Instructor solution Manual for Strategic Management Creating Competitive Advantages 11e by StudyGuide

Instructor solution Manual for Strategic Management Creating Competitive Advantages 11e By Gregory Dess, Gerry McNamara, Alan Eisner and Steve Sauerwald Chapter 1-13

Part 1

Strategic Analysis

Chapter 1 Strategic Management: Creating Competitive Advantages ... 1-2 What Is Strategic Management? ............................................................. 1-5 Defining Strategic Management .....................................................................................1-5 The Four Key Attributes of Strategic Management ....................................................... 1-5

The Strategic Management Process ........................................................ 1-7 ..................................................................................................................... Intended versus Realized Strategies ................................................................................1-7 Strategy Analysis .............................................................................................................1-7 Strategy Formulation ......................................................................................................1-8 Strategy Implementation ................................................................................................. 1-8

The Role of Corporate Governance and Stakeholder Management ................................................................. 1-9 Alternative Perspectives of Stakeholder Management ....................................................1-11 Social Responsibility and Environmental Sustainability: Moving Beyond the Immediate Stakeholders .................................................................. 1-12

The Strategic Management Perspective: An Imperative throughout the Organization ......................................... 1-15 Ensuring Coherence in Strategic Direction ............................................ 1-16 Organizational Vision .....................................................................................................1-17 Mission Statements ..........................................................................................................1-18 Strategic Objectives ........................................................................................................ 1-19

Issue for Debate ......................................................................................... 1-20 Reflecting on Career Implications ........................................................... 1-22 1-1 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Summary .................................................................................................... 1-24 End-of-Chapter Teaching Notes .............................................................. 1-27 Connect Resources .................................................................................... 1-33 Chapter 1

Strategic Management: Creating Competitive Advantages Summary/Objectives PowerPoint Slide 2: Learning Objectives At the heart of strategic management is the question: ―How and why do some firms outperform others?‖ The challenge to managers is to develop and implement strategies that will provide competitive advantages that will be sustainable over time. This chapter is divided into five sections. 1. The first section addresses the broad question: ―What is strategic management?‖ Here, we define strategic management as ―consisting of the analysis, decisions, and actions an organization undertakes to create and sustain competitive advantages.‖ We also address the four key attributes of strategic management: concern with overall objectives; involvement of multiple stakeholders; incorporation of short- and longterm perspectives; and recognition of tradeoffs between effectiveness and efficiency. We also introduce the concept of ―ambidextrous behaviors‖—the need to combine alignment and adaptability. 2. The second section discusses the strategic management process. Here, we present the three processes—analysis, formulation, and implementation—that provide the framework for the overall organization of the thirteen chapters of the book. 3. The third section focuses on the vital role of corporate governance, which is essential to ensuring that the actions of a firm‘s management are consistent with the goals of its owners—the shareholders. We also address stakeholder management. It must be taken into account throughout the strategic management process. Although the interests of stakeholders may, at times, conflict, we discuss how firms are able to achieve ―symbiosis‖ among stakeholders wherein various interests are considered interdependent and can be attained simultaneously. We address the importance of social responsibility, including environmental sustainability, as well as challenges associated with making the case for sustainability initiatives.

4. The fourth section addresses today‘s greater need for a strategic management perspective throughout the organization. With the emergence of the knowledge of economy and globalization, leaders must mobilize people throughout the organization. 5. The fifth section discusses the need for organizations to attain consistency in their vision, mission, and strategic objectives. Collectively, they form a hierarchy of goals.

Lecture/Discussion Outline We begin the chapter in LEARNING FROM MISTAKES with a clever quote from Arthur Martinez, Sears‘s former chairman: ―Today‘s peacock is tomorrow‘s feather duster‖ to help illustrate the rapid turnover among the Fortune 500 firms over a period of time. With rapid changing technologies and intensified global competition success can be temporary, and new entrants can shake up long-standing industries. The SUPPLEMENT below, from a website provides an interesting perspective on the digital economy. Extra Example: The Digital Disruption Has Already Happened World‘s largest taxi company owns no taxis. (Uber) Largest accommodation provider owns no real estate. (Airbnb) Largest phone companies own no telco infrastructure. (Skype, WeChat) Most popular media owner owns no content. (Facebook) World‘s largest movie house owns no cinemas. (Netflix) Largest software vendors don‘t write the apps. (Apple and Google) Source: www.ibmforentreprenuers.com.

Discussion Question 1: What are the implications for your careers? (This is a rather general question, but it might help remind students that they must be sensitive to changes in industry dynamics that could provide new opportunities—as well as, perhaps, erode opportunities that they may have thought they had in a particular industry.) Teaching Tip: By raising the “career implications” question, you will have the opportunity to briefly introduce the concept of the sustainability of competitive advantage(s), i.e., the criteria of rare, valuable, difficult to copy (imitate and substitute) that we will address at length in Chapters 3 and 5. The point that can be made is that students should strive to develop skills and capabilities that satisfy these four criteria to enjoy greater career success. This helps to illustrate some very practical implications of strategy concepts and heighten student interest. The opening case is about a company, Luckin Coffee, which failed because of (1) misguided strategic actions as well as weak corporate governance and (2) strong competition from established coffee chains such as Starbucks which have a significant competitive advantage. Thus, it helps to illustrate both the romantic view as well as the external control view of leadership, respectively. 1-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 2: Given that public accounting firms such as Ernst & Young may be unable to uncover financial misconduct at foreign firms, what kind of due diligence should U.S. investors undertake before investing in Chinese tech companies? Response Guidelines: This question should result in some interesting perspectives, especially from students who aspire to work for an accounting firm such as Ernst & Young. Instructors may want to point out that accounting firms are dependent on effective country-level corporate governance mechanisms such as effective rule of law, control of corruption, and government effectiveness. The country-level corporate governance in China may not have been as effective as in Ernst & Young‘s home country (the United Kingdom). Hence, accounting firms may not be as effective in China as they are in the U.K. or U.S., which should give U.S. investors some pause. Then the instructor may highlight the potential of analyzing the internal governance mechanisms, such as the board of directors. Investors may ask questions such as, are the directors on the board sufficiently motivated to monitor management? This could involve examining their compensation packages and stock holdings. Investors could also examine whether directors are independent of management. Next, investors may examine whether other large shareholders in the firm may have an interest in monitoring the firm on behalf of smaller shareholders. These questions may be a visible starting point to conduct due diligence before investing in Chinese tech companies. Discussion Question 3: What kind of control and monitoring structures should firm leadership implement to prevent employees from engaging in financial misconduct? Response Guidelines: This question of course implies that the firm leadership is interested in creating an ethical culture that prevents financial misconduct. Hence, instructors could start by highlighting the importance of effective corporate governance. Next, management should closely examine the speed of expansion in the Chinese market. While aggressive sales and market share goals are not inherently negative, goals should be realistic given the resources and capabilities of the firm. Disregarding the internal capabilities of the firm is a recipe for employees to cut corners to meet the aggressive goals set by firm leadership. Finally, instructors may highlight the importance of internal control mechanisms such as compensation systems. Employees typically respond strongly to financial incentives, which may be a tool that can be used to properly direct employee behavior. In addition, management should actively shape a culture of ethical conduct. This of course starts with ―leading by example‖ where the top and middle management rigorously addresses instances of misconduct. You might also mention that Luckin Coffee now trades on the Over-the-Counter Market (OTC) and as of the close of business on December 2, 2022, its stock was trading at $21.50— giving it a market value of approximately $5 billion. It now has more stores in China than Starbucks does and its revenues in the third quarter of 2022 was $547.5 million—a 65.7% increase over the same quarter in 2021. Part of the reason for this turnaround is a new CEO who has engaged external lawyers to review Luckin‘s operations and improved the market‘s confidence in the company. Luckin also benefited from a partnership with Eileen Gu, a Chinese freeski champion and Olympic gold medalist who become the breakout sensation of the 2022 Winter Olympics in Beijing.

Source: Luckin Coffee. 2022. Luckin Coffee Inc. Announces Third Quarter 2022 Financial Results. https://kdvr.com/business/press-releases/globenewswire/8701646/luckincoffee-inc-announces-third-quarter-2022-financial-results/, November 22: np; Toh, M. Luckin Coffee is back and bigger than Starbucks in China. www.cnn.com, May 25: np.

