Before Extraordinary Loss

7.16%

5.45%

Extraordinary Loss (net of tax benefit of $750)

-0.65%

0.00%

Net Income

6.50%

5.45%

15 .

RELATIONSHIP BETWEEN THE INCOME STATEMENT AND THE BALANCE SHEET The balance sheet is prepared at a point in time; it shows what the company owns (assets) and what the company owes (liabilities owed to outsiders plus the residual interest owed to owners) at a specific date. Ownership interest is increased by (1) owners investing additional cash or property or (2) the company earning more revenue than expenses. Earning an excess of revenue over expenses increases an ownership equity account called retained earnings. Retained earnings is an historical record of earnings retained in the business. It is increased by earning a net income and decreased by both losses and declaration of dividends. Using Serendipity as an example, here’s how it works: Retained Earnings Balance, end of 1999 Add: 19X9 Net Income Deduct: Dividends Declared Preferred $( 350,000) Common ( 18,000,000) Total Dividends Retained Earnings Balance, end of 2000

$218,600,000 49,750,000

($ 18,350,000) $250,000,000

Once again, it’s important to remember that there is no cash in the retained earnings account. Retained earnings represents a claim against the excess of the book value of assets over liabilities.

Because the users of financial statements need more information about a company’s earning power than is provided by the change in retained earnings shown on the balance sheet, the income statement was developed to show, in detail, the revenues and expenses that caused the change in retained earnings resulting from operations.

STATEMENT OF CASH FLOWS Although the balance sheet and the income statement provide the investor with information about a company’s financial position at a point in time and the results of operations for a period of time, neither statement shows in any detail the result of investing and financing activities. The statement of cash flows was developed to provide detailed information about the impact on cash of the operating activities of a company (summarized in the income statement) as well as its investing and financing activities. Specifically, the statement is intended to help financial statement readers assess: 1.

2.

3.

4.

5.

the ability to generate positive future cash flows the ability to meet its obligations and pay dividends the need for external financing the reasons for the differences between cash receipts and revenues and between cash disbursements and expenses the effects on a firm’s financial position of both its cash and non-cash investing and financing activities

Cash flows are separated by business activity. The three business activities shown on the statement are operating activities, investing activities, and financing activities.

Operating activities are those transactions relating to the production and delivery of goods and services in the normal course of operations. Because Serendipity’s financial statements are prepared using the accrual basis of accounting, cash receipts are not equivalent to net income.

Serendipity’s Consolidated Statement of Cash Flows was prepared using the indirect method. The indirect method begins with net income and makes various adjustments to reconcile it to cash flows from operating activities.

Adjustments (1) add back to net income those items recognized as expenses that did not require cash (e.g., depreciation) and (2) deduct those items that required the use of cash but were not shown as expenses (e.g., increases in prepayments).

16 .

Serendipity Manufacturing Company, Inc.

CONSOLIDATED STATEMENT OF CASH FLOWS Year ended December 31, 2000 (in thousands) Cash Flows from Operating Activities Net Income

$ 49,750

Adjustments to Reconcile Net Income to Net Cash from Operating Activities Depreciation and Amortization Increase in Marketable Securities Increase in Accounts Receivable Decrease in Inventory Increase in Prepaid Expenses Increase in Deferred Taxes Increase in Accounts Payable Decrease in Accrued Expenses Increase in Income Taxes Payable Total Adjustments

$ 28,000 (8,000) (11,000) 5,000 (1,000) 7,000 3,000 (6,000) 2,000 $ 19,000

Net Cash Provided by Operations

$ 68,750

Cash Flows from Investing Activities Purchase of Fixed Assets Net Cash Used for Investing Activities

$ (38,400) $ (38,400)

Cash Flows from Financing Activities Decrease in Notes Payable Decrease in Long-Term Debt Proceeds from Issuance of Common Stock Payment of Dividends Net Cash Used in Financing Activities Increase in Cash Cash at Beginning of Year Cash at End of Year

17 .

$ (10,000) (6,000) 9,000 (18,350) $ (25,350) 5,000 15,000 $ 20,000

Here’s how we might interpret Serendipity’s cash flow statement: Sources of Cash: Operations Issuance of common stock Cash Inflows During the Year

$68,750,000 9,000,000 $77,750,000

Uses of Cash Purchase of fixed assets Payment of Dividends Payments made on notes payable and other long-term debt Cash Outflows during the Year

$38,400,000 18,350,000 16,000,000 $72,750,000

Serendipity’s cash balance increased by $5,000,000 from the end of 1999 to the end of 2000. Operations were a significant source of cash, generating an excess of cash-in over cash-out of $68,750,000. (Favorable exchange rates, the effect of which are included in net income, accounted for a $2,000,000 increase in cash.) Cash was also generated by issuing additional common stock for $9,000,000. Cash was used to purchase additional fixed assets, to declare and pay dividends, and to reduce long-term debt.

18 .

THE STRATEGY WIZARD There is an interesting computer program called Strategy Wizard that was written to go with this Wheelen and Hunger textbook. It is a short (32 kb) executable file that students can download from www.pearsonhighered.com/wheelen for use with this book. Deena Malkina created the program while she was an undergraduate student at the University of Colorado, Boulder in July 2001. She wrote the program as part of a strategy class (BCOR 4000) taught by Leon Schjoedt. She used it in a class presentation to illustrate how information technology can be helpful in decision making. According to Deena, “It basically allows you to fill out a strategic audit, including a SWOT, then displays a recommended corporate strategy, such as Growth (horizontal, vertical, concentric, conglomerate), Stability (pause, no change), etc. based on your inputs.” Try out the Strategy Wizard on your own and then assign it to students for one or more cases. It is a good way to motivate them to read the case and analyze it before class. It also provides you with a convenient outline to use in open class discussions of complex, comprehensive strategy cases. Students find it to be an enjoyable experience.

How to Obtain the Strategy Wizard Using your Internet browser, go to the Pearson website for this textbook. The URL is www.pearsonhighered.com/wheelen. (If you cannot find the file on the website, contact David Hunger at jdhunger@iastate.edu.) Once you have downloaded the file to your computer, simply go to the directory where you have downloaded the file. Click on the file StrategyWizard.exe. The program will begin.

How to Use the Strategy Wizard Select a case for the students to analyze. The case should be a typical comprehensive strategic management case.

Tell your students to download the Strategy Wizard file from www.pearsonhighered.com/wheelen. It is probably contained in a zip file that needs to be unzipped before it can be used. This is because most servers and virus protection programs refuse to allow an executable file (a program with .exe as a suffix) to be downloaded onto a personal computer.

Once the student clicks on the file StrategyWizard.exe, it will open to the first of two pages. The first page lists the following: Current Situation Performance: 3 choices (Weak, Solid, Strong) Strategic Posture: 3 choices (Weak, Solid, Strong) Corporate Governance: 4 choices (Chaos Management, Entrepreneurship Management, Marionette Management, Partnership Management) External Environment Societal: 3 choices (Hostile, Stable, Friendly) Task: 3 choices (Unfavorable, Stable, Favorable) Functional Strengths: 6 categories (Marketing, Finance, R & D, Operations, HRM, IS) Each of the above categories lists a series of items from which the student can select one (except in Functional Strengths, where the student selects all that apply). For example, the Performance category includes three items to choose from: Weak, Solid, and Strong. The student picks one of these. Under Functional Strengths, the student is informed to select all items that apply (such as Marketing, Finance, R & D, Operations, HRM, and IS). Before going to the second page, the student should click on the Print button (at the bottom of the page) to print this page. The student then clicks on the Next button to go to the second page of the Strategy Wizard.

19 .

The second page of the Strategy Wizard lists the following: SWOT Strengths: 6 items (Strategy/Management, Cost Leadership, Size/Market Share, Differentiation, Resources, and Flexibility). Click on the appropriate strengths for the case.

Weaknesses: 6 items (the same items as under Strengths). Click on the appropriate weaknesses.

Opportunities: 4 items (Horizontal Concentration, Concentric Diversification, Vertical Concentration, Conglomerate Diversification). Select all that apply to the case.

Threats: 6 items (Competition, Poor Demand, Regulations, Technological Advances, Economic Downturn, International Issues). Select all that apply to the case.

Once the student completes this page, he/she should click on the Submit! button at the bottom/left of the page. The program will automatically select what it thinks is the most appropriate corporate strategy for a case. For example, it might state the following: Retrenchment: Divestment or Liquidation strategy. Company is unable to sustain continued business operations.

The student should then click on the Print button at the bottom/middle of the page. This (along with the printout of the first page done earlier) will provide a hardcopy record of the student’s choices and the program’s recommended strategy. The student is then free to click on the Exit button at the bottom/right of the page.

Teaching Suggestions Ask the students to staple pages one and two together, print their name on it, and bring the completed printout to class.

Begin the class as you usually do. Start the discussion of the assigned case by asking students to describe the company in the case and the problems or issues that it is facing. Then ask how each person in the class marked the Performance category on the Strategy Wizard. See if everyone agrees. Ask them to defend their position. Go through the rest of the Strategy Wizard categories and use it to discuss each student’s analysis of the case. Which categories have the most agreement in the class? Which categories contain the most disagreements? Ask the class if everyone agrees with the strategy recommended by the program. Use this as a way of discussing corporate strategic alternatives.

You may also ask the students to hand in their printouts to earn some class participation points.

Students enjoy doing this exercise. It gives them something simple but concrete to do as part of their case analysis.

Feel free to assign the Strategy Wizard to individual students or to groups. The program works with any comprehensive strategy case. Enjoy!

20 .

PART B CHAPTER NOTES

CHAPTER ONE BASIC CONCEPTS OF STRATEGIC MANAGEMENT This chapter sets the stage for the study of strategic management and business policy. It summarizes research supporting the conclusion that those corporations that are able to learn from their experiences and manage strategically perform at a higher level than corporations that do not. It describes a number of triggering events that act to initiate strategic change in most organizations. A normative model of strategic management is presented as the basic structure underlying the book. Key concepts are defined and explained as part of the discussion of the model.

The chapter also introduces the strategic audit as a method of operationalizing strategic decision making.

LEARNING OBJECTIVES 1.

2.

3.

4.

5.

6.

7.

8.

Discuss the benefits of strategic management.

Explain how globalization, innovation, and environmental sustainability influence strategic management.

Discuss the differences between the theories of organizations.

Discuss the activities where learning organizations excel.

Describe the basic model of strategic management and its components.

Identify some common triggering events that act as stimuli for strategic change.

Explain strategic decision-making modes.

Use the strategic audit as a method of analyzing corporate functions and activities.

TOPICS OUTLINE COVERED 1. The Study of Strategic Management a. Phases of Strategic Management b. Benefits of Strategic Management 2. Globalization, Innovation, and Sustainability: Challenges to Strategic Management a. Impact of Globalization b. Impact of Innovation c. Impact of Sustainability 3. Theories of Organizational Adaptation 4. Creating a Learning Organization 5. Basic Model of Strategic Management a. Environmental Scanning b. Strategy Formulation c. Strategy Implementation d. Evaluation and Control e. Feedback/Learning Process 6. Initiation of Strategy: Triggering Events 7. Strategic Decision Making a. What Makes a Decision Strategic b. Mintzberg’s Modes of Strategic Decision Making c. Strategic Decision-Making Process: Aid to Better Decisions 8. The Strategic Audit: Aid to Strategic Decision Making SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS

1-1.

How do the three elements of globalization, innovation, and sustainability impact your understanding of strategy?

Globalization is the integrated internationalization of markets and corporations. As more industries become global, strategic management is becoming more important in keeping track of international developments and positioning a company for long-term competitive advantage. Innovation is meant to describe new products, services, methods, and

2 Copyright © 2015 Pearson Education, Inc.

organizational approaches that would position a company to achieve strong returns. Sustainability refers to a set of business practices that focus on the triple bottom line for an organization. Each of these is a new frontier that is impacting the way in which businesses develop and implement strategy.

1-2.

Organizational strategy can be divided roughly into two categories: a) formulation and b) implementation. Although there is legitimate crossover between the two, how would you characterize the issues involved in each effort?

There are four basic phases of strategic management. Phase 1 is basic financial planning, phase 2 is forecast-based planning, phase 3 is externally oriented strategic planning, and phase 4 is strategic management. Phases 1, 2, and 3 are all considered part of the formulation category. Each of these stages suggests the need to scan the internal and external environment and develop a plan adapting to projections and forecast. The last phase, strategic management, is about the choices an organization makes to implement the planned strategy. In this stage, everyone across the organization is enlisted to support the strategic goals.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 1-3.

Why has strategic management become so important in business?

Research indicates that organizations that engage in strategic management generally outperform those that do not.

The attainment of an appropriate match or fit between an organization’s environment and its strategy, structure, and processes has positive effects on the organization’s performance. The three most highly rated benefits of strategic management are a clearer sense of a firm’s strategic vision, a sharper focus on what is strategically important, and an improved understanding of a rapidly changing environment. As the world’s environment continually changes and becomes increasingly complex, strategic management is used by today’s corporations as one way to make the environment more manageable.

1-4.

How does strategic management typically evolve in a company?

Strategic management in a corporation appears to evolve through four sequential phases according to Gluck, Kaufman, and Walleck. Beginning with basic financial planning, it develops into forecast-based planning, then into externally oriented planning, and finally into a full-blown strategic management system. The evolution is most likely caused by increasing change and complexity in the corporation’s external environment. The phases are thus likely to be characterized by a change from primarily an inward-looking orientation in the first phase to primarily an outward-looking orientation in the third phase, and to a more integrative orientation in the final strategic management phase with equal emphasis on both the external and internal environments.

1-5.

What is a learning organization? Is this approach to strategic management better than the more traditional top-down approach in which strategic planning is primarily done by top management?

Simply put, a learning organization is one that is able to learn from its experiences. In reality, it is much more complicated. The text points out that learning organizations are skilled at four main activities: (1) systematic problem solving; (2) experimenting with new approaches; (3) learning from their own experience and past history as well as from the experiences of others; and (4) transferring knowledge quickly and efficiently throughout the organization. This means that people at all levels, not just top management, need to be involved in strategic management—by helping to scan the environment for critical information, suggesting changes to strategies and programs to take advantage of environmental shifts, and working with others to continuously improve work methods, procedures, and evaluation techniques. Research indicates that those organizations that are willing to experiment and able to learn from their experiences are more successful than those that do not.

Top-down strategic management assumes that only top management is in a position to contribute to strategic planning. This approach can work reasonably well in a bureaucratic organization with very little horizontal communication. Top-down strategic planning forces all units to get involved in the planning process and makes sure that all units fit into the overall corporate mission, objectives, strategies, and policies. A limitation of the top-down

3 Copyright © 2015 Pearson Education, Inc.

approach is that all motivation comes from the top and lower units may simply go through the motions in order to please the boss. The likelihood of fresh, new strategic concepts at lower levels of the organization becomes less, the more the stimulus for strategic planning comes from above.

1-6.

Why are strategic decisions different from other kinds of decisions?

Strategic decisions deal with the long-run future of the entire organization and have three characteristics that differentiate them from other types of decisions: (1) they are rare—strategic decisions are unusual and typically have no precedent to follow; (2) they are consequential—strategic decisions commit substantial resources and demand a great deal of commitment; and (3) they are directive—strategic decisions set precedents for lesser decisions and future actions throughout the organization. See Top Decisions: Strategic Decision-Making in Organizations by Hickson, Butler, Cray, Mallory, and Wilson for further discussion.

1-7.

When is the planning mode of strategic decision making superior to the entrepreneurial and adaptive modes?

The planning mode is generally superior to the entrepreneurial and adaptive modes when the organization is fairly large, when knowledge is spread throughout the organization, and when the organization has at least a moderate amount of time to engage in strategic planning. The book proposes that the planning mode is more rational and thus a better way of making most strategic decisions. It may not, however, always be possible. The entrepreneurial mode can be very useful when time is short, when one person or group is able to grasp the essentials of the business and its environment, and that person or group is able to influence the rest of the organization to accept its strategic decision.

The adaptive mode is generally not considered to be very effective in most situations, but seems to be the fallback mode when entrepreneurial or planning modes can’t operate effectively because of political infighting or lethargy.

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A1-1. Describe the triple bottom line.

The term used to describe a business’ sustainability is the triple bottom line. John Elkington coined the phrase in 1994 to suggest that organizations do pay attention to three different bottom lines. These include: (1) Traditional profit/loss; (2) People Account—social responsibility of the organization; and (3) Planet Account—the environmental responsibility of the organization. This has become increasingly important for organizations today.

For instance, companies seek LEED certification for their buildings and mold a reputation for being friendly to the world. LEED certification is available to buildings that are created to be self-sustaining, with little impact on the environment.

A1-2. What is meant by a hierarchy of strategy?

A hierarchy of strategy is a term used to describe the interrelationships among the three levels of strategy (corporate, business, and functional) typically found in large business corporations. Beginning with the corporate level, each level of strategy forms the strategic environment of the next level in the corporation. This means that corporate level objectives, strategies, and policies form a key part of the environment of a division or business unit. The objectives, strategies, and policies of the division or unit must therefore be formulated so as to help achieve the plans of the corporate level. The same is true of functional departments that must operate within the objectives, strategies, and policies of a division or unit.

A1-3. Does every business firm have business strategies?

Every business firm should have a business strategy for every industry or market segment it serves. A business strategy aims at improving the competitive position of a business firm’s products or services in a specific industry or market segment. Firms must therefore have business strategies even if they are not organized on the basis of operating divisions. Nevertheless, it is still possible that some business firms do not have clearly stated business

4 Copyright © 2015 Pearson Education, Inc.

strategies. If they hope to be successful, however, they must have at least some rudimentary (even though unstated) position they take in terms of getting and keeping customers or clients.

A1-4. What information is needed for the proper formulation of strategy? Why? In order to properly formulate strategy, it is essential to have information on the important variables in both the external and internal environments of the corporation. This includes general forces in the societal environment as well as the more easy-to-identify groups such as customers and competitors in the task environment. A corporation needs to have this information in order to identify a need it can fulfill via its corporate mission. It is also important to have information on the corporation’s structure, culture, and resources. A corporation needs to have this information in order to assess its capabilities to satisfy a customer’s need by making and/or distributing a product or service.

Information on both the internal and external environments can also help a corporation predict likely opportunities and threats. Long-term strategies can be designed with these in mind.

A1-5. Reconcile the strategic decision-making process depicted in Fig. 1.5 with the strategic management model depicted in Fig. 1.2.

The strategic management model depicts the key input variables (internal and external environments) and the key output factors (mission, objectives, strategy, and policies). It shows how strategy formulation, implementation, and evaluation and control are related, and how a change in any one factor (e.g., corporate objectives) affects other factors (e.g., strategies, policies, programs, budgets, procedures, evaluation and control techniques). This model, however, does not depict how these output factors are generated. In contrast, the strategic decision-making model depicts how the process of strategic management happens in the form of strategic decisions. It is a series of interrelated activities depicted as eight distinct steps. These two models therefore complement each other and are very useful in increasing one’s understanding of strategic management.

SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE This end of chapter exercise is a good way to motivate students to apply some of the concepts in the chapter, particularly those from the strategic management model. Decisions are made every day, but not all decisions are seen as strategic ones.

The text states that strategic decisions are (1) rare, (2) consequential, and (3) directive. These deal with the longterm future of the entire organization. To aid in the decision making, the authors suggest an eight step decisionmaking process. Found on page 25 in the text, these include: (1) evaluating current performance results; (2) reviewing corporate governance; (3) scanning and assessing the external environment; (4) scanning and assessing the internal corporate environment; (5) analyzing the strategic factors; (6) generating and selecting the best alternative strategy; (7) implementing selected strategies; and (8) evaluating implemented strategies. These guidelines for making and evaluating decisions at a strategic level can be important for leaders.

Most people in business on most days deal with company tactics and decisions at a level that is not strategic.

However, every decision made by every employee in a company ultimately impacts the success of the strategy for that company. As pointed out by Malcolm Gladwell in his book The Tipping Point, it is the collection of thousands of decisions all aimed in relatively the same direction that can lead a company to the achievement of a strategy. How do you decide what type of decision is strategic?

Open today’s issue of The Wall Street Journal and look for an article about new moves being made by a corporation, specifically the decisions that are strategic. At what level is each of the decisions that you identified?

Functional/Business/Corporate? Why do you believe this to be the case? What is your assessment of these decisions? Will they be effective? Why? How have you decided this?

This is a good exercise to encourage students to begin analyzing the strategic decision-making process. This exercise serves two purposes. It gets everyone up to speed in terms of identifying “real-world” strategic decisions. It also forces them to re-read Chapter 1 to get a solid understanding of what differentiates a good from a poor strategic decision. Encourage them to use the models presented in the chapter to justify their reasoning. You can give them

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this assignment on the first day of class and then use the second day to discuss Chapter 1 and the various strategic decisions people have found. This is a good way to encourage student participation in the class.

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CHAPTER TWO CORPORATE GOVERNANCE This chapter describes the basic governance mechanisms of the corporation: the board of directors and top management. These are the people who are primarily tasked with the strategic management process if the corporation is to have long-term success in accomplishing its mission. The responsibilities of both are described and explained. It proposes a board of directors’ continuum on which boards can be placed in terms of their involvement in strategic management. Agency theory is contrasted with stewardship theory. The chapter explains how the composition of the board can affect both its performance and that of the corporation. It also describes the impact of the Sarbanes-Oxley Act on corporate governance in the United States and trends in corporate governance around the world. Top management is discussed in terms of executive leadership, strategic vision, and managing the strategic planning process.

