ØYSTEIN D. FJELDSTAD RANDI LUNNAN (EDITOR)
STRATEGY
Chapter 1
Introduction and overview
A strategy is a plan or pattern for achieving a company's overall goals.1 Strategy is about the company's relationship with its environment, its activities and resources, and its organization.
Leadership comes from the Old Norse word "leida", which means to lead or set in motion. Strategic leadership sets a direction that ensures the organization's survival and growth. This means making, anchoring, and implementing choices that contribute to the success of the organization. Strategic management thus involves analysis, selection, and implementation of the company's most important actions.
The term strategic is used to distinguish between short-term tactical, operational choices and strategic choices that are long-term and future-oriented. Strategy is about choices but also about processes that ensure that good choices are made and implemented.
Strategic choices, processes, and analysis
Strategic choices
A company makes three main strategic choices:2
1. Which products and services it will deliver in which markets.
2. Which activities and resources it will use to deliver its products and services.
3. How it will organize its activities and resources to balance exploitation and exploration
These three choices must support each other in such a way that the company gains competitive advantage. The products and services must be attractive to relevant customers and at least as attractive as the competitors' offerings, preferably more so. The activities and resources that contribute to delivering products and services shape both value for customers and costs for the company and must be consistent with the product/market choices. If the company is to be competitive over time, it must innovate. How much innovation, how to innovate, and in which areas will shape future product/market and activity/resource choices.
These three choices are mutually dependent on each other. If the company is to develop new products, the company's resources and organization provide constraints that determine how and when the products can be developed. A strategy, therefore, requires attention to all three choices, the consistency between them, and how they support each other.
1 This definition is taken from Nag, R., D.C. Hambrick and M.J. Chen (2007). What is strategic management, really? Inductive derivation of a consensus definition of the field. Strategic Management Journal, 28(9): 935-955.
2 Miles, R.E. & Snow, C.C. (2003). Organizational Strategy, Structure and Process Stanford, Calif: Stanford Business Classics.
Figure 1.1 The adaptive cycle
Strategy process
The strategy process must be designed to ensure that the company makes and implements good strategic choices. Steps that are typically included in a strategy process are:
- Establish an overall goal: mission mission and vision
- Conduct strategic analyses
- Make strategic choices
- Implement the chosen strategy
How to conduct the strategy work is also a choice. The order of the steps and the level at which they are carried out depends on the management, the characteristics of the company, the situation it finds itself in, and the environment. Depending on external developments and the characteristics and traditions of the company, some companies will emphasize planning in their strategy work, while others will emphasize learning.
Establish an overall goal: mission and vision
The mission says something about why the company exists - typically, what needs it will meet and in what way. The mission reflects the overall strategic choice. The vision expresses what the company wants to achieve and describes the ambitions the company has in relation to its mission
Conduct strategic analysis
Strategic analysis provide insight into the company's external environment and internal situation. In small organizations, management often performs the analysis , while in larger organizations, it is typically done by staff and hired consultants. External and internal data sources are used in the analysis work. It is common for employees to contribute information related to their areas of responsibility through surveys and workshops.
Making strategic choices
Strategic choices are made through a combination of rational techniques and dialogue at different levels of the organization. Rational techniques are used to assess the possible consequences of different options. Dialogue is stimulated through workshops and meetings that are used to elicit, explore, and reconcile different views and preferences. Various brainstorming and ranking techniques are often used to involve participants. Major strategic decisions typically include a financial analysis of the consequences of the most relevant choices.
Implement selected strategy
Implementing a strategy involves translating choices into actions. Implementation includes creating an
understanding of the new strategy and what it means for individuals, setting new goals for the individual units to achieve, making necessary investments, adapting the organization, and developing employees to master new tasks. It is common to organize implementation as a project to coordinate the various measures. Furthermore, often the strategy operationalized and implemented by the various units in the organization based on their new goals and guidelines, developing appropriate actions.
Strategic analysis
Strategic analysis provides insight into which goals are attractive and realistic to set and what the company can do to achieve them. The analysis is used to make strategic choices, which are put into practice through implementation. The analysis clarifies what opportunities and threats the company faces in its environment, what strengths it has to seize opportunities and overcome threats, and what weaknesses it must overcome to seize opportunities and overcome threats. The findings from strategic analysis can be summarized using a SWOT table, which in turn can be used to generate options for action.
The various analyses describe and assess the company's external environment and internal conditions. In analysis, it is common to go back and forth between the models. A first draft of the external analysis can set the framework for the internal analysis. Insights that emerge from the internal analysis can be used to revise the external analysis.
Strategic analyses covered in the book
Models for external analysis
PESTEL analysis (chapter 4)
All businesses are affected by political, economic, social, technological, environmental, and legal macro conditions. A review of these factors is called a PESTEL analysis. In the PESTEL analysis, you identify macro trends that may affect the business and predict their potential impact. The company is affected by customer needs, resource availability, competition in the industries, and geographical locations in which it chooses to operate. Macro trends can be used to develop scenarios. Scenarios envision alternative future macro conditions in a consistent way, allowing a company to prepare for future threats and opportunities.