What Is Strategic Management?

PowerPoint Slide 3: The Importance of Leadership PowerPoint Slide 4: Two Perspectives of Leadership PowerPoint Slide 5: Leaders Can Make a Difference PowerPoint Slide 6: Defining Strategic Management PowerPoint Slide 7: Two Fundamental Questions PowerPoint Slide 8: Strategic Management PowerPoint Slide 9: Strategic Management Trade-offs We point out that it is very important for managers to see their jobs as more than just custodians of the ―status quo.‖ Rather, they must proactively anticipate change and continually refine, as well as, when necessary, make significant changes to their strategies. This has become particularly important as competitive environments become characterized by increasing rates of unpredictable change. A.

Defining Strategic Management

We define strategic management as ―consisting of the analysis, decisions, and actions an organization undertakes in order to create and sustain competitive advantages.‖ We believe this definition captures two main elements of the field of strategic management. First, strategic management entails three on-going processes: analysis, decisions, and actions. That is, managers must analyze the internal and external environment as well as their hierarchy of goals in order to formulate and implement strategies. Second, the essence of strategic management is the study of why some firms outperform others. We draw on Michael Porter‘s work to make the important distinction between strategy and operational effectiveness. Managers must create advantages that are sustainable over a period of time, instead of merely temporary. That is: How can we create competitive advantages in the marketplace that are not only unique and valuable but also difficult for competitors to copy or substitute? (This perspective, of course, draws upon the resource base view of the firm that we address in detail in Chapters 3 and 5.) Discussion Question 4: Are you familiar with some firms that created advantages in the marketplace that were very temporary? B.

The Four Key Attributes of Strategic Management

Here, we address four key attributes of strategic management. Strategic management is directed toward organizational goals and objectives; includes multiple stakeholders in decision 1-5 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

making; incorporates both short-term and long-term perspectives; and, recognizes trade-offs between effectiveness and efficiency. EXHIBIT 1.1 provides our definition of strategic management and these four attributes. Discussion Question 5: What are some examples of leaders who failed to incorporate some of these attributes in their decision making? What were the implications? The SUPPLEMENT below points out the importance of a key attribute of strategic management: recognizing trade-offs between efficiency and effectiveness. Extra Example: When a Firm Needs Farmers and Vikings Executives who excel at execution resemble Nordic Vikings, who attacked when they saw an unprotected spot and retreated when they realized they could not win, maneuvering their longboats toward the next opportunity. Once Vikings seized a bit of land, however, they often remained to farm it. Over time, they came to value the security of protecting what they had, more than the adventure of pursuing new opportunities. Organizations are susceptible to a similar dynamic. As a business matures, early entrepreneurs leave for new adventures or settle into safe routines at the firm. New employees join the company for its perceived stability, not for adventure. What started as a Viking outpost becomes a farming community. Companies with too few Vikings on the payroll struggle to execute with sufficient urgency. That is why soon after assuming control of a portfolio company, Garantia‘s (a producer of rainwater tanks) executives would implement a trainee program to attract the best and brightest college graduates, a practice the firm has continued as it has expanded. These graduates provide a steady stream of Vikings and exert constant pressure on executives who might otherwise lapse into the comfort of farm life. Source: Sull, D. 2010. Are you ready to rebound? Harvard Business Review. 88(3): 74

Discussion Question 6: Are companies you are familiar with or work at comprised of Vikings or farmers? Would your answer vary over time? Discussion Question 7: When should firms hire more Vikings? How about farmers? We also discuss an interesting insight regarding the types of challenges that managers face. Here, we address three ―paradoxes‖ based on a 2016 HBR article by Wendy Smith and her colleagues. They are:   

The innovation paradox reflects the tension between existing products and new ones, i.e., stability and change. The globalization paradox is about the conflict between global connectedness and local needs. The obligation paradox reflects the tension between social responsibility/a broader stakeholder perspective and short-term shareholder demands.

Discussion Question 8: What are some examples of companies that have faced such paradoxes? What actions were taken? Were they successful? 1-6 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

We close the section with a brief introduction of the concept of ―ambidextrous behaviors‖—the ability to both be proactive in taking advantage of future opportunities, as well as in exploiting an existing resource base. STRATEGY SPOTLIGHT 1.1 illustrates this concept by providing four examples of ambidextrous behaviors. We also provide some suggestions on how one can become an ambidextrous leader. Ask: Discussion Question 9: Do you know of any managers or executives who have exhibited ambidextrous behaviors? How?

II.

The Strategic Management Process

PowerPoint Slide 11: Realized Strategy and Intended Strategy: Usually Not the Same. PowerPoint Slide 12: Intended vs. Realized Strategies PowerPoint Slide 13: Strategic Management Process PowerPoint Slide 14, 15, 16: Strategy Analysis PowerPoint Slide 17, 18, 19: Strategy Formulation PowerPoint Slide 20-24: Strategy Implementation We restate the three ongoing processes in strategic management—analysis, decisions, and actions—that are typically referred to as analysis, formulation, and implementation. A.

Intended versus Realized Strategies

EXHIBIT 1.2 draws on the influential work of Henry Mintzberg of McGill University. He distinguishes between ―intended‖ and ―realized‖ strategies, and we provide the example of how Superdry PLC, a British clothing brand, had to change their product mix due to unseasonably warm weather. Discussion Question 10: What are some other examples of “unrealized” or emergent strategies? EXHIBIT 1.3 depicts the strategic management process and indicates how it ties into the chapters in the book. And, consistent with the discussion in the text, the two-way arrows convey the interactive nature of the process. Teaching Tip: Refer back to the opening case. When discussing EXHIBIT 1.3, it would be helpful to ask the class to illustrate how this exhibit can be useful in outlining the issues surrounding this case and how some of the problems may have been avoided with careful attention to these aspects of analysis, formulation, and implementation. The next three subsections address each of the three key strategic management processes: analysis, formulation, and implementation. B.

Strategy Analysis

Strategy analysis consists of, in effect, the ―advance work‖ that must be done in order to effectively formulate and implement strategies. Many strategies fail because managers may want to formulate and implement strategies without a careful analysis of the overarching goals of the organization, as well as a thorough analysis of its external and internal environment.

1. 2. 3. 4. C.

Analyzing Organization Goals and Objectives (Chapter 1) Analyzing the External Environment (Chapter 2) Assessing the Internal Environment (Chapter 3) Assessing a Firm's Intellectual Assets (Chapter 4)

Strategy Formulation

A firm‘s strategy is formulated at several levels. First, business-level strategy addresses the issue of how firms compete in an industry to gain competitive advantage. Second, corporatelevel strategy focuses on two issues: (1) what businesses to compete in, and (2) how businesses can be managed to achieve synergy, that is, create more value by working together than if they operated as a stand-alone entity. Third, firms must develop international strategies as they expand beyond their national boundaries. And fourth, managers must develop entrepreneurial strategies and be aware of the competitive dynamics in their industry. 1. 2. 3. 4. D.

Formulating Business Level Strategies (Chapter 5) Formulating Corporate Level Strategies (Chapter 6) Formulating International Level Strategies (Chapter 7) Entrepreneurial Strategy and Competitive Dynamics (Chapter 8)

Strategy Implementation

Clearly, effective strategies are of little value if they are not properly implemented. Implementing strategies involves strategic controls and organizational designs; coordination and integration among activities within the firm, as well as with customers and suppliers; and effective leadership. 1.

Strategic Control and Corporate Governance (Chapter 9)

Creating Effective Organizational Designs (Chapter 10)

Strategic Leadership: Excellence, Ethics and Change (Chapter 11)

Fostering Corporate Entrepreneurship (Chapter 12)

Analyzing Strategic Management Cases (Chapter 13)

Mr. Usman Ghani, an international consultant, provides excellent insights into the strategic management process. We are very pleased to have his perspective on this central topic to our text. In addition to many insights on leadership at high levels in both business and consulting, he addresses challenges associated with the three core elements of the strategic management process (analysis, formulation, and implementation). Discussion Question 11: For your organization (or the organization that you would like to work with) what do you feel are the most important points that he makes that can enhance its strategy and operational effectiveness? (You might address such concepts as leveraging both success and failure for active learning, attitudinal and behavioral 1-9 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

pitfalls, experimenting with inclusive ideas, developing self-awareness, the role of ethics and values, etc.)

