Chapter 7

Deciding What to Do

Models for Strategy Formulation

Introduction

Chances are, most of you describe strategy as a plan—that is, what you are going to do. In the prior five chapters, you have developed methods that led you to thoroughly analyze what is happening in and around an industry. These conclusions or findings will help you build a basis for strategy selection. However, you can’t do everything that might be possible, and trying to do too much can be counterproductive. All firms have limited resources and capabilities, and some choices preclude others. That is, if you choose to do A, you cannot do B, and vice versa—so which is best? Why? Worse yet, it is often the case that managers make choices that conflict with decisions made at other times or by other managers in the firm. This means that parts of the firm work at cross-purposes, reducing efficiency and hampering competitiveness. The purpose of this chapter is to work through some models or approaches to consistency and coherence in your strategic codices.

Ultimately, strategy does involve planning in the sense that managers need to understand how the firm will compete and how, or if, it can achieve alignment with environment and industry. As we’ll see later, the window for planning, and the specificity of decisions, can vary widely depending on the industry. However, in any event, it would be a mistake to regard strategy formulation as just a planning exercise. This doesn’t capture the complexity or subtlety of strategy as a practical discipline. Effective strategy is not simply a planning exercise or a thing done once. Rather, it is a cycle of analysis, formulation, implementation, assessment, and adjustment. Strategy formulation, or planning, is one element of the process, and in fact, it may not even be a discrete part; it can be coevolving with the other elements.

Organizations need strategies for a variety of reasons other than mapping a future. A consistent and effectively communicated strategy can bind the members of the firm together by coordinating action. That is, a good strategy makes it possible for more organization members to act effectively without explicit guidance because they know what to do and why. Strategy also reduces uncertainty for managers. Finally, it can create, or at least should create, a lens or framework through which events in the industry or environment can be assessed. Managers don’t just acknowledge these events but think about what they will mean to the firm. As Michael Treacy and Fred Wiersema note, the choice of how to compete “shapes every subsequent plan and decision a company makes, coloring the entire organization…[and]…defines what a company does and therefore what it is.”¹

In this chapter, we will first consider what a strategy should address in terms of scope. Thus, we will examine some well-known approaches to theories of strategic type from Porter, Miles and Snow, and Treacy and Wiersema.

Defining Strategy

The type of strategy we will discuss in this chapter is business strategy, or strategic business unit (SBU) strategy, which is distinct from corporate strategy. Business strategy focuses on a specific product and market, which means we can deploy all the analysis we’ve done to that end. Corporate strategy is about how to co-ordinate the activities of the diversified firm, which we will address later. A common approach to the form of a business level strategy includes the following three elements.²

First, establish the scope of the strategy. Who are the customers? Are you going to address all consumers or buyers or a subset of them? Is this demographically based or geographic? What do they value? This is, as we’ve seen in the discussion of how the industry firms solve customer problems and in the discussion of substitutes, a complex issue. Customer needs can have many dimensions and therefore many ways of solving them.

In addition, the scope of the strategy should also include how you solve the problem: The nature of the product or service the firm will provide. Define the value proposition of the product/service for customers.

Second, establish the means, or how the firm is to create and deliver the product or service. This is where managers can take advantage of the industry and resource analyses to intentionally carve out unique or at least rare positions because these are required for competitive advantage. As we’ll see, this might call for the continued use of existing resources or the creation or acquisition of new ones to take advantage of opportunities. The strategy might also call for actions that shore up firm assets or positions that are under attack by others or subject to obsolescence. We’ll cover a general way to think about alignment and types of investments in this chapter.

Third, establish objectives or ends. Strategy requires a goal that can be assessed. An old saying goes: If you don’t know where you are going, any road will do—and this is true of businesses. Without a strategic goal, managers really don’t know if they are doing right. The goals might be intermediate steps toward an overall desired position. So, for example, managers in an industry where scale and fixed costs are important might target a specific market share. A goal for another firm might be to be the most profitable firm in the industry. Think about how these goals differ and what they would mean to the firm if communicated properly: How would share-driven firms see sales opportunities differently than profit-centered firms? Should the differences cause managers and sales reps to behave differently from one firm to the other? Finally, the goals need to be time bound or have a fixed end point. This doesn’t mean that managers have to develop five- or ten-year plans: Goals here might be relatively near term, depending on the volatility of the industry.