Stakeholder analysis (chapter 4)
A stakeholder analysis identifies organizations and groups affected by the company's strategy and assesses their potential to influence its implementation A stakeholder analysis provides insight into who (the stakeholders) the company needs to pay particular attention to when choosing a strategy and how to deal with them.
Industry analysis (chapter 4)
A company's ability to capture value depends on the strengths of the industry in which it operates. An industry analysis provides understanding of the structure of an industry in terms of the competitive forces exerted by customers, suppliers, competitors (existing and potential new competitors), substitutes, and complementary players - organizations that positively influence the demand for the company's products and the effect of these forces on profitability. Insights from the analysis can be used to inform potential actions to improve a company’s competitive position.
Models for internal analysis
Value creation analysis (chapter 2)
A company creates value for its customers, and therefore for its owners, through the activities it performs. Value creation analysis is used to understand how value is created and how it can be improved. Value creation analysis is based on customers' needs and what the company must deliver to meet those needs. Value creation analysis identifies (1) the activities that create and deliver the products and services, (2) the costs associated with each of those activities, and (3) structural factors, such as scale, that drive costs and value. The analysis is used to assess how changes in the activity set affect customer value and costs associated with delivering products and
services.
Resource analysis (chapter 3)
Value creation (performance of activities) requires access to resources. Resources include financial and physical assets, relationships and networks, information, and knowledge that can be used for value creation. In resource analysis, you identify actual and potential resources and assess whether they can provide a basis for competitive advantage. A resource provides a competitive advantage if it helps the company to deliver better products and services to customers over time or to deliver them more cost-effectively than its competitors. The analysis is used to assess which resources the company should develop and protect and to assess how this should be done.
Business
models (chapters 2, 5-8)
A business model describes how a company creates value and derives profit from its value creation. The business model links together the choices about which customers the company will serve with what kind of products and services, what value proposition it will offer through those products and services, which activities and resources it will use, and the external relationships associated with them, and finally, how it gets paid and how it protects its revenue streams. The choice of business model is more abstract than the choice of strategy. Companies may have similar business models but very different strategies. We distinguish between four different business models: value chain that produces goods, value network that connects customers, places, and things, value shop that solves individual customer problems, and value access where the company makes a resource available as a service. Each business model has typical characteristics related to value propositions, activities, resources, relationships, revenue sources, and protection mechanisms. The characteristics of the business model have implications for both the choice and implementation of strategy.
Sustainability
(chapter 9)
Sustainable strategy is about taking responsibility for vulnerable groups and using resources in a way that ensures that they are not destroyed or degraded but can also be available for future generations. Developing a sustainable strategy can change a customer's value proposition by, for example, suggesting new ways of using resources or products. This involves changing the company's value creation and business model. Circularity is a good example because the company's activities and resources are expanded from a limited part of the value creation to extend over the entire lifetime of a product. Companies can choose different approaches to sustainability. One focus is to follow standards for reporting on the environmental, social, and governance implications of the company's operations. Companies can also use sustainability as a differentiating element in their strategy. Managers' and employees' own values can be an important driver in companies' sustainability strategy development
Development of strategic options and choices (chapter 10)
Developing and choosing among of alternative strategic actions is supported by the analytical models described earlier, supplemented by some tools that are specifically aimed at comparing alternatives. Developing good strategies is a creative process. The process can use the results of the analytical models, including the PESTEL and SWOT analysis, as input. The analytical models are also used to provide insight into the impact of different strategies. The industry analysis can be used to identify market segments that are not served or where the products offered do not have the characteristics that customers want. Blue Ocean is a model for mapping unmet customer needs in an industry and identifying how the company can meet them. The industry analysis is also used to identify opportunities to improve supply and to understand how to make the company less vulnerable to competition. Value creation analysis is used to identify and assess changes in the company's activities that can increase the value of the products and services or reduce the cost of delivering them. Resource analysis is used to assess what the company can do with its resources and how it can acquire or develop resources it lacks. An idea for change that emerges from one of the three areas - industry, value creation, or resources - almost always has consequences for the other two as well as for the organization design. A new strategy represents a holistic choice where the consequences for all areas are considered. The business model says something about the
effects that strategic changes may have on the position in the industry, on value creation, and on resources, and it must therefore be carefully considered when evaluating different strategies. Strategies have financial consequences. A financial model, such as net present value, internal rate of return, or multiple earnings, is typically used to assess the financial effects and support the choice between alternative strategies.
Strategic analysis of company context
Networks and institutions (chapter 11)
Companies have long-term collaborations with other players. These collaborative relationships form a network of companies that depend on each other for success. The network relationships contribute to the coordination of activities, resources, and goals and are therefore important in both the design and implementation of the strategy. Companies offer their products and services in markets that are regulated by institutions. Institutions can be both formal and informal and regulate companies' interaction with other players in the market.