III.

The Role of Corporate Governance and Stakeholder Management

PowerPoint Slide 25: Corporate Governance and Stakeholder Management PowerPoint Slide 26: Corporate Governance PowerPoint Slide 27: Stakeholder Management PowerPoint Slide 28: Two Views of Stakeholder Management We discuss three important and related concepts: corporate governance, stakeholder management, and social responsibility. Clearly, these topics (especially corporate governance) have generated quite a bit of controversy and the topic should lead to some spirited discussion. Corporate governance addresses the relationship between various participants in determining the overall direction and performance of corporations. It consists of three primary participants—shareholders, management, and the board of directors. EXHIBIT 1.4 illustrates these three participants. (Corporate governance is discussed in much more detail in Chapter 9. However, it is such a ―hot‖ topic, that we wanted to introduce it in the text‘s opening chapter.) Discussion Question 12: What are some other recent examples of poor corporate governance? (Examples would include Bank of America, Wells Fargo, Volkswagen, Uber, etc.) Discussion Question 13: What are the causes of such poor governance? We address some examples of extremely high executive pay—in many cases the pay is disproportionate to how well the CEO‘s firm performed (see examples from the financial industry). The SUPPLEMENT below provides some information on the increased rapid turnover of CEOs among large firms and the growing pressure that CEOs face from investors and other stakeholders. Extra Example: Increasing Turnover Among CEOs of U.S. Corporations The rate of turnover among CEOs of large corporations has increased as corporate directors and activist investors demand strong results—and rapidly seek management changes if they don‘t happen quickly. Thus, more pressure is placed on CEOs and other C-level staff. Grace periods are being shortened and top executives must quickly tackle challenges and demonstrate their capabilities. 1-10 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

In 2018, 1,452 CEOs of public and private companies and nonprofit groups left their position—25 percent more than those who departed in 2017 (and this was just shy of the highest annual CEO departures recorded during the 2008 financial crisis)—according to executive recruiting company, Challenger, Gray & Christmas. Although 27 percent of these departures were retirements, many CEOs resigned amid board questions about performance—and some because of professional or sexual misconduct allegations. As noted by Ken Freeman, former dean of Boston University‘s Questrom School of Business, ―CEOs and other top executives must start earning their stripes from Day 1 on new jobs, and there‘s little margin for error.‖ And, social media and the availability of data about firms‘ performance compound the pressure, adding ―constant, up-to-the minute scrutiny of CEOs,‖ he says. Source: Hymowitz, C. 2019. Prove yourself now. Bloomberg Businessweek. April 1: 44.

Teaching Tip: As we note, executive compensation is a ―hot‖ topic and might be a subject that you would like to spend some time on (even though we address corporate governance issues in much more detail in Chapter 9). It is early in the term and this might get many students‘ ―blood pressure‖ up and lead to spirited debates. You might also ask ―How much is too much?‖ Some students may argue ―whatever the market conditions are, because of the market for scarce talent,‖ others may state that ―it should depend on how much others make—such as the next highest executive at a firm (or a multiple of the lowest paid in the corporation—such as the case at Whole Foods, Inc.),‖ and still others may believe that ―managers should not receive entrepreneurial rewards without taking entrepreneurial risks (e.g., the case of Welch at GE and Eisner at Disney who earned around $1 billion during their tenures)—since such executives joined the company when it was already very successful and there was little employment risk—not to mention the risk of one‘s personal financial assets (i.e., ―skin in the game‖).‖ Or, of course, you could take one of these positions and see how the class reacts—consider asking individual students to take a position and others to rebut it, etc. Given the usual student interest in executive pay, the SUPPLEMENT below should stimulate additional discussion, i.e., do students agree with the ―sentiment‖ below. Extra Example: Executive Compensation The Rock Center for Corporate Governance at Stanford University posed the question (response was 1,202 people): How much does the average CEO of a major corporation make? The answer was quite surprising: $1 million, which is both a round number and seems like a lot of money. The real answer is quite a bit higher: $10.3 million (according to a 2015 report from the compensation trackers at Equilar). Approximately three-quarters of those surveyed said that CEOs are not ―paid the correct amount relative to the average worker‖—and this view held up across political affiliations, i.e., 25 percent of Republicans felt they were paid appropriately, only slightly higher than 16 percent of Democrats and 11 percent of Independents. Not surprisingly, David F. Larcker, a professor at the Stanford Graduate School of Business, said in the report: ―While we find that members of the public are not particularly knowledgeable about 1-11 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

how much CEOs actually make in annual pay, there is a general sense of outrage fueled by the political environment.‖

Source: Rosenberg, R. 2016. Their CEO got $142 million more than he deserved. financeyahoo.com. February 17: np.

The SUPPLEMENT below provides some interesting insights on surveys of capitalism versus socialism among younger Americans. It might be interesting to ask your students why such perspectives are so pervasive. Extra Example: Americans‘ Positive Image of Capitalism Is Eroding… One would have to go back to the 1960s—or 1930s—to find a time when the primacy of the free market system was being so widely questioned. According to a recent Gallup poll, merely 56 percent of Americans state that they have a positive image of capitalism. Similarly, in a Fox News poll, 36 percent of adults approved of a shift in the United States ―away from capitalism and more toward socialism‖—a significant increase from 2012 when just 20 percent said so. Among Millennials and Gen Z, skepticism about free markets is actually the majority view. In Gallup‘s poll, 51 percent of those 18 to 29 had a positive view of socialism—perhaps more the largely fuzzy Scandinavian/Bernie Sanders version as opposed to the Soviet/Berlin Wall hard stuff—compared to 45% for capitalism. Such a finding is consistent with a Harvard survey of young adults in which 51 percent said they did not support capitalism—and only 19 percent said they ―identify as a capitalist.‖ Perhaps, surprisingly, such sentiments come amid an economy that is by all traditional indicators booming with full employment and 3 percent growth. Although many still believe that America is still the land of opportunity, a 2019 Fox News agency found that just 42 percent of Americans did not think ―the way capitalism works in the United States these days give them a fair shot.‖ And, in a country that has always held true to the premise that one could make it through hard work—or at least your children could—18 percent thought that the American Dream is out of reach for their family. Perhaps, the perception of the lack of upward mobility fuels much of such populist anger: Despite all the anecdotal success stores, if you were born in the wrong zip code, to the wrong parents, the road to The Forbes 400 has never looked longer or narrower. Source: Lane, R. 2019. Reimagining capitalism. Forbes, March 31: 30-35.

Alternative Perspectives on Stakeholder Management

In this section we recognize, of course, that there are often conflicting demands among an organization‘s stakeholders. However, managers need to acknowledge the interdependence among stakeholders and strive to achieve symbiosis, that is, the recognition that stakeholders are interdependent upon one another for their success and well-being. EXHIBIT 1.5 lists seven key stakeholder groups and the nature of their claims. 1.

Zero-Sum or Symbiosis

We address the many stakeholder challenges faced by Walmart.

Discussion Question 14: What are some ways Walmart’s stakeholder demands may conflict? How might they be highly interdependent and positively (or negatively) related to each other? Discussion Question 15: Can you give other examples of other such collective initiatives? And, in your example, have all stakeholders benefited (or been penalized) equally? B.

Social Responsibility and Environmental Sustainability: Moving Beyond the Immediate Stakeholders 1.

Social Responsibility

Managers must consider the needs of the broader community-at-large and act in a socially responsible manner. Social responsibility is the expectation that businesses or individuals will strive to improve the overall welfare of a society. The following SUPPLEMENT summarizes some of the central points in the debate as to the value of corporations to devote significant resources to corporate social responsibility: Extra Example: Stakeholders versus Shareholders Although corporate social responsibility may appear to be an ―apple-pie virtue,‖ it is quite controversial. Below are some of the chief arguments for and against it: Proponents will claim that it… BURNISHES A COMPANY‘S REPUTATION. In the wake of corporate scandals, corporate social responsibility builds goodwill—and can pay off when scandals or regulatory scrutiny inevitably arise. ATTRACTS TALENT. Many young professionals expect their employers to be active in social issues. Membership in Netimpact.org, a network of socially-conscious MBA graduates, jumped from 4,000 in 2002 to 10,000 in 2004. On the other hand, Detractors will argue that it… COSTS TOO MUCH. Giving by corporate foundations reached an all-time high of $3.6 billion last year. However, it can come at the expense of other priorities, such as research and development, and is rarely valued by Wall Street. IS MISGUIDED. Many corporate executives believe, as economist Milton Friedman does, that the role of business is to generate profits for shareholders—not to spend others‘ money for some perceived social benefit. Source: Grow, B., Hamm, S. & Lee, Louise. 2005. The debate over doing good. Business Week, August 15: 76-78.