When you’ve fleshed out and answered these questions, you will likely have some statements and ideas that can be organized as a first pass at defining what your strategy is. Figure 7.2 is a general schematic for how that might look:

The goal is competitive advantage, so note how you need to identify the resources (based on your analysis of the industry, your firm, and your competitors) that would get you there. Do you own these resources or do you need to acquire them? Strategy is thus that set of decisions that gets you on your way to above-average performance. Implicit here is the notion of means, or why to choose some resources rather than others. This is the confusing, must-make-a-choice part, but there are general ways of creating or formulating a strategy based on a consistent means approach. We’ll address three popular strategy typologies or classifications. According to their respective authors, strategic types can focus thinking and efforts to attain certain ends and also warn us from other approaches that may not be effective. In other words, these models can guide strategic choice.

Porter’s Generic Strategies

Porter’s generic strategies are well known enough that the concepts have entered general business language. According to his model³ (see Figure 7.2), firms can pursue the strategy of being the low-cost producer in an industry, or alternatively, firms can pursue a strategy of producing products or services for which buyers are willing to pay a price premium called, as we’ve seen before, differentiation. Porter also acknowledges that both sorts can be pursued on a smaller (focused) scale. The useful idea from a “how do we create a strategy” point of view is that to pursue either sort of strategy, there are some actions or investment decisions that make sense, meaning they are consistent with the strategy, and some that do not.

Cost Leadership Strategies

Firms seek to be the low-cost producer in an industry (i.e., the means to competitive advantage). This should automatically make successful cost leaders above-average performers because at any given price level, the cost leader will have lower cost, hence higher profits and profit margins (see Figure 7.4). As Porter notes, though, that all firms including cost leaders have to produce products comparable to others in terms of product features and quality. In other words, there is a lower limit to features and benefits that buyers are willing to accept. Typically, there is one cost leader in an industry (though in some industries, a number of firms can be quite close in cost structure).

A cost leader’s advantage derives from having the lowest cumulative cost in performing value activities compared to other firms across the industry. To clarify, Porter introduces the idea of the value chain, or sequence of steps performed, to transform inputs to outputs. Recall from chapter 5 (Figure 5.1) how the firms in an industry are part of a value chain extending from suppliers (and their suppliers) to buyers (and their buyers, as well). In that figure, the firms in the industry are treated as a black box, but in Figure 7.3 that box is opened. The sequence of steps illustrates how a firm generally adds value to the inputs it purchases and then sells to buyers. A firm may not perform all these steps—for example, sales and marketing or service may be outsourced—or may perform many more, as vertically integrated firms are wont to do. Nonetheless, the basic idea is that firms perform a set of activities in their businesses, and these steps have costs associated with them. In practice, the goal is to accurately describe the steps and the size, growth, and cost drivers associated with each activity—as well as develop an idea of how the competition does it. This is what activity based costing does.

Porter identifies a number of significant cost drivers (i.e., behaviors that affect how costly an activity is). These include the following:

• Economies of scale. Average costs decline as output increases. Porter observes that economies of scale can be found in almost all value activities but are not all equally significant. Note that diseconomies (i.e., increasing average costs) can also occur as activities grow large.
• Learning. This is more inclusive than strict learning curves (LCs) and includes harder to quantify experience. Thus, product design changes, production layout modifications, and even the resident experience of large but comparatively rare projects can yield learning cost savings.
• Pattern of capacity utilization. Activities with large fixed-cost components like plant and equipment will exhibit differing cost behaviors depending on capacity utilization or the extent to which the capital is used. For instance, in a cyclical production environment, a firm may choose a capacity to handle the greatest demand or a capacity to handle a lesser level and rely on inventory as a buffer.
• Linkages. These address relationships between parts of the value chain and how a higher level view can optimize costs. It may make sense, for example, to increase the costs of one step if it reduces the cost of another driver by an even larger amount. For example, paying more for higher quality inputs may reduce quality inspection and repair time. Similarly, to use the earlier example, holding inventory may be less costly than adding or maintaining production capacity for seasonal extremes. Linkages also refer to relationships with value activities outside the firm, such as with suppliers or buyers.
• Timing. First movers can capture or create important positions (like brand name and subsequent lower per-unit marketing costs) or learning effects. On the other hand, later movers can enter with new technologies or avoid legacy costs (such as labor contracts or pensions) or free-ride on the market developing moves of pioneers.
• Discretionary policies. These reflect what the managers of the firm actually decide to do on issues, such as product/service features and performance, service level, delivery time, warranty policy, human resource polices, and the like. Remember that firms must offer products/service that meet a minimum level of features and quality, so managers are not entirely free to choose—but, policy can make a difference in costs.