LEARNING OBJECTIVES 1.

2.

3.

4.

5.

Describe the role and responsibilities of the board of directors in corporate governance.

Explain how the composition of a board can affect its operation.

Describe the impact of the Sarbanes-Oxley Act on corporate governance in the United States.

Discuss trends in corporate governance.

Explain how executive leadership is an important part of strategic management.

TOPICS OUTLINE COVERED 1. Role of the Board of Directors a. Responsibilities of the Board b. Board of Directors Composition c. Nomination and Election of Board Members d. Organization of the Board e. Impact of the Sarbanes-Oxley Act on U.S. Corporate Governance f. Improving Governance g. Evaluating Governance h. Avoiding Governance Improvements i. Trends in Corporate Governance 2. The Role of Top Management a. Responsibilities of Top Management SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS

2-1.

What are the roles and responsibilities of an effective and active board of directors?

The board of directors is required by law to direct the affairs of the corporation, but not to manage them. Stuart has written that a board is responsible for (1) effective leadership, (2) strategy of the organization, (3) the balance of risk and initiative, (4) succession planning, and (5) sustainability. The role of the board is to carry out three basic tasks: (1) monitor; (2) evaluate and influence; and (3) initiate and determine.

2-2.

What are the issues that suggest the need for oversight of a particular company’s management team?

The board of directors holds the top management team responsible for implementing and guiding the strategy set forth. There are several red flags that would indicate the need for oversight of a management team. When the corporate objectives are not being met, management teams may be at fault. When a clear vision is not articulated, the CEO must be responsible. Also, when the strategic planning process is not being monitored by the top management team, oversight may be called for.

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SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 2-3.

When does a corporation need a board of directors?

A board of directors is needed to protect the interests of the corporation’s owners, its shareholders. By law, when a company incorporates, it must have a board of directors—even if the stock is held only by the founder and his/her spouse. A good case can be made that a small, closely held corporation has no need for a board. Because the owners are likely to compose both top management and board membership, the board becomes superfluous at best, and may even create more problems than it solves by getting in the way of management’s quick response to opportunities and threats. The board meets only to satisfy legal requirements. Even when stock is more widely owned in a publicly held corporation, the board may be composed of nothing but a few insiders who occupy key executive positions and a few friendly outsiders who go along with the CEO on all major issues. Nevertheless, the rationale for the board of directors seems to be changing from simply one of safeguarding stockholder investments to a broader role of buffering the corporation from its task environment and forcing management to manage strategically. If nothing else, the board can do the corporation a great service by simply offering top management a different point of view.

The board’s connections to key stakeholders in the corporation’s task environment can also provide invaluable information for strategic decision making. This is the main reason why advisory boards are often used by companies that are not incorporated and thus have no shareholders.

2-4.

Who should and should not serve on a board of directors? What about environmentalists or union leaders?

This is a wide-open question with no simple answer. Some may argue that representatives from each stakeholder group in the corporation’s task environment should be included so as to keep top management aware of key environmental considerations. Others may argue that only outsiders with no personal stake in the corporation (e.g., not a member of a local bank or a key supplier, etc.) would be best able to bring the amount of objectivity needed to help make strategic decisions. This is the point of view taken in the United States by the Sarbanes-Oxley Act. A good argument can be started by suggesting that a representative from labor be a director. This is done in Germany.

If this makes some sense, who should it be—a union member who is an employee of the corporation or an employee of another corporation? If the firm is not unionized, what then? Further discussion can be generated by suggesting that the composition of the board reflects the key demographics of the corporation’s workforce in terms of race, sex, and age. Environmentalists could provide excellent information to top management, but could be a problem if they argue only for environmental considerations without regard to the corporation’s other stakeholders.

This question provides the instructor with the opportunity to get the class involved in a discussion of agency and stewardship theories. Agency theory suggests that insiders should be kept to a minimum and that the board be heavily composed of objective outsiders who own large blocks of stock. Because of their stake in corporate decisions, affiliated directors would not be considered for board membership. This would ensure that the board would primarily represent shareholder interests and objectively monitor the “hired hands” serving as top management. This is the point of view taken by the Sarbanes-Oxley Act in the United States. In contrast, stewardship theory views top management as concerned “stewards” of the corporation—people who may have a greater concern for the corporation as a whole and its survival than do the shareholders, and who may only be interested in earnings per share and little else. Stewardship theory suggests that the board should be composed of people who can provide important information from the task environment and valuable insight to top management.

It would work to consider interests beyond shareholder value.

2-5.

Should a CEO be allowed to serve on another company’s board of directors? Why or why not?

The majority of outside directors are active or retired CEOs of other corporations. The chapter states that the average board member of a U.S. Fortune 500 firm serves on three boards and that only 40% of U.S. boards limit the number of directorships a board member may hold in other corporations. CEOs from other firms are highly valued because

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they can provide excellent advice to the CEO. Having a CEO from another firm serve on a corporation’s board of directors results in an interlocking directorate between the two corporations. The text points out that this is a good way to obtain inside information about an uncertain environment and objective expertise about potential strategies and tactics. For these and other reasons, well-interlocked firms are better able to survive in a highly competitive environment. This is a good reason for allowing a firm’s CEO to serve on the boards of other companies. The CEO is likely to bring back information and contacts that can be very useful to the corporation.

There is a down side, however, to allowing a CEO to sit on the boards of other firms. For one thing, serving on another company’s board requires time and energy devoted to something other than the job he/she is paid to fulfill.

Given the increasing pressure placed on board members, such service is becoming increasingly onerous. Because of this, the typical CEO now sits on only one board in addition to his/her own—down from two additional boards in the 1990s. Consequently, a board should work closely with its CEO to decide which other boards are most useful to the company for the CEO to join.

2-6.

What would be the impact if the only insider on a corporation’s board were the CEO?

One result would be a board composed primarily of outsiders who would be objective, but also dependent upon the CEO for information about the company and its activities. Thanks to Sarbanes-Oxley and other actions by the New York Stock Exchange, this appears to be a trend in most U.S. Fortune 500 companies. As of 2007, the typical U.S. Fortune 500 board had an average of ten directors, only two of whom being insiders. The number of insiders tends to be higher for boards in other countries. Even when a CEO might be the sole insider on the board, he/she still has a great deal of influence because the CEO usually also serves as the Chairman of the Board. Nevertheless, an increasing number of boards are selecting a “lead director” to oversee the evaluation of top management, so this can counter the dual CEO/Chair’s power. A positive result of the CEO being the only insider on a board is that the board would be more likely to be objective and serious about its responsibility to oversee the corporation’s management. A negative result would be the lessened opportunity to view potential successors in action or to obtain alternate points of view to management decisions.

2-7.

Should all CEOs be transformational leaders? Would you like to work for a transformational leader?

According to the text, top management must successfully handle two responsibilities that are crucial to the effective strategic management of the corporation: (1) provide executive leadership and a strategic vision and (2) manage the strategic planning process. The text further argues that successful CEOs often provide this executive leadership by taking on many of the characteristics of the transformational leader by communicating a clear strategic vision, demonstrating a strong passion for the company, and communicating clear directions to others. Such transformational leaders, such as Bill Gates at Microsoft, Steve Jobs at Apple, and Anita Roddick at The Body Shop, have been able to command respect and energize their employees. They not only articulated a strategic vision, but they also presented a role for others in the company to identify with and follow. Their communication of high performance standards coupled with their confidence in their fellow employees often raised performance to a high level. Nevertheless, such transformational leaders can be very difficult to work for and their overconfidence may even get the firm in trouble. Their forcefulness may drive other competent people away when they fail to allow for differences of opinion. Hint to the instructor: Once the class has discussed the pros and cons of transformational leaders, ask them how many would like to work for such an executive? Use Donald Trump as an example (“You’re fired!”). You may be surprised by the number of people who would not like to work for such a CEO. ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A2-1. What recommendations would you make to improve the effectiveness of today’s boards of directors?

The following are among the many suggestions often made: • Add more outsiders (people not affiliated with the corporation) to the board of directors. Keep the percentage of insiders (typically top management) to less than 50% of board membership.

• Separate the positions of CEO and Chairman so that top management cannot unduly influence the board’s

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• •

• •

meetings and agenda. This should improve the board’s ability to properly evaluate top management. If the Chair can’t be separated from the CEO, select a Lead Director from among the outside directors.

Use a committee composed of outsiders to nominate potential new directors. This will help to ensure that potential members are not friends of top management who may owe more allegiance to the CEO than to the shareholders.

Nominate people to the board who have knowledge valuable to the board and who have expertise of value to top management. These should be people who will have the respect of top management and who can both advise and criticize top management as needed. Make sure that they are diverse in terms of background and experience.

Require board members to own substantial amounts of stock in the corporation to ensure that they have a personal as well as professional stake in the welfare of the corporation.

Allow shareholders to nominate people for election to director.

A2-2. Is there a conflict between agency theory and the concept of organizational stakeholders?

Agency theory is concerned with problems that occur in relationships between principals (owners) and their agents (top management). Because agents are, in effect, “hired hands,” their interests are not usually aligned with those of the owner (stockholders) of a corporation. Consequently, agency theory is primarily interested in ways to better align these two sets of interests, such as management owning significant shares of stock or having a strong financial stake in the long-term performance of the corporation via long-term incentive plans. This helps to ensure that management looks beyond selfish short-term benefits of a decision to the more strategic issues that concern stockholders. The concept of organizational stakeholders, in contrast, looks at more than just owners and managers.

It argues that groups other than stockholders and top management have a significant stake in the actions of the corporation and need to be considered in strategic decisions. What might benefit owners and management might hurt employees, the local community, or the environment. The concept of stakeholders thus proposes that the suggestions of agency theory are incomplete and insufficient to ensure that top management deals fairly not only with stockholders, but also with the needs of all concerned stakeholder groups. As it is currently defined, agency theory is more in agreement with Milton Friedman’s narrow view of the responsibilities of a corporation than with the stakeholder view more common to concerns of social responsibility. (See Chapter 3 for Friedman’s view of corporate responsibility.) This could change if society begins to consider top management not only as direct agents for stockholders, but also as indirect agents for other groups with a stake in the corporation’s activities. Agency theory could thus be expanded to include the concerns of other interested groups and thus incorporate the stakeholder approach.

SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE The end of chapter exercise asks the student to evaluate the “best” and the “worst” manager for whom the student has worked. The questionnaire is based on the concept of French and Raven’s “bases of power.” This concept is usually discussed in Introduction to Management as well as in Organizational Behavior textbooks as a part of their discussion of leadership. You may need to briefly explain what each base means as part of your discussion of their scores. Briefly, reward power is based on someone’s ability to give another something that is valued for doing what the other person wants. Coercive power is based on someone’s ability to give someone something that is disliked if the other person does not do what is desired. Legitimate power is like authority in that it is based on one person’s belief that another person has the right to ask him/her to do something. Referent power is like charisma in that it is one person’s ability to get others to identify with him/her and to want to be like that person. Expert power is based on a person’s knowledge or abilities in an area that is important for job performance and that the person is willing to share with someone else.

List the five bases of power on the board. Ask around five members of the class to provide you with their scores for their “best manager” on each of the bases. Write their totals under each of the five bases on the board and then calculate the average for each base. Do the same thing for the same five students for their “worst boss.” In most instances, the average “best boss” will score higher than the average “worst boss” on referent, expert, and reward power, and lower on coercive and legitimate power. Because the “best manager” tends to have many of the characteristics of the transformational leader, this questionnaire provides some interesting information to use in

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answering the fifth discussion question: Would you like to work for a transformational leader?

ADDITIONAL TEACHING MODULE CORPORATE GOVERNANCE STYLES Just as boards of directors vary widely on a continuum of involvement in the strategic management process, so do top management teams. For example, a top management team with a low involvement in strategic management will tend to be functionally oriented and will focus its energies on day-to-day operational problems; this type of team is likely either to be disorganized or to have a dominant CEO who continues to identify with his or her old division. In contrast, a top management team with high involvement will be active in strategic planning. It will try to get division managers involved in planning so that top management will have more time to scan the environment for challenges and opportunities.

Both the board of directors and top management can be placed on a matrix that reflects four basic styles of corporate governance.

Styles of Corporate Governance

Degree of Involvement

High

Entrepreneurship Management

Partnership Management

Chaos Management

Marionette Management

by Top Management Low

Low

High

Degree of Involvement by Board of Directors Chaos Management When both the board of directors and top management have little involvement in the strategic management process, their style is referred to as chaos management. The board waits for top management to bring it proposals. Top management is operationally oriented and continues to carry out strategies, policies, and programs specified by the founding entrepreneur who died years ago. The basic strategic philosophy seems to be, “If it was good enough for old J.B., it’s good enough for us.” There is no strategic management being done here.

Entrepreneurship Management A corporation with an uninvolved board of directors but a highly involved top management has entrepreneurship management. The board is willing to be used as a rubber stamp for top management’s decisions. The CEO, operating alone or with a team, dominates the corporation and its strategic decisions. An example is Control Data Corporation under the leadership of its founder, William C. Norris. For twenty-nine years, Norris dominated both the company’s top management and its board of directors. Insisting that the company could profit by addressing “society’s unmet needs,” Norris directed corporate investments into the rejuvenation of ghettos and support of windpowered generators and tundra farming, among other projects. Although these investments tended to result in losses, few people were willing to challenge his strategic decisions. Some employees even referred to him as “the Pope.” A former Control Data executive noted, “More often than not, he’s proven his critics wrong, so now his visions aren’t challenged.”

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Marionette Management Probably the rarest form of strategic management style, marionette management occurs when the board of directors is deeply involved in strategic decision making, but top management is primarily concerned with operations. Such a style evolves when a board is composed of key stockholders who refuse to delegate strategic decision making to the president. The president is forced into a COO role and can do only what the board allows him/her to do. This style also occurs when a board fires a CEO but is slow to find a replacement. The COO or executive vice-president stays on as “acting” president or CEO until the selection process is complete. In the meantime, strategic management is firmly in the hands of the board of directors.

Marionette management occurred at Winnebago Industries when the company’s board of directors, chaired by its founder, 72-year-old John K. Hanson, took away Ronald Haugen’s title as chief executive officer but left him as company president. No new CEO was named. Hanson, whose family owned 46% of Winnebago’s stock, had given up the CEO title in 1983 to President Haugen, a long-time employee. Outside observers noted that although Chairman Hanson did not also hold the title of CEO, he appeared to have taken on the CEO’s responsibilities once again.

Partnership Management Probably the most effective style of strategic management, partnership management is epitomized by a highly involved board and top management. The board and top management team work closely to establish the corporate mission, objectives, strategies, and policies. Board members are active in committee work and utilize strategic audits to provide feedback to top management on its implementation of agreed-upon strategies and policies. This appears to be the style in a number of successful corporations such as Texas Instruments, Target, and General Electric Company.

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CHAPTER THREE SOCIAL RESPONSIBILITY AND ETHICS IN STRATEGIC MANAGEMENT The chapter examines the relationship between business firms and society and presents issues in social responsibility and ethics. It describes the relationship between social responsibility and corporate performance. The chapter considers stakeholder concerns and presents various responsibilities of business firms as well. Ethics and ethical behavior are considered in light of the challenge from moral relativism. It describes guidelines for ethical behavior according to utilitarianism, individual rights, and justice approaches.

LEARNING OBJECTIVES 1.

2.

3.

4.

5.

Discuss the relationship between social responsibility and corporate performance.

Explain the concept of sustainability.

Conduct a stakeholder analysis.

Explain why people may act unethically.

Describe different views of ethics according to the utilitarian, individual rights, and justice approaches.

TOPICS OUTLINE COVERED 1. Social Responsibilities of Strategic Decision Makers a. Responsibilities of a Business Firm b. Sustainability c. Corporate Stakeholders 2. Stakeholder Analysis 3. Ethical Decision Making a. Some Reasons for Unethical Behavior b. Encouraging Ethical Behavior 4. View on Ethical Behavior SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS

3-1.

How has moral relativism led to criminal activities by some employees in companies?

Moral relativism suggests that morality is relative to some personal, social, or cultural standard. There is no method for deciding whether one decision is better than another. For this very reason, many people justify their unethical positions, arguing that there is not one absolute code of ethics.

3-2.

How does a company ensure that its code of ethics is integrated into the daily decision-making process of the company and is not just a symbolic trophy or plaque hanging on the wall?

When management of a company wants to improve the ethical behavior of employees in the organization, a code of ethics should be communicated in training programs, in performance appraisal systems, policies and procedures, and also through their own actions.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS: 3-3.

What is the relationship between corporate governance and social responsibility?

This question is partially answered by the last trend in corporate governance presented in Chapter 2. Quite simply, it states that society, in the form of special interest groups, increasingly expects boards of directors to balance the economic goal of profitability with the social needs of society. Issues dealing with workforce diversity and the environment are now reaching the board level. If business corporations are to avoid increased governmental restrictions on their activities, management will need to be even more aware of the various needs of their stakeholder

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groups. The board of directors is in a unique position to view the corporation as a whole and to evaluate management’s performance in terms of stakeholder criteria. To the extent that boards use only shareholder value as their key criteria, they may not be acting responsibly from society’s point of view. Increasingly, concerns over social responsibility may be directed through the board of directors. Agency theory defines the board’s interests quite narrowly. Perhaps it is time for agency theory to be expanded to include stakeholders other than just shareholders.

Stewardship theory may provide the rationale to expand the responsibilities of the board and top management in terms of the corporation’s overall social responsibilities. This is likely to continue being a controversial issue for quite some time.

3-4.

What is your opinion of Apple having a code of conduct for its suppliers? What would Milton Friedman say? Contrast his view with that of Archie Carroll’s.

Do a company’s responsibilities end at its boundary, or do its responsibilities extend to include its suppliers and distributors? This very thorny question has become a point of contention in the area of social responsibility. The question includes a basic question in organization theory: what is the boundary of an organization? Certainly, one could argue that a company is composed of its employees and all of its assets, such as land, buildings, and equipment. These can thus define a company’s boundary. Given this view, everything else may be called a company’s “environment” and therefore outside of a company’s control or responsibility. One could thus argue that a company such as Apple or Nike cannot be held responsible for the actions of a separate and independent supplier company/contractor. The very popularity of outsourcing as a substitute for vertical integration means that more firms are contracting with other firms to fulfill functions a company no longer wishes to do on its own. If the contract is long term in nature or if the purchasing company owns a substantial amount of stock in the supplying company, then the hands-length nature of transactions is compromised and it becomes difficult to discern where one firm’s boundary begins and another firm’s leaves off. Such a relationship suggests that one company does have some influence over another company’s actions by nature of the other company’s dependency on the first company.

One could thus argue that a company’s social responsibilities extend beyond what is normally thought of as its boundary to the extent that it has some control and influence over the other company’s actions. Clearly, Apple’s management was thinking this way when it drafted its code of conduct.

Milton Friedman would probably be very much against Apple’s meddling with the rights of its suppliers to freely contract with their employees. Using Carroll’s categories, Friedman would probably argue that the only responsibilities of a business firm are economic and legal. Friedman does say that business should play “within the rules of the game.” This can be interpreted as meaning a supplier’s legal responsibilities to follow the rules established within that country. If a purely economic justification is used, it may be difficult but still possible to justify ethical and discretionary responsibilities. Carroll points out that a refusal to consider ethical responsibilities is likely to lead to an increase in a firm’s legal responsibilities—which, considering the usual inefficiencies of government, will lead to higher costs and lower long-run business efficiency. Either the U.S. federal government or the United Nations may force companies in developed countries to follow a code like Gap’s or else face sanctions.

Friedman would say that this is foolishness, but Carroll would argue that this is a natural result of ignoring one’s ethical responsibilities.

3-5.

Does a company have to act selflessly to be considered socially responsible? For example, when building a new plant, a corporation voluntarily invested in additional equipment that enabled it to reduce its pollution emissions beyond any current laws. Knowing that it would be very expensive for its competitors to do the same, the firm lobbied the government to make pollution regulations more restrictive on the entire industry. Is this company socially responsible? Were its managers acting ethically?

This is a tough question. At first, it seems to be more appropriate to a philosophy class than to a strategic management class. Should motivation and attitudes be considered when judging a company’s actions? The legal system normally does this when differentiating between different degrees of guilt: intentionally killing is called murder and is usually punished severely; unintentional killing is called homicide and may not be punished at all if it is considered to be an accident or self-defense. Using this approach, one could say that a company is not socially responsible unless its motives fit its actions. A counterargument could be made, however, by arguing that the

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essence of the free enterprise system is laissez-faire capitalism in which the selfish motivations of business people result in a better society in terms of material goods. In this system, it is acceptable for a successful business firm to selfishly work for its own good, given that its actions result in side effects that are functional for society as a whole.