Teaching Tip: You could likely generate some interesting debate by asking students to take alternative positions on this issue. Perhaps, assign one student to the “pro” position 1-13 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

and one to the “con” position. Also, give them a chance to rebut the other person’s perspective. You could then ask a few others to join the debate by taking their preferred side on this issue. (The debate could become more spirited by raising very “intense” issues such as natural disasters, including the tsunami that hit Japan on March 11, 2011.) 2.

The Triple Bottom Line: Incorporating Financial as Well as Environmental and Social Costs

Next, we state that many companies are measuring what they call the ―triple bottom line.‖ Such a technique involves an assessment of environmental, social, and financial performance. We state that environmental sustainability is now a value embraced by most successful corporations. Discussion Question 16: Do you know of organizations that may have, in effect, used the “triple bottom line” approach to assess environmental, social, and financial performance? It is important to stress that when considering the ―triple bottom line,‖ there are not always tradeoffs. At times, firms can attain symbiosis—that is increase their effectiveness in attaining multiple bottom lines simultaneously. STRATEGY SPOTLIGHT 1.2 addresses how ESG funds can not only be good for the planet but also for investors‘ wallets. We provide a brief discussion of ESG (environmental, social, governance) and SRI (Socially Responsible Investing). These socially oriented investment approaches recognize that corporate responsibility and societal concerns are important considerations in investment decisions. And investors can ―do well by doing good,‖ as the cliché goes. The SUPPLEMENT below addresses some challenges in measuring the social impact firms may have on society. Extra Example: The Challenges of Measuring ESG Measuring the financial performance of companies has become a standard practice in the financial world. This is partly because financial reports are routinely audited by accounting firms such as Ernst & Young and because the financial community has agreed on standard financial performance metrics such as Return on Assets (ROA). Measuring the social performance of companies—often in the form of ESG scores—is a much bigger challenge. The reason for these difficulties is a fundamental disagreement about what should be measured in ESG scores. ESG scores are typically provided by independent research firms and intended to help companies to understand their ESG risks. However, it is often unclear what exactly ESG scores measure, which puts managers and shareholders in a difficult situation since they rely on ESG scores to make strategic decisions. Academic research published in the Strategic Management Journal has found that six-well established ESG ratings lack agreement, even after adjusting for differences in definitions. Take MSCI, Inc. as an example. MSCI is one of the largest providers of ESG scores, counting large asset managers such as BlackRock as its clients. MSCI‘s ESG scores are used to label a company as ―sustainable,‖ which allows investment firms to include the firm in ESG funds. Yet, MSCI‘s 1-14 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

ESG scores are coming under increasing scrutiny. Some argue that MSCI‘s ESG scores do not measure a company‘s impact on the planet and its people but the potential impact of the world on a company and its shareholders. A Bloomberg Businessweek report, for instance, shows that MSCI strategically upgrades companies‘ ESG scores by adjusting how the world may affect its business. This subtle difference allows MSCI to strategically adjust what its ESG scores measure in any given company. Take McDonald‘s as an example. MSCI upgraded McDonald‘s ESG rating in 2021, despite McDonald‘s impact on the global climate as the world‘s largest beef purchaser. What did MSCI do? It determined that climate change does not pose a substantial risk to McDonald‘s, which resulted in carbon emissions being dropped from McDonald‘s ESG score. Without climate concerns weighing on McDonald‘s, its ESG score improved. This example should be a cautionary tail of the difficulties of effectively measuring a company‘s ESG score. Source: Simpson, C., Rathi, A., & Kishan, S. 2021. Sustainable investing is mostly about sustaining corporations. www.bloomberg.com, December 10: np; and Chatterji, A. K., Durand, R., Levine, D. I., & Touboul, S. 2016. Do ratings of firms converge? Implications for managers, investors and strategy researchers. Strategic Management Journal, 37(8): 1597–1614.

We also provide a perspective on how corporate social responsibility (CSR) can be viewed in terms of three ―theaters‖ which are:   

Theater 1: Theater 2: Theater 3

Focusing on Philanthropy Improving Operational Effectiveness Transforming the Business Model

Discussion Question 17: What examples have you read about in which companies have succeeded (or failed) with such initiatives? What were the outcomes? We close this section with discussion of ―Making the Business Care for Sustainability Initiatives.‖ This becomes a challenge because companies want to know returns on their investments—and the ROI on sustainability initiatives are typically very difficult to quantify. Among the reasons are: 1. The data necessary to calculate ROI accurately are often not available when it comes to sustainability projects. 2. Many of the benefits from such projects are intangible. 3. The payback period is on a different time frame. We then provide examples of how companies such as 3M, Diversey, and IKEA are addressing these challenges. The SUPPLEMENT below addresses some of the challenges associated with implementing some ―good-sounding‖ and seemingly valuable environment sustainability initiatives. Extra Example: It‘s Not Easy to Implement What May Seem Like Reasonable Environmental Initiatives. Starbucks has plans to do away with plastic straws by the year 2020. Lyft has dedicated itself to become ―carbon neutral.‖ Candy producer Mondelez claims that all of its wrappers will be recyclable by 2025, and Goldman Sachs has banished the use of paper cups. However, there is 1-15 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

rather scant evidence that such gestures truly benefit customers, shareholders, employees—or the environment. Let‘s take a closer look at Starbucks. It plans to reduce plastic waste by eliminating plastic straws for recyclable lids. However, straws are a tiny share of waste, accounting for about 0.025 percent of the eight million tons of plastic that flow annually into the ocean. That aside, the new lids contain more plastic than the straws! Although the lids are ostensibly recyclable, consumers must separate them from the cups and throw them into recycling bins. Are many people—realistically— going to go to that trouble? Then, there are other practical concerns. In 2008, Starbucks set a ―bold goal‖ to serve 25 percent of its beverages in reusable cups by 2015. It later dropped the goal to only 5 percent. Why? Mainly because it was inefficient for baristas to wash dirty cups while other customers waited. And, to top off, cleaning mugs required water and paper towels—which also end up in the trash. Source: Finley, A. 2019. Would you like guilt with your latte? The Wall Street Journal, May 28: A19.

IV. The Strategic Management Perspective: An Imperative throughout the Organization PowerPoint Slide 30: Social Responsibility and Environmental Sustainability PowerPoint Slide 31: Empowered Strategic Management There is an emerging need for empowerment and a strategic management perspective throughout organizations. This is primarily due to today‘s increasingly complex, interconnected, and everchanging global economy. We reinforce this point with the quotation from MIT‘s Peter Senge, perhaps the best-known writer in the area of organizational learning. To develop and mobilize people and other organizational assets, leaders are required throughout the organization. Clearly, there is a need for three types of leaders: local line leaders, executive leaders, and internal networkers. The SUPPLEMENT below provides and interesting and colorful perspective on the need for empowerment throughout organizations. Extra Example: Avoid the Heroes and Drones Imagery in Organizations! Sally Helgesen, author of The Web of Inclusion: A New Architecture for Building Great Organizations, expresses the need for leaders throughout the organization. She asserts that many organizations ―fall prey to the heroes-and-drones syndrome, exalting the value of those in powerful positions while implicitly demeaning the contributions of those who fail to achieve top rank. Culture and processes in which leaders emerge at all levels, both up and down as well as across the organization, typify today‘s high performing firms.‖ Source: Helgesen, S. 1996. Leading from the grassroots. In Hesselbein, F. Goldsmith, M. & Beckhard, R. (Eds.) The leader of the future: 19-24, San Francisco: Jossey-Bass. 1-16 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

