# Strategic Analysis: Understanding a Firm’s Competitive Environment

## A Firm's Micro Environment: Porter's Five Forces

1. What makes up a firm’s external micro environment, and what tools do strategists use to understand it?
A firm’s micro environment is illustrated in the green circle in . These entities are all directly connected to the firm in some way, and firms must understand the micro environment in order to successfully compete in an industry. All firms are part of an industry—a group of firms all making similar products or offering similar services, for example automobile manufacturers or airlines. Firms in an industry may or may not compete directly against one another, as we’ll discuss shortly, but they all face similar situations in terms of customer interests, supplier relations, and industry growth or decline.
Harvard strategy professor Michael Porter developed an analysis tool to evaluate a firm’s micro environment. Porter’s Five Forces is a tool used to examine different micro-environmental groups in order to understand the impact each group has on a firm in an industry (). Each of the forces represents an aspect of competition that affects a firm’s potential to be successful in its industry. It is important to note that this tool is different than Porter’s generic strategy typology that we will discuss later.

### Industry Rivalry

Industry rivalry, the first of Porter’s forces, is in the center of the diagram. Note that the arrows in the diagram show two-way relationships between rivalry and all of the other forces. This is because each force can affect how hard firms in an industry must compete against each other to gain customers, establish favorable supplier relationships, and defend themselves against new firms entering the industry.
When using Porter’s model, an analyst will determine if each force has a strong or weak impact on industry firms. In the case of rivalry, the question of strength focuses on how hard firms must fight against industry rivals (competitors) to gain customers and market share. Strong rivalry in an industry reduces the profit potential for all firms because consumers have many firms from which to purchase products or services and can make at least part of their purchasing decisions based on prices. An industry with weak rivalry will have few firms, meaning that there are enough customers for everyone, or will have firms that have each staked out a unique position in the industry, meaning that customers will be more loyal to the firm that best meets their particular needs.

### The Threat of New Entrants

In an industry, there are incumbent (existing) firms that compete against each other as rivals. If an industry has a growing market or is very profitable, however, it may attract new entrants. These either are firms that start up in the industry as new companies or are firms from another industry that expand their capabilities or target markets to compete in an industry that is new to them.
Different industries may be easier or harder to enter depending on barriers to entry, factors that prevent new firms from successfully competing in the industry. Common barriers to entry include cost, brand loyalty, and industry growth. For example, the firms in the airline industry rarely face threats from new entrants because it is very expensive to obtain the equipment, airport landing rights, and expertise to start up a new airline.
Brand loyalty can also keep new firms from entering an industry, because customers who are familiar with a strong brand name may be unwilling to try a new, unknown brand. Industry growth can increase or decrease the chances a new entrant will succeed. In an industry with low growth, new customers are scarce, and a firm can only gain market share by attracting customers of other firms. Think of all the ads you see and hear from competing cell phone providers. Cell phone companies are facing lower industry growth and must offer consumers incentives to switch from another provider. On the other hand, high-growth industries have an increasing number of customers, and new firms can successfully appeal to new customers by offering them something existing firms do not offer. It is important to note that barriers to entry are not always external, firms often lobby politicians for regulations that can be a barrier to entry. These types of barriers will be covered in greater depth in more upper level courses.

### Threat of Substitutes

In the context of Porter’s model, a substitute is any other product or service that can satisfy the same need for a customer as an industry’s offerings. Be careful not to confuse substitutes with rivals. Rivals offer similar products or services and directly compete with one another. Substitutes are completely different products or services that consumers would be willing to use instead of the product they currently use. For example, the fast food industry offers quickly prepared, convenient, low-cost meals. Customers can go to McDonald’s, Wendy’s, Burger King, or Taco Bell—all of these firms compete against each other for business. However, their customers are really just hungry people. What else could you do if you were hungry? You could go to the grocery store and buy food to prepare at home. McDonald’s does not directly compete against Kroger for customers, because they are in different industries, but McDonald’s does face a threat from grocery stores because they both sell food. How does McDonald’s defend itself from the threat of Kroger as a substitute? By making sure their food is already prepared and convenient to purchase—your burger or salad is ready to eat and available without even getting out of your car.

### Supplier Power

Virtually all firms have suppliers who sell parts, materials, labor, or products. Supplier power refers to the balance of power in the relationship between firms and their suppliers in an industry. Suppliers can have the upper hand in a relationship if they offer specialized products or control rare resources. For example, when Sony develops a new PlayStation model, it often works with a single supplier to develop the most advanced processor chip it can for their game console. That means its supplier will be able to command a fairly high price for the processors, an indication that the supplier has power. On the other hand, a firm that needs commodity resources such as oil, wheat, or aluminum in its operations will have many suppliers to choose from and can easily switch suppliers if price or quality is better from a new partner. Commodity suppliers usually have low power.

### Buyer Power

The last of Porter’s forces is buyer power, which refers to the balance of power in the relationship between a firm and its customers. If a firm provides a unique good or service, it will have the power to charge its customers premium prices, because those customers have no choice but to buy from the firm if they need that product. In contrast, when customers have many potential sources for a product, firms will need to attract customers by offering better prices or better value for the money if they want to sell their products. One protection firms have against buyer power is switching costs, the penalty consumers face when they choose to use a particular product made by a different company. Switching costs can be financial (the extra price paid to choose a different product) or practical (the time or hassle required to switch to a different product). For example, think about your smartphone. If you have an iPhone now, what would be the penalty for you to switch to a non-Apple smartphone? Would it just be the cost of the new phone? Smartphones are not inexpensive, but even when cell phone service providers offer free phones to new customers, many people still don’t switch. The loss of compatibility with other Apple products, the need to transfer apps and phone settings to another system, and the loss of favorite iPhone features, such as iMessage, are enough to keep many people loyal to their iPhones.
1. What makes up a firm’s external micro environment, and what tools do strategists use to understand it?
The second layer of a firm’s external environment is its micro environment, which includes the components of a firm’s industry, such as competitors, suppliers, and customers. Porter’s Five Forces of industry competition (industry rivalry, threat of new entrants, threat of substitutes, supplier power, and buyer power) capture the dynamic relationships between these components.


# Strategic Analysis: Understanding a Firm’s Competitive Environment

## The Internal Environment

1. How and why do managers conduct an internal analysis of their firms?
A firm’s internal environment is illustrated in  by the innermost orange circle. The internal environment consists of members of the firm itself, investors in the firm, and the assets a firm has. Employees and managers are good examples; they are firm members who have skills and knowledge that are valuable assets to their firms. Evaluating a firm’s internal environment is not just a matter of counting heads, however. Successful firms have a wide range of resources and capabilities that they can use to maintain their success and grow into new ventures. A thorough analysis of a firm’s internal situation provides a manager with an understanding of the resources available to pursue new initiatives, innovate, and plan for future success.

### Resources and Capabilities

A firm’s resources and capacities are the unique skills and assets it possesses. Resources are things a firm has to work with, such as equipment, facilities, raw materials, employees, and cash. Capabilities are things a firm can do, such as deliver good customer service or develop innovative products to create value. Both are the building blocks of a firm’s plans and activities, and both are required if a firm is going to compete successfully against its rivals. Firms use their resources and leverage their capabilities to create products and services that have some advantage over competitors’ products. For example, a firm might offer its customers a product with higher quality, better features, or lower prices. Not all resources and capabilities are equally helpful in creating success, though. Internal analysis identifies exactly which assets bring the most value to the firm.

### The Value Chain

Before examining the role of resources and capabilities in firm success, let’s take a look at the importance of how a firm uses those factors in its operations. A firm’s value chain is the progression of activities it undertakes to create a product or service that consumers will pay for. A firm should be adding value at each of the chain of steps it follows to create its product. The goal is for the firm to add enough value so that its customers will believe that the product is worth buying for a price that is higher than the costs the firm incurs in making it. As an example,  illustrates a hypothetical value chain for some of Walmart’s activities.
In this example, note that value increases from left to right as Walmart performs more activities. If it adds enough value through its efforts, it will profit when it finally sells its services to customers. By working with product suppliers (procurement), getting those products to store locations efficiently (inbound logistics), and automatically keeping track of sales and inventory (information technology), Walmart is able to offer its customers a wide variety of products in one store at low prices, a service customers value. Primary activities, the ones across the bottom half of the diagram, are the actions a firm takes to directly provide a product or service to customers. Support activities, the ones across the top of the diagram, are actions required to sustain the firm that are not directly part of product or service creation.

### Using Resources and Capabilities to Build an Advantage over Rivals

A firm’s resources and capabilities are not just a list of equipment and things it can do. Instead, resources and capabilities are the distinctive assets and activities that separate firms from each other. Firms that can amass critical resources and develop superior capabilities will succeed in competition over rivals in their industry. Strategists evaluate firm resources and capabilities to determine if they are sufficiently special to help the firm succeed in a competitive industry.