Corporate Strategy (chapter 12)
A corporation consists of two or more legal entities (business units) combined in one company. The companies in the corporation will typically be responsible for their own product/market combinations. Corporate strategies concern creating and exploiting synergies and complementarities between the various business units, including financial, operational, competitive, competence based synergies, and exploiting demand complementarities. The types of synergies and complementarities reflect the relationships studied in the industry analysis, value creation analysis, and resource analysis. A corporation can follow a portfolio strategy or an operational strategy. A corporation grows through (1) organic growth, (2) acquisitions and mergers, or (3) strategic alliances. These constitute three different ways of changing the Corporation's product/market and resource/activity choices.
Clusters (chapter 13)
An industry cluster consists of companies and institutions that are connected through vertical and horizontal relationships within a geographical area. A company benefits from being part of a strong industry cluster by accessing demanding customers and excellent resources, as well as interacting with strong and competitive competitors and suppliers. Together these actors form a network that interact closely to push the firm to develop innovative new solutions. Companies use knowledge about industry clusters to decide where to locate their activities and to develop the clusters they are part of.
International strategy (chapter 14)
Companies internationalize to (1) gain access to markets and customers, (2) reduce costs and improve efficiency, and (3) gain access to resources. Operating abroad is associated with disadvantages such as interacting with market actors in different languages, different cultures, and lacking local relationships and knowledge. The benefits of setting up abroad must, therefore, outweigh these disadvantages. Valuable trademarks, unique knowledge of products and production processes, particularly good access to resources, and good relationships with international suppliers and other business associates are examples of owner-specific advantages that enable the company to overcome the disadvantages. Trade, contract, and outsourcing are three ways of operating internationally. They differ in terms of the company's degree of control, flexibility, and use of resources. Internationalization can be understood as a process of learning and relationship building. In an international strategy, the choice between standardized strategies across different countries and local adaptation is important. The choices are governed by the need for global integration to deliver efficiently, as well as meeting variations in customer preferences across markets.
Strategy
processes (chapter 15)
We can distinguish between three main types of strategy processes, and these can be linked to different forms of leadership. The first is planning, the second emergent, and the third is experimental. All processes have elements of both planning and learning, but these are emphasized and applied differently The introduction to Chapter 15 simplifies elements of these processes by describing the steps in a planning process.
Planning-oriented strategy processes treat strategy development as rational, step-by-step problem-solving and strategies as something that can be analyzed and planned. They start with the establishment of a vision and mission, followed by external and internal analysis, development of various alternative strategies, selection of a strategy, and finally, its implementation. The process can be top-down or bottom-up. In a top-down process, senior management ensures that the analyses are carried out, they make the overall strategic choices, and the organization is tasked with implementing these. In a bottom-up process, various units and employees provide input on threats and opportunities, strengths and weaknesses, as well as suggestions for actions and strategies. These are summarized by management, which then either selects or organizes a broader selection process. Finally, the chosen strategy is implemented. However, things rarely develop exactly as planned. The actual strategy will, therefore, differ from the planned one; it emerges.
Emergent strategy processes can be the result of necessary adjustments to a planned strategy, but a company may also choose this as its main approach to setting direction. When an opportunity arises, it is seized, and in the delivery of products or services, resources and activities are developed and changed. If it works, the company continues to build on the choices that have been made. Over time, the sum of these actions has consequences for the company's position - its implicit choice of product/market and activity/resource combinations. In experimental strategy processes, management deliberately constructs small-scale experiments to see if something can work. These experiments are also combinations of product/market and activity/resource choices, but the difference is that they are done to learn. Sometimes, the first products are prototypes. If a trial proves successful, it is scaled up. In a scale-up, the company can radically change how it delivers the product or service, which resources it draws on, which customers it addresses, and how it organizes this. Experimental processes are common in digital industries because prototyping is easy, and the pace of change is high.
Strategic organization (chapter 16)
An organizational form denotes a way of organizing. We can distinguish between organizational forms that focus on efficiency, organizational forms that are focused on innovation, and organizational forms that combine the two.
Organizing for efficiency typically uses a hierarchical division of labor and standardization to control and coordinate activities and resources. Coordination takes place at a higher level in the hierarchy through planning, standardization, and management meetings. Organizing for innovation uses teams that combine competencies based on the tasks to be solved. Team members use networks to gather information and coordinate activities with others. Teams can be assembled by management, or they can be self-organizing. Efficient operations and innovation are difficult to combine. Some organizations distinguish between units responsible for delivering innovative products and services and units responsible for delivering existing products and services efficiently. Companies collaborate with others to carry out their activities. Organizing, therefore, also includes interaction with external partners.