We do not demand that a firm be altruistic when fulfilling its economic and legal responsibilities. Why should we then require that a firm be altruistic when fulfilling its ethical and discretionary responsibilities? This is not the type of question that pragmatic undergraduate business students are used to. Grad students will enjoy playing with the concepts involved. This question could either result in some interesting class discussion or it could bomb. Hopefully, it will make the class think on a higher level than simply regurgitating the book.

3-6.

Are people living in a relationship-based governance system likely to be unethical in business dealings?

The chapter states that developing nations tend to have relation-based governance. Transactions are based on personal and implicit agreements, not on formal contracts enforceable by a court. Information about a business is largely local and private—thus cannot be easily verified by a third party. In contrast, rule-based governance relies on publicly verifiable information—the type of information that is typically not available in a developing country. The rule-based system has an infrastructure, based on accounting, auditing, ratings systems, legal cases, and codes, to provide and monitor this information. If present in a developing nation, the infrastructure is not very sophisticated.

The relation-based system in a developing nation is inherently nontransparent due to the local and nonverifiable nature of its information. A businessperson needs to develop and nurture a wide network of personal relations. In a relation-based system, the culture of the country (and the founder’s family) strongly affects corporate culture and business ethics. What is “fair” depends upon whether one is a family member, a close friend, a neighbor, or a stranger. Because behavior tends to be less controlled by laws and agreed-upon standards than by tradition, business people from a rule-based developed nation perceive the relationship-based system in a developing nation to be less ethical and more corrupt. In contrast, the people living in a relationship-based country see their behavior as following what to them are well-known traditional guidelines and don’t necessarily understand why foreigners from developed nations have such difficulty understanding how things are done. What is perceived by one person to be corruption is simply how things are done in a developing nation.

3-7.

Given that people rarely use a company’s code of ethics to guide their decision making, what good are the codes?

The chapter states that managers tend to ignore codes of ethics and try to solve ethical dilemmas on their own. To combat this tendency, corporations should not only develop a comprehensive code of ethics, but also communicate the code in their training programs, performance appraisal systems, and policies and procedures. Developing codes of ethics can be a useful way to promote ethical behavior, especially for people who are operating at Kohlberg’s conventional level of moral development. A code of ethics (1) clarifies company expectations of employee conduct in various situations and (2) makes clear that the company expects its people to recognize the ethical dimensions in decisions and actions. If nothing else, developing and communicating a comprehensive code of ethics can help protect a company from lawsuits.

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A3-1. How appropriate is the theory of laissez-faire in today’s world?

As indicated in the chapter, Milton Friedman contends that it is very appropriate. The quote from his classic article, “The Social Responsibility of Business Is to Increase its Profits” does suggest a certain modification, however, to pure laissez-faire. He states that business should work to increase its profits “so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” These “rules of the game” form the crux of the argument. What should these rules be and who should communicate and enforce them?

This leads directly into Archie Carroll’s contention that there are four responsibilities of business corporations: economic, legal, ethical, and discretionary. Pure laissez-faire argues for economic responsibilities only. Friedman modifies laissez-faire by presumably adding legal responsibilities. One could make the point that the “rules of the game” should include ethical responsibilities as well. The problem, of course, is what happens to the concept of

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laissez-faire when one adds all these responsibilities to it and then expects businesspeople at all levels to accept them without outside force? Does laissez-faire as proposed by Adam Smith and argued by others include only economic responsibilities? If legal and ethical responsibilities are also expected by society of business corporations, is it still “free enterprise” laissez-faire or some other kind of system?

A3-2. Using Carroll’s list of four responsibilities, should a company be concerned about discretionary responsibilities? Why or why not?

Except for a few die-hard followers of Milton Friedman’s philosophy, few people would agree that a business firm should fulfill only its economic and legal responsibilities and completely ignore ethical ones. The same is not true of discretionary responsibilities, however. Because discretionary responsibilities are defined by Carroll as purely voluntary, there is no pressure by anyone for a business firm to fulfill them. One can argue, nevertheless, that there are three good reasons to undertake these kinds of responsibilities. The first reason is the morality rationale—it may be the right thing to do, even though the company may not benefit and may even be hurt in the short run. The second reason is enlightened self-interest. If a firm undertakes a discretionary activity, it may gain short-run advantages in the marketplace (e.g., a company offering free day care to its employees may attract more potential workers at lower wages). It may also serve as a role model for government to legislate if and when that responsibility moves from discretionary to ethical and finally to legal (and thus the firm is able to do things its way instead of the government’s way). The third reason is also one of enlightened self-interest. If a company develops a reputation for voluntarily doing socially useful activities even though it gains little economically in return, it may collect valuable public relations credit in people’s minds. This may translate into better sales or a willingness on the part of some government agency to overlook a questionable activity the company might unthinkingly engage in.

SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE The end of chapter exercise asks the student to evaluate the position of an organization facing a particular dilemma and to suggest a course of action to the manager. Students should read the exercise and make the decision in an ethical manner for the manager. Ideally, students may analyze the problem in three ways: fiduciary duty, stakeholder analysis, and the Kantian categorical imperative. If students view the manager’s fiduciary duty to the shareholders as paramount, they will decide to make the gamble. If they see a duty to stakeholders other than shareholders (e.g., employees, customers, etc.), they will still choose to act as if the product closer to release is THE ONE. Students will also reach a conclusion based on the Kantian categorical imperative explained in the chapter.

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CHAPTER FOUR ENVIRONMENTAL SCANNING AND INDUSTRY ANALYSIS This chapter examines key aspects of the external environment of the corporation with special emphasis on environmental scanning, industry analysis, and forecasting. Environmental scanning is presented as the first part of the strategic management model and a crucial task for strategic managers. The emphasis is upon monitoring strategic factors and utilizing possible sources of information. Porter’s approach to industry analysis is discussed in some detail. Forecasting is then addressed in terms of assumptions and basic techniques. Industry scenario construction/writing is explained. The chapter ends with a suggested way to synthesize external factors through the use of an EFAS Table.

LEARNING OBJECTIVES 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

List the aspects of an organization’s environment that can influence its long-term decisions.

Identify the aspects of an organization’s environment that are most strategically important.

Conduct an industry analysis to explain the competitive forces that influence the intensity of rivalry within an industry.

Discuss how industry maturity affects industry competitive forces.

Categorize international industries based on their pressures for coordination and local responsiveness.

Identify key success factors and develop an industry matrix.

Construct strategic group maps to assess the competitive positions of firms in an industry.

Develop an industry scenario as a forecasting technique.

Use publicly available information to conduct competitive intelligence.

Construct an EFAS table that summarizes external environmental factors.

TOPICS OUTLINE COVERED 1. Aspects of Environmental Scanning a. Identifying External Environmental Variables 2. Strategic Importance of the External Environment a. Scanning the Societal Environment: STEEP Analysis b. Identifying External Strategic Factors 3. Industry Analysis: Analyzing the Task Environment a. Porter’s Approach to Industry Analysis b. Industry Evolution c. Categorizing International Industries d. International Risk Assessment e. Strategic Groups f. Strategic Types g. Hypercompetition 4. Using Key Success Factors to Create an Industry Matrix 5. Competitive Intelligence a. Sources of Competitive Intelligence b. Monitoring Competitors for Strategic Planning 6. Forecasting a. Danger of Assumptions b. Useful Forecasting Techniques 7. The Strategic Audit: A Checklist for Environmental Scanning 8. Synthesis of External Factors—EFAS

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SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS 4-1.

How does STEEP analysis aid in the development of the strategy in a company?

STEEP analysis is designed to monitor trends in the society and natural environments. In doing so, this analysis requires scanning the environment for sociocultural, technological, economic, ecological, and political environmental forces that may impact the way an organization does business.

4-2.

The effects of climate change on companies can be grouped into six categories of risk. Use any two of these to explain the impact upon the resort hotel industry.

The six types of risk are regulatory risk, supply chain risk, product and technology risk, litigation risk, reputational risk, and physical risk. Each of these can impact the resort hotel industry. For each of these risks, the student should be able to give several examples of the impact for the resort hotel industry.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS: 4-3.

Discuss how a development in a corporation’s natural and societal environments can affect the corporation through its task environment.

Developments or trends in a corporation’s natural or societal environment typically do not affect the corporation directly but indirectly through their impact on one or more stakeholder groups in the corporation’s task environment.

As mentioned in the text, the trend toward dual-career couples is a recent development in the societal environment of any company operating in the United States or Canada. Sociocultural forces regarding the changing role of women, plus the trend toward single family households, combined with the economic forces of high interest rates and inflation in the 1970s to send both men and women searching for full-time jobs in addition to their being parents. This development in the societal environment continues to effect companies through its impact on employee/union groups (who ask for parental leave and/or company-sponsored day care centers), customers (employed parents who increasingly shop for convenience goods because of time constraints), and special interest groups and even governments (who ask business firms to help support local schools and deal with community social problems). As another example, the trend toward global warming may not directly affect a company making toys, but may affect it indirectly through a sociocultural trend supporting the use of rechargeable batteries and solar cells as replacements for disposable batteries. Such a sociocultural trend may be reflected in changing customer preferences or in new government regulations or incentive programs.

4-4.

How would you determine the level of competitive intensity in an industry?

The answer to this question can be found in Figure 4.2 in Chapter 4. By this time, students should be able to list the five forces presented by Michael Porter plus the sixth force (other stakeholders) proposed by Ed Freeman. They are briefly: • Threat of new entrants • Rivalry among existing firms • Threat of substitute products or services • Bargaining power of buyers • Bargaining power of suppliers • Relative power of other stakeholders Once they have listed the forces, push the students to explain how each of the forces can affect the level of competitive intensity within an industry. Use price of the company’s product (i.e., How will a change in each of the forces affect the average price of the product?) and then look at how changes in each force might affect average product quality and other characteristics of the product offered in this particular industry. Arbitrarily select for analysis a well-known industry such as airlines or automobiles. After examining past and present forces operating in a particular industry, ask the students to try to predict what will happen to each of these forces in the future and how these developments might affect the future competitive intensity of the industry. Here’s an example of an exercise

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you could use in class.

What are the forces driving industry competition in the airline industry?

First, ask each person in the class to individually evaluate each of the forces. Alternatively, form groups to evaluate the forces. Next, ask the class (or each group) to indicate whether they marked high, medium, or low for each force.

Ask individuals/groups for their rationale to get some discussion going. Next, ask the class which of these forces are changing and to indicate why. The next step is to ask the class to evaluate the future level of competitive intensity in the airline industry. Would they invest or look for a job in this industry?

The authors’ opinions regarding the current level of these forces are as follows. The overall level of competitive intensity is high and bound to get higher. Feel free to disagree.

4-5.

•

Threat of new entrants: High. Almost anyone can buy used airplanes and start a charter service. As other nations privatize their high-cost, state-owned airlines, new low-cost entrants will emerge.

•

Rivalry among existing firms: High. As more airlines leave their nationally protected areas, they are entering areas previously controlled by other airlines. Because there are few ways to differentiate airline service, many carriers become commodities, competing primarily on price. Price wars result from this high degree of rivalry.

•

Bargaining power of buyers/distributors: Medium to Low. As more airlines are selling directly to customers via the Internet, travel agents as the primary distributors have become less important to carrier sales. The lowered power of travel agents is indicated by the fact that major airlines were able to institute a cap on travel agent commissions so easily and to emphasize ticket sales via corporate websites.

•

Bargaining power of suppliers: High. With only two large airframe manufacturers compared to many more airline companies, supplier bargaining power is quite high.

•

Relative power of other stakeholders: Medium. Who are the key stakeholders? Pilot and flight attendant unions are traditionally strong at the established carriers (raising costs). Nonunionized carriers thus gain a cost advantage (raising the level of competitive intensity). Because airline crashes get major attention, governments are quick to pass safety regulations (raising costs and thus competitive intensity). However, national concerns also cause governments to safeguard domestic airlines from strong foreign competition thus lowering competitive intensity.

Is Pepsi Cola a substitute for Coca Cola?

This is a good question to check how well students understand the basic concepts of industry analysis. Those with a very superficial understanding of the topics discussed in this chapter will tend to answer “yes” to this question. They are using their own common sense understanding of a substitute being another product within the same category.

Because Coke and Pepsi are both colas, most people think of them as substitutes for each other. They have almost identical product characteristics. According to Porter, however, substitute products are those products that appear to be different but can satisfy the same need as another product. This means that in Porter’s mind, substitutes do not have similar product characteristics, but are still able to satisfy the same need. This indicates that Porter would not view Pepsi and Coke as true substitutes, but two versions/brands of the same product. Thus, Porter would view coffee and tea (both having caffeine) as being substitutes for a soft drink cola. The whole idea of Porter’s approach to industry analysis is to get people to go beyond the obvious when considering what affects the level of competitive intensity within an industry.

4-6.

How can a decision maker identify strategic factors in a corporation’s external international environment?

The chapter suggests that one begin by listing three or more trends emerging in each of the four forces of a firm’s societal environment in an environmental trend analysis matrix (see Tables 4.1 and 4.3). Then estimate the likely

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impact of these general trends upon the primary stakeholders (e.g., communities, creditors, competitors, etc.). These data form a series of strategic issues—those trends and developments that are very likely to determine the future environment. Plot these strategic issues on an issues priority matrix (see Fig. 4.2). Those issues judged to have a high probability of occurring and a high probable impact on the corporation are strategic factors. Categorize these factors as opportunities or threats. Keep in mind that some strategic factors may be both opportunities and threats, depending on how they are viewed.

4-7.

Compare and contrast trend extrapolation with the writing of scenarios as forecasting techniques.

As indicated in the chapter, extrapolation is simply the extension of present trends into the future. It relies on the assumption that the environment is reasonably consistent and changes slowly in the short run. As a result, extrapolation is fairly easy to do, as witnessed by its being the most widely used form of forecasting. Nevertheless, extrapolation is like driving a car backward without using a mirror or twisting one’s head to look backward.

Everything will be fine until a sudden turn is reached! Like driving backward, extrapolation is fine if the time frame to be predicted is short and one is lucky. In contrast, scenario writing is based upon a series of historical data plus informed hunches from key people in the company who have access to environmental information or from a Delphi panel of outside experts. Like extrapolation, scenario writing is a very popular forecasting technique, but unlike extrapolation, it can get very complicated and time consuming. One approach to constructing an industry scenario is suggested by Porter in the chapter. It has at least one clear-cut advantage over extrapolation: it encourages forecasters to make their assumptions explicit. One is thus more likely to recognize the dangers of driving backward.

Scenario writing, if done conscientiously, could be seen as an attempt to construct a mirror to use in such hazardous driving!

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A4-1. Why is environmental uncertainty an important concept in strategic management?

A key part of strategic management, environmental scanning is a tool used to help avoid strategic surprise and cope with an uncertain environment. If the environment was certain and predictable, environmental scanning would be a rather easy chore. Simple extrapolation would be the only type of forecasting needed. In a complex and changing world, however, those corporations that engage in environmental scanning and strategic planning tend to deal better with environmental uncertainty and to be more successful than their nonplanning brethren.

A4-2. What can a corporation do to ensure that information about strategic environmental factors gets the attention of strategy makers?

This is a very real problem in most large corporations given the usual obstacles to good communication. The very people who are in the best positions to gather this data are often the ones who either fail to pass it on because it’s too much of a chore, or they fail to notice it because no one told them how important certain developments are to top management. Because proper information dissemination is an important part of environmental scanning, corporations attempt to schedule a series of analytical reports for top management’s information. Some of these reports are depicted in Figure 4.1 in the chapter. The purchasing department, for example, might be tasked with the job of compiling a quarterly analysis of the availability and reliability of present and future suppliers. The market research department might prepare analyses of present and future customers for certain products and services with special attention to demographic shifts. Each report would need to conclude with a list of strategic factors to monitor in the coming months or years. Other approaches are, of course, possible to get needed information to the attention of strategy makers. It might be useful to generate some of these ideas in class.

A4-3. If most long-term forecasts are usually incorrect, why bother doing them?

This question is based on the assumption that most long-term forecasts are usually incorrect. One must keep in mind that some things are easier to forecast than others. For example, a forecasted drop in the demand for tricycles in three years will very likely occur if it is based on a strong drop in the present birth rate. Nevertheless, most people

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would probably agree that forecasts going out five to ten years have a low probability of becoming reality in today’s dynamic world. The text takes the position that even if predictions prove to be wrong, the very act of scanning and forecasting the environment helps managers take a broader perspective. It also forces managers to take an active rather than a passive orientation toward its external environment. It encourages calculated risks over WAHs (wild a** hunches) and is more likely to result in strategic management instead of reactive management.

SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE How far should people in a business firm go in gathering competitive intelligence? Where do you draw the line?

This is an interesting exercise to use not only for covering ethics in Chapter 3, but also for introducing some of the concepts found in Chapter 4, Environmental Scanning and Industry Analysis. For this reason, you might want to use this exercise when discussing ethics in Chapter 3 rather than at the end of Chapter 4.

Approach 1: First, ask your students to complete this exercise. Second, list all the items on the blackboard in which a large percentage of the class rates each of them as 4 or 5. Third, list all the items in which a large percentage of the class rates each of them a 2 or 1. Fourth, list all the items in which a large majority rates them as a 3. Once these three sets of items are listed on the board, ask the class what differentiates one group from another. Try to identify the criteria the class used to rate the items. This provides the rationale the students in your class are using to make ethical decisions. You might also want to challenge the class as a whole by asking for minority opinions—those who rated a particular item significantly differently than did the class as a whole.

Approach 2: Have the class complete the exercise and hand in their ratings anonymously on a separate sheet of paper. Have them keep one copy of their ratings. After class, calculate the means for each item, put them into one of the three categories mentioned above, and list them on a transparency. Show the class their average responses by group. Ask them what differentiates one group from another and probe for the criteria they used to rate the items.

Ask them to look again at their personal ratings of the items and identify where they differ from the overall average class rating. Encourage individual students to challenge the average class ratings. Some interesting discussion is bound to result. You may want to provide the class with the average responses found in the Jones and Bryan study cited below.

This exercise was developed from a questionnaire constructed by William Jones, Jr. and Norman Bryan, Jr. of Georgia State University for their article “Business Ethics and Business Intelligence: An Empirical Study of Information-Gathering Alternatives,” in the June 1995 issue of the International Journal of Management (pages 204–208). A total of 108 undergraduates in a strategic management class completed the questionnaire during the early part of the term, prior to a discussion of ethics. The resulting mean responses were as follows: The business firm should try to get useful information about competitors by: 4.55

Careful study of trade journals.

1.13

Wiretapping the telephones of competitors.

2.59

Posing as a potential customer to competitors.

1.57

Getting loyal customers to put out a phony “request for proposal” soliciting competitors’ bids.

4.21

Buying competitors’ products and taking them apart.

3.54

Hiring management consultants who have worked for competitors.

1.44

Rewarding competitors’ employees for useful “tips.”

4.00

Questioning competitors’ customers and/or suppliers.

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1.97

Buying and analyzing competitors’ garbage.

1.37

Advertising and interviewing for nonexistent jobs.

4.09

Taking public tours of competitors’ facilities.

1.58

Releasing false information about the company in order to confuse competitors.

3.70

Questioning competitors’ technical people at trade shows and conferences.

3.29

Hiring key people away from competitors.

3.59

Analyzing competitors’ labor union contracts.

1.46

Having employees date persons who work for competitors.

2.61

Studying aerial photographs of competitors’ facilities.

Jones and Bryan indicated that appropriate actions received mean responses between 3.51 and 5.00. Those items with a mean between 2.5 and 3.5 reflected student uncertainty about whether the action was appropriate or not.

Items with a mean response of less than 2.5 were judged inappropriate.

Jones and Bryan were surprised to find no statistically significant differences between males and females or on the basis of age. They suggested that the strong emphasis in the business curriculum on strategic management might have tended to suppress any gender and age differences.

ADDITIONAL TEACHING MODULE (Use when discussing forecasting) THE ROLLING J-CURVE When current environmental trends (such as the price of oil) look bad or when a new product introduction is not doing as well as expected, managers and analysts are tempted to use the infamous rolling J-curve style of forecasting, in which present trends are discounted in the hope that everything will soon improve as hoped. Wellknown among strategic planners, the rolling J-curve forecast is feared with good reason by most executives. For example, if a new program is not resulting in increased sales as anticipated, the person in charge of the program simply alters the forecast by announcing that the decrease is only temporary and that the expected increase will occur sometime soon. Sales can thus be diagramed on a chart with the actual sales figures curving downward over time and the estimated future sales figures forming the upward curve of the J (while everyone continues to hope for a “light at the end of the tunnel”). Companies can go bankrupt using these kinds of forecasts in which hope substitutes for analysis.

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CHAPTER FIVE ORGANIZATIONAL ANALYSIS AND COMPETITIVE ADVANTAGE This chapter completes the section on environmental scanning by examining the internal environment of a corporation. Often called organizational analysis (to contrast it with industry analysis), internal scanning is a key part of the resource-based view of the firm—the view that a company’s sustained competitive advantage is primarily determined by its resource endowments. The chapter contrasts the industry value chain from the corporate value chain. Following the popular functional approach, the chapter breaks the internal environment down into the corporation’s structure, culture, and resources. The chapter proposes that to the extent that a corporation’s present structure and culture are compatible with present or potential strategies, they can be considered strengths or weaknesses. Corporate resources are discussed in terms of marketing, finance, research and development, operations, human resources, and information systems. The point is made that a corporation’s resources include not only measurable assets, such as buildings and people, but also the skills and competencies of the people within the functional areas. The chapter ends with a suggested way to summarize internal factors through the use of an IFAS Table.