### Using VRIO

The analytical tool used to assess resources and capabilities is called VRIO. As usual, this is an acronym developed to remind managers of the questions to ask when evaluating their firms’ resources and capabilities. The four questions of VRIO, which focus on value, rarity, imitation, and organization, are illustrated in .
If each question can be answered with a “yes,” then the resource or capability being evaluated can be the source of a competitive advantage for the firm. An example will help you better understand the VRIO process.
Imagine that you are a top manager for Starbucks and you want to understand why you are able to be successful against rivals in the coffee industry. You make a list of some of Starbucks’ resources and capabilities and use VRIO to determine which ones are key to your success. These are shown in .
You look at your list and decide to pick a few of the entries to evaluate with VRIO ():
According to the evaluation above, Starbucks’ brand helps it compete and succeed against rivals, as does its excellent customer service. However, simply having a lot of locations globally isn’t enough to beat rivals—McDonald’s and Subway also have thousands of worldwide locations, and both serve coffee. Starbucks succeeds against them because of their brand and customer service.
1. How and why do managers conduct an internal analysis of their firms?
Managers cannot lead their firms to success without understanding what the firm is able to do. An analysis of the firm’s resources and capabilities, as well as its gaps, is essential in determining the best path forward for the firm. A good strategy for competitive advantage capitalizes on a firm’s key resources and capabilities, as identified and evaluated using the VRIO (value, rarity, imitation, and organization) analytical tool.
Resources and capabilities that satisfy VRIO criteria are the key things that a firm is best at, and these should be leveraged so the firm can compete against rivals.


# Strategic Analysis: Understanding a Firm’s Competitive Environment

## Competition, Strategy, and Competitive Advantage

1. What does it mean to compete with other firms in a business environment, what does it mean when a firm has a competitive advantage over its rivals, and what generic strategies can a firm implement to gain advantage over its rivals?
Now that you understand more about the environment that businesses operate in, let’s take a deeper look at exactly how they operate. Businesses exist to make profits by offering goods and services in the marketplace at prices that are higher than the costs they incurred creating those goods and services. Businesses rarely exist alone in an industry; competition is a usually a key part of any marketplace. This means that businesses must find ways to attract customers to their products and away from competitors’ products. Strategy is the process of planning and implementing actions that will lead to success in competition.
The analytical tools we discuss here are part of the strategic planning process. Managers cannot successfully plan to compete in an industry if they don’t understand its competitive landscape. It is also unlikely that a firm planning to launch a new product they are not equipped to make will be successful.

### Competition

Porter’s Five Forces model is centered around rivalry, a synonym for competition. In any industry, multiple firms compete against each other for customers by offering better or cheaper products than their rivals. Firms use PESTEL to understand what consumers are interested in and use VRIO to evaluate their own resources and capabilities so that they can figure out how to offer products and services that match those consumer interests and that are better in quality and price than the products offered by their competitors.
A firm is described as having a competitive advantage when it successfully attracts more customers, earns more profit, or returns more value to its shareholders than rival firms do. A firm achieves a competitive advantage by adding value to its products and services or reducing its own costs more effectively than its rivals in the industry.

### Generic Business-Level Competitive Strategies

When discussing business strategy, a business is a firm or a unit of a firm that centers its activities around one primary type of product or service line. Business-level strategy is the general way that a business organizes its activities to compete against rivals in its product’s industry. Michael Porter (the same Harvard professor who developed the Five Forces Model) defined three generic business-level strategies that outline the basic methods of organizing to compete in a product market. He called the strategies “generic” because these ways of organizing can be used by any firm in any industry.

### Cost Leadership

When pursuing a cost-leadership strategy, a firm offers customers its product or service at a lower price than its rivals can. To achieve a competitive advantage over rivals in the industry, the successful cost leader tightly controls costs throughout its value chain activities. Supplier relationships are managed to guarantee the lowest prices for parts, manufacturing is conducted in the least expensive labor markets, and operations may be automated for maximum efficiency. A cost leader must spend as little as possible producing a product or providing a service so that it will still be profitable when selling that product or service at the lowest price. Walmart is the master of cost leadership, offering a wide variety of products at lower prices than competitors because it does not spend money on fancy stores, it extracts low prices from its suppliers, and its pays its employees relatively low wages.

### Differentiation

Not all products or services in the marketplace are offered at low prices, of course. A differentiation strategy is exactly the opposite of a cost-leadership strategy. While firms do not look to spend as much as possible to produce their output, firms that differentiate try to add value to their products and services so they can attract customers who are willing to pay a higher price. At each step in the value chain, the differentiator increases the quality, features, and overall attractiveness of its products or services. Research and development efforts focus on innovation, customer service is excellent, and marketing bolsters the value of the firm brand. These efforts guarantee that the successful differentiator can still profit even though its production costs are higher than a cost leader’s. Starbucks is a good example of a differentiator: it makes coffee, but its customers are willing to pay premium prices for a cup of Starbucks coffee because they value the restaurant atmosphere, customer service, product quality, and brand.
Porter’s typology assumes that firms can succeed through either cost leadership or differentiation. Trying to combine these two, Porter suggests, can lead to a firm being stuck in the middle.

### Focus

Porter’s third generic competitive strategy, focus, is a little different from the other two. A firm that focuses still must choose one of the other strategies to organize its activities. It will still strive to lower costs or add value. The difference here is that a firm choosing to implement a focused strategy will concentrate its marketing and selling efforts on a smaller market than a broad cost leader or differentiator. A firm following a focus-differentiation strategy, for example, will add value to its product or service that a few customers will value highly, either because the product is specifically suited to a particular use or because it is a luxury product that few can afford. For example, Flux is a company that offers custom-made bindings for your snowboard. Flux is a focus differentiator because it makes a specialized product that is valued by a small market of customers who are willing to pay premium prices for high-quality, customized snowboarding equipment.

### Strategic Groups

When managers analyze their competitive environment and examine rivalry within their industry, they are not confronted by an infinite variety of competitors. Although there are millions of businesses of all sizes around the globe, a single business usually competes mainly against other businesses offering similar products or services and following the same generic competitive strategy. Groups of businesses that follow similar strategies in the same industry are called strategic groups, and it is important that a manager know the other firms in their strategic group. Rivalry is fiercest within a strategic group, and the actions of one firm in a group will elicit responses from other group members, who don’t want to lose market share in the industry. Take a look at : although all of the firms shown are in the retail industry, they don’t all compete directly against one another.
Although some cross competition can occur (for example, you could buy a Kate Spade wallet at Nordstrom), firms in different strategic groups tend to compete more with each other than against firms outside their group. Although Walmart and Neiman Marcus both offer a wide variety of products, the two firms do not cater to the same customers, and their managers do not lose sleep at night wondering what each might do next. On the other hand, a Walmart manager would be concerned with the products or prices offered at Target; if laundry detergent is on sale at Target, the Walmart manager might lose sales from customers who buy it at Target instead, and so the Walmart manager might respond to Target’s sale price by discounting the same detergent at Walmart.
1. What does it mean to compete with other firms in a business environment, and what does it mean when a firm has a competitive advantage over its rivals and what generic strategies can a firm implement to gain advantage over its rivals?
Competition is the battle for customers. Firms compete against rivals offering similar products and services and try to attract customers by making sure their product or service is a little better or less expensive than those of their competitors. The firm that is most successful in this battle, measured in terms of profitability or in terms of market share, has a competitive advantage.
Generic competitive strategies are the basic templates for organizing firm activities in order to achieve competitive advantage in an industry. A firm will perform value chain activities, such as marketing and research and development, in order to support the overall competitive strategy it has chosen.
Following a generic cost-leadership strategy requires that a firm try to save money throughout the value chain so that it can offer customers low-priced goods and services. In contrast, differentiators add value to their products and services while performing value chain activities so that they can charge premium prices to consumers.
A third generic competitive strategy, focus, is chosen in combination with one of the other two strategies by firms who decide to target smaller geographic or demographic customer groups.


# Strategic Analysis: Understanding a Firm’s Competitive Environment

## Strategic Positioning

1. What elements go into determining a firm’s strategic position?
A manager who has done all of the analysis described so far in this chapter has some decisions to make based on all of the information the analysis has revealed. A firm’s decisions on how to serve customers and compete against rivals is called strategic positioning. In order to develop its position, a firm combines its understanding of the competitive environment, including the firm’s own resources and capabilities, its industry situation, and facts about the macro environment. A strategic position includes a choice of generic competitive strategy, which a firm selects based on its own capabilities and in response to the positions already staked out by its industry rivals. The firm also determines which customers to serve and what those customers are willing to pay for. A strategic position also includes decisions about what geographic markets to participate in.
Most importantly, a firm’s strategic position should try to be unique in some way that competitors cannot imitate quickly or easily. Competitive advantage is achieved when a firm attracts more customers or makes more profit than rivals. This cannot happen unless the firm organizes its activities to provide customers with better value than rivals.
1. What elements go into determining a firm’s strategic position?
A firm develops a strategic position in response to the factors present in its competitive environment. Strategic analysis is essential in identifying and understanding the factors that a strategic position must address. The choice of strategic position factors in a firm’s key resources and capabilities when choosing a generic competitive strategy, product or service to be offered, target market, and geographic reach to compete successfully against rivals in an industry. To be successful in allowing a firm to achieve a competitive advantage in its industry, a firm’s strategic position should be different from its competitors’ positions in the same industry and should be hard for competitors to copy so that the firm’s competitive advantage lasts.