Firms can pursue a cost leadership strategy by changing the cost position of the firm so as to make total costs for the value-added steps performed comparatively lower than competitors. This requires control of cost drivers or developing a new value chain. To control the cost drivers, though, you have to understand how they actually work well enough to intervene. As Porter notes, it also important to understand how much each driver contributes to overall cost: The greatest benefit to intervention and control comes with the largest drivers. To illustrate, in the discount retail industry, Wal-Mart has implemented control mechanisms in several ways. The distribution center approach allowed the company to buy in larger amounts, gaining some purchasing economies. Wal-Mart was also a first mover in its rural stores, thereby shutting out competition and achieving lower per-store real estate costs. The company also learned greatly, from investments in IT, to manage personnel costs at sales and at inventory control and reordering.⁴

Firms can also modify or develop a new value chain. This probably requires even more analysis and insight than driver control does because it requires additional detailed understanding of how alternative structures would work. Chain reconfiguration can include deploying automation, new distribution channels, new production processes, and the like. Again, Wal-Mart provides an excellent example with the reconfiguration of supply and inventory. The usual practices in the discount retail industry were to order and ship on a store-by-store basis and hold the inventory at that store for eventual shelving. Wal-Mart developed a new chain wherein receiving and shipping are centralized at distribution centers, and stores are regionally served by deliveries. One result is that very little inventory is held at the store level (10% of store square footage versus 25% industry average). In addition, Wal-Mart’s innovations in cross docking means that little inventory actually exists anywhere in the system. These changes to the typical value chain have provided significant savings to the company.

There are threats to a cost leadership strategy. These strategies are not intrinsically inimitable and competitors achieve similar cost position by deploying the same sorts of technologies or practices (if the gains to first movement are not great). Another problem arises when new production technologies emerge and the investments cost leaders have made are rendered obsolete, if only in certain markets. The emergence of minimills in the steel industry as cost-effective competitors to the larger, integrated mills was based on the development of the electric arc furnace, an innovation of the 1960’s and 1970’s. The new technology changed the cost competitiveness of incumbents dramatically and for the worse.⁵ Cost leaders also run the risk of losing contact with the minimum features and the quality standards for the product, especially as consumer tastes evolve.

To summarize, firms can pursue cost leadership strategies by investing in the resources and capabilities that allow them to control cost drivers. These firms will be most interested in issues like capacity, scale, efficiency, productivity, the development side of R&D, and so on.

Differentiation Strategies

Firms pursuing this approach focus on attaining advantage through product or service attributes that buyers value enough to pay a price premium compared to the product/service offerings in the industry. The caveat here is that costs have to be around that of the competition. If that happens, differentiators can earn above-average returns because at any given cost level, differentiators have higher revenues, hence higher profits. There can be multiple successful differentiators in an industry because each can choose to emphasize a unique or particular bundle of attributes. Note well that differentiation exists only in the mind of the buyer: Firms can claim their products or services are differentiated but if consumers don’t see it that way, they won’t be willing to pay the defining price premium. On the other hand, no matter how interesting or unique you consider a firm’s approach to competition, if it is not charging (and getting!) a price premium, it is not pursuing a differentiation strategy.

Buyers will perceive value when they determine that the product or service will reduce their costs or increase their satisfaction compared to competing products. In either case, the firm can capture part, but not all, of that value with a higher price. For example, firms can reduce buyer costs by offering lower financing costs (but remember, the firm offering this is absorbing a cost here) or make the product more efficient (think about the premium hybrid cars were getting when gas prices went up) or make the product more reliable. Firms can increase satisfaction by appealing to buyer needs for prestige or status (especially true in luxury items), by providing product customization such as bespoke or tailored clothing or emphasizing the quality of inputs, as Jim Koch does with the hops and barley malt that go into Sam Adams beers. Another approach is to focus on the reliability of outbound logistics as FedEx does or no-question product returns in customer service for firms like L.L.Bean or Orvis. Porter advocates analyzing the value chain to seek or create specific differentiation drivers. These can include the following:

• Policy decisions. Firms make choices about product or service features and how the product or service is delivered or communicated to the buyer. For example, the firm might position itself as a turnkey or full service provider (thereby absorbing some of the customer’s set up costs), advertise more heavily than competitors, and so on.
• Location. Firms may dominate particular areas and thereby be more convenient. Wal-Mart, as observed earlier, pioneered stores in rural areas. Wal-Mart is very price competitive when in direct competition with K-Mart or Target but when a Wal-Mart store is not near other stores, product prices are higher by roughly 7%.⁶ Comparatively speaking, this still provides value to buyers as the higher prices are more than offset by the additional time and cost of driving to more competitive, suburban areas.
• Timing. Especially in brand or image issues, building that image early and reaching a customer set can pay off.
• Linkages. These, again, occur between stages of the value chain internally and between the firm and its upstream and downstream partners. From an internal perspective, product quality may be a cost issue for the producing firm as described earlier, but it is also a perception issue for buyers, which is why, in the automotive industry, the J. D. Power Initial Quality Study matters so much. To the extent that the firm co-ordinates linkages to improve quality through control measures such as total quality management or through superior inputs and processes, then this is reflected in higher customer satisfaction with the product.