EXAMPLE
Case: Strategy in Ancient Greece
The concept of strategy and the practice of strategy in democracy
The term strategy (στρατηγία stratēgia) comes from Greek and describes the leader's plan to achieve a goal. The term is composed of stratos, meaning army, and agein, meaning to lead. Strategos (στρατηγός) means army leader or general. The goal of a strategy was to defeat enemies, secure food supplies, and defend oneself. Athens' heyday was from around 500 to 338 BC until the Greek states were placed under King Philip of Macedon. During this period, Athens was a member and organizer of several alliances with other Greek city-states, including an alliance with Sparta against Persia, but it also waged war against Sparta for almost 30 years (431-404). During its heyday, the Athenians developed democracy. Members of the popular assembly and city leaders were to be recruited from among the citizens so that power was not reserved for a few powerful men. However, membership in democratic arenas did not apply to everyone, only to free men and children of citizens. Officials were elected by lot and only for one year at a time. The strategists were the
most important officers and the only ones that were not chosen by lot. Ten strategists were elected annually to manage military matters and conduct foreign policy, and these were often re-elected for several years. Outside of military matters, the strategists were ordinary members of the People's Assembly and had to gain influence on a par with other citizens. Athens did not have a large war chest, and wars were financed by contributions from cooperating city-states but also by financial contributions from the strategists themselves. Investments were rewarded with a share of the spoils of war. The war effort was subject to scrutiny. For example, after the Battle of Arginusai in 406 BCE, eight strategists were court-martialed and sentenced to death for failing to save survivors from drowning.
The Greek military was based on democratic principles with relatively weak discipline. The army was characterized by hoplites or spearmen. They came primarily from the middle class. The equipment was relatively simple and provided by the individual soldier. The equipment was heavy, up to 27 kg, with a spear with an iron tip almost three meters long. The breastplates defended against enemy arrows, and a series of hoplites formed a fearsome wall fronted by long spears. In 490, King Darius I of Persia attempted to subjugate the Greek states. At the Battle of Marathon, the Athenians defeated the Persians. One of the reasons was that the hoplites protected against the Persian arrows, while their spears had a greater range than the Persians were used to.
Strategists Themistocles
One young man who took part in the Battle of Marathon was Themistocles. He was born in 524 and was considered "illegitimate" because his mother was not from Athens. He refused to accept this disadvantage and is said to have challenged the best young men of the aristocracy in physical activities. He spent much time acquiring speaking skills and rhetoric. He acquired a considerable fortune and eventually became a respected figure in the popular assembly. After the Battle of Marathon, the Athenians celebrated their victory, believing that the Persians had finally been defeated. Themistocles warned against celebrating their success too early, saying that they had only seen a foretaste of the Persians' ambitions. He likened Athens to a top athlete who should keep his body oiled and fit for future battles, as the peace would be short-lived. Not all Athenians agreed with this bleak vision of the future, preferring to focus on peace and reconstruction.
Copyright: Ernst Wallis et al. (own scan) [Public domain or Public domain], via Wikimedia Commons
Athens had a small fleet and had won battles with the help of the hoplites. Themistocles believed that the future would depend on strength at sea and that the Athenians needed to acquire a stronger fleet. He based his argument on the defense of food supply and military considerations. Athens was dependent on grain from the Black Sea and needed a fleet to defend its transportation. He also reasoned that when the Persians returned, the hoplites would be outmaneuvered by a much larger Persian army. If a strong Athenian fleet joined forces with the fleets of other Greek city-states, together, they could pose a real threat to the Persians. The aristocracy saw its power threatened by this because rowers were from the lower classes, while aristocrats traditionally led the army. Themistocles also had to convince the popular assembly that they needed a new port. Themistocles was lucky because silver was discovered in a mine that belonged to Athens. Many wanted the profits from the sale to be distributed equally among the citizens of Athens. Themistocles believed that the profits should finance the expansion of the fleet and the port. To support his argument, he used the threat of Aegina, another city-state
with which Athens was in constant dispute, but his real motivation was Persia. He couldn't say this out loud because he was dependent on buying wood from Macedonia, an ally of Persia to build ships, and because many Greeks did not believe the threat from Persia was real. Themistocles managed to persuade the assembly and obtained funds to build two hundred ships and a harbor. Archaeologists have found many potshards with Themistocles' name carved into them, indicating that his plans met with considerable opposition from the assembly.
The ships Themistocles had built were triremes, light, and fast warships with three sets of oars on each side. A trireme was 36 meters long and 4.5 meters wide and carried up to 170 oarsmen. A longer ship would be too heavy and difficult to maneuver; a shorter one would be too slow. The ship could reach 6-7 knots (approx. 12 km/h). A trireme was labor-intensive, cramped, and expensive to operate. The ships drew water and had to be towed ashore every day, which favored short distances
Copyright: MoreVector/Shutterstock
The Battle of Salamis Themistocles' predictions of a new Persian invasion turned out to be correct. King Xerxes led the invasion in March 480 with an army of 200,000 and over a thousand warships. The popular assembly contacted the Oracle of Delphi, who declared that "Zeus will give Athens a wall of wood, and holy Salamis will destroy the sons of women." The citizens of Athens interpreted this statement in different ways; some thought they should fortify the city with wood, but Themistocles managed to convince many that the wooden wall meant the fleet of triremes and that Saint Salamis was on the Athenians' side. He got most of the assembly to agree to meet the Persians and man the two hundred ships, which required the participation of almost the entire male population of Athens.