### Chapter Review Questions

1. Why do managers use strategic analysis?
2. What information does a SWOT analysis provide managers? What information might it miss?
3. Describe a firm’s macro environment and how managers use PESTEL to understand it.
4. What is a firm’s micro environment, and why is it important?
5. What is an industry, and how do Porter’s Five Forces help a manager trying to understand a firm’s industry environment?
6. What are firm resources and capabilities, and what information does VRIO provide about them?
7. When does a firm have a competitive advantage over its rivals?
8. What are generic competitive strategies, and how are they implemented in a firm’s value chain activities?
9. What do strategic group members have in common with each other? What impact do firms outside a strategic group have on those in that group?
10. How does strategic analysis help a firm develop its own strategic position? Why should that position be unique?

### Management Skills Application Exercises

1. (Analytical Skills) Assume that you have been hired by a local small-business consulting firm. You have been asked by your boss to review a proposal from a client who is considering opening a new Pilates and yoga studio in a trendy part of town. Because you know SWOT analysis, you have been asked to group the following attributes about the proposed business into a SWOT analysis:

2. (Interpersonal Skills) Your instructor may assign you to a small group, and you will receive either a “Team A” or “Team B” assignment. Team A groups will need to meet for 15 minutes in a face-to-face setting, while Team B members will meet electronically either by setting up a meeting via Skype or using text messaging on their cell phones. Team A members will need to set up a time and location for their meeting while Team B members will need to share their contact information with a team leader.
Your instructor will assign a company to discuss and report on. Team A will discuss a firm’s internal environment while team B will discuss the firm’s external environment. In class, each team will report its conclusions about its assignment and report on the benefits and challenges that meeting in person or electronically posed.
3. (Communication) Set up an interview with a manager at a local business who is involved in the strategic planning process at her company. Ask her what type of planning she is involved in (strategic, operational). Discover if she involves the employees who report to her in the planning process and how planning is tied to goal setting. Write a report on your findings. The interview should take no more than 15 minutes.

### Managerial Decision Exercises

1. Select three different businesses from different industries, such as a hospitality business (hotel, restaurant, fitness center), a manufacturing company, and a not-for-profit business. Perform a SWOT analysis for each business.
2. Perform a quick PESTEL analysis of the companies listed below. What is the largest risk for each of the companies? Assume that you had $100,000 to invest in one of more of these companies. Explain how you would allocate your investment and why you chose this particular allocation.

3. Technology has the ability to disrupt industries. You are involved in an industry that is undergoing change and disruption by taking this class. The traditional textbook industry is being disrupted by the availability of digital textbooks, and free textbooks such as this one are further impacting traditional textbook publishers. Place the following statements into Porter’s Five Forces model.

### Critical Thinking Case

### Tesla Aims for the Mass Market

Elon Musk cofounded Tesla in 2003 with the vision of making electric cars that could rival, and even replace, traditional gas-engine cars in the consumer marketplace. At the start of the 21st century, the external environment was beginning to show favorable signs for the development of electric cars: people were becoming more concerned about the environment and their carbon footprints, and gas prices were beginning a steep climb that had already spurred the sales of hybrid gas-electric cars such as the Toyota Prius.
The automobile industry was not responding to these environmental trends, instead relying on the fact that trucks such as the Ford F-150 and Chevrolet Silverado were still the two top-selling vehicles in America in 2003. Musk saw a different future for vehicles, and Tesla introduced the all-electric Roadster in 2008. Four years later, the more practical Model S was introduced, and Tesla sales began to climb.
As a new entrant in the automobile industry, though, Tesla faced several challenges. Manufacturing and distribution in this industry are extremely expensive, and Tesla had to develop the capability of efficiently manufacturing large quantities of cars. Tesla also had to establish dealerships for its cars, although it also decided to sell cars online, taking advantage of tech-savvy consumers’ comfort with online shopping. Perhaps Tesla’s greatest challenge was convincing consumers to trust the new technology of all-electric cars. Range anxiety became an actual term, describing people’s fear that their car batteries would run out before they reached their destinations. To combat this, Tesla developed an extensive network of charging stations so consumers could be confident that they could charge their cars conveniently.
Elon Musk has been a master of raising money to fund Tesla’s efforts to successfully enter the mainstream automobile manufacturing industry; so far, Tesla’s entry has cost billions of dollars. Tesla has also taken advantage of tax incentives to develop its charging stations and to sell its cars, because Tesla customers receive tax credits for the purchase of their cars. Tesla cars are not inexpensive, however, and that has limited their marketability. Most Americans cannot afford the Model S or more recent Model X’s high prices (up to and exceeding $100,000).
In 2017, Tesla launched the Model 3, designed to transform the car industry by being its first mass-market, affordable model. The company started taking “reservations” for the model in 2016, promising that it would arrive with a $35,000 price tag. By mid-2017, the reservations list had reached half a million customers, creating a new problem for Tesla. How could it possibly manufacture that many cars when production levels for all of 2016 were less than 84,000 cars?
2. What PESTEL factors supported Tesla’s success? Which factors posed challenges?
3. How has Tesla’s strategic position changed since it was founded in 2003?
4. What kind of responses would you expect from Tesla’s rivals in the automobile manufacturing industry to the Model 3’s popularity?
Sources: Tesla company website: https://www.tesla.com/ and investor relations site: http://ir.tesla.com/; Edmunds, “Top 10 Best Selling Cars in 2003.” https://www.edmunds.com/car-reviews/top-10/top-10-best-selling-vehicles-in-2003.html (updated May 12, 2009); Bill Vlasic, “In Pivotal Moment, Tesla Unveils its First Mass Market Sedan.” New York Times, July 29, 2017, https://www.nytimes.com/2017/07/29/business/tesla-model-3-elon-musk.html?ref=business.


# The Strategic Management Process: Achieving and Sustaining Competitive Advantage

## Introduction

### Learning Outcomes

After reading this chapter, you should be able to answer these questions:
1. What is the strategic management process?
2. What is the difference between a firm’s vision and its mission?
3. Why is strategic analysis important to strategy formulation?
4. What are strategic objectives, levels of strategy, and a grand strategy? How are they related?
5. How and why do managers plan? Why are goals important in the planning process?
6. How and why do managers evaluate the effectiveness of strategic plans?


# The Strategic Management Process: Achieving and Sustaining Competitive Advantage

## Strategic Management

1. What is the strategic management process?
In the previous chapter we focused on analyzing and understanding a firm’s competitive environment. In this chapter, we see how the information strategic analysis provides gets put to work. The strategic management process is the set of activities that firm managers undertake in order to try to put their firms in the best possible position to compete successfully in the marketplace. Strategic management is made up of several distinct activities, shown in . This chapter will detail the role each activity plays in developing and sustaining a successful competitive position.
While  presents strategic management as an orderly process. However, most top managers deal with all of the steps simultaneously; they engage in environmental scanning to update their analytical view of the firm, they are executing strategies formulated in the past, they are formulating strategies to execute in the future, and so on. While it is useful to discuss the strategic management process in a stepwise fashion, it’s important to point out that the cycle occurs such that everything is being done at once.
1. What is the strategic management process?
The strategic management process is the set of activities that firm managers undertake to put their firms in the best possible position to compete successfully in the marketplace. Strategic management is made up of several distinct activities: developing the firm’s vision and mission; strategic analysis; developing objectives; creating, choosing, and implementing strategies; and measuring and evaluating performance.