A firm can pursue a differentiation strategy through creating or defending rareness in how it performs value chain activities, or it can reconfigure the value chain in a useful way. Some examples of the first approach include:

Making the product fit the buyer’s intended use criteria better. If the product is easier to use or if the firm provides training that helps buyers more easily master complex usage, this can justify a price premium. This is not a job for technical experts in the product—what is usually needed here is investment in personnel bridges between the technical knowledge and the user (who usually thinks rather differently from the expert).

Managing the buyer’s perception through product signaling. Signals are indictors that lead people to draw conclusions about product or service attributes and value. These include the appearance, packaging, and placement of products; advertising and brand building; customer sets and influential users; and the like. The important thing here is how these characteristics guide the thinking of potential buyers, which means what these signals should be and how they are delivered ought to be central to a differentiation strategy. Advertising and marketing are investments in resources!

Identifying important new or unknown purchase criteria. Managers that can identify these have found a set of unmet or undeserved needs, which can lead to effective new products. This requires substantial research work with customers.

Identifying and responding to channel and buyer developments. When buyers are changing (becoming more sophisticated, for example, or using new channels such as the Internet), firms can create differentiation by changing how those buyers are addressed. More sophisticated buyers may value sales techniques that better acknowledge or use buyer knowledge. In construction products industries, for instance, engineers are influential and respond to longer-term, relationship-based selling. Supporting such a sales force requires investments and measurements that are very different from “one-off” selling structures.

Firms can also pursue changes in the value chain to create differentiation. Thus, developing new channels (as Disney has historically done by theme parks to leverage characters) or integrating forward (as Apple has done by opening company stores) varies the traditional value chains in interesting and profitable ways.

Differentiation strategies can be threatened. Firms may charge too great a price premium for products or services. If the price exceeds the benefit to buyers, they won’t buy. Differentiation can also be too costly, and when it is, profits are eroded—even if the firm gets a premium price. A common problem is that managers underestimate the need to signal value, arguing that the product/service qualities are self-evident. Relatedly, managers might convince themselves that product features are the same as benefits when buyers don’t see it that way. Firms may also miss changes or evolution in buyer criteria. In the last chapter, the case of IBM as a leader in the personal computer business was used to illustrate how IBM’s brand name created value in the new product market because it signaled competence and reliability when buyers were uncertain about the technology. Thus, when buyers began to figure out that PCs were based on Intel microchips and Microsoft operating systems, which were not proprietary to any one PC maker, and that any computer using these components was roughly equivalent, IBM’s brand lost strength. The computer clone producers were able to thrive (and IBM fail) because buyers no longer derived sufficient value from IBM’s knowledge of computers to offset the price.

To summarize, crafting a differentiation strategy will require identifying customers or customer sets (their purchasing and use criteria), devising products and service configurations that meet those criteria, and developing means of signaling those configuration characteristics to buyers. These firms will be more interested in issues like marketing and promotion, research (though development is also very important), and quality (or perceived quality).

Focus Strategies

In focus strategies, firms keep a very narrow or limited arena (target segments) of competition. This could be a geographically based segment or demographic. Firms can pursue either cost leadership or differentiation strategies here, and the criteria addressed earlier apply. There are two potential pitfalls. First is distinguishing between differentiation and focused differentiation. The latter is concerned not with general product attributes but with segments that have special needs. The example Porter uses to illustrate is IBM as a differentiator in the computer industry and Cray, Inc., as a focused differentiator. Perhaps an alternate might be Toyota as a differentiator serving multiple niches and Bugatti or Lamborghini as a focused differentiator. The second pitfall is failing to be certain that the focus niche is actually different from the general niche (as opposed to simply being part of it). This might be the problem for firms pursuing a geographic niche against firms that have national coverage. In order for this to work, the markets have to differ some.