LEARNING OBJECTIVES 1.

2.

3.

4.

5.

6.

Apply the resource-based view of the firm and the VRIO framework to determine core and distinctive competencies.

Explain company business models and how they can be imitated.

Use value chain to assess the activities of an industry and of an organization.

Explain why different organizational structures are utilized in business.

Assess a company’s corporate culture and how it might affect a proposed strategy.

Construct an IFAS Table that summarizes internal factors.

TOPICS OUTLINE COVERED 1. A Resource-Based Approach to Organizational Analysis—VRIO a. Core and Distinctive Competencies b. Using Resources to Gain Competitive Advantage 2. Business Models 3. Value-Chain Analysis a. Industry Value-Chain Analysis b. Corporate Value-Chain Analysis c. Scanning Functional Resources and Capabilities 4. Basic Organizational Structures a. Corporate Culture: The Company Way b. Strategic Marketing Issues c. Strategic Financial Issues d. Strategic Research and Development (R&D) Issues e. Strategic Operations Issues f. Strategic Human Resource Management (HRM) Issues g. Strategic Information Systems/Technology Issues 5. The Strategic Audit: A Checklist for Organizational Analysis a. Synthesis of Internal Factors (IFAS) SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS

5-1.

How does the resource-based view of the firm provide a superior means of evaluating a company’s competitive advantage?

A resource-based approach to organizational analysis highlights the resources of the firm with which it can confront

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the environment for success. This kind of analysis not only identifies resources, but also examines how well the organization is developing and taking advantage of the resources they display. Grant proposed a five-stage approach to resource-based analysis: (1) identify the firm’s resources as strengths or weaknesses; (2) combine the firm’s strengths into competencies; (3) appraise the profit potential of said competencies; (4) select a strategy that best exploits the resources; and (5) identify resource gaps and weaknesses.

5-2.

Explain how using an IFAS Table impacts the understanding of a company’s internal resources and capabilities.

An IFAS (Internal Factor Analysis Summary) is one way to organize the internal factors into strengths and weaknesses as well as to analyze how well a particular company’s management is responding to these specific factors in light of the perceived importance of these factors to the organization.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 5-3.

What is the relevance of the resource-based view of the firm to strategic management in a global environment?

The resource-based view of the firm is an attempt to bring attention to the importance of a corporation’s resources in strategic management. For much of the 1980s, Porter’s concepts of industry analysis and competitive strategy dominated the field of strategic management to such an extent that many felt that industry structure alone seemed to determine a firm’s profit potential. Unfortunately, this emphasis on the industry tended to ignore a firm’s core skills and competencies. What good is the knowledge that a niche in the market exists that can be reached through a focused differentiation competitive strategy if a corporation doesn’t have the resources to implement such a strategy? Experts on the resource-based view suggest that differences in performance among companies may be explained best not through differences in industry structure identified by industry analysis, but through differences in corporate assets and resources and their application. The resource-based view of the firm is compatible with the traditional concepts of SWOT and distinctive competence, popular in the field since the 1960s. The only danger with the resource-based approach is that analysts may put too much emphasis on internal factors and not enough on external factors. Nevertheless, the idea that the durability and imitability of corporate resources determine competitive advance is a very useful one.

5-4.

How can value-chain analysis help identify a company’s strengths and weaknesses?

Value-chain analysis, as proposed by Porter, is a way of examining the nature and extent of the synergies that do or do not exist between the internal activities of a corporation. The systematic examination of individual value activities can lead to a better understanding of a corporation’s strengths and weaknesses. Its advantage over other methods of analyzing a firm’s internal environment is its ability to visualize a company in terms of strings of product value chains, which can be tied together in places to achieve economies of scope.

5-5.

In what ways can a corporation’s structure and culture be internal strengths or weaknesses?

If a corporation’s structure is compatible with present and potential strategies, it can be viewed as an internal corporate strength. If, however, the structure is not compatible with either present or potential strategies, it is a definite weakness and will act to constrain strategy formulation. For example, if a corporation is structured on the basis of function, this may be a weakness if the firm wishes to grow by acquiring other profitable corporations. In order to implement such a strategy, the strategy formulators may have to reorganize on a divisional basis. To the extent that top and middle managers have no experience with such a structure, a lot of unforeseen problems can emerge that may seriously affect the success of the strategy.

Corporate culture—a collection of beliefs, expectations, and values shared by a corporation’s members—acts to shape the behavior of people in a corporation. Because corporate culture has a powerful influence on the behavior of managers as well as other employees, it may strongly affect a corporation’s ability to shift its strategic direction.

Acting in a manner similar to structure, to the extent that a corporation’s culture is compatible with present and

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potential strategies, it can be viewed as an internal corporate strength. To the extent that it is not compatible, it may spell disaster for a strategic change in the implementation stage. A strategy that contradicts an entrenched culture may find itself being quietly (or not so quietly) sabotaged by the corporation’s most loyal and competent employees.

5-6.

What are the pros and cons of management’s using the experience curve to determine strategy?

Bruce Henderson of the Boston Consulting Group popularized the experience (or learning) curve concept in strategic management. Based on the assumption underlying the BCG growth-share portfolio matrix (discussed with corporate strategy in Chapter 7), Henderson argues that the key to profits lies in market share. Results from PIMS research support this notion. If a corporation is able to sell a very large number of new products by offering them at a very low price (actually below per unit cost unless vast quantities are sold), it will gain a dominant market share and preempt competition by keeping the price too low for potential competitors to earn profits. This forms a formidable entry barrier. The corporation successfully using the experience curve will earn large profits either as a star or when it eventually becomes a cash cow. Certainly, a glance at history supports Henderson’s argument.

Model-T Fords and Bic ballpoint pens are just two examples. The experience curve is thus a basis for using financial and operating leverage to achieve a low cost business-level strategy (as discussed in Chapter 6).

The experience curve concept does have its limitations, however. For one thing, it does not consider that a corporation can be very profitable with very low leverage by occupying a dependable niche in the marketplace based on some differentiating strategy such as quality or snob appeal. Rolls Royce automobiles and Apple’s iPods are just two examples of firms ignoring the experience curve by pricing at a cost above the market price and still achieving solid profits. As pointed out in Chapter 6, differentiation and focus strategies can be very successful without using the experience curve. Another limitation of the experience curve is that much of its success is based on economies of scale. The use of computers and robots, however, negates much of the experience curve advantages. The curve in a CAD/CAM plant might be so steep that all the experience advantages are learned in the production of two thousand instead of two million units. The implication is that a firm following Henderson’s strategy of cost leadership based on an assumed experience curve might find it very difficult to reach the required high market share break-even point when its competitors using CAD/CAM can quickly meet its price in the marketplace by going quickly down their own experience curves. Although it is possible to have a number of successful niches in a given product/service market, only one star position is available in the growth-share matrix. The risk is therefore very high to a corporation contemplating a low-cost strategy by using an assumed experience curve.

5-7.

How might a firm’s management decide whether it should continue to invest in current known technology or in new, but untested, technology? What factors might encourage or discourage such a shift?

Igor Ansoff recommends that strategic managers deal with the issue of technology substitution by: (1) continuously searching for sources from which new technologies are likely; (2) as the technology surfaces, making a timely commitment either to acquire the new technology or to prepare to leave the market; and (3) reallocating resources from improvements in the older process-oriented technology to investments in the newer, typically product-oriented technology as the new technology approaches commercial realization. Even though Ansoff’s recommendation is not presented in the chapter, his common sense approach may be proposed by students in class discussion (with a little help from the instructor). As mentioned in the chapter, Christensen proposes in his book, The Innovator’s Dilemma, that such a shift as proposed by Ansoff is typically discouraged by a company’s emphasis on satisfying its current customers and on its concern with return on investment. The higher risks involved with disruptive compared with incremental innovation tends to discourage expensive experimentation with new, but untested, technology.

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A5-1. What kind of internal factors help managers determine whether a firm should emphasize the production and sales of a large number of low-priced products or a small number of high-priced products?

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The number of factors that can be discussed in answering this question is enormous. A few of the most important factors can be brought out by going through each functional area. For example, under marketing, a strong market research group may be able to identify the kinds of niches available to the products or services under consideration.

In terms of finance, the production of a large number of low-priced products suggests a large capital-intensive manufacturing facility. It may be possible, however, to produce a few high-quality goods with a small amount of capital because the needed manufacturing facilities may be small, utilizing craft labor. R&D may be an important consideration also. In order to produce high-quality products, a fairly sophisticated applied R&D effort may be needed. An expensive engineering staff may be needed, in contrast, to design the assembly line needed to keep costs as low as possible for a low-priced product. The type of manufacturing system in place will, of course, be a dominant factor in choosing either approach. If the facilities are primarily job shops, for example, a plan to produce a large number of low-priced products would not be feasible in the short run. Costs would be extremely high because of the need for overtime and the lack of automated equipment. In terms of human resource management, a fairly unskilled and low-paid workforce cannot normally be expected to produce a high-quality product on old assembly line machinery. Either the workforce would need to be replaced or an extensive job training and job enrichment program would need to be established. Either approach costs both time and money.

A5-2. Why should information systems be included in the analysis of a corporation’s strengths and weaknesses?

Although not always considered a major part of the traditional, functionally organized business corporation, information systems have become very important to those corporations operating in a dynamic and complex environment. From a strategic management point of view, information systems are important because they can (1) provide a basis for analyzing early warning signals that originate both externally and internally and (2) provide the information necessary to make strategic decisions. To the extent that a corporation has a completely integrated information system, it is a strength that can provide a significant competitive advantage. Environmental scanning is more systematic with information dealing with strategic factors getting to corporate- and business-level planners and decision makers in a timely manner. A computerized information system can be used to develop a series of likely industry scenarios as well as a number of alternative strategies and implementation programs. Efficiencies coming from a well-integrated information system can also be shared with customers and suppliers, thus serving as a competitive weapon in a dynamic marketplace.

SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE Can you analyze a corporation by using the Internet?

This is a good exercise to develop Internet research skills. The students are placed into teams and asked to conduct research on a company of their choice using the Internet only. By examining corporate websites (among other sources) for 10-K reports, proxy statements, and so on, the teams should be able to get a fairly good understanding of a firm’s strengths and weaknesses.

An alternative approach to this assignment is for the instructor to assign a series of well-known companies to student teams for them to research. The instructor could, for example, select an industry for each team to analyze. (Each team would, of course, be assigned a separate industry.) Each team would then carry out the assignment as given in the textbook, but only on a firm they can find within that industry. This is a good way to combine industry analysis with organizational analysis.

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CHAPTER SIX STRATEGY FORMULATION: BUSINESS STRATEGY This chapter is the first of three chapters dealing with the formulation of strategy. Following the strategic decisionmaking process introduced in Chapter 1 and depicted in Figure 1.5, these chapters emphasize steps 5(a), situation analysis of strategic factors; 5(b), the review and revision of a firm’s current mission and objectives; 6(a), the generation and evaluation of strategic alternatives; and 6(b), the selection and recommendation of the best alternative. Situation analysis is conducted using SWOT in the form of generating a Strategic Factors Analysis Summary (SFAS) matrix to summarize a corporation’s strategic factors and to help identify propitious niches. Once a corporation’s strengths, weaknesses, opportunities, and threats are identified, strategic managers should review and revise, if necessary, the mission and objectives before proceeding to developing feasible alternative strategies. The chapter then presents the TOWS matrix as one way of generating alternative corporate and business unit strategies by using strengths to capitalize on opportunities and/or working around weaknesses to avoid threats. Business strategies are explained in terms of competitive and cooperative strategies. Competitive tactics are also discussed.

LEARNING OBJECTIVES 1.

2.

3.

4.

Utilize the SFAS matrix and a SWOT diagram to examine business strategy.

Develop a mission statement that addresses the five elements of good design.

Explain the competitive and cooperative strategies available to corporations.

Identify the basic types of strategic alliances.

TOPICS OUTLINE COVERED 1. A Framework for Examining Business Strategy a. Generating a Strategic Factors Analysis Summary (SFAS) Matrix b. Finding Market Niches 2. Mission and Objectives 3. Business Strategies a. Porter’s Competitive Strategies b. Cooperative Strategies 4. Strategic Alliances SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS

6-1.

How does a hypercompetitive environment change the strategic approach for a company?

Hypercompetitive environments require companies to continue improving their competitive advantage through continuous improvement practices. D’Aveni contends that when industries become hypercompetitive, they tend to go through escalating stages of competition. Initially, firms compete on costs, then move out into untapped markets, and finally, raise barriers of entry so that no other players can join in the competition.

6-2.

Explain how our understanding of the three generic strategic approaches available to companies can be used to direct the efforts of all employees at those companies.

The three generic strategies include cost leadership, differentiation, and focused. Cost leadership is the ability of a company or business to design, produce, and market a comparable product more efficiently than its competitors.

Differentiation is the ability of a company to provide unique and superior value to the buyer in terms of product quality, special features, or after-sale service. Focus is the ability of a company to provide unique and superior value to a particular buyer group. As strategies are defined, employees are able to shape their efforts toward operating efficiently, developing innovative products and systems, or understanding a niche market.

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SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 6-3.

What industry forces might cause a propitious niche to appear or disappear?

Newman’s argument for a propitious niche includes the implication that a corporation with such a niche will be successful so long as it fills that niche. This niche is the specific competitive role held by a corporation, division, or product/service. A propitious niche is one that is so well suited to the firm’s internal and external environment that competitors are not likely to challenge or dislodge it. In terms of automobiles, both Rolls Royce and Ferrari fill two very different niches in the industry.

The key to answering this question is in understanding that a propitious niche exists not only because of environmental opportunities, but also because a company has the resources to take advantage of these opportunities.

Therefore, a niche can disappear because of changes within a company as well as because of environmental changes.

Some of the possible changes are: a.

b.

The environment/industry changes. The company/SBU continues to make its products or services, but the size of the market changes.

1)

Contracts. The market gets smaller because of factors beyond the control of the company/SBU. For example, the increasing price of gasoline in 2008 followed by a recession contracted the market for gas-guzzling, performance-oriented automobiles. The niche could then support only the strongest companies/SBUs.

2)

Expands. The company/SBU, through its own efforts, not only fills a demand in the market but also causes the market to expand. Unless the company/SBU can manufacture sufficient products to meet growing demand or is able to defend a patented process (as Proctor & Gamble did with CrestFluoride toothpaste for years), profit opportunities will cause competitors with sufficient internal resources to join the niche. Such competitors may be stronger and drive the original company/SBU out of the market, thus causing it to lose its niche.

The company/SBU changes. The same market demand continues for specific products or services, but the company/SBU itself changes so that there is no longer synchronization between itself and the market.

1)

Contracts. Due to demands for resources elsewhere in the corporation, the company/SBU may be forced to cut back its activities. It is unable to satisfy market demand. Customers either leave the market by buying a substitute product or stay in the market by buying a competitor’s product. Such unfulfilled demand encourages competitors, which may drive the original company/SBU out of the niche.

2)

Expands. Its own success in the niche may cause the company/SBU to move into nearby niches.

The need for resources in the battle for new niches may cause the company/SBU to take its original niche for granted. Small competitors may take advantage of the lack of concern by fighting to expand their piece of the market, thereby squeezing the company/SBU out of the original market and thus out of its niche.

If a company/SBU loses its niche, it is likely to become much less profitable unless it can find a new niche. The specifics of what might happen depend on how the company/SBU originally lost its niche. The possibilities for class discussion can be almost endless.

6-4.

What does a business have to consider when trying to follow a cost leadership strategy and a differentiation strategy simultaneously? Can you name a company doing this?

Michael Porter argues that a business unit that is unable to achieve one of the competitive strategies is likely to be

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“stuck in the middle” of the competitive marketplace with no competitive advantage. That unit, according to Porter, is doomed to below-average performance (see Porter’s Competitive Advantage, page 16). Research by Greg Dess and Peter Davis, as well as by Rod White, suggests, however, that this may not be the case. Examples can be found of businesses that have been able to jointly follow an overall low-cost and high-quality differentiation strategy.

Japanese companies such as Toyota in automobiles and Matsushita (Panasonic and National) in consumer electronics are good examples. Their offer of low price and high quality created serious problems for those companies following only cost leadership in the United States.

6-5.

How can a company achieve a sustainable competitive advantage when its industry becomes hypercompetitive?

According to D’Aveni, companies in a hypercompetitive industry learn to quickly imitate the successful strategies of market leaders, making it increasingly difficult to sustain any competitive advantage. As explained in Chapter 4, competitive advantage in a hypercompetitive industry comes from up-to-date knowledge of environmental trends and competitive activity coupled with a willingness to risk a current advantage for a possible new advantage.

Companies must thus be willing to cannibalize their own successful products in order to sustain their competitive advantage. Because hypercompetitive industries go through escalating stages of competition, the only real sustainable competitive advantage lies not in a corporation’s product line, but in its ability to learn and adapt to constantly changing conditions.

6-6.

Why are many strategic alliances temporary?

The temporary nature of most strategic alliances comes from their rationale for being established. Alliances are usually formed in order to remedy a weakness or to generate a new strength. It is thus an admission that a firm cannot achieve an objective on its own. As mentioned in the chapter, alliances may be formed in order to obtain access to a new technology or manufacturing facilities, enter a new market, reduce financial or political risk, and/or achieve competitive advantage. It is thus likely that many firms enter alliances with the primary goal of learning from the alliance how to overcome an identified weakness or how to build a competitive advantage. Once a firm learns what it needs, it has less reason to continue with the alliance. Why share with a partner the profits that a company can now earn by itself? This is likely to be especially true to the extent that the environment is highly uncertain. Strategic alliances became especially popular during the 1990s when too much vertical integration kept a firm from adapting successfully to changing conditions.

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A6-1. How can a company overcome the limitations of being in a fragmented industry?

As pointed out in the text, a fragmented industry is an industry with many small- and medium-sized companies competing for relatively small market shares. No one firm or group of firms is able to dominate the industry in any way. Businesses tend to be local and oriented to market segments. This may occur because the industry is relatively new and based on a product in the early stage of its product life cycle. Entry barriers are probably low and new entrants are constantly moving into the industry as others leave or go bankrupt. If there are few economies to be gained from size or no one design ever reaches the point of consumer acceptance, the industry may remain in this stage indefinitely. Often, however, the trick to becoming a successful firm in this kind of industry is to find the key to standardization that allows economies.

Domino’s Pizza achieved success in fast food by providing standardized pizza throughout North America and by guaranteeing delivery time faster than competition. Before Pizza Hut and Domino’s settled upon standardized pizza appealing to a wide variety of tastes across North American, the pizza business was a fragmented industry characterized by many small pizza “parlors” serving small market segments in cities throughout North America— thus the development of “Chicago-style” and “New York–style” pizzas, which are now available throughout North America.

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SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE Select an industry to analyze. Identify companies for each of Porter’s four competitive strategies. How many different kinds of differentiation strategies can students find?

This strategic practice exercise challenges students to list companies that illustrate cost leadership, differentiation, cost focus, and differentiation focus competitive strategies. The class will normally be able to identify companies following the broad scope cost leadership strategy based on their well-advertised low prices. Walmart and Southwest Airlines are well-known examples. Students should also be able to think of companies following the broad scope differentiation strategy. Examples are Procter & Gamble, Nordstrom’s, BMW, and Apple. They will typically have greater difficulty identifying companies following either of the focus strategies. Many of these companies are local or regional and are not as well known as the national and international firms using a broad scope strategy. After some effort, students should be able to list a few well-known firms using differentiation focus.

These may be firms such as Ferrari, which make and sell cars to the very rich, or Midamar Corporation, which offers halal foods processed according to Islamic law, or Nickelodeon, which provides cable television programs for children. Identifying firms following a cost focus competitive strategy is much more difficult. Manufactures of store brand products, such as Potlach Corporation or Dean Foods, are less well known than Procter & Gamble or Colgate Palmolive, but are just as important to U.S. grocery store sales. Local manufacturers or retail stores that emphasize a narrow product line to keep costs down may be good examples.

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CHAPTER SEVEN STRATEGY FORMULATION: CORPORATE STRATEGY This chapter focuses on formulating strategy at the corporate level. Corporate strategy deals with the three key issues facing the corporation as a whole: (1) the firm’s overall orientation toward growth (directional strategy); (2) the industries or markets in which the firm competes through its products and business units (portfolio strategy); and (3) the manner in which management coordinates activities, transfers resources, and cultivates capabilities among product lines and business units (parenting strategy). Directional strategy is composed of growth, stability, and retrenchment. Vertical and horizontal integration as well as concentric and conglomerate diversification are discussed as examples of corporate growth strategies. International entry strategies are also listed as growth strategies. Portfolio analysis is explained as a technique for managing various product lines and business units for their maximum cash flow. Corporate parenting is a resource-based approach, which attempts to use capabilities found in various parts of the corporation to generate synergies across these units.

LEARNING OBJECTIVES 1.

2.

3.

4.

Understand the three key issues that corporate strategy addresses.

Apply the directional strategies of growth, stability, and retrenchment to the organizational environment in which they work best.