# The Strategic Management Process: Achieving and Sustaining Competitive Advantage

## Firm Vision and Mission

1. What is the difference between a firm’s vision and its mission?
The first step in the process of developing a successful strategic position should be part of the founding of the firm itself. When entrepreneurs decide to start a business, they usually have a reason for starting it, a reason that answers the question “What is the point of this business?” Even if an entrepreneur initially thinks of starting a business in order to be their own boss, they must also have an idea about what their business will do. Overall, entrepreneurs start businesses for a variety of reasons. A vision statement is an expression of what a business’s founders want that business to accomplish. The vision statement is usually very broad, and it does not even have to mention a product or service. The vision statement does not describe the strategy a firm will use to follow its vision—it is simply a sentence or two that states why the business exists.
While a firm’s vision statement is a general statement about its values, a firm’s mission statement is more specific. The mission statement takes the why of a vision statement and gives a broad description of how the firm will try to make its vision a reality. A mission statement is still not exactly a strategy, but it focuses on describing the products a firm plans to offer or the target markets it plans to serve.
 gives examples of vision and mission statements for the Walt Disney Company and for Ikea. Notice that in both cases, the vision statement is very broad and is not something a business could use as a strategy because there’s simply not enough information to exhibit out what kind of business they might be. The mission statements, on the other hand, describe the products and services each company plans to offer and the customers each company plans to serve in order to fulfill their vision.
An interesting thing to note about vision and mission statements is that many companies confuse them, calling a very broad statement their mission. For example, Microsoft says that its mission is “to help people around the world realize their full potential.” By the description above, this would be a good vision statement. However, Microsoft’s official vision statement is to “empower people through great software anytime, anyplace, and on any device.” Although the second statement is also quite broad, it does say how Microsoft wants to achieve the first statement, which makes it a better mission statement than vision statement.
Why are vision and mission statements important to a firm’s strategy for developing a competitive advantage? To put it simply, you can’t make a plan or strategy unless you know what you want to accomplish. Vision and mission statements together are the first building blocks in defining why a firm exists and in developing a plan to accomplish what the firm wants to accomplish.
1. What is the difference between a firm’s vision and its mission?
A firm’s vision is a broad statement expressing the reason for the firm’s existence and what it hopes to accomplish. The mission statement explains (still broadly) how the firm intends to fulfill its vision—for example, by stating what products or services the firm will offer or what customers it wants to serve.


# The Strategic Management Process: Achieving and Sustaining Competitive Advantage

## The Role of Strategic Analysis in Formulating a Strategy

1. Why is strategic analysis important to strategy formulation?
In the previous chapter, you read about the various levels of analysis that a manager carries out in order to understand their firm’s competitive environment. A strategic analysis of a firm’s external environment (the world, competitors) and internal environment (firm capabilities and resources) gives its managers a clear picture of what they have to work with and also what needs to be addressed when developing a plan for the firm’s success. Analysis comes early in the strategic process because the information a manager gets from the analysis informs the decision-making that follows. The information is so critical that entrepreneurs writing business plans (before the business even exists) do this analysis to understand if their business idea is feasible, and to understand how to position their business relative to existing competitors or potential customers in order to maximize their odds of success.  outlines just a few of the questions that strategic analysis tools can help answer.
As an example of how the strategic tools help inform decisions, look back at the Walt Disney mission and vision in . Imagine if you were Mr. Walt Disney today, and you wanted to start a company with a vision of making people happy in the 21st century. What products or services would you plan to offer? A PESTEL analysis would tell you that technology is an important part of entertainment and that sociocultural trends include people’s preference for on-demand entertainment, to be convenient and compatible with their busy schedules. Disney’s mission statement is broad enough about products and services to include a wide variety of offerings (they are thinking about the future too!), but if you were starting this company today, where would you start? Would you make movies for movie theaters, or develop a way to offer video entertainment online? Would you make console video games or phone apps? Who would your competition be, and what do they offer? How could you offer something better or cheaper?
Managers learn about the conditions that their business will have to operate in by doing strategic analysis, and understanding those conditions is required in order to develop the plans and actions that will lead to success.
1. Why is strategic analysis important to strategy formulation?
Strategic analysis produces information that managers need in order to develop appropriate strategies for their firms. A good strategy should use a firm’s resources and capabilities to stake out a position in the marketplace that sets it apart from competitors and enables it to successfully compete in the external environment.


# The Strategic Management Process: Achieving and Sustaining Competitive Advantage

## Strategic Objectives and Levels of Strategy

1. What are strategic objectives, levels of strategy, and a grand strategy? How are they related?
Once a strategic analysis has been completed, the next step in the strategy process is to establish strategic objectives. At this point, the manager has decided why the company exists and how it will try to fulfill its mission. Strategic analysis has provided information about customer preferences, competitors, and the firm’s resources and capabilities. Now it is time to start planning for success.

### Strategic objectives

Strategic objectives are the big-picture goals for the company: they describe what the company will do to try to fulfill its mission. Strategic objectives are usually some sort of performance goal—for example, to launch a new product, increase profitability, or grow market share for the company’s product.
 shows what might be some strategic objectives for Disney. To make people happy (Disney’s vision), Disney focuses on entertainment (its mission). Top executives then decide each year what entertainment products the company will offer. Because Disney is a large corporation (more on that shortly), it has a variety of resources available to create entertainment products to offer. For example, they may decide to release three movies this year, as well as build a new theme park and create five new shows for their television network. In reality, the strategic objectives at Disney are much more complex than this, because some of these choices involve long-term efforts (they cannot build a theme park in one year).

### Levels of Strategies

Once a firm has set its objectives, it then must turn to the question of how it will achieve them. A business-level strategy is the framework a firm uses to organize its activities, and it is developed by the firm’s top managers. Examples of business-level strategies include cost leadership and differentiation. These strategies are pursued by businesses with a single product or a range of products.
For example, imagine that you own a coffee shop. You aren’t Starbucks—you are a local shop in your neighborhood, and you run it yourself. You have employees, but you are the manager, owner, and all-around decision maker. While developing your vision and mission statements, you have already made some basic decisions about how your shop will operate. For example, you have chosen to either offer quick, inexpensive coffee (cost leadership) or a full-service coffee experience (differentiation). That decision impacts whether or not you choose premium or discount suppliers, how your shop is decorated, and how many employees you have to offer attention (service) to your customers. A business-level strategy guides a company in how they approach the activities in the value chain. Operations, for example, would focus on efficiency for a cost leader and focus on adding value for a differentiator.
When you develop strategic objectives for your shop, you will decide whether or not you want to try to attract more customers (grow), maintain your business at its current level, or shrink your business (perhaps you feel you don’t have enough time to spend with your family). If you decide that your objective is to grow, for example, you should set a specific target, say, to grow revenue by 10%. Once you set that specific objective, you can exhibit out exactly what business-level actions you will need to take to reach that target.
Even if a business is much larger than a local coffee shop, the strategic objectives pursued by these larger companies are not significantly different in concept. Large companies like Nike or Apple, which have many different business units, develop strategies at several levels. Each individual business unit (say Nike Basketball) will have a manager who decides the objectives for that unit, just as in the coffee shop example. However, the company as a whole will have a chief executive officer (the top manager for the company) who develops strategy for the entire corporation. Corporate strategy is the broadest level of strategy, and is concerned with decisions about growing, maintaining, or shrinking very large companies. At this level, business-level strategy activities, such as an advertising campaign to attract new customers for a single product line, are not going to be enough to significantly impact the company as a whole.
The corporate CEO essentially manages a group of businesses (unless the firm operates as one business unit) and develops strategies to create success for the overall group. Think of the group of businesses as an investment portfolio: investors try to have a diverse set of investments to spread risk and maximize the performance of the overall portfolio. On any given day, an investment that isn’t doing so well should be offset by one that is doing well. Corporate strategy tries to achieve the same thing, and CEOs have to weigh the pros and cons of each business unit and how it is contributing to the success of the overall corporation. For example, a company that has business units that do well in the winter (ski resorts) will try to also have business units that will perform in the summer (swimming pools) to reduce the risk of having periods of low revenue. One tool that corporate strategists use to understand how each of their businesses contributes to the corporation as a whole is the BCG Matrix, illustrated in .
The BCG Matrix gives managers a quick picture of which business units are doing well and which are not. The tool has recommendations for businesses in each quadrant—for example, a business in the dog quadrant should be sold or closed. Cash cows provide income to the corporation, and stars provide growth. A CEO is always trying to balance the group of business units throughout the quadrants to maximize overall corporate performance. Note that the BCG Matrix is not applicable for firm’s that operate in one business unit.
In order to achieve the scale of growth necessary to meet corporate strategic objectives, a CEO must find ways to develop entirely new business units or reach brand-new markets. For example, for Walmart to grow their 2017 revenue by 5%, they would need to add $25 billion in new revenue. That’s more revenue than opening some new stores could generate. CEOs have several ways of growing their corporations, as shown in .
In Walmart’s case, for example, growing has meant expanding their online capabilities to better compete with Amazon. They have acquired new companies to support this goal, including Shoebuy, Jet, ModCloth, and Flipkart to reach customers and increase their online product selection, as well as Parcel, to build delivery services.
International strategy is similar to corporate strategy because it is concerned with the large-scale actions involved in entering a brand-new geographic market. For companies operating internationally, strategic questions focus on how to successfully enter and compete in a foreign market. International strategy can combine with business-level or corporate-level strategies because a growth strategy at either scale can involve entering new markets in order to reach new customers.