Stuck in the middle is Porter’s term for firms that are not disciplined enough to pursue one strategy and end up making investments in pursuit of two, usually uncoordinated, strategies. Porter broadly argues that firms cannot simultaneously be cost leaders and differentiators because the typical investments for one strategy conflict with investments for the other. Thus, firms that pursue both generally underperform because they are neither cost leaders nor successful differentiators. At any given price level, then, their costs are not the lowest, and simultaneously, at any given cost level their prices are not the highest. They are, in fact, getting squeezed in profits from both ends which makes them perform worse than successful implementers of either strategy. Still, per Porter, there are a few conditions under which firms can be both: if all other competitors are stuck in the middle, if the firm pioneers a significant innovation, or if cost is determined by market share and differentiation helps achieve greater share. Additionally, research in the automotive industry shows that Toyota and Honda have achieved cost leadership positions, and they still claim differentiated price premia in their product classes. That is, unlike other car manufacturers they were able to avoid a cost, quality tradeoff, and produce reliable, high-quality cars at low cost. This is attributed, in part, to the deployment of lean production techniques, such as just-in-time inventory, cellular manufacturing, and so on. Since these techniques are broadly available to manufacturers, hybrid strategies should not be limited to Porter’s limits.⁷

Miles and Snow’s Typology

Another well-known strategy typology is that of Raymond Miles and Charles Snow.⁸ From their perspective, strategy is about aligning the organization with the environment (i.e., given the opportunities and threats in the environment and industry, what resources do managers need to best fit in the industry). Strategy is also about sustaining such coalignment but because conditions keep changing, this is a moving target.

Miles and Snow argue that the process of sustained alignment with the environment requires that managers be sensitive to industry dynamics. That is, conditions change and organizations ought to change to reflect that. Their model of the adaptive cycle illustrates the decisions managers must continuously and simultaneously face and resolve.

The entrepreneurial problem is concerned with what to sell. In other words, managers addressing this are making a commitment to a particular product-market domain, or what is sold to whom, which is an answer to the definition of strategic scope. From an adaptation perspective, one of the serious challenges is that changes outside often affect the value of the entrepreneurial solution (see PEST from chapter 3, for example), which means that it must be revisited to realign products or services with needs. The volatility of the industry (that is, how fast changes in the problem buyers have or the solutions to it are developed) matters greatly.

The engineering problem deals with how to make or produce the entrepreneurial solution. These are the choices of production technologies, distribution, and production control and communication systems. This also bears revisiting because new technology production processes arise, as do challenges to efficiency of the current approach (e.g., volume increases might make investing in more automated production feasible while standing pat could be costly)

The administrative problem centers around how to systematize or routinize the successful activities developed in pursuit of the entrepreneurial and engineering problems. In other words, mangers want to avoid reinventing the wheel. At the same time, managers have to be cautious not to stifle creativity and innovation. Therefore, the administrative problem calls for choosing the right mix of systems and processes to best meet environmental demands.

Based on the adaptive cycle and the responses managers choose, Miles and Snow describe a range of strategies firms can employ. These are organizational types that occupy a spectrum from strategic Defenders to Prospectors (see Figure 7.6).

Defenders are firms that desire a stable product or service market. Their solution to the entrepreneurial problem is usually a narrow offering in terms of who is served and with what. The focus of growth is deeper into the existing market, not into new markets. The Defender’s solution to the engineering problem is to become exceedingly efficient technologically, usually leveraging a single core production technology. The administrative problem is one of control and efficiency where finance and production staffs tend to be the most powerful. The Defender organization is usually hierarchical where reporting structures matter and built along functional lines, such as production or sales, etc. The executive group tends to have risen through the company ranks and is therefore long tenured and planning driven. A key assumption for the strategist in the Defender mode is that the environment is fairly stable. The noteworthy strategic investments will usually be in production capital and processes.

A benefit to this approach is that if successful, Defenders are difficult to dislodge. The drawback is that industry shifts in customer needs or production technologies can be very disruptive.

Prospectors are, in general, the opposite of Defenders. The entrepreneurial challenge is to identify and exploit new market opportunities through new product or service introduction. For Prospectors, the product or service line should constantly be evolving and changing. The competitive environment is perceived as dynamic and a key role is monitoring (e.g., PEST and industry assessments) to respond effectively. Given the entrepreneurial issues, the engineering approach is to keep production flexible. In contrast to Defenders, there is comparatively little mechanization or routinization; production will be more like a job shop with technologies that are often prototypical. The administrative problem is one of co-ordination and facilitation. Prospector governance structures tend to be less hierarchical and formal and are organized around projects and product lines. The dominant management personnel are from marketing and R&D. Strategic investments will be in monitoring and fast product development.

The Prospector strategy is responsive to change, but there can be profitability problems emerging from product line proliferation and cost. Extensive product lines add significant management overhead. Moreover, since the firm is not heavily invested in one production technology or has chosen general rather than focused technologies so as to switch if need be, average costs can be adversely affected. Growth for Prospectors tends to be in spurts or irregular, which makes cash flow management more difficult. Internal coordination is likely to be tough, as there are many fairly autonomous agents.