We provide examples of empowerment at both the Virgin Group that is well known for its culture and informal structure, as well insights as from Netflix. Discussion Question 18: With regard to the Virgin Group, what do you think would be some of the key challenges in bringing about change? We close this section with STRATEGY SPOTLIGHT 1.3 which further reinforces the benefits of broad involvement throughout the organization in the strategic management process. It is about how listening to lower-level executives in a firm can prevent strategic mistakes. The SUPPLEMENT below emphasizes the importance of empowering people throughout the organization. At USA Mortgage, the CEO realized, belatedly, the importance of having his middle managers involved in planning sessions. Extra Example: The Value of Bringing in Middle Level Managers for Planning Sessions Doug Schukar was very excited when his residential mortgage bank in St. Louis, USA Mortgage, increased the loans it funded from $113 million in January 2009 to $1.2 billion by the end of the year. While other lenders struggled, he boosted his sales efforts. However, by failing to keep key middle managers informed of growth plans such as acquisitions, he let them get blindsided by the huge volume of work that came from the company‘s rapid expansion. Result: Almost all resigned, and he had to hire replacements. Today, he includes middle managers in annual and quarterly planning sessions. Source: Harnish, V. 2011. Five ways to get your strategy right. Fortune. April 11: 42.

Ensuring Coherence in Strategic Direction

PowerPoint Slide 32-36: Coherence in Strategic Direction Successful organizations express priorities through stated goals and objectives that form a hierarchy of goals that include its vision, mission, and strategic objectives. What visions lack in specificity, they make up for in their ability to evoke powerful and compelling mental images. On the other hand, strategic objectives tend to be more specific and provide a more direct means of determining if the organization is moving toward broader, overall goals. EXHIBIT 1.6 depicts the hierarchy of goals and its relationship to two attributes: general versus specific and time horizon. We also address some of the benefits that firms may obtain when they communicate their long-term perspectives and priorities. Among these are: 1. Investor presentations of long-term plans provide an opportunity for discussions to take place regarding the continuing corporate performance on two critical elements: a long-time value creation story (drawing on the past) and a long-term value creation plan (drawing on the future). 1-17 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

2. Investors are increasingly seeing ESG (environmental, social, governance) issues as financially material and expect sound management in order to deliver better performance over the long term. 3. A corporation can obtain many collateral benefits when it communicates its long-term purpose. Among these are the ability to inspire—and retain—talented managers and employees. A.

Organizational Vision

An organizational vision has been described as a goal that is ―massively inspiring, overarching, and long-term.‖ It should represent a destination and evoke passion. We review a study of executives from 20 countries that points out the importance of ―a strong sense of vision‖ as well as ―strategy formulation to achieve a vision.‖ We state the visions of three organizations—Medtronic, McDonald‘s, and Intel, as well as Microsoft‘s initial vision: ―A computer on every desk in every home.‖ The SUPPLEMENT below (going back in history nearly one hundred years) provides an example of a vision emerging from the middle levels of the organization. Unfortunately, the top executives ignored it. Extra Example: David Sarnoff‘s Visionary Leadership In 1906, a young Russian immigrant found work as an office boy at Marconi Wireless Telegraph Company. He clawed his way up to Chief Inspector at the age of 22. And, ever watchful for ways to advance his career, he decided to attend a demonstration of a new kind of circuit—one that could generate continuous electromagnetic waves. The young man returned to work, convinced he had seen the future. Memos flew. He described how music could be broadcast to hundreds of thousands of homes at once, and from a single transmitter. Every family in America would buy a ―radio box.‖ And Marconi would manufacture and sell them all. He wondered why executives couldn‘t see that there would be millions of dollars to be made. The company‘s more senior managers thought he had lost his mind. After all, they were in the telegraph business. Years later, Marconi Wireless became RCA, the Radio Corporation of America. And former office boy David Sarnoff became its president. As for those fellows he worked with, history lost track of them. Source: Provided by CSX Intermodal (undated). We acknowledge their contribution.

Discussion Question 19: Would executives in companies with which you are familiar been more receptive to such initiatives by lower-ranking executives? Why? Why not? STRATEGY SPOTLIGHT 1.4 discusses how the change of Alibaba‘s vision served to create a more expansive view of the future. We close the section with a brief discussion of some of the reasons that visions fail:  The Walk Doesn‘t Match the Talk  Irrelevance 1-18 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

  

Not the Holy Grail Too Much Focus Leads to Missed Opportunities An Ideal Future Not Reconciled with the Present

The SUPPLEMENT below is another example of a well-known firm—Komatsu—which faltered when it missed opportunities because it placed too much focus on its vision. Extra Example: How Komatsu ―Encircled‖ Caterpillar Faced with the challenge of rival Caterpillar‘s entry into Komatsu‘s protected home market, Ryoichi Kawai, then CEO of Komatsu, focused the whole company on beating Caterpillar. ―MaruC‖ became the rally cry, which meant ―Encircle Caterpillar.‖ And, to make the enemy visible and omnipresent, Kawai purchased the largest Caterpillar bulldozer available and placed it on the roof of Komatsu headquarters. The story is well-known of how Kawai leveraged his aggression against Caterpillar into a highly disciplined and effective process of building up Komatsu‘s strengths and market position. (In fact, it became the most-used Harvard case study.) However, there was a lesser-known downside. The two decades of focusing on a ―life-and-death battle‖ with Caterpillar prevented Komatsu from identifying new opportunities in related areas of business and from pursuing genuine breakthrough innovations in its core earthmoving-equipment business. Eventually, Tetsuya Katada took over and formally abolished the ―Maru-C‖ slogan and removed all the symbols Kawai had built to represent the Caterpillar battle. The result was successful expansion into related areas, such as robotics, and several fundamentally different and highly innovative products, such as earthmoving equipment for undersea operations. Source: Bruch, H. & Ghoshal, S. 2004. A bias for action. Boston: Harvard Business School.

Discussion Question 20: What are some effective (or ineffective) organization visions with which you are familiar? Why are they successful (or unsuccessful? (We have found that many students—especially those with a fair amount of work experience—may be somewhat cynical, primarily because the “walk doesn’t match the talk”.) B.

Mission Statements

A company‘s mission statement differs from its vision in that it encompasses both the purpose of the company as well as the basis for competition and competitive advantages. Teaching Tip: Many students may have a very “cynical” perspective about mission statements. They may view them as empty platitudes or public relations statements. And, they may have been in organizations where managers did not “walk the talk.” You might, for example, ask students to critique the university’s mission statement. Alternatively, you may ask if any of them have worked in organizations that had mission statements and ask them if the mission statements were effective and if management “walked the talk.” EXHIBIT 1.7 contains the Vision Statement and Mission Statement of The Walt Disney Company. This exhibit helps to distinguish between these two strategy concepts. Effective mission statements incorporate the concept of stakeholder management, and suggest that organizations must respond to multiple constituencies if they are to survive and 1-19 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

prosper. They have the greatest impact when they are used to reflect an organization‘s enduring, overarching strategic priorities and competitive positioning. We provide the mission statements of Federal Express and Brinker International (whose restaurant chains include Chili‘s and On the Border). The two examples serve to illustrate how mission statements can vary in length and detail. Few mission statements identify profit or any financial indicator as the sole purpose of the firm. Good mission statements must communicate why an organization is special and different. The SUPPLEMENT below points out how Haier Group, a large Chinese appliance manufacturer, eliminates distance to customers by adopting various measures and strategies. ―Serving customers with quality‖ became part of their mission statement. Extra Example: The Mission of Haier Group‘s CEO: Getting Closer to Customers Zhang Ruimin, CEO of the Haier Group, realized that having a sole focus on generating huge profits today could not ensure his company‘s survival tomorrow. He chooses to focus on quality instead. He did so by following insights from Peter Drucker‘s management book, whose words Zhang took to heart: ―There is only one valid definition of business purpose: to create a customer.‖ This insight prompted Haier Group to explore opportunities to create customers in the era of cyberspace and the internet. The result was an internet and telephone marketing network and a physical logistics and services network that allows Haier to excel in determining customers‘ needs, rapidly delivering products, and after-sales services in both rural and urban areas all over China. Another step Zhang has taken is to invert Haier‘s organizational pyramid. He truly believes that only people on the front lines can have a deep understanding of customer‘s needs. Therefore, employees who directly face customers should be at the top, and senior executives should support them so that they can deliver on their commitments to customers. Zhang eloquently expresses his philosophy by drawing on Peter Drucker: ―All decisions I make must be consistent with the everchanging external environment. If they aren‘t, the consequences may not emerge right away, but once danger shows up, it will be too late; like the Titanic, my company will have no time to change course.‖ Source: Zhang, R. 2009. What I learned from Peter Drucker: Distance has been eliminated. www.hbr.org. November: np.