### The Grand Strategy

At all three levels, companies choose a grand strategy in response to the first question they should ask themselves: does the firm want to grow, strive for stability, or take a defensive position in the marketplace? Often, the choice of a grand strategy is based on conditions in the business environment because firms generally want to grow unless something (like a recession) makes that difficult. Note that a grand strategy and a corporate strategy can overlap significantly.
1. A growth strategy involves developing plans to increase the size of the firm in terms of revenue, market share, or geographic reach (often a combination of these, as they can overlap significantly). Walmart is implementing a growth strategy with the acquisitions discussed in the corporate strategy section.
2. A stability strategy is a strategy for a company to maintain its current income, market share, or geographic reach. A firm usually works to maintain a stable position when the alternative is to lose ground in one of those categories, for example because of competition or economic factors. In today’s business environment, publicly held firms rarely aim solely to maintain the status quo, because shareholders and the stock market reward firm growth.
3. Firms pursue defensive strategies in the face of challenges. A company that is struggling may decide to shrink its operations to reduce costs in order to survive, for example. A company facing strong new competition may have to radically rethink its product offerings or pricing in order not to lose too much market share to the newcomer. A technological innovation may make a company’s products obsolete (or at least less attractive), forcing it to work to catch up to the new technology. Ford made a defensive decision when it recently decided to stop selling sedans in the United States because of slow sales compared to trucks and SUVs.

### Operationalizing a Grand Strategy

A firm operationalizes its choice of a grand strategy differently at each level of strategy (business, corporate, international). At the business level, a growth strategy means that the manager will have to develop ways to grow the business by developing new products or expanding the customer base for existing products, either at home or abroad. Expanding a corporation can take a wider variety of forms. The CEO can develop new businesses, expand to new countries, acquire or merge with competitors, or perform previously outsourced activities. International expansion can be accomplished by exporting goods to another country or by acquiring a similar firm in another country to establish the company’s presence in that country. In all three of these cases, the grand strategy would be growth, and the strategic objectives could be expressed in terms of revenue growth, profit growth, market share growth, or even share price growth.  outlines how a grand strategy can be used to develop specific company actions.
1. What are strategic objectives, levels of strategy, and a grand strategy? How are they related?
Strategic objectives are the big-picture goals for the company: what the company will do to try to fulfill its mission. These goals are broad and are developed based on top management’s choice of a generic competitive strategy and grand strategy for the firm. For example, cost-leadership and growth competitive and grand strategies will require managers to develop objectives for growing the firm in a low-cost way.
Business-level strategy is concerned with positioning a single company or business unit that focuses on a single product or product line. The primary business-level strategies are cost leadership and differentiation, as well as focus, which is combined with one of the other two strategies (focus-cost leadership, focus-differentiation).
Corporate-level strategy is concerned with the management and direction of multi-business corporations. These large firms make decisions about what businesses and industries to operate in so they can improve their overall performance and reduce the risk they would face if all of their operations were concentrated in a single business or industry. Corporate CEOs use the BCG Matrix to evaluate their portfolio of businesses and use corporate actions like acquisitions to make significant changes to their companies.
International strategy can be combined with either of the previous two strategies to incorporate international operations into a business or corporation. International strategy answers questions of what country or countries to operate in and how to be successful in foreign operations.
Grand strategies outline an approach to firm growth. The three grand strategies are growth, stability, and defensive, and a firm chooses one of these approaches in addition to their choice of business-level, corporate, and/or international strategies. The choice of grand strategy is often dictated by conditions in the business environment such as recessions or competitor activities.


# The Strategic Management Process: Achieving and Sustaining Competitive Advantage

## Planning Firm Actions to Implement Strategies

1. How and why do managers plan? Why are goals important in the planning process?
When managers create strategies, they are making plans for how their firm will compete in the marketplace and what actions the firm will have to undertake to compete. A plan is a decision to carry out a particular action in order to achieve a specific goal. A plan includes decisions about when and how actions should be accomplished and what resources will be required to complete the actions. Because planning is one of the basic functions of management, a good manager should have good goal-setting skills, technical knowledge about the tasks necessary to reach goals, time-management skills, and the organizational skills required to arrange company resources to be available to complete the planned tasks. Planning is a combination of deciding what needs to be done, figuring out how to do it, assigning roles to people and providing them the resources to complete their tasks, and overseeing the work to make sure it gets done correctly and in a timely manner.

### Goal Setting

To examine the planning process, we need to start by understanding what the planning is for. A goal is something that you are trying to accomplish, and any firm will have many items on its list of things to accomplish. Consider the situation of a Walmart store in a college town. When it’s time for students to arrive back to school in the fall, the store needs to be ready with all the products students need when they move in. The Walmart store manager will plan months in advance and use information learned from the previous year’s sales to decide what products to order and how many, and when to have extra staff in the store to efficiently check out increased numbers of shoppers. Note that since Walmart is a global firm, goals will likely be prescribed from a higher level and the store manager’s responsibility would be to functional strategy response.
The manager’s plans will take into account the lead time for ordering products to make sure that mini-refrigerators and twin XL sheets arrive and can be stocked in the store in time for the back-to-school rush. Preparing for the back-to-school season may involve reducing prices on other items to get them out of the way to make room for all those small refrigerators, and hiring and training additional employees so that there will be enough associates to help students and their parents. The manager’s ultimate goal is to have a successful back-to-school sales season, but achieving that goal will involve completing tasks such as making product-selection decisions, meeting ordering deadlines, and setting intermediate goals for hiring and training additional employees.

### Setting Good Goals: The SMART Framework

Good goals have a few common characteristics, and  presents a framework for creating good goals.
The SMART framework can be applied to business or personal goals. A good goal should be specific, measurable, achievable, relevant, and time-bound.
Say you want to do well in this class. You need to turn that into a specific goal, because “doing well” is a little vague. Make the goal more specific by stating that your goal is to get an A in this course. Is this goal measurable? Well, yes: grades are good examples of performance measures. Is your goal achievable? That’s something you have to think about yourself: Do you usually get good grades? Are you able to put in the time to study the course material? Is the goal relevant to the achievement of a larger objective such as graduating with a good overall grade point average? If so, then getting an A in this class would contribute to that larger goal. Will you have time to accomplish your goal? Class-grade goals are inherently time-bound because the class ends on a certain date. So it’s possible that getting an A in this class is an overall SMART goal. To achieve it, however, you have to set some shorter term goals—for example, you should set a SMART goal for getting an A on the next exam.

### The Planning Process

 illustrates the planning cycle. It looks a lot like the strategy cycle shown in  because they have a lot in common. In fact, the planning process is an integral part of the strategy cycle, since developing objectives, creating strategies, and implementing firm-wide activities all require extensive planning.
The first step in planning is to set a goal to be accomplished. Making sure that the goal checks off all of the SMART criteria will help make the planning process easier and more likely to be successful, so be sure to spend some time developing a good goal.
Once you’ve figured out your goal, the next step is to design the plan. “Designing the plan” involves several distinct activities, so let’s break it down into what needs to happen. Think of planning as a problem-solving exercise. A plan is a set of actions developed to accomplish a goal, and planning is essentially figuring out what those actions should be. The goal is the end point, and the plan answers the question “How do we get there?”
When designing a plan, a manager may think of many ways to achieve a goal. They or she can have a group of employees brainstorm to come up with ideas. Not all of the potential ideas are likely to be feasible, however. Part of the manager’s task in designing a plan is to coordinate various ideas with a firm’s resources and capabilities and its time constraints (see ). When does the goal need to be accomplished? What other resources does the firm need to complete the project?
Designing the plan becomes a puzzle of figuring out what is the best way to reach a goal with the resources the firm has or can reasonably get in the time available. There is no prescription for this, and the best way to learn how to plan is to practice. Fortunately, you probably have a pretty good amount of practice already, because you’ve been planning in one form or another for a long time. You have planned study time, team practices, club events, and even meals. Strategic planning uses the same skills in a new context. Planning a product launch may sound complicated, but so is planning a wedding. The scale and scope of the things a manager must coordinate in order to reach company goals may be larger than what you are used to, but the specific skills are likely not new at all.
For example, let’s take a look at the challenge Tesla is currently facing.
Tesla has developed a mass-market car and has a line of about half a million customers waiting to buy one. Until now, Tesla has been more of a boutique car maker, manufacturing small numbers of cars that they are able to sell at high prices. The Model 3, however, has been specifically conceived as an affordable car that almost anyone can buy. The brand and reputation Tesla has built with its premium cars has generated a lot of enthusiasm and demand for this new model. So Elon Musk, CEO of Tesla, is planning to make cars in larger numbers and more quickly than ever before.
What’s Tesla’s goal? Manufacture cars at a rate of 500,000 per year in order to meet demand. Is this a SMART goal? Analysts around the world are arguing over this (is it achievable?), but it’s the goal that Tesla is focusing on, so Musk has to design a plan to reach that goal. What resources does Tesla need in order to reach this level of production? They developed a car that is easy to manufacture, because they knew that they would want to build it in large numbers. Still, they need manufacturing facilities, parts, and production employees. To get these resources, they need money. Elon Musk is a spectacular fundraiser, but they need billions of dollars to develop manufacturing capabilities on this scale. So while Tesla builds the world’s largest factory in Nevada, called the Gigafactory, Musk continues to raise funds.
Components (specifically the batteries) are also an issue for the Model 3, and Musk has built his giant factory in part to manufacture the hundreds of thousands of batteries needed to power the Model 3. Tesla’s planning involves many interrelated activities, and figuring out what the activities are, what resources Tesla needs to perform the activities, and how to obtain resources that they need but don’t have yet are the challenges Elon Musk is tackling. Tesla is a fascinating company that is multifaceted. There have been serious questions raised about their ability to produce enough cars and an examination of more recent commentary is encouraged.