Analyzers are very much a middle ground between Defenders and Prospectors and exhibit characteristics of both. Their entrepreneurial problem is to respond to new market opportunities and maintain the current loyal customer base. Growth is through line extensions and attacking new markets. They address the engineering problem with a “dual technological core” that seeks to balance high efficiency and high responsiveness. In other words, Analyzers have committed to more rationalized production than Prospectors but are not solely cost or efficiency focused in the way Defenders are. The administration problem is really structural: How can management control the dynamics of both approaches? In this strategy, marketing and production staffers share power and influence. The organizational structure tends to matrix management where managers have responsibilities in both product groups and functional roles.

Even though Analyzers emphasize stability and flexibility simultaneously, there is a limit to how far they can go in either direction, which means they can get outflanked by more specialized strategies on either cost or customer responsiveness as the industry or environment evolves. Trying to maintain two different philosophies of competition and control simultaneously is exceedingly difficult. Thus, Analyzers that lose balance tend to be both inefficient and ineffective.

Outside the range of strategies lie Reactors, or organizations that do not engage their environment consistently. Miles and Snow argue the Reactor approach is not a strategy per se but the outcome of not pursuing one of the three main types properly. For Reactors, a failure to articulate or communicate the strategy can lead to uncoordinated investments and choices. Since all three of the mainline strategies impose consistency in investment and how to respond to the market, Reactors are a contrast in how they might respond in all ways at one time or another. Reactors have been described as comparatively dysfunctional.

Treacy and Wiersema’s Value Disciplines

In the 1990s, Treacy and Wiersema introduced their notion of value disciplines, or ways that firms can organize and execute to deliver specific value to a customer base.⁹ The big idea here is the focus on what customers value—a continuation of the work done in PEST analysis that asks us to identify the drivers of choice for customers.

Treacy and Wiersema develop their classification scheme by contrasting a customer cost focus (that is, an overall cost position, which includes the purchase price plus maintenance, service, and convenience—or inconvenience—costs) with a benefits focus. Benefits are the attributes of the product or service that improve the performance or experience of the customer through product features, reputation, or service, such as advice or customization. From this, three goals emerge: Customers want the best price, the best product, or the best overall solution. Treacy and Wiersema argue that these goals can be met through the appropriate three value disciplines (or organizing structures) which are defined as operational excellence, product leadership, and customer intimacy. These are distinct ways by which managers can focus their organizations and align efforts and investments. As they point out, firms cannot please all customers, so the choice of which set to target will have significant effects on what the firm looks like. Thus, they focus on how the driving ideas behind each discipline should be reflected in operating processes and focus, organizational structure, management systems, and culture.

Table 7.1. Treacy & Wiersema rules

Value discipline rules of competition

• Focus on excelling in one dimension of customer value and

• Achieve at least basic competence in the other two dimensions (can’t drop below!)

• Improve year after year in the value discipline – stay ahead of imitators

• Organize the firm to deliver the value

Operational Excellence: Deriving the Best Total Cost

The value proposition for customers in this approach is the guaranteed low price. This price isn’t necessarily what gets paid at the register (a point-of-purchase price); it could also be the price paid over the lifetime of the product. Lifetime costs could include, above and beyond the immediate tangible expenditures, service (or the avoidance thereof—remember the Maytag repairman?) or trouble free customer service and support. In either event, operationally excellent (OE) firms will understand what customers really do want. To deliver that price, however, firms need to focus on streamlined and efficient processes to achieve lowest total cost. The four organizational dimensions of operational excellence are the following:

• Core processes. Offering a limited set of products and services. This simplifies acquisition of inputs, production processes, and training. For example, Southwest Airlines offered short-haul, point-to-point flights (no transcontinental or international flights), no checked bags, no meals, and tended to serve smaller, regional airports. This simplicity allowed them to use a single model of small and efficient planes, use small crews, and take advantage of regional airports comparative lack of traffic and congestion—all of which helped Southwest become the most efficient carrier at capital utilization. Clearly, this does not appeal to all customers but when it does, it can very effective.
• OE firms tend to have a structure that is centrally controlled with carefully planned operations. There is often little latitude for independent decision making left to employee discretion. High-level skills tend to be centralized.
• Management systems are typically oriented around reliable, fast, integrated transactions. Wal-Mart is an example used by the authors because of the way it redesigned the transaction process from order to sale and moved toward continual replenishment rather than a classic stocking inventory approach.
• The culture of the OE firm usually emphasizes efficiency and consistency. Firms that have developed these cultures also tend to make them egalitarian so that the ideas of frugality and efficiency are extended through all levels. This is critical if employees are to buy in. For instance, Nucor Steel offered few, if any, special perks to executives (such as parking spots) and operated company headquarters in a North Carolina strip mall. Lincoln Electric also eliminated many hierarchical differences to develop the attention to shared efficiency. These include no assigned parking spaces for executives and all employees eat in the same dining room. Finally, from a hiring perspective, OE firms want trainable people who will buy into the company values.