Discussion Question 21: Can you think of other measures to eliminate the distance between a company and its customers? Discussion Question 22: Can inverting the organizational pyramid really work? What would companies gain by doing so? What would they lose? C.

Strategic Objectives

Strategic objectives are used to operationalize the mission statement. That is, they help to provide guidance on how the organization can fulfill or move toward the ―higher goals‖ in the goal hierarchy—the mission and vision. 1-20 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

EXHIBIT 1.8 lists several strategic objectives divided into financial and nonfinancial objectives. While most of these objectives are directed toward generating greater profits and returns for the owners of the business, others are directed at customers or the society-at-large (such as BP Amoco‘s objective to reduce greenhouse gases over an extended period of time). For objectives to be meaningful, they must satisfy several criteria. They must be:  Measurable  Specific  Appropriate  Realistic  Timely Objectives that satisfy such criteria provide many benefits to the organization. These include: (1) channel employees throughout the organization toward common goals, (2) motivate and inspire employees to higher levels of commitment and effort, (3) help to resolve conflicts when they arise, and (4) provide a yardstick for rewards and incentives. There are, of course, other objectives that are even more specific that are often referred to as short-term objectives. These are essential components of ―action plans‖ that are vital in the implementation of a firm‘s strategy. (We address these in more detail in Chapter 9.) We provide the example of how Textron implements its strategic objectives. Organizations must ensure consistency throughout the organization when it implements strategic objectives. The SUPPLEMENT below discusses how Textron, a conglomerate with $14 billion in 2014 revenues, ensures that its corporate goals are effectively implemented. Extra Example: How Textron Implements Its Strategic Objectives At Textron, each business unit identifies ―improvement priorities‖ that it must act upon to realize the performance outlined in the firm‘s overall strategic plan. Each improvement priority is translated into action items with clearly defined accountabilities, timetables, and key performance indicators (KPIs) that enable executives to tell how a unit is delivering on a priority. Improvement priorities and action items cascade to every level at the firm—lowest levels in each of the firm‘s 10 business units. Says Lewis Campbell, Textron‘s CEO: ―Everyone needs to know: ‗If I have only one hour to work, here‘s what I‘m going to focus on.‘ Our goal deployment process makes each individual‘s accountabilities and priorities clear.‖ Source: Mankins, M. M. & Steele, R. 2005. Turning great strategy into great performance. Harvard Business Review, 83(5): 66–73.

VI.

Issue for Debate

This is an issue that should generate a lot of student interest—given the importance of values in the formulation and implementation of strategies. The issue should evoke some spirited debate because Seventh Generation is faced with a dilemma. That is, if they cross the picket line they 1-21 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

will be violating, in effect, a key part of their company values. On the other hand, if they refuse to provide product to the grocers, they would likely destroy relationships with valuable customers. To begin the discussion, you might consider asking two students to take a side (i.e., cross or not cross the picket line) on the debate. This helps, in effect, to polarize the class. Have the students debate the points of why their course of action would be preferred. After hearing the two sides, take a vote to see where the class stands on the issue. You‘ll likely find a split within the class. At this point, introduce the concept of dialectical inquiry, which we discuss in Chapter 13. Here, identify what might be considered the ―thesis‖ (cross the picket line and provide the grocers with your product) and ―antithesis‖ (don't cross the picket line and ―honor‖ your company values—after all, Seventh Generation felt the strikers had a just cause). Ask the class who the stakeholders are (customers, employees, suppliers, union, owners/shareholders, etc.), and how they are affected by each of these two options (many of these are mentioned in the second paragraph of the case—you might also address the importance of attracting and retaining talent as an important consideration in making such decisions). SEVEN GENERATION’S SOLUTION: You will probably get some creative ideas and, perhaps, even something close to Seventh Generation‘s creative resolution to the apparent dilemma: A group called the ―Values and Operating Principles Committee‖ (VOPS) was formed within Seventh Generation to solve the issue. While likely using a dialectic inquiry approach, they decided to continue to send their merchandise to the store but take the profits attributable to the sales at those stores and donate them to the union‘s strike fund. This allowed for shelf space to be maintained, as well as the relationship with both the strikers and their customers (grocers). The broader learning point to reiterate with this ―debate‖ is for students to strive to avoid the ―tyranny of the ‗go‘/‗no go‘‖ and instead seek more creative solutions. Dialectical inquiry is a useful means to this end—this decision-making process helps to address how various stakeholders are affected by the ―thesis‖ and ―antithesis‖ and a more creative solution ―synthesis‖ is often likely to emerge. During the course, especially when analyzing cases, it is helpful to draw on this example to encourage students to employ this decision-making approach when faced with two opposing alternatives. There can often be a third synthesis of ideas that will meet more stakeholder needs and desires. QUESTIONS: 1.

How important should Seventh Generation’s values be considered when deciding what to do?

Students may have a variety of perspectives on this issue—often reflecting how important they feel that non-economic factors should be in making important decisions. You might point out that Seventh Generation's mission is very specific regarding its sensitivity to broader stakeholder groups. 1-22 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

How can Seventh Generation solve this dilemma?

This, of course, is addressed above in the ―Summary.‖ It will be most interesting to see what ―synthesis‖ students come up with—and, again, emphasize the usefulness of dialectical inquiry in decision making.

VII. Reflecting on Career Implications PowerPoint Slide 37: Set Strategic Objectives PowerPoint Slide 38: Reflecting on Career Implications Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 1. 

Attributes of Strategic Management: The attributes of strategic management described in this chapter are applicable to your personal careers as well. What are your overall goals and objectives? Who are the stakeholders you have to consider in making your career decisions (family, community, etc.)? What tradeoffs do you see between your long-term and short-term goals?

Students should be aware of the context of their jobs and future careers. Ask students to describe their jobs, and they are likely to list the tasks they complete each day. Now ask them why their jobs are successful for them, and do not accept the salary as an answer. They should be trying to establish a base for the kind of career they want. Do they want to travel a lot or stay in their community? Do they want to raise children? Do they want to improve the world? How so? I enjoy telling stories of friends who took jobs right out of college that paid a high salary but were very challenging. Some of these friends burned out at a young age. The goal here is to get students to think about their careers as part of their life plans—to be balanced with their other goals of marriage, family, and service. You may not get an overwhelmingly positive response, but you will likely plant seeds that some students will appreciate. 

Intended versus Emergent Strategies: While you may have planned your career trajectory carefully, don‘t be too tied to it. Strive to take advantage of new opportunities as they arise. Many promising career opportunities may ―emerge‖ that were not part of your intended career strategy or your specific job assignment. Take initiative by pursuing opportunities to get additional training (e.g., learn a software or a statistical package), volunteering for a short-term overseas assignment, etc. You may be in a better position to take advantage of such emergent opportunities if you make the effort to prepare for them. For example, learning a foreign language may position you better for an overseas opportunity.

It may be useful to ask students how they chose their major. Was this major the same one they initially considered after high school? Some students will probably have changed their major at some point. You may get some stories about how hard their original choice was, or that there were unexpected challenges along the way. Now you can use the discussion as an analogy. Future career paths are likely to be filled with unexpected challenges, and it may be advisable to 1-23 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

consider alternatives. Most executives have worked in a variety of jobs and organizations during their careers. An alternative and supplemental approach may be to share your own career path, or the choice of your major in college, if either has evolved in unexpected ways. Students usually appreciate knowing this about their instructors. The point with these discussions is to get students to expect or even plan for unexpected job changes during their careers. They should be exploring activities to learn what they like and what they are good at. 