Athens was one of the Greek city-states. These states often disagreed, and the alliances between them were fragile. In the fall of 481, Themistocles addressed the alliance of city-states, arguing that they should put aside their differences and unite around the threat of Persia. The historian Plutarch calls the unity achieved by Themistocles a significant achievement. To bring in Sparta, whose strength was in land-based warfare, Athens had to hand over command of the fleet to Sparta. However, Themistocles ensured that he was the one who effectively commanded the fleet. Early on Xerxes was superior and was well on his way to subjugating all of Greece. Gradually, the mood among the allies became more negative, motivation waned, and many were prepared to retreat and build barricades to defend their cities. Themistocles eventually had to threaten that Athens would leave the alliance and take all the ships with it. He realized that time was running out for the alliance and that he had to step up the resistance
One evening, he sent one of his own slaves who spoke Persian to Xerxes' camp with a secret message that the Greeks were terrified, quarreling among themselves and planning to escape. All Xerxes had to do was wait and attack the ships that would exit the strait. Xerxes believed the slave and ordered all his ships to patrol the strait through the night. The Greeks slept through the night. When morning came, the Greeks observed Persian ships, and the leaders of the alliance realized that they could not escape. Morale rose, and they agreed on a joint strategy. Themistocles knew that the Greek ships were light and agile while the Persian ships were heavier and larger. Themistocles had local knowledge of the strait, which acted as a canal, and knew that the narrow
channel was subject to strong winds both in the morning and in the afternoon. Since the Persian ships were large, only a few could sail into the channel at the same time. As the Persian ships entered the channel, they were unable to turn around, and immediately surrounded by Greek ships perfectly positioned in the water and manned by well rested warriors. Using his knowledge of the wind, the fatigue of the Persian warriors, and his choice of the narrow channel as a battlefield, Themistocles overpowered the Persian fleet. Every wave of Persian ships that entered the canal was overpowered by the Greek ships. Xerxes sat on his golden throne on the beach opposite the channel and observed the defeat.
Many historians believe that the Battle of Salamis saved Greece from becoming part of the Persian Empire. Athens could continue to develop the institutions, art, and culture that later became the origin of Western civilization. The Battle of Salamis ranks as one of the most decisive battles in history. What happened to Themistocles? After the battle, he helped lead the rebuilding of Athens after the Persian invasions. He gradually gained a reputation for pride and arrogance and, therefore, began to get enemies, which eventually led to his expulsion from Athens. He died in exile at the age of 65.
Sources:
Question:
1) Why were the strategists allowed to stay in the role for more than a year?
2) What can explain the outcome of the battle between the Greeks and Persians at Salamis?
3) What was Themistocles' strategy after the battle of Marathon? What were the assumptions about the future that underpinned this strategy?
4) What were the most important factors in the implementation of the strategy? What could have prevented the strategy from succeeding?
Everitt, A. (2016). The Rise of Athens: The Story of the World's Greatest Civilization Random House: New York. Store norske leksikon Wikipedia
Value creation: performing activities
THEORY
A business performs activities (what it does) using resources (what it has). Both the company's activities and its resources can provide a competitive advantage. Activities and resources are complementary: Resources are needed to perform activities and performing activities creates and develops resources. In this chapter, we focus on activities.
The activities that a company chooses to perform and how it chooses to perform them affect value for the customer and overall costs for the business. The activity description is used as a basis for analyzing how decisions about the set of activities - so-called configurational decisions3 - affect value and costs of product and service delivery. This analysis supports strategic choices about:
- Composition: which activities the company will perform and which, if any, it will outsource
- Localization: where the activities will be carried out
- Technology: how the activities will be carried out, i.e., methods, processes, and equipment used
- Coordination: how the company coordinates interrelated activities
This method of analysis has much in common with engineering practices: Based on knowledge of physical laws and applications, an engineer creates structures that meet performance and economic requirements. Similarly, when developing the strategy, the set of activities chosen needs to provide high value creation for customers, at the lowest possible unit cost for the company.
Competitive advantage and value creation
A company has a competitive advantage if customers value its services and products more than similar offerings from competing companies, or if the company's unit costs are lower than those of competing companies. A company can gain competitive advantage by making strategic choices about its activities. This includes choices regarding each individual activity, as well as, the composition of the activity set.
Value creation is the performance of activities where the value to the customer (user) exceeds the cost associated with the performance of the activities. The company uses input factors such as fixed assets, labor, raw materials, and intellectual and financial capital to perform activities that customers, users, or a third party are willing to pay for. By giving customers or users something they want, value is created for them. When the payment exceeds the costs, value is also created for the owners of the business. Value creation can take different forms. Manufacturing companies carry out activities that result in a physical product that the customer can buy. Service companies perform activities directly for customers. For example, postal services transport letters and parcels, and doctors and hospitals treat patients.