Apply portfolio analysis to guide decisions in companies with multiple products and businesses.

Develop a parenting strategy for a multiple-business corporation.

TOPICS OUTLINE COVERED 1. Corporate Strategy 2. Directional Strategy a. Growth Strategies b. Controversies in Directional Growth Strategies c. Stability Strategies d. Retrenchment Strategies 3. Portfolio Analysis a. BCG Growth-Share Matrix b. Advantages and Limitations of Portfolio Analysis c. Managing a Strategic Alliance Portfolio 4. Corporate Parenting a. Developing a Corporate Parenting Strategy b. Horizontal Strategy and Multipoint Competition SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS

7-1.

List the means available to a company for horizontal growth and explain why a company might pursue one over another.

A firm can achieve horizontal growth by expanding its operations into other geographic locations and/or by increasing the range of products and services offered to current markets. Horizontal growth can be achieved by internal development or externally through acquisitions and strategic alliances. Depending on the company’s comfort with risk as well as the resources they have available, a company may select any of these strategies for horizontal growth.

7-2.

Evaluate the types of retrenchment strategies that might be used by companies in stagnant industries.

Retrenchment refers to reducing the company’s level of activities. A turnaround strategy emphasizes the improvement of operational efficiency and is probably the most appropriate when a company’s problems are

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pervasive but not yet critical. A captive company strategy involves giving up independence in exchange for security.

A company with a weak competitive position may not be able to engage in this strategy. The sell-out strategy makes sense if management can still obtain a good price for its shareholders and the employees can keep their jobs by selling the entire company to another firm. Bankruptcy involves giving up the firm to the courts in return for some settlement of the corporation’s obligations. Finally, liquidation is the termination of the firm all together.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 7-3.

How does horizontal growth differ from vertical growth as a corporate strategy? From concentric diversification?

Students often confuse these three strategies. Horizontal growth is the expanding of a firm’s activities into other geographic regions and/or by increasing the range of products and services offered to current markets. It often involves the acquisition of another firm in the same industry (an example of external growth), but it could also be through the expansion of a firm’s products in its current markets (e.g., through line extensions) or expansion into another geographic region (an example of internal growth). One example of external horizontal integration was the acquisition of Miller Brewing by South African Breweries. An internal example is Lowe’s expansion into the northern and western United States. Vertical growth, in contrast, involves a firm’s taking over a function previously performed by a supplier or a distributor. This would typically involve the addition of activities in other industries either forward (downstream) or backward (upstream) on the industry value chain of current products or services.

The additions are primarily justified in terms of support of the current product lines regardless of their being in other industries (and thus can be argued to be diversification). Concentric diversification, in contrast, is the addition of products or divisions that are related to the corporation’s main business, but are added because of the attractiveness of other industries rather than because they support the activities of the current product lines. The additions may be through acquisition or through internal development. The firm buys or develops another division that is similar to its present product line. PepsiCo’s diversification into snack foods to complement its line of soft drinks is an example of concentric diversification—the products are not alike, but have a “common thread” relating them. If Coca Cola bought PepsiCo, it would be an example of horizontal integration. If it purchased its distributors, this would be an example of forward vertical integration. Its acquisition of Taylor Wines, however, is an example of concentric diversification.

7-4.

What are the tradeoffs between an internal and an external growth strategy? Which approach is best as an international entry strategy?

As pointed out in the text, research generally concludes that firms growing through acquisitions do not perform financially as well as firms that grow through internal means. There are, however, some tradeoffs for each approach.

Here are some of them: Internal Growth Pros ▪ ▪ ▪ ▪ Cons ▪ ▪ ▪ ▪

More likely to be based on some proprietary development giving competitive advantage.

More likely to fit well with current business units/products.

Can finance slowly out of returned earnings.

If plan is no good, can always cut losses before in too deep.

May take a long time to develop a new product or new concept.

May be hard to get current managers to try something new.

May ignore other uses of money with quicker return.

Favored program may take time away from current businesses

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External Growth Pros ▪ ▪ ▪ ▪ Cons ▪ ▪ ▪ ▪

Can grow quickly.

Good way to use financial leverage to boost EPS. Don’t have to build anything from scratch.

Can generate a lot of excitement on Wall Street and boost stock price.

All-or-nothing gamble.

Need a lot of money and/or financial moxie to do it right.

Can purchase someone else’s problems.

50% of all acquisitions fail to achieve the purchaser’s objective.

The same list of pros and cons fit an international entry strategy. Internal growth in the form of a green-field development has an additional con of sometimes going against a particular country’s laws. External growth in the form of acquisitions has an additional con of running up against a country’s laws against foreigners purchasing total control of a company important to national interests.

7-5.

Is stability really a strategy or just a term for no strategy?

An argument can be made that stability is not really a strategy in itself, but is just a pause between strategies.

Because one way to view strategy is as a direction the corporation is taking in order to reach its objectives, standing still has no direction and thus is not a strategy. The text takes the position, however, that stability is a strategy in itself. Just as no decision is the same as making a decision, it is argued that even though stability may be viewed as not choosing a strategy, it is therefore a strategy by default. Stability may be a very appropriate long-term strategy for a small business in which the owner/manager does not want the corporation to grow beyond his/her abilities to manage it personally and is very happy with the level of lifestyle the business provides. Typically, however, stability is perceived only as a viable short-term strategy while strategic managers are waiting for key factors needed for growth to fall into place. Nevertheless, to the extent that stability helps explain the movement of a corporation toward its objectives, it deserves to be called a strategy.

7-6.

How is corporate parenting different from portfolio analysis? How is it alike? Is it a useful concept in a global industry?

The basic difference between these two approaches to corporate strategy lies in the questions they attempt to answer.

According to the text, portfolio analysis attempts to answer the following two questions: •

How much of our time and money should we spend on our best products and business units in order to ensure that they continue to be successful?

•

How much of our time and money should we spend developing new costly products, most of which will never be successful?

The basic theme of portfolio analysis is its emphasis on cash flow. Portfolio analysis puts corporate headquarters into the role of an internal banker. In portfolio analysis, top management views its product lines and business units as a series of investments from which it expects to get a profitable return. The product lines/business units form a portfolio of investments that top management must constantly juggle to ensure the best return on the corporation’s invested money.

Corporate parenting attempts to answer two similar, but different, questions: •

What businesses should this company own and why?

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•

What organizational structure, management processes, and philosophy will foster superior performance from the company’s business units?

Portfolio analysis attempts to answer these questions by examining the attractiveness of various industries and by managing business units for cash flow, that is, by using cash generated from mature units to build new product lines.

Unfortunately, portfolio analysis fails to deal with the question of which industries a corporation should enter or with how a corporation can attain synergy among its product lines and business units. As suggested by its name, portfolio analysis tends to primarily take a financial point of view and views business units and product lines as if they were separate and independent investments. Corporate parenting, in contrast, views the corporation in terms of resources and capabilities that can be used to build business unit value as well as generate synergies across business units. The central job of corporate headquarters is not to be a banker, but to coordinate diverse units to achieve synergy. This is especially important in a global industry in which a corporation must manage interrelated business units for global advantage. Corporate parenting is similar to portfolio analysis in that it attempts to manage a set of diverse product lines/business units to achieve better overall corporate performance. It is different in that it is an approach to organizational learning that aims to disseminate knowledge and competencies throughout the organization.

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A7-1. How does transaction cost economics apply to vertical growth? To concentric versus conglomerate diversification?

Transaction cost economics is especially applicable to the question of vertical growth versus outsourcing (i.e., the classic make-or-buy decision). It argues that vertical growth is more efficient than contracting for goods and services in the marketplace when the transaction costs of buying goods on the open market become too great. The transaction costs become too great when the transactions (a) involve a high level of uncertainty, (b) involve highly specialized assets, and (c) must occur frequently. However, when highly integrated firms become excessively large and bureaucratic, the costs of managing the internal transactions may become greater than simply purchasing the goods on the open market, thus justifying outsourcing over vertical growth.

The second part of the question is a “mind stretcher.” Because the text does not apply transaction cost economics to either concentric or conglomerate diversification, this question really forces the student to do some original thinking.

Transaction cost economics might suggest that diversification of any kind is more efficient than just concentrating in one industry when the costs of one firm’s operating in two industries are lower than the summed costs of two separate firms. This phenomenon can occur when synergies exist to provide economies of scale or scope. Given that such synergies are more likely to exist when a firm engages in concentric diversification, transaction cost economics would propose that concentric diversification should be generally more efficient than conglomerate diversification.

(Try this question out on your grad students to see what they can do with it!)

A7-2. Must a corporation have a common thread running through its many activities in order to be successful? Why or why not?

The concept of a corporate mission implies that throughout a corporation’s many activities, there should be a “common thread” or unifying theme, and that those corporations with such a common thread are better able to direct and administer their many activities. This is one way to achieve a “strategic fit” so that overall corporate effectiveness and efficiency are achieved. There are, however, a number of corporations that do not have a common thread connecting their divisions, yet are successful. These corporations are often referred to as conglomerates because they are an assemblage of separate firms having different products in different markets but operating together under one corporate umbrella. Operating in effect as holding companies, they typically have no real common thread other than return on investment (i.e., financial synergy). General Electric and Berkshire Hathaway are just two of the many examples of successful conglomerates. They can be very successful because their operations in many diverse businesses allow them to spread their risks over many different markets. Just as the

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common thread concept implies a heavy marketing orientation, the conglomerate approach implies a heavy finance orientation. The lack of concern for a common thread enables a conglomerate to acquire and sell off divisions without regard to any synergy other than financial. Corporate strategy makers are thus able to focus entirely on ROI. They need only to involve themselves in divisional (business) strategies to the extent that funds are requested to support the strategies. The problem with this approach, however, is that corporate top management may not understand divisional problems in any sense other than financial and is thus strongly tempted to sell off troubled divisions rather than help them recover. Although General Electric is a conglomerate, its outstanding pool of executive talent enables it to transfer core competencies from one division to another. It is an excellent example of using parenting strategy to boost the performance of seemingly unrelated SBUs. One could therefore conclude that a common thread is not necessary for corporate success, especially if one has a distinctive competency in managing diverse businesses.

A7-3. What is the value of portfolio analysis? Its dangers?

Portfolio analysis is a popular approach to aid the integration and evaluation of environmental data. It is just as useful for a single business corporation with a number of separate products as it is for a large corporation with autonomous operating divisions. By carefully examining both market or industry factors and business strengths or market share, it is possible to pinpoint factors of strategic importance to corporate or divisional success. Portfolio analysis thus serves as a convenient technique for comparing external opportunities and threats with internal strengths and weaknesses. The advantages and limitations of portfolio analysis are listed in the chapter.

A7-4. What concepts or assumptions underlie the BCG growth-share matrix? Are these concepts valid?

Why or why not?

The product life cycle and the experience curve underlie the BCG growth-share matrix. The development of question marks into stars and then into cash cows suggests the introduction, growth, and maturity stages of the product life cycle. Dogs appear to be those products or units on the decline stage of the product life cycle. The experience curve discussed in Chapter 5 is certainly key to understanding the implications of the BCG matrix. The experience curve is based on the idea that unit production costs decline by some fixed percentage as the accumulated volume of production in units doubles. In order to make a question mark product a star, the suggested manufacturing strategy is to build capacity ahead of demand in order to achieve the lower unit costs that develop from the experience curve. On the basis of some future point on the experience curve, the idea is to price the product very low to preempt competition and quickly increase market demand and thus market share. The resulting high number of units sold and high market share should result in high profits when overall market growth slows and the company reduces its investment in the product—thus a cash cow is born.

Both of these concepts are well known and useful ways to conceptualize the useful lives of specific products and of the relation of unit costs to volume. Unfortunately, they lose some of their value when they are taken too much at face value and generalized too far. Different products have different product life cycles. What applies to one product will probably not apply to another. Examples can be shown of companies that have supported their products to extend their lives by “putting a tail” on the maturity part of the product life cycle. The experience curve of the industry as a whole or of one company might not hold true for a particular company. The experience curve does not “just happen”—a firm has to invest a lot of time and money into getting that experience. The trend toward computerized robot technology and flexible manufacturing means that learning times (and thus experience time) are becoming shorter and products can now be economically manufactured in small, customized batches instead of in large assembly line production. This potential quick movement down the experience curve, coupled with the ability to target an increasing number of market niches, may mean that the strategy of building large mass-production facilities ahead of demand may be doomed to failure. Future market share may be composed of a series of market segments, each with their own specialized (and thus low volume) product. In this instance, the prescriptions of the BCG matrix will not be useful and may in fact hurt a company if applied as given.

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SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE What is the future of electronic publishing?

After a brief summary of the publication of the first Internet book, Stephen King’s Riding the Bullet, this exercise asks students to form into small discussion groups to discuss the future of Internet publishing. The exercise proposes some questions as discussion guides, such as what are the pros and cons of Internet publishing.

The issue of Internet publishing is an important one for the publishing industry. It has the potential to affect newspapers, periodicals, and books. It is already changing the music industry. For a publisher, its corporate strategy must include the Internet. One could use parenting strategy to assess the fit of a new Internet business unit with a publisher’s more traditional print-oriented units. It appears that the fit between parenting opportunities and parenting characteristics may be high. There are many Internet opportunities to disseminate knowledge, and the parent has access to the copyrighted knowledge that is desired by the marketplace. Unfortunately, there appears to be a high likelihood of a mismatch between the strategic factors and the parenting characteristics. Computerization is a strategic factor for Internet businesses, but has been traditionally unimportant for the traditional publisher. For one thing, most of the publishing houses’ backlists are not computerized. Even for their current lists of books, every publisher uses its own combination of packaged and in-house software. As a result, there are probably 2,000 different formats in use for storing books electronically. This is compounded by the fact that most publishers outsource printing to specialized printers who use their own software with specialized formatting.

Moving to Internet publishing could be viewed as part of a horizontal growth strategy. As defined in the chapter, horizontal growth can be achieved by expanding a firm’s products into other geographic locations and/or by increasing the range of products and services offered to current markets. It could easily be argued that the Internet is just another distribution channel for a company’s current products. The problem with this view is that some items may do well on the Internet, whereas others may not. The issue is which items should be made Internet-accessible?

Currently, most people do not like reading on their computer screens. Products are being invented that may overcome that resistance. Nevertheless, paper books have many advantages over electronic books. This becomes very clear when students are asked to decide if their textbooks should be electronic or in paper form. They should first understand that there is, thus far, no real financial savings for buying an electronic over a paper book. Consider that the typical cost of an electronic textbook is about the same as that of a used textbook. Even if the cost of the e-book is slightly less than that of a used paper book, the paper book has some resale value, whereas the e-book has none. The mystery writer Patricia Cornwell proposed that e-books will not replace paper books. She states, “I see it as an enhancement to the library—a more portable way to have your library with you… Imagine if you could carry all your textbooks to class in a little handheld computer.” (“Patricia Cornwell on E-Books,” PC Magazine, August, 2001, p. 30.)

Jason Ohler, in his article, “Taming the Technological Beast,” (in the January–February 2001 issue of The Futurist) proposes a useful exercise to evaluate a new technology. He asks students to assume that they are employed by a fictitious Science and Technology Administration and that their job is to analyze the effects of a technology before it is released to the public. He applies his analytical approach to the e-book. Ohler points out, “The e-book is a splendidly mysterious and engaging technology because of its wild-card status. It continues some traditions, modifies others, creates entirely new ones, and in general promises to wreak a slow havoc on life as we know it.” He sums up the advantages and disadvantages in a chart on page 19 of the January–February 2001 issue of The Futurist.

Among the e-book advantages are: environmentally friendly, easier to carry, personalizes the reading experience, easier to swap, harder to censor, and more adaptable to different reading styles. Its disadvantages include the need for an expensive technological infrastructure, increased eyestrain, increased expenses, sacrificed depth for breadth of experience, more difficulty in enforcing copyrights and compensating authors, and displaced workers in traditional publishing.

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CHAPTER EIGHT STRATEGY FORMULATION: FUNCTIONAL STRATEGY AND STRATEGIC CHOICE This chapter is the last of three dealing with the formulation of strategy. It reconnects with the resource-based view of the firm presented in Chapter 5 by discussing the importance of core and distinctive competencies to competitive advantage and corporate growth. The chapter discusses functional strategies in the areas of marketing, finance, R&D, operations, purchasing, logistics, human resources, and information systems. The chapter also provides criteria for deciding if specific functional activities should be provided internally or outsourced. It discusses strategy selection in terms of corporate scenarios, attitudes toward risk, external and internal pressures, as well as the needs and desires of key managers. After presenting ways to improve strategic choice, the chapter ends with the development of policies to fit the strategy.

LEARNING OBJECTIVES 1.

2.

3.

4.

Discuss the impact that the various types of functional strategies have on the achievement of organizational goals and objectives.

Explain which activities and functions are appropriate to outsource/offshore in order to gain or strengthen competitive advantage.

List and explain the strategies to avoid.

Construct corporate scenarios to evaluate strategic options.

TOPICS OUTLINE COVERED 1. Functional Strategy a. Marketing Strategy b. Financial Strategy c. Research and Development (R&D) Strategy d. Operations Strategy e. Purchasing Strategy f. Logistics Strategy g. Human Resource Management (HRM) Strategy h. Information Technology Strategy 2. The Sourcing Decision: Location of Functions 3. Strategies to Avoid 4. Strategic Choice: Constructing Scenarios a. Constructing Corporate Scenarios b. The Process of Strategic Choice 5. Using Policies to Guide Strategic Choices SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS

8-1.

How can an operations strategy be used to understand and exploit a particular product offering?

The operations strategy determines how and where a product or service is to be manufactured, the level of vertical integration in the production process, the deployment of physical resources, and relationships with suppliers. Each of these details can be exploited in terms of strategic implementation, allowing for competitive advantage.

8-2.

How are corporate scenarios used in the development of an effective strategy?

Corporate scenarios are pro forma balance sheets and income statements that forecast the effect each alternative strategy and its various programs will likely have on division and corporate return on investment. The results of a detailed scenario construction should be anticipated net profits, cash flow, and net working capital for each version.

1 .

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 8-3.

Are functional strategies interdependent, or can they be formulated independently of other functions?

Functional strategy is the approach a functional area takes to achieve corporate and business unit objectives and strategies by maximizing resource productivity. It is concerned with developing and nurturing a distinctive competence to provide a company or business unit with a competitive advantage. Each company or business unit has its own set of functional departments, each with its own functional strategy. Because the orientation of each functional strategy is dictated by its parent unit’s business strategy, functional strategies must interrelate if they are to be successful. For example, a company’s competitive strategy of differentiation through high quality means that each functional strategy must support high quality. Distribution (part of marketing strategy) will probably be through quality distributors and retailers that emphasize customer service and support. Operations will probably emphasize highly skilled employees and flexible manufacturing to adjust production to customer requests. Even though both of these functional strategies can be formulated independently, they will need to mesh with each other if the competitive strategy is to be properly supported. Although this has traditionally been a job of the general manager in charge of the parent SBU, it is increasingly being managed by cross-functional teams composed of managers from each of the functional areas.

8-4.

Do you believe that penetration pricing or skim pricing will be better at raising a company’s or a business unit’s operating profit in the long run?

When pricing a new product, a company or business unit can follow a marketing strategy of skim pricing or penetration pricing. For new product pioneers, skim pricing offers the opportunity to skim the cream from the top of the demand curve while the product is novel and competitors are few. Penetration pricing offers the pioneer the opportunity to utilize the experience curve to gain market share and dominate the industry. Skim pricing is purely a short-term phenomenon and is used to gain high profits quickly in order to pay for expensive R&D and marketing costs before new entrants engage in price competition. Therefore, it cannot be used to raise long-term operating profits unless the firm follows a differentiation strategy of continually entering markets early through exceptional R&D and exiting before the heavy-hitting late movers such as IBM or Procter & Gamble force margins down.

8-5.

How does mass customization support a business unit’s competitive strategy?

Mass customization is an operations functional strategy. According to the text, mass customization requires flexibility and quick responsiveness. Appropriate for an ever-changing environment, mass customization requires that people, processes, units, and technology reconfigure themselves to give customers exactly what they want, when they want it. The result is low cost, high quality, customized goods and services. Mass customization is one way to support a differentiation strategy in a hypercompetitive market in which customers are demanding a highly differentiated product at a reasonable price. The customer is primarily interested in purchasing a product designed to its own specifications and delivered where and when it needs them. Even though price may be secondary to specific product characteristics, it cannot be significantly higher than the price for a mass produced good.

8-6.

When should a corporation or business unit consider outsourcing a function or an activity?

Outsourcing is purchasing from someone else a product or service that had been previously provided internally. As such, it is an example of reverse vertical growth/integration. According to the text, the key to outsourcing is to purchase from outside only those activities that are not key to the company’s distinctive competencies. Otherwise, the company may give up the very capabilities that made it successful in the first place, thus putting itself on the road to eventual decline. An outsourcing decision will depend on the fraction of total value added that is represented by the activity under consideration, and by the amount of potential competitive advantage in that activity for the company or business unit.