Ambidexterity: In Strategy Spotlight 1.1, we discussed the four most important traits of ambidextrous individuals. These include looking for opportunities beyond the description of one‘s job, seeking out opportunities to collaborate with others, building internal networks, and multitasking. Evaluate yourself along each of these criteria. If you score low, think of ways in which you can improve your ambidexterity.

Ask students to list examples of how they have exhibited these traits in their employment histories. Then ask them to share these with a classmate, a think-pair-share type of activity. The sharing with a classmate may spark a discussion of various ways that each student could pursue ambidextrous capabilities. The main value is awareness. Students will probably understand the need for ambidextrous capabilities, but they may not think about them very deeply or understand how to apply them to their work life. 

Strategic Coherence: What is the mission of your organization? What are the strategic objectives of the department or unit you are working for? In what ways does your own role contribute to the mission and objectives? What can you do differently to help the organization attain its mission and strategic objectives?

Students should understand how their efforts are helping their employers to succeed. One approach would be to have students list three or four activities they do in their jobs. Then rank the activities according to the strategic importance to their firm. I would ask students to share their rankings. Ask how each of their work activities contributes to their employers‘ competitive advantage. Then I would ask them to think of ways to increase the time and energy they spend on such strategic activities and decrease their time and energy investment in other activities. One caveat is that all of us must spend some time and energy on non-strategic activities, but students should be aware of the difference. 

Strategic Coherence: Setting strategic objectives is important in your personal career as well. Identify and write down three or four important strategic objectives you want to accomplish in the next few years (finish your degree, find a better paying job, etc.). Are you allocating your resources (time, money, etc.) to enable you to achieve these objectives? Are your objectives measurable, timely, realistic, specific, and appropriate?

It may be useful to ask students if they spend any time and energy in activities that do not contribute to their strategic objectives. Then ask why these activities are not productive. This line 1-24 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

of questioning may help to clarify the difference between the productive and unproductive activities, and it clarifies the types of activities that are productive. After this discussion, then the students are more likely to be ready for a discussion of objectives that are measurable, timely, realistic, specific, and appropriate.

VIII. Summary We began this introductory chapter by defining strategic management and articulating some of its key attributes. Strategic management is defined as ―consisting of the analysis, decisions, and actions an organization undertakes to create and sustain competitive advantages.‖ The issue of how and why some firms outperform others in the marketplace is central to the study of strategic management. Strategic management has four key attributes: it is directed at overall organizational goals, includes multiple stakeholders, incorporates both short-term and long-term perspectives, and incorporates trade-offs between efficiency and effectiveness. The second section discussed the strategic management process. Here, we paralleled the above definition of strategic management and focused on three core activities in the strategic management process—strategy analysis, strategy formulation, and strategy implementation. We noted how each of these activities is highly interrelated to and interdependent on one another. We also discussed how each of the 12 chapters fit into the three core activities and provided a summary of the opening vignettes in each chapter. Next, we introduced two important and interrelated concepts—corporate governance and stakeholder management. Corporate governance consists of three primary elements— management, boards of directors, shareholders (owners)—which play the key role in determining a corporation‘s strategic direction. Stakeholder management addresses the individuals (and organizations) that must be taken into account throughout the strategic management process. We identified several key stakeholders in all organizations, and the nature of their claims. Successful firms go beyond an overriding focus on satisfying solely the interests of owners. Rather, they recognize the inherent conflicts that arise among the demands of the various stakeholders, as well as the need to endeavor to attain ―symbiosis‖—that is, interdependence and mutual benefit—among the various stakeholder groups. We also addressed environmental sustainability and some of the challenges associated with ―selling‖ environmental sustainability initiatives to management. In the fourth section, we discussed the rate of unpredictable change that managers face today. Managers and employees throughout the organization must have a strategic management perspective and become more empowered. The final section addressed the need for consistency between a firm‘s vision, mission, and strategic objectives. Collectively, they form an organization‘s hierarchy of goals. Visions should evoke powerful and compelling mental images. However, they are not very specific. Strategic objectives, on the other hand, are much more specific and are vital to ensuring that the organization is striving toward fulfilling its vision and mission.

Chapter 1: Strategic Management: Creating Competitive Advantages Analyze your university (or college) from the stakeholder concept. Identify the stakeholders and the nature of their claims on the organization. What are the implications for administrators? Teaching suggestions: You might want to begin by asking the students to identify the difference between shareholders and stakeholders in the context of the university. Discussion should be oriented towards identifying the various stakeholder groups mentioned in the text, such as: *Customers:

students, alumni, recruiting organizations, organizations using research outputs from the university, *Employees: teaching staff including faculty, research associates, teaching associates and the non-teaching or administrative staff, operational staff, *Suppliers: funding organizations and donors, stationery and teaching equipment suppliers, suppliers of utilities, etc., *Community: taxpayers and the general public who have expectations from the university and can influence its functioning and funding and, of course, the state would be the owner in the case of a state university. You might then want to ask whether stakeholder management is zero sum or symbiotic? This would be an interesting issue with which to generate discussion. You can play the role of a devil‘s advocate to enliven the discussion. It can be argued that if faculty and other employees desire higher salaries, this would require that the ―customers‖ have to pay more for their services. Similarly, more funds for research would mean lesser funds for the administrative and support staff. Taxpayers would want to pay less, which means increased tuition burden to the students and so on. This would bring out the competing and conflicting nature of the claims of the various stakeholder groups. You might want to then highlight the value of stakeholder symbiosis. Stakeholders are dependent upon each other for their success and well-being. 1. Top quality research needs excellent financial and support facilities. And administrators must recognize that in order to ensure the effective functioning of the university, neither the teaching staff nor the support staff should be starved. Further, research can also enhance the ability of the university to generate external funds. 2. Similarly, customers cannot expect to have better quality education unless they are prepared to pay for it. Alternatively, taxpayers need to pay a certain level of taxes in order to maintain the university at a reasonable level of performance. 1-26 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

3. Universities also have the social responsibility of inculcating right attitude, and shaping the integrity and character of the students, so that they become good citizens in all walks of life. You might then want to ask the students to give examples of other social responsibilities of universities. Some of the social responsibilities that can be discussed, to mention a few, are setting examples in terms of waste recycling, promoting environment friendly campus and research lab facilities, being involved with community services, ensuring diversity in the recruiting of students, staff, and faculty. Conclusion: The expectations of various stakeholder groups are not constant over time and keep changing with changes in technology, globalization, and other societal changes. An administrator would have to recognize this dynamic nature of stakeholder management and strive toward achieving mutual benefit through stakeholder symbiosis.

End-of-Chapter Teaching Notes Chapter 1: Strategic Management, Creative Competitive Advantages Summary Review Questions 1. How is “strategic management” defined in the text, and what are its four key attributes? (In text, What Is Strategic Management?, LO 1-1) Response: Strategic management is the analyses, decisions, and actions an organization undertakes in order to create and sustain competitive advantages. The four key attributes of strategic management are that it  Directs the organization toward overall goals and objectives  Includes multiple stakeholders in decision making  Needs to incorporate short-term and long-term objectives  Recognizes trade-offs between efficiency and effectiveness 2. Briefly discuss the three key activities in the strategic management process. Why is it important for managers to recognize the interdependent nature of these activities? (In text, The Strategic Management Process, LO 1-2) Response: The three key attributes in the strategic management process are analyses, decisions, and actions. Analyses, also called strategy analysis, refer to managers‘ development of an understanding of the organization‘s internal and external environment, and the organization‘s overarching goals. These understandings are an important prerequisite for the strategic management process. Decisions, also called strategy formulation, refer to the overall plans that firms develop to compete and outperform their rivals. These plans exploit the results of analyses, in that firms try to use their strengths, limit weaknesses, exploit opportunities, and defend against threats simultaneously. Actions, also called strategy implementation, refer to ensuring that proper strategic controls and organizational designs are put in place to carry out the strategy. The interdependent nature of these activities stems from various feedback mechanisms that occur as managers implement their firms‘ strategies. Unforeseen environmental developments, unanticipated resource constraints, and/or changes in managerial preferences will force firms to modify their intended strategy, combining it with an emergent strategy, and resulting in a realized strategy. The realized strategy will in turn be modified by further unforeseen events. The continually modified realized strategy will consist of refined analyses, decisions, and actions that are constantly being updated. 1-28 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