Value configuration. We call the composition of activities the company's value configuration. A value configuration analysis has two main levels. The first is a categorization of the company's activities with a qualitative and quantitative description of what is performed and how the performance of activities contributes
3 To configure means to put something together into a whole.
to cost for the company and value for customers. At this stage of the analysis, the business is broken down into the main categories of value-creating activities, providing an overview of effort and value creation by category. There are two main groupings of activities:
- Primary activities, which directly create value for the customer, and
- Supporting activities (or secondary activities), which indirectly create value by influencing the performance of primary activities.
We distinguish between four general value configurations that differ in the activities they perform and the economics of performing those activities:
- Value access describes businesses that create value by investing in resources to which it gives customers access. Hotels, parking garages, and a range of cloud services have this value creation logic.
- Value chain describes the activities in businesses that create value by transforming inputs into products. The value chain is used to describe production companies such as manufacturers of paint, food, or car parts.
-Value shop describes businesses that solve individual customer problems or create unique solutions for customers. Hospitals, consultancies, and architectural firms apply a value shop logic.
-Value network describes businesses that connect people, places, and things. Examples of value networks are telecom companies, transportation companies, payment services, and platforms that facilitate various types of interaction between users.
The second level is the identification of structural factors that link choices regarding activities to unit costs and value for the customer. These structural factors are called drivers. Value and cost drivers are structural factors that affect value creation for the customer and the unit costs associated with performing the activities, respectively. Some important examples of such drivers are economies of scale, learning effects, localization effects, interaction effects between activities, network effects, and, not least, the company's product/market decisions that affect both what it will cost to deliver the products or services and how customers will value them.
Structural factors drivers that affect value and cost
To understand the important role of drivers in the analysis, an analogy can be useful. Any construction, such as a building, has a structure. The structure of a building includes the positioning of walls and the roof in relation to each other, as well as the positioning and dimensioning of beams and other supporting structures. The choices of the building's structure affect the benefit and enjoyment users get from it, as well as the costs associated with building and using it. If it is cheaper per square meter to build and operate a large building than a small building, there is economy of scale. A large building is better suited to hosting conferences and large companies and is therefore attractive to some customers.
The timing of an activity affects value and cost. A company that starts up a new concept earlier than its competitors will typically have high initial costs because many things are untested, and there is no guarantee that suitable suppliers of input factors will be available. On the other hand, such a company can benefit from learning as a head start vis-à-vis future competitors. Learning is, therefore, a cost driver. The associated function - the learning curve - represents the unit cost as a function of accumulated volume over time. This means that unit costs decrease as the company learns how to perform its activities efficiently.
Marketers group customers into segments. This is called positioning. Positioning affects the value of the activities. If the product is well adapted to the needs of the customer segment, the customer's willingness to pay is high, all other things being equal.
Decisions about an activity, such as location and the volume for which it is to be performed, typically affect both the cost and value associated with other activities. Such systemic effects make it necessary to make joint strategic decisions about the activities considering implications on total costs and value. A small change in one
activity can have a major impact on other activities and the drivers
Elaboration of drivers
The cost of creating and providing a product or service depends on the relationship between the input factors and the final delivery. The relationship between the input factors and the final delivery is, in turn, dependent on the technology used in the performance of the activity. Technology is the use of knowledge and equipment in the performance of an activity. In a microeconomic analysis, the economic properties of the technology are described using product functions. A simple version of a product function:
(1) q = f(K,l)
says something about how many units of a good (q) (for example, prepared rooms in a hotel) can be obtained from a fixed asset (for example, furnishings) and labor (man-hours) (K,l). Based on knowledge of the product function, the cost per unit associated with different volumes of q can be calculated. The functional relationship between q (number of units) and the cost per unit for a given activity provides a picture of how the scale of operations affects the costs of an activity or set of activities. Therefore, such a function is called a cost driver. Specifically, it describes unit cost c as a function f of volume q.
c = f(q)
The relationship is called structural because the cost per unit is a function of a structural characteristic of the activity, namely the volume it is dimensioned for. If unit costs decrease when volume increases, this is called economies of scale.
The unit cost c associated with volume q is only achieved if the capacity is fully utilized. Capacity utilization is, therefore, also a cost driver, i.e., the unit cost can be expressed as a function of capacity utilization.
Different activities are affected differently by the drivers. Economies of scale may be large in one activity but smaller or completely absent in another.
Configurational decisions are strategic when they involve large activity categories that are important for the customer's willingness to pay or the company's unit costs. To tackle activity set decisions, models are needed to represent and analyze the value and cost impacts of different choices. Understanding the drivers is key to this. The most important drivers are, as discussed and exemplified above, scale, capacity utilization, learning, localization, and activity links. These link the configuration decisions to value and cost per unit delivered. You can see from Table 2.1 how they can affect cost and value.