Product Leadership: Providing the Best Product

The value proposition of the product leadership (PL) firm is to provide products that push or exceed existing performance boundaries and to keep doing it. These firms have to be agnostically creative or willing to identify and implement good ideas whether internally or externally developed. The also have to be very fast to market, and willing to leapfrog or cannibalize their own products before cash flows from current winners are exhausted. For this approach, successful Product Leaders can expect to command price premia for what they do.

• The core processes of PL firms focus on both invention and commercialization, whether by taking advantage of existing market opportunities or creating them. Clearly, this requires not only creative and technical product or process skills but also an equivalent commitment to skills in marketing and market development—otherwise the new product gets lost in the general background noise. A good example of how this is done is the Walt Disney Company after Michael Eisner assumed control. Eisner revitalized the animated film division with releases like The Little Mermaid, Aladdin, and The Lion King. Among other issues, Eisner invested $30 million in a new computer animated production system that helped cut the development cycle time for animated features from 4 or 5 years to 12 to 18 months.¹⁰ Further, Disney aggressively developed new marketing approaches, such as the trailer for The Lion King, which was the first 12 minutes of the film; built strong internal coordination across divisions by introducing new characters to division heads to facilitate exploitation of the characters in multiple venues; and coordinated licensing opportunities with external partners like Burger King or Mattel.¹¹
• The structure of PL firms tends toward the loosely structured organization, often with temporary, project driven structures. In contrast to OE firms where skills are usually concentrated in central positions, in PE firms they are evident throughout the organization. In this project-based environment, managers organize around intermediate milestones and outcomes on tight deadlines.
• Management systems are oriented around results in new product success. The idea is to maintain an appropriately risk-oriented frame of mind—to reward experimentation and not punish failure (as long as it is clear lessons from failure are learned and applied).
• PL cultures value and encourage accomplishment, imagination, and creativity. From a recruiting and selection point of view, this can mean a focus on the unconventional thinker if not outright mavericks. This can be very difficult to do as it calls for hiring people you may not like or that you believe will not fit well in your firm—yet it is these characteristics that provide the needed innovation and creativity.¹²

Customer Intimacy: Providing the Integrated Solution

The value proposition for firms pursuing excellence in customer intimacy (CI) is that they can provide customers with more than just product or a salable service. Rather, they focus on the total needs of the customer to provide the best total solution. This works best for customers who don’t know what they really need—or are addressing symptoms rather than underlying causes. Thus, CI firms need to be able to diagnose needs and deliver results, which often entails much more than core products or services. Often, training, customization, service, or creative purchasing and financing might be involved. This means that CI firms have to be very selective about customers: Pure transaction oriented customers are not wanted because they can cut out the proposed value. What pays is a longer term, very engaged relationship in which the client retains some dependence on the skills and knowledge of the CI firm. The value for the CI firm is the premium it can charge for a package of goods and services.

• The process focus is on identifying suitable customer candidates and developing them. That is, CU firms help the customer learn what the real problem is and what the solution should be. Further, CI firms invest in getting the solution delivered properly through production and service groups that are client driven rather than, say, technology driven. IBM (already referred to in chapter 6 and used as an example by Treacy and Wiersema) is one of the best historic examples. In his history of IBM, Kevin Maney quotes technology historian Stan Augarten on the differences in approach:
  • When a team of IBM salesmen called on a customer, they worked hard to show how the installation of an IBM computer would get the payroll out faster, keep better track of sales, boost efficiency, and save money.
  • When a group of UNIVAC salesmen visited a client, however, they tended to harp on technological matters—mercury delay lines, decimal versus binary computation—that went right over the heads of their customers, who were chiefly interested in the answer to one question: What will a computer do for me?¹³
• The structure of CI firms pushes decision making down to the employees closest to the customer. Obviously, this can be a risk, but the argument is that no one knows better than the person in the field (and that person will possess high-level skills) as to what will keep the client. In addition, the physical structure of the CI firm will often be different with representatives sharing business space with the client so as to provide superior service.
• Management systems are oriented around developing and maintaining satisfaction in a small set of carefully selected clients. The important metric is share of that customer’s relevant expenditures and retention.
• The CI culture values behaviors that lead to customer satisfaction and strong relationships rather than strict (short-term) sales and revenues. As always, selection for the right personalities and attributes will be key, but even more important is the training that creates the expertise the customer needs.