### Implementing Plans for Different Levels of Firm Activity and Time Horizons

Developing plans happens simultaneously at multiple levels in any company. Plans, as in our earlier grade example, often require different steps in order to achieve a large-scale objective. If a firm decides on growth as a grand strategy, actions at every level of firm activity should contribute to firm growth, and managers at all of those levels should develop plans so that their part of the firm is working to implement the growth strategy. A grand strategy cascades throughout the company, becoming more and more specific, until front-line employees are working on specific tasks that support the grand strategy.
Time is an important consideration when top managers develop company goals and the plans to achieve them. In general, firms have two time spans that they plan for: short term and long term. A short-term strategic plan is one that can be accomplished in a year or sooner. A long-term strategic plan is developed when an objective cannot be accomplished in less than a year. Companies generally have both scales of plans in place at any given time: short-term plans might involve quarterly sales goals, for example, but a firm might have a longer-term goal of establishing operations in another country or building a new facility. Tesla’s Gigafactory and Apple’s new headquarters at Apple Park in Cupertino, California, are both multiyear, multibillion dollar projects, and so would be good examples of long-term plans. In Tesla’s case, the Gigafactory was initially planned many years ago when the company knew that it wanted to mass-produce cars at the scale required for the Model 3.

### Scale Levels of Planning

Another dimension that impacts strategic planning is scale. We have already looked at some large-scale planning concepts, such as business-level and grand strategies. However, the day-to-day planning that managers do to take steps toward those bigger objectives is key to achieving success.  shows the typical levels of planning going on in a company at any given time.
Notice that, if you compare  to , the “what” and “how” are switched. The switch is a scale switch. Vision and mission are both conceived at the broadest scale, and so even the “how” of the mission is a large-scale idea. In contrast, when managers are planning, the “how” of operational planning lays out precise actions and steps to follow to achieve a specific objective.
Let’s look at the levels one by one. Strategic planning is what we’ve been discussing so far. It’s the high-level planning performed by company executives in order to set the overall direction of the company. Grand strategies are part of strategic planning, as are business-level strategies such as cost leadership. Strategic planning connects the company’s actions back to its vision and mission statements (the “why does this company exist” question).
Tactical planning is mid-level planning that consists of broad ideas of what the company should do to pursue its mission. This is the sort of planning done by division managers. For example, Walmart division managers carry out the company’s growth and cost-leadership strategies by finding ways for the company to grow and continue to be able to offer low prices. They may decide where to locate distribution centers to maximize store-stocking efficiency, which manufacturers of goods they can buy inventory from at low prices, and where to build new stores to attract more customers.
Operational planning lays out the front-line activities that each employee in the company will do to advance the tactical plans. A McDonald’s restaurant manager develops operational plans, but you might recognize them more as employee schedules or promotional plans. Operational plans are the daily activities required for the company to function, including ordering inventory or supplies, scheduling workers and defining their work tasks, and developing sales goals and promotions to help achieve those goals. At McDonald’s, as at other companies that pursue a cost-leadership strategy, scheduling enough employees to work in the restaurant at specific times to keep the store functioning smoothly without scheduling more than you need (and incurring excess labor costs) is a critical task for the manager, and doing that task successfully is how the manager contributes to the company’s larger cost-leadership strategy.

### Implementing Planned Strategies

Implementation of planned strategies refers to the execution of a strategy by assigning tasks for people to carry out to accomplish the company’s strategic goals. Although a manager may talk about “implementing a differentiation strategy,” the real implementation of a strategy happens at the bottom of not just the strategy hierarchy, but the organizational hierarchy, in the actions of operational employees who carry out planned tasks that add value to the company’s product. Such tasks include research and development to add unique features, monitoring manufacturing to ensure company products meet high quality standards, and marketing the product to add brand value in the eyes of consumers.
1. How and why do managers plan? Why are goals important in the planning process?
Managers plan in order to decide what actions the firm will perform in order to achieve a specific goal. Planning includes decisions about when and how the goal should be accomplished and what resources will be required to perform the planned action. Planning is one of the basic functions of management, along with organizing, leading, and controlling.
Firms typically have several levels of planning happening simultaneously: one based on time and another based on detail. The time scale is expressed in terms of short-term (within the year) or long-term (over a yearlong) planning. Planning details become more specific as the manager moves downward in the hierarchy of planning levels. Strategic planning is the responsibility of firm leadership (CEO), while unit or division managers take the CEO’s broad plans and focus them to be more suitable for their own units (tactical planning). Operational planning is the frontline manager’s domain—they develop specific action plans for operational employees so that their work advances the entire firm towards the large-scale strategic goal.
Good goals are specific, measurable, achievable, relevant, and time-bound. These terms can be remembered by using the acronym SMART. Goals are critical to planning because they focus firm activities on specific objectives or outcomes.


# The Strategic Management Process: Achieving and Sustaining Competitive Advantage

## Measuring and Evaluating Strategic Performance

1. How and why do managers evaluate the effectiveness of strategic plans?
The last step in the strategy cycle in  is measuring and evaluating performance. The “M” in SMART goals is also about measurement. A company’s actions need to be measured so that managers can understand if the firm’s strategic plans are working. Any action in a plan should be designed so that the people performing the action and the manager who is supervising employees can understand whether or not the action is accomplishing what it was designed to. You have been living in this sort of framework all of your life. For many life goals, standards exist to measure achievements. For example, students are given standardized tests to see if they are learning what they are expected to, and the results are used to assess the effectiveness of education at all levels.
In businesses, measurement is also a fact of life. Investors decide whether or not to invest in a particular company based on its performance, and publicly held companies are required to disclose their financial performance so investors can make informed decisions. So the overall performance of a business is often defined by its financial measures, but how do they make sure their financial performance will make investors happy? Strategy. Firms make strategic plans in order to be successful. This chapter has explained the steps of making those plans, but a final step closes the circle of the strategy cycle. Checking to see if that success is happening is as important as making the plans in the first place.
Performance measurement comes in many forms, from financial reports to quality measures like defect rates. Any activity a firm can perform can have a performance measure developed to evaluate the success of that activity.  lists a few common firm objectives and how actions to achieve them might be evaluated. Evaluation involves setting a performance standard, measuring the results of firm activities, and comparing the results to the standard. One specific form of evaluation is called benchmarking, a process in which the performance standard is based on another firm’s superior performance. In the hospitality industry, for example, Disney theme park operations are used as standards for other companies in the theme park industry. Universal theme parks, for example, likely compare their customer satisfaction to Disney’s in order to evaluate whether or not they are also offering a superior park experience to their customers.
Performance evaluation closes the strategy cycle because of what managers do with the feedback they get in the evaluation process. When a manager compares performance to a standard, they are deciding whether or not the performance is acceptable or needs to be improved. The strategy cycle is a process managers use to achieve an advantage in the marketplace, and the measurement and evaluation stage tells managers whether the advantage is being achieved. If firm performance meets or exceeds objectives, then the manager reports the success to middle and upper-level managers. The company CEO may develop more ambitious objectives based on that success, and the strategy cycle starts over. If performance fails to meet objectives, the operational manager must develop new actions to try to meet the objectives or report to higher-level managers that the objectives cannot be met. In this case, a new round of operational planning begins, or upper managers examine their strategic plan to see if they need to make adjustments.
The strategy process is always circular. Performance feedback becomes part of the strategic analysis of the firm’s capabilities and resources, and firm leadership uses the information to help develop better strategies for firm success.
1. How and why do managers evaluate the effectiveness of strategic plans?
Performance evaluation is to determine if plans have been successful and identify any changes that might be necessary. This is done both at the end and the beginning of strategic planning because when managers measure firm activities and progress towards objectives, the information they learn by doing that measurement becomes part of the analysis they use to develop improved plans and objectives to keep the firm on track to fulfill their mission and improve their overall performance.

### Chapter Review Questions

1. What does a mission statement explain about a firm that a vision statement does not?
2. Describe the three levels of strategy and what a manager developing strategy at each level is concerned with.
3. Give an example for why a firm would pursue each of the three grand strategies.
4. What actions can help a firm grow?
5. What managerial skills and actions are included in the planning process?
6. Why are good goals important to the planning process?
7. What are the strategic planning time frames? How do they work together?
8. Why is performance measurement often the start of new strategy development?