There are two approaches to creating the functions that describe the drivers. One is to collect comparable data from other companies within a group or from other similar companies in the industry, from other industries, or from other geographical areas and analyze them. This is called benchmarking. The second is to obtain data on alternative technological solutions in terms of quality, capacity, requirements for fixed assets, direct input factors, and labor and create functions based on this. The functions are then used to assess how the choices described in the introduction to this chapter affect the value and cost associated with the individual activities and the activity configuration as a whole. Comparison with other ways of configuring the activities is important to understand the company's competitive position.
Table 2.1 Cost and Value Drivers
Capacity utilization By distributing fixed costs across multiple units
Extra capacity is an asset in many service businesses. It allows for immediate processing of customer requests.
Learning Reduce costs by improving routines Improve the quality of the product
Location Better factor access. Access to affordable labor and raw materials
Positioning Choose products/services that cost less to produce and customers who use or require less service
Activity linkages Mutual adaptation and coordination of activities can lower the total cost even if the cost of an activity increases in isolation
Value system
Proximity to the customer or access to the latest technology and knowledge in the delivery
Better align products/services and activities with customer needs
Technology development can increase the quality of components and processes and, thereby the value of products and services
The company's activities are part of a larger system of activities carried out by the company in interaction with other companies. Examples include suppliers, customers, and other subsidiaries within a group, as well as other complementary actors that affect the performance of the company's activities. The larger system of activities that the company is part of, which includes activities performed by complementary, is called the value system An analysis of the companies activities as well as the activities within the broader value systems may quickly become extensive. How comprehensive should we describe and analyze the value system? The answer is: It is necessary to describe the activities that significantly influence decisions about the company's own activities. In the first instance, this will be customers, suppliers, and complementary businesses, and for some businesses, also the customers' customers and/or suppliers' suppliers that perform these activities. These need to be described because the company's ability to increase value for its customers sometimes comes from performing the activities in such a way that its customers can increase the value of its products and services to its customers and, therefore, they have a higher willingness to pay. Think also about ways in which the company can lower the supplier's costs associated with delivering products and services, and how by doing so, the company can negotiate lower prices for what it buys.
Payment for activities
Activities are directly or indirectly linked to payment from customers. How companies charge for performing their activities varies and can be an important strategic decision. Some companies charge to allow customers to share the use of a valuable resource and the price is based on variations in demand. Others charge based on the cost of inputs, with a markup based on a standard calculation.
Customers have different needs and a different willingness to pay to have their needs met. How much a company is paid for carrying out its activities depends on two factors:
- The value the product or service has for the customer.
- The competitive situation in the company's markets. For example, if there are many providers of the same product or service, and their offerings are relatively similar, the customer can choose between these providers to meet his or her needs, and the willingness to pay is reduced because of competition
How much the company is left with is called the company's margin. The margin depends on the customers’ willingness to pay for the activities that the company performs, minus the costs it incurs for the use of fixed assets, direct inputs (raw materials, energy, etc.) and labor. The company's costs for the inputs it uses depend, in turn, on the competitive situation in the markets for these inputs.
TOOLS
Value configuration analysis
A value configuration analysis consists of seven steps. For each of the steps in the analysis, you can use the activity diagram to record your findings.
Steps in a value configuration analysis:
1. Identify the most important activities the company performs in its value creation and draw these in an activity diagram. What are the primary activities? What are the supporting activities?
2. Identify the company's customers/customer segments and describe how the company's products and services create value for customers.
3. Conduct a strategic cost analysis.
4. Analyze how the company's various activities contribute to value creation for the customer.
5. Identify the most important organizations (companies and other organizations) the company buys from, sells to, or collaborates with. Draw these in a value system diagram (some of the drivers are related to the interaction with other actors in the value system).
6. Identify, per activity, the key drivers of the company's costs and value to the customer.
7. Make configurational decisions that maximize the company's value creation.
Strategic cost analysis
1. Identify activities and allocate costs: direct inputs - labour - operating assets. Put the activity names from step 1 on the outer side of the diagram (to the left and below in relation to the headings in the diagram). In the chart, enter the cost type, e.g., wages for production workers, and the cost (for each type) per unit produced for each activity category. Allocate the costs to the activity (activity category) that uses the input factor. For example:
a. Raw materials and components are assigned to production
b. Paper for order confirmations is assigned to purchasing
2. Assess cost drivers for each activity category and how they interact.
3. Analyze competitors' value configurations and assess their costs in relation to the costs of the company you are analyzing and find reasons for cost differences.
Figure 2. Activity diagram
Identify and assess the cost drivers for the individual activities.
1. For each activity, review the list of possible drivers. Identify the drivers that have the greatest impact on the unit costs of the activity. For example, investigate whether there are economies of scale in the logistics activities or whether the production activities can be performed at lower cost by locating them elsewhere. Create a new diagram as in the step above, but this time, enter the names of the drivers.