According to the proposed outsourcing matrix in Figure 8.1, a firm should consider outsourcing an activity or function whenever it has low potential for competitive advantage. If that activity comprises only a small part of the total value of the firm’s products or services, it should be purchased on the open market (assuming that quality

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providers of the activity are plentiful). If, however, the activity contributes highly to the company’s products or services, the firm should purchase it through long-term contracts with trusted suppliers or distributors. A firm should always produce at least some of the activity or function (i.e., taper vertical integration) if that activity has the potential for providing the company some competitive advantage. Full vertical integration should only be considered, however, when that activity or function adds significant value to the company’s products or services in addition to providing competitive advantage.

8-7.

What is the relationship of policies to strategies?

Generally speaking, the text views policies as the link between strategy formulation and implementation. They are the broad guidelines to be used in the implementation of strategy. The text takes the position that the dividing line between formulation and implementation is the difference between the planning activities of formulation and the action-oriented activities of organizing, directing, and controlling. Because the development of policies primarily involves planning, not action, policies more properly belong within strategy formulation.

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A8-1. What are the pros and cons of technological leader versus technological follower as a functional strategy?

This question is related to the earlier question about first versus late movers. The technological leader strategy is a functional strategy necessary for a company to be a first mover in an industry. R&D can help a company to pioneer an innovation and reap the first mover advantages. The leader strategy is normally expensive. In contrast, the technological follower strategy can be fairly cheap. This functional strategy is appropriate for those firms choosing to reap the benefits of late movers. Many of the advantages of the technological leader and follower strategies are listed in Table 8.1 of the text.

A8-2. What are the advantages and disadvantages of the devil’s advocate, dialectical inquiry, and consensus approaches to making strategic choices?

Research generally indicates that either the devil’s advocate or dialectical inquiry methods are superior to consensus in decision making. The drive in consensus to get everyone to agree on an alternative can result in “groupthink”—a situation when all try to overcome their personal reservations in order to show unanimity and be a team player even if the alternative chosen is defective. On the positive side, however, consensus results in a positive team approach to implementation. Both devil’s advocate and dialectical inquiry are conflict-oriented and can create problems in implementation. Nevertheless, both work to ensure that an alternative is critically evaluated before agreement is reached. Both need to be set up in advance of the discussion. In the case of the devil’s advocate, one person or group is assigned the task of finding everything wrong with a particular alternative. The advocate must propose nothing, but only criticize the alternative in question. In contrast, dialectical inquiry requires two separate proposals be developed. Both sides must defend their own alternative and attack the alternative presented by the other.

The limitations of the devil’s advocate are as follows. (a) Only one proposal is presented. It is either accepted or rejected. Thus, participants don’t have an opportunity to compare the alternative under consideration with another possibility. (b) Because the devil’s advocate defends nothing, the person(s) taking this position may be criticized for “taking cheap shots” at an alternative everyone likes and may hesitate to continue the attack in the face of group pressure. Thus, the devil’s advocate must have the strong support of the leader of the group in order to be effective.

The limitations of dialectical inquiry are as follows. (a) Two people or groups must spend much time preparing their position for debate in front of an audience. The emphasis may turn to presentation skills and “scoring points” over serious analysis. (b) The win–lose nature of this approach may create ill feelings and conflict among participants.

Thus, people on the losing side may find difficulty joining the “winners” in implementing the alternative chosen.

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A8-3. Should functional strategies be categorized under strategy formulation or under strategy implementation?

The answer to this question depends upon one’s position in the hierarchy of strategy. At the top management level of a corporation, both divisional (business-level) and functional strategies could be viewed as ways of implementing corporate strategy. For example, suppose a corporation decides to concentrate on one industry as its corporate growth strategy. This strategy would need to be implemented by a business strategy oriented to improving the company’s competitive position. The same can be said of functional strategy. Strategy formulation and implementation can be interchangeable terms based on one’s location in a corporate hierarchy. This text categorizes all strategies under the heading of strategy formulation because of their common planning orientation.

Implementation begins when one moves from planning into organizing and directing activities.

SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE Analyze eBay’s situation as of 2016. What do you believe eBay’s core issues are? Which marketing strategy was eBay following: market development or product development? Do you agree with it? What decision-making process should the CEO utilize to make the decisions necessary to address the company’s product, customer approach, and business model going forward?

What do you believe eBay’s core issues are? The previous CEO, Meg Whitman, had spent $6 billion to significantly expand the company through a series of acquisitions such as Skype, PayPal, StubHub, Rent.com, Shopping.com, Stumbleupon, and 25% interest in Craigslist. She succeeded, but by 2008, eBay was in trouble. Its stock price had lost half its value. The core auction and retail businesses, which accounted for the majority of revenue, were showing signs of weakness. The number of active users had been flat for three quarters, at 83 million. The number of new products listed on the site had increased only 4% from the previous year. The number of stores selling goods at fixed prices on eBay declined from a year earlier, to 532,000. Competition had increased as rival websites, particularly Amazon, now provided similar Web services and eroded eBay’s competitive advantage. (All of this information is presented in the case exercise.) These are symptoms of an underlying problem. Encourage students to dig for the underlying problem. Was Whitman wrong to expand the range of eBay’s products through acquisition?

Although PayPal was an example of vertical growth, the rest of the acquisitions were either horizontal growth or concentric diversification. A good argument can be made that although each of these acquisitions looked appealing, they were too many, too soon. Management appears to have been distracted by new business growth opportunities, took its eye off its core business, and was unable to integrate the new businesses with the old. Whitman and her team probably assumed that eBay’s lead in Web auctions was sustainable without much reinvestment and thus wasted time and money on other ventures. This mistake has been made by many other companies, most notably by Sears Roebuck when it acquired insurance and real estate businesses instead of investing in its retail stores.

Which marketing strategy was eBay following: market development or product development? Do you agree with it?

Using a market development strategy, a company or business unit can (1) capture a larger share of an existing market for current products through market saturation and market penetration or (2) develop new uses and/or markets for current products. Using the product development strategy, a company or unit can (1) develop new products for existing markets or (2) develop new products for new markets. Aside from PayPal, eBay appeared to follow a product development strategy by acquiring new businesses whose services it could sell to its existing Web auction market. Because the company seemed to dominate the Web auction market in 2007, market development probably did not make sense at the time as a way to increase sales or profits. There is a lesson here. Although product development seemed to make sense, it should have been done in a more careful and deliberate manner, always keeping an eye on the primary business to make sure competitors weren’t taking bites out the company’s market share.

What decision-making process should the CEO utilize to make the decisions necessary to address the company’s product, customer approach, and business model going forward? Because John Donahoe was hired by eBay’s board to turn the company around, he may be tempted to act quickly and autocratically. The usual retrenchment tactics of cutting expenses by laying employees off and divesting recently acquired businesses may not be the smartest approaches. Following the information provided in the chapter, it would make sense for him to call together his top

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management team for a day-long meeting on identifying eBay’s underlying problems and generating alternative solutions. Once some alternatives are generated, he could use dialectical inquiry to form teams tasked to present the pros and cons of each alternative at a meeting one week in the future. Once all the alternatives are discussed, the top management team would be forced to decide the best alternative. This would be the best way to get all the managers to “buy into” the recommended solution and work hard to accomplish it.

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CHAPTER NINE STRATEGY IMPLEMENTATION: GLOBAL STRATEGY This chapter specifically addresses the question of how and when to expand operations beyond the borders of the company’s home country. Some of the popular options for international entry are: exporting, licensing, franchising, forming a joint venture, acquisitions, greenfield development, production sharing, turnkey operations, BOT concept, and management contracts. A multinational corporation (MNC) is a highly developed international company with a deep involvement thought the world, plus a worldwide perspective in its management and decision making. This approach works best when the industry has moved from being multidomestic to global. Strategic alliances between an MNC and a local partner are becoming increasingly popular as a means by which a corporation can gain entry into other countries. Corporations operating internationally tend to evolve through five common stages. The stages of international development are: stage 1—domestic company, stage 2—domestic company with export division, stage 3—primarily domestic company with international division, stage 4—multinational corporation with multidomestic emphasis, and stage 5—MNC with global emphasis. Nearly 80% of midsize and larger companies send some of their employees abroad as expatriates. The three most widely used techniques for international performance evaluation are ROI, budget analysis, and historical comparisons.

LEARNING OBJECTIVES 1.

2.

3.

4.

5.

Describe the means of entry by which an organization can do business in another country.

Explain the elements of international strategic alliances that lead to success.

Discuss the stages of international development.

Explain how companies can improve their staffing efforts as they expand beyond their home country.

Discuss the unique issues related to measuring organizational performance that are presented with the administration of a truly international company.

TOPICS OUTLINE COVERED 1. International Entry 2. International Coordination a. International Strategic Alliances 3. Stages of International Development 4. International Employment 5. Measurement of Performance

SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS 9-1.

What are the nine means by which a company can enter a new international market?

A corporation can select from several strategic options regarding the most appropriate method for entering a foreign market or establishing facilities in another country. Some of the most popular options for international entry are as follows: exporting, licensing, franchising, forming a joint venture, acquisitions, greenfield development, production sharing, turnkey operations, BOT concept, and management contracts.

9-2.

What are the advantages of using a strategic alliance when operating in a new country?

Strategic alliances, such as joint ventures and licensing agreements, are a popular means by which a corporation can gain entry into other countries. The key to successful implementation is the selection of the local partner. Strategic alliances reduce the risk by partnering with experts in the new country. It is a quick method of obtaining local management, and it reduces the risk of expropriation and harassment by host country officials. It may also enable a firm to enter a country that restricts foreign ownership.

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SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 9-3.

What are the stages of international development?

Stage 1 (Domestic company)—it exports some of its products through local dealers and distributors in the foreign countries. The impact on the organization’s structure is minimal. Stage 2 (Domestic company with export division)—success in stage 1 leads the company to establish its own sales company with offices in other countries.

Stage 3 (Primarily domestic company with international division)—the company establishes manufacturing facilities in addition to sales and service offices in the foreign country. Stage 4 (Multinational corporation with multidomestic emphasis)—the company is a full MNC and increases its investments in other countries. Stage 5 (MNC with global emphasis)—the most successful MNCs move into this stage in which they have worldwide human resources, R&D, and financing strategies.

9-4.

How can an expat program be improved to the benefit of the organization?

There are several recommendations for improving the expatriation process. Have a compelling reason for sending a current employee to a new country. Choose individuals who are open to the assignment and committed to adapt to the new environment. Assign sponsors/mentors in both the home country and the new country. Develop a means of maintaining very open, frequent communication throughout the assignment. Design a plan for repatriation. Craft an approach for sharing the experiences.

9-5.

How does the issue of transfer pricing impact the results of an MNC?

A study of 79 MNCs revealed that international transfer pricing from one country to another is primarily used not to evaluate performance, but to minimize taxes. Transfer pricing can be one way that the parent company can reduce taxes and “capture profits” from a subsidiary.

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A9-1. Japanese corporations typically involve many more organizational levels and people in the development of implementation plans than do U.S. corporations. Is this appropriate? Why or why not?

Although the text does not discuss Japanese practices in this chapter, they have received a lot of attention from the press in terms of quality circles, participative decision making, and the like. Bill Ouchi, in his book Theory Z, points out that the Japanese “ringi” process involves circulating a formal proposal throughout an organization for approval at every level before the decision is made. In American terms, it may seem to take the Japanese forever to make a decision. This results from the Japanese managers’ desire to involve those who will implement the decision in the initial formulation of strategy. Western strategy makers, by contrast, tend to make key decisions at the top (with some input from below as requested) and assume that it will be accepted without criticism and implemented appropriately. Implementation plans may thus be drafted rather generally by top management and given to lower level managers to “flesh out” the required plan of action.

Arguments for and against the Japanese-style participative approach to implementation planning tend to boil down to the question of tradeoffs. Which is most important in a particular situation: time or commitment? It also brings up another question: how much consideration should be given to implementation questions when formulating strategy?

The Japanese method appears to see less of a distinction between strategy formulation and implementation. Rather, the two tend to be handled together in the planning stages. This is done because the Japanese tend to involve more corporate levels in the formulation process and thus cannot ignore implementation issues. In the United States, these issues might be ignored because top management might consider itself to be “responsible” for strategy formulation decisions.

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CHAPTER TEN STRATEGY IMPLEMENTATION: ORGANIZING AND STRUCTURE Following the basic management functions of planning, organizing, directing, staffing, and controlling, the text views strategy formulation as primarily composed of planning activities, strategy implementation as primarily composed of organizing, directing, and staffing activities, and evaluation and control as primarily composed of controlling activities. This chapter begins by specifying who implements strategy and what must be done (e.g., programs, budgets, and procedures). It proposes a matrix of change to assess the impact new programs will have on an organization’s current activities. It stresses the importance of finding synergy among organizational activities.

The rest of the chapter emphasizes organizing activities by looking closely at the design of organizations and jobs.

Chandler’s proposition that structure follows strategy is explained in terms of stages of corporate development. The chapter also explains the organizational life cycle and what happens when corporations go into decline. Building on the discussion of basic organization structures in Chapter 5, this chapter presents three advanced designs of the matrix, the network (or cluster), and the cellular/modular structure. Reengineering, six sigma, and job design are explained as implementation methods.

LEARNING OBJECTIVES 1.

2.

3.

4.

5.

Describe the major issues that impact successful strategy implementation.

Explain how you would develop programs, budgets, and procedures to implement strategic change.

List the stages of corporate development and the structure that characterizes each stage.

Explain how matrix, network, and modular structures are used to implement strategy.

Discuss the issues related to centralization versus decentralization in structuring organizations.

TOPICS OUTLINE COVERED 1. Strategy Implementation a. Who Implements Strategy?

2. What Must Be Done? a. Developing Programs, Budgets, and Procedures b. Achieving Synergy 3. How Is Strategy to Be Implemented? Organizing for Action a. Structure Follows Strategy b. Stages of Corporate Development c. Organizational Life Cycle 4. Flexible Types of Organizational Structure a. The Matrix Structure b. Network Structure—The Virtual Organization c. Cellular/Modular Organization: A New Type of Structure 5. Reengineering and Strategy Implementation a. Six Sigma b. Designing Jobs to Implement Strategy c. Centralization versus Decentralization

SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS 10-1. How do timing tactics impact the strategy implementation efforts of a company?

A timing tactic deals with when a company implements a strategy. Some companies are first movers, or pioneers.

By being first movers, companies are able to establish a reputation as an industry leader, move down the learning curve to assume the cost leader position, and earn temporarily high profits. Late movers may be able to imitate the technological advance of others, keep risks down by waiting until a new technological standard is established, and

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take advantage of market segmentation.

10-2. What issues would you consider to be the most important for a company that is considering the use of a functional structure?

One of the most important issues when utilizing a functional structure is leadership. The leader of the organization must be ready to share leadership with the functional directors whom he or she enlists. Functional structures often work well at Stage II, when companies focus their efforts in one industry.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 10-3.

How should a corporation attempt to achieve synergy among functions and business units?

The text points out that one of the goals of strategy implementation is synergy among functions and business units.

This is one reason why corporations commonly reorganize after an acquisition. If some sort of synergy cannot be achieved, there is no real reason to acquire another firm other than trying to exit one business and enter another. The extent to which synergy can be achieved depends on the strategy being pursued. A large amount of synergy is needed in vertical and horizontal growth as well as in concentric diversification. The corporation pursues these strategies in order to achieve the benefits of efficiency coming from marketing, operating, investment, or management synergy. The firm is looking for advantages of scale or scope. If, however, the corporation is pursuing conglomerate diversification as a strategy, top management may want only financial synergy in which high cash flow from one unit makes up for low cash flow from another unit. In this case, there is no attempt to combine any activities across business units (usually called subsidiaries in this case) because of the holding company nature of the corporation. Management’s philosophy is one of buying and selling companies without much attempt to gain the benefits of synergy.

10-4.

How should an owner–manager prepare a company for its movement from Stage I to Stage II?

The corporation reaches the transition point from Stage I to Stage II when it gets too big for the owner–manager and his/her team of do-everything managers and workers to effectively keep track of all of the firm’s activities because they lack the necessary in-depth knowledge of functional areas. To prepare the firm for this transition, the owner– manager needs to train those in the company who are willing to learn functional skills and knowledge. Some may take night courses at a local community college or university, whereas others may participate in various management development programs offered by organizations such as the American Management Association. In some instances, specialists in certain areas may need to be hired from outside the company. The owner–manager will also need to start changing his/her style from one of making all the important decisions to one of delegating some areas of responsibility to others with more in-depth knowledge and experience. As others in the company build their expertise in certain areas, the owner–manager needs to begin giving them increased decision-making autonomy.

10-5. How can a corporation keep from sliding into the decline stage of the organizational life cycle?

The concept of the organizational life cycle proposes that, like the product life cycle, organizations tend to move through the stages of birth, growth, maturity, decline, and death. According to Danny Miller in his book, The Icarus Paradox, companies go into decline because the very characteristics that helped make them successful tend to be taken to extremes over time and eventually cause a decrease in performance. (See the additional teaching module at the end of this section.) The noted sociologist Robert Merton referred to this phenomenon as “trained incapacity” in which one’s abilities can function as “blind spots” when those abilities are pushed too far. This tendency to do things the “company way” can lead to an inability to adapt appropriately to changing conditions. In this case, a company may need to “unlearn” its traditions and policies in order to revitalize itself. Miller and Friesen describe this as the revival stage. One way to keep from getting in a rut like this is for top management in particular to frequently question its mission, objectives, strategies, and policies, as well as its programs, budgets, and procedures.

People within the organization need to be told to always be looking at other companies for better ways of doing things (i.e., benchmarking). Reengineering is being heavily touted as one way for a corporation to renew itself by rethinking and redesigning its business activities.

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10-6.

Is reengineering just another management fad, or does it offer something of lasting value?

Reengineering is the radical redesign of business processes to achieve major gains in cost, service, or time. It involves a fundamental rethinking of the way work is done, the use of cross-functional work teams, a new information and management system, and a new value system with greater emphasis on the customer. It is an effective way to implement a turnaround strategy and is thus a part of the revival stage of the organizational life cycle. Cynics point out that management tends to be “fad driven.” Just as zero defects, management by objectives, and zero-based budgeting were hot topics in the 1960s and 1970s, total quality management and reengineering were the hot topics of the early 1990s. Like other fads, reengineering has gone through the various stages of discovery, successful application by a few well-known firms, followed quickly by oversaturation by the business media, research studies showing mixed results, and finally, the stage when business firms view the concept as “out of fashion” and move on to the next emerging fad, leaving the concept to live on only as a paragraph in textbooks.

By now, reengineering has gone through the last stage of going out of fashion—in other words, it is being replaced

by Six Sigma and lean sigma programs. Adherents of reengineering argue, however, that it offers something of lasting value because it is the first management concept to emphasize the redesigning of both the organization and jobs in light of environmental and technological changes. As such, this concept may find a permanent place in the literature on organizational change. Reengineering is important because it looks at job design as the building block to organization design—something that organizational theorists have been slow to do. Traditional organization theory views organizational design from the outside in. Structure is thus viewed as a response to environmental change. Job design tends to be ignored by organizational theorists in favor of the “macro” approach. Reengineering, by contrast, views organizational design from the inside out. Job design comes first, then organizational design.

Reengineering thus tends to combine the “macro” approach of organizational theory and the “micro” approach of organizational behavior. This is one reason why traditional academics who like to segment their areas of study have difficulty with the more integrative and practitioner-oriented concept of reengineering. Unless these academics are able to see reengineering as a useful way to bridge the gap between organization and job design, they may help cynics ridicule it as another fad and thus bury an otherwise useful approach to strategy implementation and organizational change.

10-7.

How is the cellular/modular structure different from the network structure?

Miles, Snow, and colleagues propose in this chapter that the evolution of organizational forms is leading from the matrix and the network to the cellular or modular. According to them, “a cellular organization is composed of cells (self-managing teams, autonomous business units, etc.) that can operate alone but that can interact with other cells to produce a more potent and competent business mechanism.” It is this combination of independence and interdependence that allows the cellular organizational form to generate and share the knowledge and expertise to produce continuous innovation. The cellular form includes the dispersed entrepreneurship of the divisional structure, customer responsiveness of the matrix, and self-organizing knowledge and asset sharing of the network. As proposed, the cellular/modular structure is similar to the current trend in industry of using internal joint ventures to temporarily combine specialized expertise and skills within a corporation in order to accomplish a task that individual units alone could not accomplish.

In contrast, the network structure is really a sort of nonstructure by its virtual elimination of in-house business activities. Long-term contracts with suppliers and other strategic alliances replace the services the company could provide for itself.

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A10-1. Does structure follow strategy or does strategy follow structure? Why? Although Chandler and others have made convincing arguments that a change in strategy tends to be followed by a change in structure, a good argument can be made for strategy following structure as well. To the extent that the

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formulators of strategy seriously consider implementation issues in choosing a strategic alternative, they will have to assess the compatibility of a desired strategy with the present corporate structure. If the desired strategy cannot be implemented given the present structure, how much time, money, and effort will be needed to change the structure?

Such a cost-benefit analysis may find the desired strategy to be too costly to implement.