### Management Skills Application Exercises

1. (Analytical Skills) You have recently completed a leadership development program, and your company has given you a retail store to manage. The employees at your store are diverse in terms of age, race, gender, and fluency in English. Your company has told you to set individual performance objectives for your employees to increase your store’s profitability.

2. (Ethical skills) You have probably experienced a situation in which you were not happy with the service you received as a customer of a business. Put yourself in the shoes of the manager of a business, and think about the following:

3. (Personal skills) Use the strategy cycle (

### Managerial Decision Exercises

1. Each of the following statements is a goal or objective, but it is not expressed very clearly. Rewrite each statement as a SMART goal, and be ready to explain what you had to change to make it SMART.

2. Entrepreneurs must be strategic thinkers in order to develop the plans and objectives necessary to start a business that will last. Imagine you are starting a new music-streaming service. You have decided to differentiate your service from the others already in the marketplace. Think of three ways to add value to your service and also the performance measures you’ll need to use in order to know if your added value is really valued by customers.

### Critical Thinking Case

### Interface Inc.’s Strategy for Sustainability

Watch Interface CEO Ray Anderson present his vision for Interface, Inc.:
https://www.youtube.com/watch?v=NskixbVn0BE
Interface, Inc. is the world’s largest manufacturer of carpet tile. Headquartered in Atlanta, Georgia, the global company manufactures the kind of carpet that millions of commercial buildings of all types have on their floors. Carpet manufacturing is a historically dirty business. Not only is commercial carpet a petroleum-based product, the manufacturing process is water-intensive, and carpet squares are installed using toxic glue. Because this carpet is aimed at the commercial market (think schools, libraries, malls, office buildings), it usually does not have a long life span. Malls and schools regularly remove and replace carpet after just a few years because of fading and wear from daily foot traffic. This puts millions of square feet of old carpet into landfills annually.
In 1994, Ray Anderson, the founder of Interface, was put on the spot when he was asked what his company was doing to be sustainable. He realized that the answer to the question was, unfortunately, “not much.” Anderson realized that in order to improve the company’s sustainability performance, Interface was going to have to radically reimagine every part of their business.
Unlike what many CEOs in his position might have done, Anderson decided to do just that. He gave Interface a new vision, which he called Mission Zero. The objective was to reduce Interface’s environmental impact to zero by the year 2020. To accomplish this vision, the company looked at every aspect of its operations and developed what it called the “Seven Fronts of Sustainability”:
To achieve the seven sustainability goals, Interface needed to redesign their operations from start to finish and even reconsider what constituted the start and finish for their products. Anderson empowered employees and invested in research to develop new ways to design, manufacture, and install carpet tiles. Interface also reimagined how its clients would use and dispose of carpet tiles.
Changing the strategy of a successful company is always risky, but Anderson felt he had to take the risk. Developing action plans for such a radical change meant that every step of the business had to be rethought, and Interface is on the way to achieving Ray Anderson’s vision. “Since January 2014, Interface's plants in Holland and Northern Ireland have been using around 90% less carbon and 95% less water than in 1996, with no waste going to landfill. Its plant in Scherpenzeel, Netherlands, has hit two of its zero targets.”
How has Interface made these changes? In addition to changing the way they thought about their product’s life cycle, Interface has implemented performance measures to track its progress and it has incentivized employees to be part of the company’s successful redesign. Connecting company actions to real cost savings was a key part of Ray Anderson’s vision. “Over time, programs that linked bonuses for employees at all company levels to reductions in waste started to put meat on the bones of Ray's ‘business case for sustainability.’” Interface’s costs have dropped as they have learned to use fewer resources to manufacture their products, and the cost savings have improved profitability even as Interface continues to invest in Mission Zero.
2. What reaction do you think employees had when Ray Anderson announced he wanted to change the company’s mission?
3. How would you turn the Seven Fronts of Sustainability into SMART goals?
4. How is tying rewards to improved sustainability performance a form of strategic control?
Sources: Interface Inc. company website: http://www.interfaceglobal.com/Company.aspx and sustainability site: http://www.interfaceglobal.com/Sustainability.aspx ; Thorpe, Lorna (2014). “Interface is a carpet-tile revolutionary.” The Guardian Sustainable Business. https://www.theguardian.com/sustainable-business/sustainability-case-studies-interface-carpet-tile-revolutionary; Davis, Mikhail (2014). “Radical Industrialists: 20 years later, Interface looks back on Ray Anderson's legacy.” Greenbiz.com. https://www.greenbiz.com/blog/2014/09/03/20-years-later-interface-looks-back-ray-andersons-legacy.


# Organizational Structure and Change

## Introduction

### Learning Outcomes

After reading this chapter, you should be able to answer these questions:
1. What are mechanistic versus organic organizational structures?
2. What are the fundamental dimensions of change?
3. How do managers deal with change?
This chapter will cover several concepts that deal with how leaders develop and shape organizations. An understanding of the concepts in this chapter is essential for leaders who need to pull people together to accomplish the essential work of a business in a consistent process over time. We will address the essential ideas.


# Organizational Structure and Change

## Organizational Structures and Design

1. What are mechanistic versus organic organizational structures?
First, an organizational structure is a system for accomplishing and connecting the activities that occur within a work organization. People rely on structures to know what work they should do, how their work supports or relies on other employees, and how these work activities fulfill the purpose of the organization itself.
Second, organizational design is the process of setting up organizational structures to address the needs of an organization and account for the complexity involved in accomplishing business objectives.
Next, organizational change refers to the constant shifts that occur within an organizational system—for example, as people enter or leave the organization, market conditions shift, supply sources change, or adaptations are introduced in the processes for accomplishing work. Through managed change, leaders in an organization can intentionally shape how these shifts occur over time.
Finally, organizational development (OD) is the label for a field that specializes in change management. OD specialists draw on social science to guide change processes that simultaneously help a business achieve its objectives while generating well-being for employees and sustainable benefits for society. An understanding of OD practices is essential for leaders who want to maximize the potential of their organizations over a long period of time.
Together, an understanding of these concepts can help managers know how to create and direct organizations that are positioned to successfully accomplish strategic goals and objectives.
To understand the role of organizational structure, consider the experience of Justin, a young manager who worked for a logistics and transportation company. Their success at leading change in the United States gave their leaders the confidence that Justin could handle a challenging assignment: organize a new supply chain and distribution system for a company in Northern Europe. Almost overnight, Justin was responsible for hiring competent people, forming them into a coherent organization, training them, and establishing the needed infrastructure for sustained success in this new market.
If you were given this assignment, what would you do? How would you organize your employees? How would you help them understand the challenge of setting up a new organization and system? These are the kinds of questions that require an understanding of organizational structure, organizational design, organizational change, and organizational development.
One of the first issues Justin will need to address deals with how they will organize the system. “The decisions about the structure of an organization are all related to the concept of organizational design. There are two fundamental forms of structure to remember when designing an organization.
To address these questions, we need to be familiar with two fundamental ways of building an organization.
The formal organization is an officially defined set of relationships, responsibilities, and connections that exist across an organization. The traditional organizational chart, as illustrated in , is perhaps the most common way of depicting the formal organization. The typical organization has a hierarchical form with clearly defined roles and responsibilities.
When Justin sets up the formal organization, they will need to design the administrative responsibilities and communication structures that should function within an organizational system. The formal systems describe how flow of information and resources should occur within an organization. To establish the formal organization, they will identify the essential functions that need to be part of the system, and they will hire people to fill these functions. They will then need to help employees learn their functions and how these functions should relate to one another.
The informal organization is sometimes referred to as the invisible network of interpersonal relationships that shape how people actually connect with one another to carry out their activities. The informal organization is emergent, meaning that it is formed through the common conversations and relationships that often naturally occur as people interact with one another in their day-to-day relationships. It is usually complex, impossible to control, and has the potential to significantly influence an organization’s success.
As depicted in , the informal organization can also be mapped, but it is usually very different than the formal organization. The chart you see in this example is called a network map, because it depicts the relationships that exist between different members of a system. Some members are more central than others, and the strength of relationships may vary between any two pairs or groups of individuals. These relationships are constantly in flux, as people interact with new individuals, current relationships evolve, and the organization itself changes over time.
The informal organization in Justin’s design will form as people begin interacting with one another to accomplish their work. As this occurs, people will begin connecting with one another as they make sense of their new roles and relationships. Usually, the informal organization closely mirrors the formal organization, but often it is different. People quickly learn who the key influencers are within the system, and they will begin to rely on these individuals to accomplish the work of the organization. The informal organization can either help or hinder an organization’s overall success.
In sum, the formal organization explains how an organization should function, while the informal organization is how the organizational actually functions. Formal organization will come as Justin hires and assigns people to different roles. They can influence the shape of the informal organization by giving people opportunities to build relationships as they work together. Both types of structures shape the patterns of influence, administration, and leadership that may occur through an organizational system.
As we continue our discussion of structure and design, we will next examine different ways of understanding formal structure.