2. Analyze the relationship between cost and the independent variable in the identified drivers. For example, clarify - preferably draw a graph - how much the cost per unit could be reduced by, for example, greater volume in production.
Strategic value-added analysis (differentiation)
1. Identify the customer.
2. Describe what the company does for customers and the impact of the company's activities on the value of this "job being done". Use the activity diagram here as well.
3. Assess existing and new sources of increased value creation for the customer in the company's value configuration.
4. Assess the cost of existing or new sources of value added.
Make value configuration decisions
The value configuration configuration decisions include:
-Positioning - which customers should the company serve?
-What activities will the company carry out? What activities will be carried out by others, including customers? Draw the new activity set for your company.
-How should the activities be carried out - technology?
-Where will the activities be carried out - location?
The configuration decisions have six steps (three in terms of cost and three in terms of value for the customer.
Costs:
1. Develop a strategy to lower costs by by changing the value configuration to take advantage of cost drivers
2. Verify that cost reduction efforts do not change the value to customers (or choose to make such changes).
3. Test that the cost reduction strategy is sustainable.
Value for the customer:
1. Select the configuration of value activities that create the most value for the customer relative to the costs associated with delivering the product or service.
2. Check that the value-added strategy is sustainable.
3. Reduce the cost of activities that do not affect the chosen value added by the customer.
SUMMARY
A business creates value when it performs activities that customers or others are willing to pay for, and their
willingness to pay is greater than the costs associated with performing the activities. Both the customer's willingness to pay and the supplier's price depend on how the value system is configured, not just on the direct competitive situation. The company's profits, therefore, depend both on how much value it creates together with the other players in the value system and on how large a share it can compete and "negotiate" for. In this chapter, we have described the basic features of a method of analysis that is based on a company's value creation from an activity perspective. This includes strategic decisions such as choices related to the configuration of the activity set in the firm, and the interaction between these activities and activities performed by other actors in the value system. The analysis starts by identifying the most important activity categories of the company. This is followed by the identification of unit concepts, such as, the number-of-rooms/day for a hotel. The next step is the assignment of costs and value per unit to the product or service. Value for the customer can be difficult to assess, and it may be necessary to do this more coarsely than for cost, and you may need to use a qualitative description of value creation. The final step in the analysis is to identify the most important drivers of value and cost for each activity category and model (in simplest form graphically) how these drivers affect costs and value. These analyses are then incorporated into the company's strategic choices.
IMPORTANT CONCEPTS
-Activities: something a company does
-Resources: something a company has that enables it to carry out activities
-Composition: which activities the company will perform and which, if any, it will outsource
-Location: where the activities will be carried out
-Technology: how the activities will be carried out, i.e., methods and equipment used
-Coordination: how to coordinate activities
-Competitive advantage: customers value the services/products of a company more than similar offerings from competing companies, or the company's costs per unit are lower than those of competitors
-Value creation: performance of activities where the value to the customer (user) exceeds the cost associated with the performance of the activity
-Value configuration: the composition of activities in a business
-Primary activities: activities that directly create value for the customer
-Supporting activities: activities that indirectly create value by influencing the performance of primary activities
-Drivers: structural factors that link choices about activities to unit cost in the activity and value for the customer
-Value system: the larger system of activities that a company is part of
FACT BOOX
- Companies perform activities to create value for their customers, owners, and other stakeholders.
- The company makes choices about its activity set.
- Activity configuration refers to a set of activities that are put together to effectively create value.
- Configuring the activities means making decisions about the activity configuration.
- Configurational decisions must be made based on which customer needs the company will meet and how they will be met, such as which markets with which products or services.
- The first configurational choice is which activities the company will perform to deliver its products or services to customers and which activities will be performed by others.
- Other key configurational choices are:
o Technology used in performing the individual activities
o Location of the activities - i.e., where they will be performed
o Coordination of activities - i.e., how they should be coordinated so that they deliver the desired results in the most cost-effective way possible. Coordination must consider both the company's own activities and activities carried out by others.
- Drivers are structural factors that affect the cost to the business and value to the customer when performing the activities. They say something about the impact of the configurational choices.
- Examples of drivers are scale, learning, localization, positioning, and interaction between activities.
- The drivers are used in the configurational decisions.
- Configuration of activities is a process where each configurational choice must take the others into account. This means that you often must come back to the different choices as you see how they affect each other.
QUESTION
1. Identify a primary activity and a support activity for a business. Discuss the scale and capacity utilization drivers in each of these.
2. Describe a complementary activity. Find examples.
3. Discuss how learning can reduce your company's costs. Also consider how learning can lead to increased value for a customer. Can a company achieve both at the same time, or must the company choose to do few activities repeatedly to improve its processes or results, or to increase learning to, for example, better satisfy customers' special needs?
4. By coordinating activities, your company can reduce costs or increase value for a customer - can you think of examples?
MIND MAP