Research does support the contention that structure follows strategy. As shown earlier in Chapter 5, the reverse also appears to be true. Logic suggests that responsible strategy makers will consider the current corporate structure as a serious consideration in the choice of a strategic alternative. This fits with the resource-based approach. Chandler himself implies that one of the problems of strategy formulation in the past has been a lack of serious consideration of structural issues. This is suggested in the chapter when Chandler proposes that the creation of new strategy is followed by the appearance of new administrative problems, which contribute to a decline in economic performance.

One is left wondering why the strategy makers in the corporations Chandler studied failed to foresee the need for structural changes at the time they created their strategy. Perhaps if they had been able to foresee all the needed implementation problems, the chosen strategy might have been quite different and more in line with their present structure. All this is merely conjecture, of course. Hindsight is always clearer than foresight.

SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE The Synergy Game Excerpted from Teaching Note by Y. Sarason and Catherine Banbury A key strategic issue for organizations is whether or not to diversify their business. In order for diversification to have performance implications, there must be some economies of scale or economies of scope, which has become known as “synergy.” Economies of scale are relatively easy to identify, as the advantages come from size.

Economies of scope have proven more difficult, as it is harder to decipher if operating in two or more lines of business will cause an increase in performance. A relatively consistent finding in strategy research has been that organizations that diversify into related businesses outperform businesses that diversify into unrelated businesses.

The issue that has become central to researchers as well as managers is how to identify the relatedness of businesses.

Early researchers defined related by SIC code. This proved limited insight into the processes that result in increased performance. Resource-based theorists present the case that increased performance among some diversified firms is due to overlapping capabilities or “core competencies.” Central to this issue is how managers view their businesses as related. This exercise puts students in the role of managers by having them identify how businesses of recognizable firms are related.

In this exercise, we use a game show format as an experiential exercise to help participants identify sources of synergy or core competencies among recognizable diversified firms. We list various products or services, the possible sources of synergy, and the actual company being described in the following table. Please feel free to develop more examples of your own.

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Products or Services

Synergy

Company

Family restaurants, airline catering, hotels, retirement centers

Standardized food service and hospitality setting

Marriott

Motorcycles, autos, sit-down lawn mowers, generators

Engine technology

Honda*

Athletic footwear, Rockport shoes, Greg Norman clothing, sportswear

Marketing and distribution for athletic-conscious products

Reebok*

Televisions, portable telephones, personal device assistants, pagers, two-way mobile radios

Manufacturer of untethered communications products

Motorola

Beer, cigarettes, coffee, soft drinks, cheese, chocolates

Distribution and marketing of consumable products

Philip Morris

Acetaminophen, tranquilizers, anti-inflammatory drugs, wound care products

Brand name, R&D, of healthcare products

Johnson and Johnson

Dinner ware, fiber optics, liquid crystal display, lighting, specialty glass

R&D of sand-based technology

Corning

Max Factor, Vidal Sassoon, Joy soap, Pepto-Bismol, Vicks 44, Folgers, Pringles, Tampax, Pampers, Cheer, Charmin

R&D, manufacturing and distribution of consumer products

Procter & Gamble

Television station, radio station, amusement parks, movie studio, retail outlets, cable station, distribution network, cruise lines, animation school

Family entertainment

Walt Disney

Razors, Oral B toothbrushes, Duracell batteries, stationary products, toiletries, Braun coffee makers

Distribution of consumer goods

Gillette

Pocket television, portable CD player, portable radio

Miniaturization of electronic audio products

Sony

Digital pianos, amplifiers, electric guitars, receivers, motorcycles, sound cards, digital and portable keyboards and synthesizers, snowmobiles

Electronic musical devices (except for the motorcycles and snowmobiles)

Yamaha

*Already presented in the exercise at the end of Chapter 10 of the textbook.

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CHAPTER ELEVEN STRATEGY IMPLEMENTATION: STAFFING AND DIRECTING This chapter deals specifically with staffing the corporation with people having the appropriate mix of abilities and skills, and directing people to use their abilities and skills most effectively and efficiently to achieve organizational objectives. The chapter explains how a change in strategy is most likely to have a significant impact on staffing needs. Research is presented on matching the manager to the strategy. Executive succession issues are considered.

Downsizing is discussed as a commonly misused way to implement a turnaround strategy. International staffing issues are presented in terms of managing international assignments and adjusting to cultural differences. The chapter also explains how a corporation’s culture can be evaluated and managed to better suit the new strategy.

Action planning, management by objectives (MBO), and total quality management (TQM) are presented as useful techniques to coordinate implementation activities. Hofstede’s research on the dimensions of national culture is used to explain why some management techniques can work well in some countries but not in others.

LEARNING OBJECTIVES 1.

2.

3.

Explain the link between strategy and staffing decisions.

Discuss how leaders manage corporate culture.

Utilize an action planning framework to implement an organization’s MBO and TQM initiatives.

TOPICS OUTLINE COVERED 1. Staffing a. b. c. d.

2. Leading a. b. c. d. e.

Staffing Follows Strategy Selection and Management Development Problems in Retrenchment International Issues in Staffing Managing Corporate Culture Action Planning Management By Objectives Total Quality Management International Considerations in Leading SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS

11-1. What are the critical issues that a company must consider when trying to match its staffing to its strategy?

Strategy is implemented effectively when staffing is ready to meet the challenges set forth. There are several issues that leaders must consider when matching staffing to strategy. A number of programs such as organizational and job design, reengineering, Six Sigma, MBO, TQM, and action planning can be used to implement a new strategy.

Leaders must manage the corporate culture and find the right mix of qualified staff. It is also essential that leadership pay attention to star employees as well as the majority of the workforce in terms of performance and fit.

11-2. What are the unique impacts on a company that must staff in international settings?

Implementing a strategy of international expansion takes a great deal of planning and can be very expensive.

Primarily due to cultural differences, managerial style and human resource practices must be tailored to fit particular countries. One approach to staffing managerial positions of multinational corporations is to employ people with an international orientation, regardless of their country of origin.

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SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 11-3.

What skills should a person have for managing a business unit following a differentiation strategy?

Why? What should a company do if no one is available internally and the company has a policy of promotion from within?

Research does appear to support the proposition that the manager of a corporation or business unit should be matched to the strategy for successful implementation. Those executives who successfully implement a differentiation business strategy tend to have a high internal locus of control and have more experience in R&D. Because of the likely growth orientation of the strategy, managers should probably have a greater willingness to take risks, a higher tolerance for ambiguity, and sales/marketing experience. These characteristics make sense because of the product/market orientation needs of any unit interested in setting its products or services apart in the competitive marketplace. If this type of person is not available internally, then the company must recruit an appropriate outsider.

In the case of a promotion from within policy, the policy should be reconsidered and an exception made. Otherwise, the company must take a chance on promoting one of its own—a good reason for proceeding cautiously.

11-4.

When should someone from outside a company be hired to manage the company or one of its business units?

Research suggests that firms in difficulty can improve their chances for success if they bring in an outsider who does not have the same devotion to past management practices as do most internal candidates. Many examples can be provided of corporations turning to external turnover specialists (sometimes called “hatchet men”) to regain their past success by firing “deadwood” and eliminating popular but unprofitable divisions, units, and projects. The probability of hiring an outsider to lead a firm in difficulty increases if there is no heir apparent, if the last CEO was fired, and if the board of directors is composed of a large percentage of outsiders. The insider/outsider distinction may not really be the important issue. Rather, the best answer may lie in finding the right person to implement the needed strategy regardless of where the person is found.

11-5.

What are some ways to implement a retrenchment strategy without creating a lot of resentment and conflict with labor unions?

The chapter discusses some of the problems involved in downsizing, a program usually used in implementing a retrenchment strategy. Unless staffing issues are dealt with appropriately in retrenchment, a situation can develop in which retrenchment feeds on itself and acts to further weaken instead of strengthening the company. The text proposes six guidelines for successful downsizing: • • • • • • 11-6.

Eliminate unnecessary work instead of making across-the-board cuts.

Contract out work that others can do cheaper.

Plan for long-run efficiencies.

Communicate the reasons for actions.

Invest in the remaining employees.

Develop value-added jobs to balance out job elimination.

How can corporate culture be changed?

The chapter points out that communication is key to the effective management of a change in culture. Top management must be committed to a culture change and communicate that commitment to everyone in the organization. The new culture must be part of a “strategic vision” that can capture the emotions of the employees. A series of programs need to be established to move the corporation from one culture to another and a strong rationale given to justify such a radical change. Progress toward the goal must be measured at intervals and results communicated widely. A system of incentives also must be developed to reward those who support and encourage the culture change.

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11-7.

Why is an understanding of national cultures important in strategic management?

An understanding of different national cultures is important in all aspects of strategic management. Because international trade is becoming increasingly important, knowledge of national cultures is important to environmental scanning. One must scan not only key forces in one’s industry, but also different societal forces in other parts of the world where the company might do business. An understanding of national cultures is also important to the formulation of strategy. Many cultures are very ethnocentric and do not like foreigners controlling key parts of their country. In Saudi Arabia, for example, non-Saudis cannot own land, they can only rent it. Most countries have rules regarding ownership of companies in industries that are deemed important to that country’s welfare (for example, the U.S. defense and airlines industries). A company must have an understanding of these differences if it is to formulate various entry strategies into different countries or regions. An understanding of different cultures is especially important in strategy implementation. Because of cultural differences, managerial style and human resource practices must be tailored to fit the particular situations in other countries. Hofstede found in his research that national culture is so influential that it tends to overwhelm even a strong corporate culture. In measuring the differences among five national dimensions from country to country, he was able to explain how a certain management practice might be successful in one nation but fail in another. Knowledge of these kinds of differences is crucial for any multinational corporation. An understanding of national cultures is also important to evaluation and control.

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A11-1. How might manager–strategy fit be accomplished short of firing current managers?

If the current manager of an SBU is capable, but does not appear to have the skills and experiences necessary to implement a particular strategy, the company might wish to either provide him/her with additional training or an assistant having some of those skills/experiences. Unfortunately, because most companies want to get implementation moving quickly and don’t want two managers to do the job of one, a better option is to transfer existing managers from one unit to another. Another approach is to consider the skills and experiences of the existing manager in the process of strategy formulation when choosing among strategic alternatives. If there is little difference in the expected results from two different strategies, it makes sense to select the strategy which best fits the existing manager’s skills and experiences.

A11-2. Does culture follow strategy or does strategy follow culture? Why? This question derives from the question raised in Chapter 9 regarding the relationship between structure and strategy. The answer is much the same. To the extent that the formulators of strategy seriously consider implementation issues in choosing a strategic alternative, they will have to assess the compatibility of a desired strategy with the present culture. If the desired strategy cannot be implemented given the present culture, a lot of time, money, and effort will be needed to change the culture. Research reported in this chapter does support the contention that culture follows strategy. As shown earlier in Chapter 5, the reverse also appears to be true. The type of culture within a corporation will act to influence the selection of feasible alternative strategies. To the extent that the culture derives from the “distinctive competence” of the company, this may be very appropriate. Don’t throw away a good culture just because the current strategy is not as successful as it could be. Some might even say that a good culture is more important than a good strategy. Clearly, both strategy and culture are very important and need to be carefully evaluated before any significant change in either is recommended. Both strategy and culture affect each other simultaneously.

A11-3. Compare and contrast action planning with management by objectives.

An action plan states what actions are going to be taken, by whom, during what time frame, and with what expected results. Action plans are the primary means by which programs are developed for the implementation of strategy.

Management by objectives (MBO) is also a technique useful for the development of programs. Like action planning, MBO pinpoints individual responsibilities for each unit objective and specifies a time frame when that objective is

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to be achieved. Unlike action planning, however, MBO takes a more organization-wide approach to planning implementation programs and budgets. For MBO to work, it should be a complete system. Action planning can be done, in contrast, at the individual level only. The key difference is that MBO is a system of hierarchical objectives beginning at the top of the corporation and cascading down through the divisions and work units. MBO also encourages the superior to negotiate the subordinate’s objectives with the subordinate’s input. MBO includes action planning as part of the discussions between a manager and his/her subordinate. Action planning alone, however, can be done strictly on a top-down basis with little to no input from the subordinate.

A11-4. What value does a total quality management program have in implementing strategy?

Total quality management (TQM) is an operational philosophy that stresses commitment to customer satisfaction and continuous improvement. It aims at improving quality, increasing flexibility, and reducing costs in order to better satisfy the customer. Because TQM aims to reduce costs as well as improve quality, it can be used as a program to implement either an overall low cost or a differentiation business strategy. Like MBO, TQM helps keep employees’ minds on a crucial objective of strategic management: increasing sales and profits by pleasing the customer. Because the mission of most business firms is customer driven, TQM helps to clarify and fine-tune the company’s mission statement. TQM makes the key point that because competitive advantage is usually only temporary, the organization must emphasize continuous improvement to improve product quality and reduce costs.

According to TQM, customers can be internal as well as external to the organization. To the extent that a company is able to continually improve its service to its internal customers, it is more likely to keep internal transaction costs low and thus be in a better position to reap the benefits and avoid the disadvantages of vertical integration.

A11-5. How can MBO help improve the implementation of strategy?

MBO is a powerful implementation technique because it is a system that links plans with performance. It forces managers to communicate the objectives of the overall business unit to their subordinates so they are better able to see how they fit into the company’s goal accomplishment. MBO, therefore, acts to tie together corporate, business, and functional objectives, as well as the strategies developed to achieve them. This forms a hierarchy of objectives similar to the hierarchy of strategy mentioned in Chapter 1. The mutual give and take, together with the sense of personal responsibility exemplifying a successful MBO program, serves to motivate employees to help implementation activities succeed.

SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE Using the Keirsey Temperament Sorter This is a fun exercise that provides students some insight into their own personality and how they compare with others in their decision-making style. First, ask the class to complete and score their Keirsey Temperament Sorter before class. When the students come to class, each of them should give you a sheet of paper with their name and personality type: Guardian, Artisan, Idealist, or Rational. As suggested in the chapter, put them into groups based on their personality type. One idea is to form some groups containing the same personality type and some other groups with representatives of all personality types. Ask them not to discuss their personality types during the exercise.

Give each group about 30 minutes to accomplish a defined task. You could either give them a short case to discuss such as The Audit, or an exercise such as generating an idea for an entrepreneurial venture. Give them no further information—keep it deliberately vague. If you are asked questions, turn the question into a question by asking, “What do you think?” When time is up, ask a spokesperson from each group to (1) describe the process the group went through and (2) present orally each group’s recommendation (for a case) or proposal (for a new venture). After each group makes its presentation, ask the class as a whole to identify each group’s dominant decision-making style in terms of how they did their assignment.

You may choose to do any one or all three of the options listed at the end of the exercise in the textbook: •

On a sheet of paper, each person in the class identifies his/her personality type and votes which team did the best on the project.

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•

The class as a whole tries to identify each group’s dominant decision-making style in terms of how they did their assignment. See how many people vote for one of the four types for each team.

•

Each member of a group guesses if she/he was put into a team composed of the same personality types or in one composed of all four personality types.

You may want to lecture a bit about the Keirsey Temperament Sorter and about each of the four styles. Take the test online at http://www.advisorteam.com. You will be given the opportunity to become a registered member of the Advisory Team and to subscribe to the free newsletter, The Team Advisor Personality Zone. The website provides access to further information about the Temperament Sorter and personality types.

Use this exercise to illustrate how important it is to consider personality differences when staffing an organization.

Should creative, entrepreneurial firms have a larger number of some personality types (such as Artisans) than others? Do large bureaucracies thrive on Rationalists and Guardians to the disadvantage of Artisans and Idealists?

What is the best style for strategic decision making? Should a strategic planning committee be composed of a mixture of all four styles or just one style?

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CHAPTER TWELVE EVALUATION AND CONTROL This chapter examines the final segment of strategic management—the evaluation of performance and the control of work activities. Beginning with a basic five-step feedback model, measures of corporate, divisional, and functional performance are described. Activity-based costing and enterprise risk management are explained. Advantages and limitations of ROI, ROE, and EPS as performance measures are listed. Economic value added (EVA) and market value added (MVA) are proposed as measures of shareholder value. The balanced scorecard is explained.

Responsibility centers are suggested to pinpoint performance in various parts of the corporation. Benchmarking is discussed as a way to compare a company’s products, services, and practices with industry leaders. The chapter also discusses transfer pricing and information systems in controlling international activities and processes. The chapter explains two of the most frequent negative side effects of the monitoring and measuring of performance activities— short-term orientation and goal displacement. Guidelines are presented to help keep the likelihood of occurrence of these negative side effects to a minimum. Long-term incentive plans are also recommended to better link compensation to strategic performance.

LEARNING OBJECTIVES 1.

2.

3.

4.

5.

Explain how various types of measures and controls are utilized to properly assess performance including activity-based costing, ERM, ROI, and EVA. Develop a balanced scorecard to examine key performance measures of a company.

Apply the benchmarking process to a function or activity.

Explain how strategic information systems are being utilized to support specific strategies.

Discuss the issues with measuring organizational performance and how organizations can establish proper controls to achieve objectives.

TOPICS OUTLINE COVERED 1. Measuring Performance a. Appropriate Measures b. Types of Controls c. Activity-Based Costing d. Enterprise Risk Management e. Primary Measures of Corporate Performance f. Balanced Scorecard Approach: Using Key Performance Measures g. Primary Measures of Divisional and Functional Performance h. Responsibility Centers 2. Using Benchmarking to Evaluate Performance 3. Strategic Information Systems a. Enterprise Resource Planning b. Radio Frequency Identification and Near Field Communication c. Divisional and Functional IS Support 4. Problems in Measuring Performance a. Short-Term Orientation b. Goal Displacement c. Guidelines for Proper Control d. Aligning Incentives

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SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS 12-1. Explain why ROI might not be the best measure of firm performance?

The most commonly used measure of corporate performance is ROI. It is simply the result of dividing net income before taxes by the total amount invested in the company. Although using ROI has several advantages, it can be easily manipulated.

12-2. What are the best methods for evaluating the top management team?

Through its strategy, audit, and compensation committees, a board of directors closely evaluates the job performance of the top management team. The CEO’s ability to establish strategic direction, build a management team, and provide leadership are more critical for the organization in the long run.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 12-3.

Is Figure 12.1 a realistic model of the evaluation and control process?

Figure 12.1 is certainly not a complete model of the control process. For example, it does not include the development of an information system so that performance can be measured in Step 3. Nevertheless, the model is adequate as a simple representation of the basic steps in evaluation and control. It is slightly misleading to the extent that it suggests that all control is post hoc, that is, after the fact. As pointed out in the text, a corporation will often need “steering” or feed-forward controls to assess slight deviations before they become performance breakdowns.

These controls really provide feedback to the manager. If a process is going slightly off the desired course, the manager in charge will have to decide if the deviation is important enough to correct. If left alone, the deviation may correct itself. If the manager intercedes, she/he may cause a reaction, potentially throwing the process off track in the other direction. These activities are not included in Figure 12.1. In addition, the model is a negative feedback system that does not include any positive feedback, such as giving praise and recognition when performance exceeds the standard. Recognizing and rewarding performance that exceeds what is expected is an important part of human motivation and should be included in any evaluation and control process.

12-4.

What are some examples of behavior controls? Output controls? Input controls?

Behavior controls specify how something is to be done through policies, rules, standard operating procedures, and orders from a superior. Output controls specify what is to be accomplished by focusing on the end result of the behaviors through the use of objectives and performance targets or milestones. Input controls focus on resources, such as knowledge, skills, abilities, values, and employee motivation. Some examples of behavior controls are company procedures, quotas of sales calls to potential customers, and rules regarding attendance and tardiness.

Some examples of output controls are sales quotas, cost reduction or profit objectives, and surveys of customer satisfaction. Some examples of input controls are years of education and experience. Although output controls, with their emphasis on the “bottom line,” are generally considered superior to behavior controls, behavior controls are very appropriate when results are hard to measure and a clear cause-effect relationship exists between activities (behaviors) and results. Input controls are the least useful and are most appropriate when output is difficult to measure and there is no clear cause-effect relationship between behavior and performance (such as in college teaching).

12-5.

How does EVA improve our knowledge of performance over ROI, ROE, or EPS?

Economic value added (EVA) is being increasingly recommended as an improvement over traditional measures because of EVA’s strong relationship to a company’s stock price. It uses stock price to measure the difference between the pre-strategy and post-strategy value of a corporation. However, EVA is often difficult to calculate. It is for this reason that simpler measures such as ROI, ROE, and EPS continue to have widespread usage. Like the traditional measures, shareholder value can be manipulated in the short run by following a profit strategy or by manipulating the buying and selling of stock. Another limitation of EVA is its concern with only one aspect of the

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task environment—the shareholder. The conclusion seems clear: there is no one best measure or group of measures.

The key is to use those measures that have the most value to those most affected by corporate performance and to keep them in perspective by understanding their advantages and limitations.

12-6.

What issues affect your faith in a transfer price as a substitute for a market price in measuring a profit center’s performance?

The use of a transfer price allows a corporation to convert a cost or expense center into a profit center. In theory, this sounds like a good way to avoid the kind of suboptimization often occurring in large corporations when a unit or division thinks only of achieving its own goals to the detriment of the corporation as a whole. To the extent that the transfer price reflects the true market price of the items in question, this approach can improve efficiency within a corporation. If, however, it is difficult to decide upon a “fair market price” (because the item in question is rarely sold on the open market or because the market is regulated by government or manipulated by cartels), the exact amount of the transfer price is open to manipulation by powerful, interested parties within the corporation.