### Types of Formal Organizational Structures

Now, Justin will need to choose and implement an administrative system for delegating duties, establishing oversight, and reporting on performance. They will do this by designing a formal structure that defines the responsibilities and accountability that correspond to specific duties throughout an organizational system. In this section, we’ll discuss the factors that any manager should consider when designing an organizational structure.

### Bureaucracy

One of the most common frameworks for thinking about these issues is called the bureaucratic model. It was developed by Max Weber, a 19th-century sociologist. Weber’s central assumption was that organizations will find efficiencies when they divide the duties of labor, allow people to specialize, and create structure for coordinating their differentiated efforts, usually within a hierarchy of responsibility. He proposed five elements of bureaucracy that serve as a foundation for determining an appropriate structure: specialization, command-and-control, span of control, centralization, and formalization.

### Specialization

The degree to which people are organized into subunits according to their expertise is referred to as specialization—for example, human resources, finance, marketing, or manufacturing. It may also include specialization within those functions. For instance, people who work in a manufacturing facility may be well-versed in every part of a manufacturing process, or they may be organized into specialty units that focus on different parts of the manufacturing process, such as procurement, material preparation, assembly, quality control, and the like.

### Command-and-Control

The next element to consider is the reporting and oversight structure of the organization. Command-and-control refers to the way in which people report to one another or connect to coordinate their efforts in accomplishing the work of the organization.

### Span of Control

Another question addresses the scope of the work that any one person in the organization will be accountable for, referred to as span of control. For instance, top-level leaders are usually responsible for all of the work of their subordinates, mid-level leaders are responsible for a narrower set of responsibilities, and ground-level employees usually perform very specific tasks. Each manager in a hierarchy works within the span of control of another manager at a level of the organization.

### Centralization

The next element to consider is how to manage the flows of resources and information in an organization, or its centralization. A highly centralized organization concentrates resources in only one or very few locations, or only a few individuals are authorized to make decisions about the use of resources. In contrast, a diffuse organization distributes resources more broadly throughout an organizational system along with the authority to make decisions about how to use those resources.

### Formalization

The last element of bureaucracy, formalization, refers to the degree of definition in the roles that exist throughout an organization. A highly formalized system (e.g., the military) has a very defined organization, a tightly structured system, in which all of the jobs, responsibilities, and accountability structures are very clearly understood. In contrast, a loosely structured system (e.g., a small, volunteer nonprofit) relies heavily on the emergent relationships of informal organization.

### Mechanistic and Organic Structures

Using the principles of bureaucracy outlined above, managers like Justin have experimented with many different structures as way to shape the formal organization and potentially to capture some of the advantages of the informal organization. Generally, the application of these principles leads to some combination of the two kinds of structures that can be seen as anchors on a continuum (see ).
On one end of the continuum is mechanistic bureaucratic structure. This is a strongly hierarchical form of organizing that is designed to generate a high degree of standardization and control. Mechanistic organizations are often characterized by a highly vertical organizational structure, or a “tall” structure, due to the presence of many levels of management. A mechanistic structure tends to dictate roles and procedure through strong routines and standard operating practices.
In contrast, an organic bureaucratic structure relies on the ability of people to self-organize and make decisions without much direction such that they can adapt quickly to changing circumstances. In an organic organization, it is common to see a horizontal organizational structure, in which many individuals across the whole system are empowered to make organizational decision. An organization with a horizontal structure is also known as a flat organization because it often features only a few levels of organizational hierarchy.
The principles of bureaucracy outlined earlier can be applied in different ways, depending on the context of the organization and the managers’ objectives, to create structures that have features of either mechanistic or organic structures.
For example, the degree of specialization required in an organization depends both on the complexity of the activities the organization needs to account for and on the scale of the organization. A more organic organization may encourage employees to be both specialists and generalists so that they are more aware of opportunities for innovation within a system. A mechanistic organization may emphasize a strong degree of specialization so that essential procedures or practices are carried out with consistency and predictable precision. Thus, an organization’s overall objectives drive how specialization should be viewed. For example, an organization that produces innovation needs to be more organic, while an organization that seeks reliability needs to be more mechanistic.
Similarly, the need for a strong environment of command-and-control varies by the circumstances of each organization. An organization that has a strong command-and-control system usually requires a vertical, tall organizational administrative structure. Organizations that exist in loosely defined or ambiguous environments need to distribute decision-making authority to employees, and thus will often feature a flat organizational structure.
The span of control assigned to any specific manager is commonly used to encourage either mechanistic or organic bureaucracy. Any manager’s ability to attend to responsibilities has limits; indeed, the amount of work anyone can accomplish is finite. A manager in an organic structure usually has a broad span of control, forcing her to rely more on subordinates to make decisions. A manager in a mechanistic structure usually has a narrow span of control so that they can provide more oversight. Thus, increasing span of control for a manager tends to flatten the hierarchy while narrowing span of control tends to reinforce the hierarchy.
Centralization addresses assumptions about how an organization can best achieve efficiencies in its operations. In a mechanistic structure, it is assumed that efficiencies will occur in the system if the resources and decisions flow through in a centralized way. In an organic system, it is assumed that greater efficiencies will be seen by distributing those resources and having the resources sorted by the users of the resources. Either perspective may work, depending on the circumstances.
Finally, managers also have discretion in how tightly they choose to define the formal roles and responsibilities of individuals within an organization. Managers who want to encourage organic bureaucracy will resist the idea of writing out and tightly defining roles and responsibilities. They will encourage and empower employees to self-organize and define for themselves the roles they wish to fill. In contrast, managers who wish to encourage more mechanistic bureaucracy will use tools such as standard operating procedures (SOPs) or written policies to set expectations and exercise clear controls around those expectations for employees.
When a bureaucratic structure works well, an organization achieves an appropriate balance across all of these considerations. Employees specialize in and become highly advanced in their ability to perform specific functions while also attending to broader organizational needs. They receive sufficient guidance from managers to stay aligned with overall organizational goals. The span of control given to any one manager encourages them to provide appropriate oversight while also relying on employees to do their part. The resources and decision-making necessary to accomplish the goals of the organization are efficiently managed. There is an appropriate balance between compliance with formal policy and innovative action.

### Business Structures

Aside from the considerations outlined above, organizations will often set structures according to the functional needs of the organization. A functional need refers to a feature of the organization or its environment that is necessary for organizational success. A business structure is designed to address these organizational needs. There are two common examples of functional structures illustrated here.
Product structures exist where the business organizes its employees according to product lines or lines of business. For example, employees in a car company might be organized according to the model of the vehicle that they help to support or produce. Employees in a consulting firm might be organized around a particular kind of practice that they work in or support. Where a functional structure exists, employees become highly attuned to their own line of business or their own product.
Geographic structures exist where organizations are set up to deliver a range of products within a geographic area or region. Here, the business is set up based on a territory or region. Managers of a particular unit oversee all of the operations of the business for that geographical area.
In either functional structure, the manager will oversee all the activities that correspond to that function: marketing, manufacturing, delivery, client support systems, and so forth. In some ways, a functional structure is like a smaller version of the larger organization—a smaller version of the bureaucracy that exists within the larger organization.
One common weakness of a bureaucratic structure is that people can become so focused on their own part of the organization that they fail to understand or connect with broader organizational activities. In the extreme, bureaucracy separates and alienates workers from one another. These problems can occur when different parts of an organization fail to communicate effectively with one another.
Some organizations set up a matrix structure to minimize the potential for these problems. A matrix structure describes an organization that has multiple reporting lines of authority. For example, an employee who specializes in a particular product might have both the functional reporting line and a geographic reporting line. This employee has accountability in both directions. The functional responsibility has to do with her specialty as it correlates with the strategy of the company as a whole. However, her geographic accountability is to the manager who is responsible for the region or part of the organization in which she is currently working. The challenge is that an employee may be accountable to two or more managers, and this can create conflict if those managers are not aligned. The potential benefit, however, is that employees may be more inclined to pay attention to the needs of multiple parts of the business simultaneously.
1. What are mechanistic versus organic organizational structures?
The organizational structure is designed from both the mechanistic and the organic points of view, and the structure depends upon the extent to which it is rigid or flexible. Flexible structures are also viewed as more humanistic than mechanistic structures. The mechanistic organizational structure is similar to Max Weber’s bureaucratic organization. Organic structures are more flexible in order to cope with rapidly changing environments. These structures are more effective if the environment is dynamic, requiring frequent changes within the organization in order to adjust to change. It is also considered to be a better form of organization when employees seek autonomy, openness, change, support for creativity and innovation, and opportunities to try new approaches.
All organizations need structures to accomplish their work, and they need an ability to change in order to sustain and renew themselves over time