Mintzberg’s Critique of Strategy

There are some criticisms of this analysis, planning, investment, and structuring approach. One issue that critics (particularly Henry Mintzberg)¹⁴ have of this planning approach is that it makes the assumption that there really is a choice for managers. Do managers really choose a “best” way or are they constrained by past decisions and are merely validating them with the current plan? This is the crux of the strategy as planning problem: Strategic investments are often long term and they definitely affect organizational structure and processes (think about the investments and commitments that have been made). However, to the extent that the environment or market or completion doesn’t play along with expectations, it may be hard to change directions. It is costly to stop or reverse strategic trajectories and managers might also have prestige, firm tradition, and other (nonstrategic) issues wrapped up in the decision. Thus, once managers start down a particular strategic path, it is not clear that they really choose strategies later—they just endorse prior decisions.

Another critique from Mintzberg is concerned with the real-world problem of thinking versus learning where thinking implies that the strategic problem can be rationally approached and all relevant knowledge gathered before making the decisions. Learning implies that conditions reveal themselves or change forms over time. Mintzberg questions, in particular, the validity of possessing really adequate knowledge in advance. This has several implications. First, differences between the world that’s envisioned in the plan and the world as it eventually comes to be realized leads to gaps in and failure of implementation of the strategy. Managers are scrambling to be effective based on current knowledge, even if that means varying from the formal idea. The second problem is that this sort of a priori planning might ignore what he terms “emergent” strategy or the way that managers sometimes find a real and strong pattern in what they do that was not explicitly anticipated. This often comes from success in solving immediate but recurring problems. For example, it is doubtful that Sam Walton envisioned the efficient organization Wal-Mart was to become in the late 1960s when he tried to solve the delivery and inventory problems that his stores in small towns faced. The distribution center (and subsequent changes in inventory management, cross docking, etc.) was a solution to an immediate problem that eventually became institutionalized as strategy.

These are powerful criticisms, yet the core ideas of strategic thinking remain. The three models you read about in this chapter are useful ways of organizing a theory or story of what to do (and there are more!). The most important takeaway is that effective strategies will be internally consistent in aligning objectives, investments, and context. This is where the mindful approach becomes important: It is not enough to just create a strategy, but you also have to keep paying attention to what is happening in the world and reflecting on whether the assumptions that drove your particular strategic choices are still accurate and relevant. Then, strategy becomes dynamic.

Summary

After reading about these three theories of strategic types or approaches, you’ve probably figured out that while they are not identical by any means, they share a number of similarities. For example, Porter’s Cost Leader is much the same as Miles and Snow’s Defender and Treacy and Wiersema’s operationally excellent firms. Similarly, prospectors look much like Product Leaders. That’s useful because it means there is a lot of consistency across classification structures—which means the choice of approaches will be somewhat easier.

The two really important outcomes of these approaches are these: First, note how each scheme calls for an internally consistent set of decisions. To be a Cost Leader or an Analyzer or a Customer Intimate firm requires specific and interconnected sorts of resources, skills, and capabilities. Strategy is a set of investments and commitments that presumably leads to above-average performance, but without structure or consistency, these can be opportunistic, reactive, and disjointed. That will not serve you and does not amount to any kind of strategy. Thus, you have to make sure you understand the scope of the strategy (Whom will you serve? What do they want or need?) and how you are going to do this. Practically speaking, this is often an iterative process of narrowing down and more closely matching customer sets with skills and resources, both in hand and desired. At the end, what you want is clear and consistent definition of all the components.

The second outcome is to understand that these are not short-term solutions if you do not already find yourself as a clear example of a type. For example, in two models significant attention is paid to the cultures around each type. Culture takes years to build or shift because deep-seated beliefs and values have to change, and this is usually quite difficult. Even more difficult, sometimes, is changing upper management’s real values: Will they stick to a strategic vision, such as PL, if a quick sale can be had at a deep discount? Signals that the strategy is just lip service erode the effectiveness very quickly!

Finally, note how each of these models can act as the binding mechanism discussed earlier in the chapter. When it is developed and communicated well, and when the organizational structures, culture, compensation, and processes are aligned with it, strategy provides a lens on the world for members of an organization that reduces uncertainty and makes their jobs easier.