Corporate politics may dictate a certain price, which gives advantage to the president’s favorite project or division and unfairly penalizes another division that happens to be out of favor.

12-7.

Is the evaluation and control process appropriate for a corporation that emphasizes creativity? Are control and creativity compatible? Explain. (This is an open question.)

This is a wide-open question meant to generate discussion. The chapter does not mention this issue. There is some feeling that a large number of controls do constrain creative impulses. The argument seems to be that a person’s mind must be able to run free without constraint in order to generate new innovative concepts. Data from advertising agencies and R&D labs do suggest that corporations emphasizing creativity tend to reduce the number of controls used. Control is not ignored, however. Data is just not collected on intermediate activities such as time in the office or manner of dress. The emphasis tends to be on the end result of activities (output controls) rather than upon the activities themselves (behavior controls). Control and creativity are thus compatible if the controls are appropriate and used properly. Creative types may be like artists in that to be successful, they need both talent and discipline.

Most creative types, however, choose to impose their own form of discipline on themselves. To the extent that managers attempt to regulate the activities that go into creativity, they may destroy the very thing they are trying to nurture.

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A12-1. Why bother with shareholder value or a stakeholder scorecard? Isn’t it simpler to evaluate a corporation and its SBUs just by using standard measures such as ROI or earnings per share?

The answer to the second question is a simple yes. The standard measures, such as sales, profits, earnings per share, return on investment, and so on, are certainly easier to grasp and more commonly used than any of the proposed “improved” models. Then why bother with these interesting measures such as ROVA or shareholder value as measured by economic value added (EVA)? The answer to the question hinges on one’s willingness to overlook the limitations of commonly accepted measures as listed in detail in the text. Nevertheless, the proposed measures have problems of their own.

The stakeholder scorecard, as proposed by Freeman, seems to violate guidelines one and two from the text.

Although the scorecard provides much more information on a corporation’s task environment than does any set of traditional measures, it runs the risk of overwhelming management with too many controls. Are all of them meaningful and useful? Unless the scorecard includes some priorities indicating which measures are most important (and least important) to the corporation, it may just create confusion. The other danger is that if priorities are placed on the measures, the emphasis may very well end up being on the standard measures of sales, EPS, and ROI! Nevertheless, Freeman’s set of measures does at least point out that management needs to consider more than just the standard measures of performance.

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Economic value added (EVA), a measure of shareholder value, is being increasingly touted as an improvement over traditional measures. Based on the assumption that the stock market is the ultimate decider of corporate performance, an emphasis on this measure forces management to especially monitor all forces that can affect stock price and dividend rate. In the long run, this may be an excellent measure, but it is hard to see how it is an improvement over ROI (if ROI is used in a long-term manner) other than its relationship to stock price. Like the traditional measures, shareholder value can be manipulated in the short run by following a profit strategy or by manipulating the buying and selling of stock. Another limitation is this measure’s concern with only one aspect of the task environment—the shareholder. The conclusion seems clear: there is no one best measure or group of measures. The key is to use those measures that have the most value to those most affected by corporate performance and to keep them in perspective by understanding their advantages and limitations.

In contrast, the balanced scorecard combines financial measures that tell the results of actions already taken with operational measures on customer satisfaction, internal processes, and the corporation’s innovation and improvement activities—the drivers of future financial performance. This may be the best way to measure overall corporate performance.

A12-2. Is benchmarking just another fad or is it really useful for all firms? Why? Benchmarking involves learning how other successful companies do something and imitating or perhaps even improving on their techniques. Pioneered in the United States by Xerox Corporation, benchmarking is similar to the time-tested practice of “reverse engineering” in which a company buys the product of another company to take it apart in order to learn how it is made. Given that Xerox developed the concept of competitive benchmarking in the early 1980s, it appears that the concept is here to stay. It is especially useful to companies that are falling behind others in the industry. Xerox developed the concept when management realized that Japanese companies were slowly taking over the copier market by making and selling products superior to those of Xerox at a cheaper price.

Because this is a situation that is bound to affect various companies in the future, benchmarking is likely to be increasingly adopted. Unlike MBO, TQM, or reengineering, almost everyone who uses benchmarking finds it to be very useful and well worth the time and money it takes to do it.

A12-3. Why are goal displacement and short-run orientation likely side effects of the monitoring of performance? What can a corporation do to avoid them?

Goal displacement and short-run orientation are likely side effects of evaluation and control because no system can be all-inclusive. Goal displacement occurs because people find it easier to focus on a surrogate of performance (the measure) than on the performance itself. To the extent that the measure tends to be confused with what it is supposed to be measuring, work activities will be oriented more toward the measures and less toward actual performance. A short-term orientation occurs not because of poor measures, but because most managers tend to want quick feedback. Those activities that require a great deal of time before feedback occurs tend to be neglected for those activities providing more immediate feedback. The measures by themselves do not cause a short-term orientation; rather, it is the time frames in which they are used that cause the result. ROI, for example, can be calculated over a five-year period just as well as a one-year period. The measures, however, do cause managers to focus their activities and to want feedback on how they are doing. To the extent that short-run performance is measured and rewarded, a short-term orientation is a natural result.

In order to avoid these negative side effects, a corporation should consider the guidelines for proper control given in the chapter. Emphasis should be especially placed on measuring all meaningful activities and results regardless of measurement difficulty and upon using long-term controls. As long as we are dealing with human beings, however, we must keep in mind that these side effects will never go away completely. A good control system can only hope to minimize them.

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SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE America’s Most Admired Companies This exercise is a good opportunity to discuss the measures used by Fortune magazine to evaluate a corporation’s overall performance. The survey measures what it calls “eight key attributes of reputation.” They are Innovation, People Management, Use of Corporate Assets, Social Responsibility, Quality of Management, Financial Soundness, Long-Term Investment Value, and Quality of Products/Services. This survey has been used in research as a surrogate for a measure of social responsibility, but has been criticized because overall profitability tends to affect (thus contaminate) the individual measures as well as the overall measure of any company.

Select some of the projects from the exercise in the textbook to assign individual students or student teams to investigate. Have them present their findings to the class. How useful is Fortune’s survey of most admired companies compared to its 100 Best Companies to Work For? How much do the lists overlap?

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CHAPTER THIRTEEN SUGGESTIONS FOR CASE ANALYSIS This chapter discusses case analysis and the case method as a means of examining strategic management in action. It presents various techniques and approaches to the analysis of complex strategy cases. The basics of financial analysis from ratio analysis to common-size statements and adjusting for inflation are presented as a way to begin serious analysis of business policy/strategic management cases. The strategic audit and the strategic audit worksheet are described as helpful tools to organize facts and to begin in-depth analysis of a corporation. The chapter ends with appendixes providing suggested techniques for case analysis and presentation, plus a list of useful resources for additional research at the library or on the Internet.

LEARNING OBJECTIVES 1.

2.

Explain the issues involved in researching a case situation.

Analyze financial statements using ratio analysis, common-size statements, Z-values, and economic measures.

Employ the strategic audit as a method of organizing and analyzing case information.

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TOPICS OUTLINE COVERED 1. The Case Method 2. Researching the Case Situation 3. Financial Analysis: A Place to Begin a. Analyzing Financial Statements b. Common-Size Statements c. Z-Value and the Index of Sustainable Growth d. Useful Economic Measures 4. Format for Case Analysis: The Strategic Audit

SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS 13-1. What ratios would you use to begin your analysis of a case?

In order to analyze a case, we must examine some of the most important financial rations. These would include liquidity ratios, profitability ratios, activity ratios, and leverage ratios.

13-2. What are the five crucial steps to follow in basic financial analysis?

The five steps in basic financial analysis are: (1) scrutinize historical income statements and balance sheets; (2) compare historical statements over time; (3) calculate changes that occur in individual categories from year to year; (4) determine the change as a percentage; and (5) adjust for inflation.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 13-3.

Why should one begin a case analysis with a financial analysis? When are other approaches appropriate?

Starting with a financial analysis of a case is a good way to assess the seriousness of the situation. Because one of the key objectives of any business corporation is to earn a profit, much can be learned by considering how it is doing financially. If the firm is doing badly financially, the student will need to consider short-term problems (“How does it avoid bankruptcy?”) as well as long-term problems (“How can it position itself in the market to take advantage of its strengths?”). If the firm is doing well financially, the student has free reign to take a long-range viewpoint and

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consider how a good firm can do better. Nevertheless, the best place to begin a case is to assess the firm’s current performance. This may be quickly done by using financial data found in its annual report. If not available, a logical starting point is whatever problems are given in the case. This would be especially appropriate when the case under consideration focuses on only one aspect of a corporation’s functioning, such as conflict between a board of directors and top management. The basic rule of thumb for beginning a case analysis is to look for problem areas wherever they may be.

13-4.

What are common-size financial statements? What is their value to case analysis? How are they calculated?

A useful approach to the analysis of financial statements is to convert both the income statement and balance sheet into common-size statements. Convert every category from dollar terms to percentages. For the income statement, net sales represent 100%, so calculate the percentage of each category so that the categories sum to the net sales percentage (100%). For the balance sheet, give the total assets a value of 100%, and calculate other asset and liability categories as percentages of the total assets. (Individual asset and liability items, such as accounts receivable and accounts payable, can also be calculated as a percentage of net sales.) To more easily note category changes, plot the annual percentages over a five-year period for each of the categories, such as cost of goods sold and accounts receivable. Connect the dots to view trends in each category. A poor trend indicates an underlying problem needing attention.

When you convert statements to this form, it is relatively easy to note the percentage that each category represents of the total. Comparisons of these percentages over the years can point out areas for additional analysis. To get a proper picture, however, make comparisons with industry data, if available, to see if fluctuations are merely reflecting industry-wide trends. If a firm’s trends are generally in line with those of the rest of the industry, there is a lower likelihood of problems than if the firm’s trends are worse than industry averages. These statements are especially helpful in developing scenarios and pro forma statements, because they provide a series of historical relationships (for example, cost of goods sold to sales, interest to sales, and inventories as a percentage of assets).

13-5.

When should you gather information outside a case? What should you look for?

The book suggests that students conduct outside research into the environmental setting of the case. It is suggested that students check each case to find out the date when the case situation occurred and then screen the business periodicals for that time period. The key is to stay within the time frame of the case. This background should provide students an appreciation for the situation as the participants in the case experienced it. A company’s annual report and 10-K form from that year can be very helpful. An understanding of the economy during that period will help students avoid making a serious error in analysis—for example, suggesting a sale of stock when the stock market is at an all-time low or taking on more debt when the prime interest rate is more than 15%. Information on the industry will provide insights on its competitive activities. This research is especially useful when preparing for group oral presentations.

Many instructors do not want students to obtain outside information on a company described in an assigned case.

They want everyone in the class to have the same information so that in an open class discussion or a written paper, analyses by different people will be comparable. Everyone is, in effect, analyzing the same case. Other instructors want students to go to the library in order to update the case and analyze the company’s current situation rather than the situation described in the case. This is a special situation, however. It is the obligation of the instructor to tell the students what level of outside research is allowable for the purpose of assignments.

13-6.

When is inflation an important issue in conducting case analysis? Why bother?

The impact of inflation upon daily life strikes a person when watching old movies on television. For example, in the movie The Man in the Grey Flannel Suit, the character played by Gregory Peck works in public relations for a corporation located in New York City in the mid-1950s. He was earning $7,000 and was being interviewed by the president of a large radio/television network for an important job paying $9,000. By 2005, earning only $9,000 in New York City would not even keep a family above the poverty level. If the movie were done now, the character

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played by Gregory Peck would be demanding ten times that amount! Fifty years of inflation make a big difference.

Adjusting for inflation is very useful when the case being analyzed takes place over a time period when there was a great deal of inflation. The danger in ignoring inflation when doing financial analysis is that one can miss key data signaling a corporation’s slow decline over time. Chief executive officers wish to keep their jobs and will tend to bias figures in their favor, especially in annual reports. Sales and profits stated in current or historical dollars (or whatever currency is being used) may seem to show substantial growth, but when they’re converted to constant dollars (or whatever currency is being used), they may show a steady decline.

There are two methods of adjusting for inflation. One is to use whatever base year is being used in that country. In the United States, 1967 has been used as the base year for many years. It equaled 100 and other years were adjusted around it. Given that in the United States (like any other country), politicians dislike people seeing how much inflation has been occurring, a new, more recent base year (1982–84) has been selected to replace 1967—a simple, but insidious disguise. Dividing sales and net income by the CPI factor in Table 13.2 for a particular year will change the reported figures to 1982–84 constant dollars. Another approach is to adjust previous years in a financial statement using the most recent year as the base year, again using an index of inflation like the Consumer Price Index (CPI). Divide the CPI factors for the other years by the one for the most recent year to obtain the appropriate adjustment factors to use in dividing into the reported figures for the previous years.

12-7.

How can you learn what date a case took place?

The student needs to place him/herself into the timeframe of the case. This is especially important when the student is going to do some outside research. Most instructors want the student to stay within the timeframe of the case and not do research on what actually happened after the case. Check the beginning and ending paragraphs of the case to see if a date is mentioned. If no date is given, check to see the date of the financial statements given in the case. It can be assumed that the case took place a couple months or so after the end of the year when the financial statements were put together. The date of the case is not the same as the date the case was written or copyrighted (as listed at the bottom of the first page of the case).

ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS These are not found in the text and may be used by the instructor for classroom discussion or exams.

A13-1. What are the pros and cons of using the strategic audit as a framework for case analysis?

The advantages of using the strategic audit are presented clearly in the chapter. Its limitations are, however, not so obvious. Like everything else in the world, a technique’s strengths can also serve as its weaknesses. For example, Chapter 1 states that the strategic audit provides a checklist of questions, by area or issue, that enables a systematic analysis of various corporate activities to be made. The problem with any checklist is that the user may tend to use it almost automatically. Even though all the questions in the audit may not be relevant to a specific situation, a person may unthinkingly use them without considering that there may be other, perhaps more important questions that need to be raised but are not on the list of questions.

The value of asking this question is to get students to realize that the strategic audit is only a tool to help them organize their analysis. Use this question as an opportunity to remind them that it is up to them to develop whatever questions are most appropriate to the case under consideration and not to do their analysis on “automatic pilot.”

SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE Convert the 1992 and 1991 income statements of Maytag Corporation into common-size statements. What does this reveal?

This is a simple exercise to ensure that the class knows how to do a common-size income statement. You would be surprised how many students failed to learn this in previous classes. An examination of the 1991 and 1992 commonsize income statements reveals some useful information. First, even though sales increased from 1991 to 1992, cost

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of sales as a percentage of net sales also increased. This suggests that either the company was less efficient in 1992 or that, because of heavy competition, the company could not raise prices to make up for higher costs of inputs.

Selling, general, and administrative expenses dropped, which are good signs. Reorganization expenses are a onetime-only expense (hopefully) and don’t indicate any trend. The same is true of the accounting change for postretirement benefits. Interestingly, these two one-time expenses totaled $382,004 and caused the firm to lose money. When these two expenses are subtracted from net income, the company would have had a $66,650 profit instead of a $315,354 loss. Nevertheless, a profit of $66,650 is only 2.19% of net sales, still lower than the 2.66% of 1991—not a good sign. To learn if this is a trend, the student must check the common-size income statements from other years.

COMMON-SIZE INCOME STATEMENT: MAYTAG CORPORATION 1992

%

1991

%

Net Sales

$3,041,223

100.00

$2,970,626

100.00

Cost of sales

2,339,406

76.92

2,254,221

75.88

Gross profits

701,817

23.08

716,405

24.12

Selling, general, admin expenses

528,250

17.36

524,898

17.67

Reorganization Expenses

95,000

3.12

-------

-----

Operating income

78,567

2.58

191,507

6.45

Interest expense

(75,004)

(2.46)

(75,159)

(2.53)

Other—net

3,983

0.13

7,069

0.23

7,546

0.25

123,417

4.15

Income taxes

(15,900)

(0.52)

(44,400)

(1.49)

Income before account changes

(8,354)

(0.27)

79,017

2.66

Effects of account changes for postretirement benefits

(307,000)

(10.09)

-------

-----

Net income (loss)

$(315,354)

(10.36)

$79,017

2.66

Income before Taxes and Accounting Changes

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ADDITIONAL TEACHING SUGGESTIONS AND MATERIALS Following are some teaching suggestions and materials you may find helpful in teaching the business policy/strategic management course. These may be of some value to you. Feel free to use them as-is or modify them to suit your needs.

• The first is a suggested assignment to get students to do ratio analysis and to construct scenarios.

• The second is a way to use EFAS and IFAS Tables and SFAS Matrixes to boost class participation in case discussion.

• The third is an example of a “cut sheet” for use in evaluating oral and written case presentations.

• The fourth is a handout entitled Understanding Financial Statements. It can be used as a handout for students who need to improve their knowledge of financial analysis, rations, and so on, and is available for download as a Word file from Pearson’s website, www.pearsonhighered.com/wheelen.

• The fifth is a computer program called The Strategy Wizard. It is a short executable file that students can also download from www.pearsonhighered.com/wheelen for use with this book.

I.

ASSIGNMENT FOR RATIO ANALYSIS AND SCENARIO CONSTRUCTION

This is an assignment developed by Tom Wheelen to force students to learn how to do ratio analysis and to construct scenarios. He uses this at the beginning of case analysis so students will be able to use these techniques in their case analyses later in the course.

Ratio Analysis: Compare the last year of financial ratios for the case to the ratios of the industry. List any ratios that you feel are significant or important. You should include the ratio from the case and the industry, a definition of the ratio, and what that ratio means to the company in the case. To find the industry ratios, first locate the Standard Industrial Classification (SIC) for the company. The SIC can be found in the Standard Industrial Classification Manual.

Industrial Norms and Key Business Ratios, by Standard and Poor’s, lists industry ratios by SIC. Be sure you use the industry ratios for the same year as the ratios in the case.

Scenario Construction There will be three paragraphs for the scenario. The first paragraph will cover the economic conditions for the time period after the case (3–5 years). You should include economic statistics. The second paragraph will cover the industry outlook for the company in the case. The last paragraph will cover the outlook for the company in the case for the next 3–5 years. Explain why you chose your pro forma percentages in light of your strategic factors and implementations.

You can use Moody’s Industrial Manual, Value Line Investment Survey, economic books, or other sources to find this information. Be sure to give the sources for all the information you used.

II.

IMPROVING DAILY CLASS PARTICIPATION USING EFAS, IFAS, AND SFAS

We have sometimes found it difficult to get quality daily class participation from our undergraduate students after assigning a case for open class discussion. We suggest the following: 1. Have each class member prepare individually or as a team (a) EFAS and IFAS Tables, and an SFAS Matrix or (b) just an SFAS Matrix for the assigned case.

5 .

2. Ask each class member to write down his/her Total Weighted Score(s) for the case under discussion on a separate sheet of paper, sign it, and hand it in to the instructor.

3. Ask various individuals to list on the board the items, ratings, and weights for each form to be discussed. Discuss how the weights and ratings were determined.

4. Compare the Total Weighted Scores listed on the board with those listed on the papers handed in earlier. Ask the students to defend their ratings.

5. Ask the students if they would buy stock in or take a job with this company. The Total Weighted Scores now seem to take on real meaning.

III.

USING A CUT SHEET TO GRADE ORAL AND WRITTEN CASE PRESENTATIONS

On the next page is an example of a “cut sheet” Tom Wheelen developed to help his teaching assistants grade oral and written case reports in his strategic management course. The cut sheet is very useful for grading case reports in large classes. The total number of points available is 67 points.

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Cut Sheet for Written/Oral Presentations 67 = 100 A+ 66 = 98.5 65 = 97.0 64 = 95.5 A 63 = 94.0

62 = 92.5 A61 = 91.0 60 = 89.5 B+ 59 = 88.0

58 = 86.5 B 57 = 85.0 56 = 83.5 B55 = 82.0 54 = 80.5

53 = 79.0 C+ 52 = 77.5 51 = 76.0 C 50 = 74.5

WT. PRESENTATION/LOGICAL ORDER

5

ADDRESS TOP MANAGEMENT

1

PAST PERFORMANCE

4 4

MISSION OBJECTIVES STRATEGIES POLICIES

4

BOARD OF DIRECTORS TOP MANAGEMENT

4

SOCIETAL (O&T) TASK (O&T) CORPORATE STRUCTURE (S&W)

8 CORPORATE CULTURE (S&W) MARKETING (S&W) FINANCE (S&W) RESEARCH & DEVELOPMENT (S&W) OPERATIONS (S&W) HUMAN RESOURCES (S&W) MANAGEMENT INFORMATION SYSTEMS (S&W) STRATEGIC FACTORS

8

STRATEGIC ALTERNATIVES

4

RECOMMENDATION (PRIORITY)

8

EVALUATION & CONTROL

4

RATIO ANALYSIS

2

SCENARIO

5

PRO FORMA

1

EXHIBITS

5

7 .

49 = 73.0 C48 = 71.5 47 = 70.0 46 = 68.5 D+ 45 = 67.0

44 = 65.5 D 43 = 64.0 42 = 62.5 D41 = 61.0 40 = 59.0

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