3. Explain the concept of “stakeholder management.” Why shouldn’t managers be solely interested in stockholder management, that is, maximizing the returns for owners of the firm—its shareholders? (In text, The Role of Corporate Governance and Stakeholder Management, LO 1-3) Response: Stakeholder management is where multiple individuals or groups, who have a stake in or can influence an organization‘s performance, are included in the strategic management process. So, top managers will be interested in satisfying the needs of shareholders and other stakeholders such as customers, suppliers, employees, creditors, government, and the community. Managers who are interested solely in stockholder management are likely to make decisions that satisfy short-term profit objectives. These decisions might include downsizing, neglect of asset maintenance, or put pressure on suppliers to lower prices. However, these decisions are likely to adversely affect long-term performance. Top managers who pay attention to all stakeholders are less likely to make decisions counter to the firm‘s objective of long-term profit maximization. 4. What is “corporate governance”? What are its three key elements and how can it be improved? (In text, The Role of Corporate Governance and Stakeholder Management, LO 1-3) Response: Corporate governance is defined in the text as the relationship among various participants in determining the direction and performance of corporations. The primary participants are (1) the shareholders, (2) the management (led by the chief executive officer), and (3) the board of directors. Corporate governance is designed to focus the efforts of the CEO on maximizing longterm shareholder wealth. The board of directors is elected or chosen by shareholders, and is charged with monitoring and evaluating CEO performance. Corporate governance can be improved by including other stakeholder representatives on the board of directors. These other members would ensure that top management will respond to these interests and become more socially responsible in addition to earning profits. Managers will respond to and exploit overlapping stakeholder interests, which can lead to increased longterm profits. Another way to improve corporate governance is to align managerial incentives with organizational performance. This alignment is often done through incentive-based pay or compensation through stock options. Rather than pursuing self-interest such as perks and salary, top managers will be motivated to make their organizations succeed. 5. How can “symbiosis” (interdependence, mutual benefit) be achieved among a firm’s stakeholders? (In text, The Role of Corporate Governance and Stakeholder Management, LO 1-3)

Response: Stakeholder management will, in part, be tricky because of competing interests. For example, customers may want lower prices while shareholders might want higher prices (which may lead to higher profits). However, stakeholder symbiosis can also result because stakeholders depend on each other for success and well-being. Firms can achieve stakeholder symbiosis by learning stakeholder interests and looking for overlaps. For example, Outback Steakhouse discovered that employees and customers both benefited by employing staff who agreed with the company‘s principles and beliefs. Such staffs tended to have lower turnover and more satisfied customers. Inclusion of stakeholders such as the community, government, and environmental groups can also increase a firm‘s reputation. For example, firms that use a triple bottom line and evaluate their performance in financial, social, and environmental dimensions are likely to have good reputations with customers, governments, and the community at large. 6. Why do firms need to have a greater strategic management perspective and empowerment in the strategic management process throughout the organization? (In text, The Strategic Management Perspective: An Imperative throughout the Organization, LO 1-5) Response: In today‘s complex and dynamic business environment, top managers do not have all the answers. Rather, top managers will be responsible for communicating their firms‘ strategies to lower-level managers, and in turn empower these managers with discretion to respond quickly and appropriately to opportunities as they arise. Such empowerment enables a firm to respond more quickly to the needs of customers and stakeholders, thus improving competitiveness. 7. What is meant by a “hierarchy of goals”? What are the main components of it, and why must consistency be achieved among them? (In text, Ensuring Coherence in Strategic Direction, LO 1-6) Response: An organization‘s hierarchy of goals refers to goals ranging from, at the top, those that are less specific yet able to evoke powerful and compelling mental images, to, at the bottom, those that are more specific and measurable. The main components are, at the top, the organizational vision, which evokes powerful and compelling mental images, the mission statement, which includes both the purpose of the organization, its scope of operations, and the basis of its competitive advantage, and the strategic objectives, which include shorter-term and measurable goals that guide middle-level managers as they implement the mission statement. There must be consistency among these goals in order to maximize employee motivation and a sense of equity and fairness when rewards are allocated. Inconsistency among the goals between 1-30 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

any level can result in confusion among employees as to what the firm values, and subsequently to loss of identification with the firm, loss of motivation, and turnover. Experiential Exercise and Application Questions 1. Strategy Spotlight 1.1 discusses four activities that underlie ambidextrous behaviors—a dual capacity for alignment and adaptability. Interview two managers in a public, private, or volunteer organization and ask them the following questions: (1) How often do you engage in each of these activities? (2) In your view, which are most important and why? and (3) How would the most effective managers you know “score” on each of these activities? Do you think that the differences in the responses you obtain are due to differences with regard to the managers’ personalities, the particular position they have within the organization, or the type of industry in which they work? Response: This exercise can be used to understand how ambidextrous individuals operate in organizations. You may draw students' attention to the fact that managers have limited time and attention; hence it becomes important to be extremely purposeful concerning what activities managers engage in. Students become aware of the challenges of using ambidextrous capabilities, but will also see the need for them. In addition, tying this question to personal differences or higher-level influences such as organizations or industries should result in an interesting discussion of the extent to which the external environment affects managers. 2. Using the internet or library sources, select four organizations—two in the private sector and two in the public sector. Find their mission statements. Complete the following exhibit by identifying the stakeholders that are mentioned. Evaluate the differences between firms in the private sector and those in the public sector. Response: This exercise is intended to highlight the differences between private and public sector organizations. Students are likely to discover that private sector organizations will focus more on customers and employees. Public sector organizations are likely to focus more on the community at large or broader groups such as taxpayers, the government, or people with a common problem or interest. An interesting extension of this exercise is to reverse it. Offer a couple of other stakeholder groups, such as the Rainforest Coalition, an organization promoting higher ethical standards for lawyers, or Greenpeace, and ask students what organizations will have these as stakeholders. Then ask why. This exercise is designed to allow students to appreciate some of the advantages to organizations of having multiple diverse stakeholders. 3. On the internet, visit one of these company sites: www.walmart.com, www.ge.com, or www.ford.com. What are some of the key events that would represent the “romantic” 1-31 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

perspective of leadership? What are some of the key events that depict the “external control” perspective of leadership? Response: For these companies, students may have to look a bit to get to the information on company leadership. Usually at the bottom of the first page is a link to ―about us.‖ Interestingly, for Ford, the link to ―The Ford story‖ takes you to social media, not information about Ford. There, customers can share their stories about their experiences with Ford products. For www.walmart.com, the Walmart story includes information related to the romantic perspective of leadership, in which the leader determines organizational success. Sam Walton had a vision about retailing as a way to satisfy customers, and his idealistic vision is repeated throughout the website. You have to look a bit for this information, though. It‘s buried in links placed at the bottom of the page. For the external control perspective, Walmart simply satisfied a latent demand of consumers for a wide assortment of goods at the lowest possible prices. For http://www.ge.com, the GE website includes information on the romantic perspective of leadership. There is a link to all the early leaders of GE, back to 1892. No link to Thomas Edison, though, was easily available. There were also links to various leaders and what they are doing to make GE successful. For the external control perspective, GE claims to be responding to market and society needs in various ways, from products to corporate hiring practices, although their performance in recent years has been very poor. For www.ford.com, the Ford website includes information on its historical roots, which is linked to the romantic perspective of leadership. It takes a couple of clicks, but you can get to Henry Ford‘s vision of paying workers $5 a day in 1914. The company still carries the Ford name, which suggests that a long-standing corporate culture drives decision making. There are also links to corporate governance and the members of the board of directors. These emphasize the importance of these leaders for representing Ford‘s perspective to outside interests. For the external control perspective, Ford offers a number of explanations for its organizational success, such as great styling, a strong presence in social media, and descriptions of competitive advantages such as flexible, global production, and cost savings. And Ford‘s sustainability report emphasizes its responsiveness to various stakeholders and social responsibility. 4. Select a company that competes in an industry in which you are interested. What are some of the recent demands that stakeholders have placed on this company? Can you find examples of how the company is trying to develop symbiosis (interdependence and mutual benefit) among its stakeholders? (Use the internet and library resources.) Response: This exercise enables students to see how stakeholders other than shareholders are affecting corporate governance. To extend students‘ findings, ask them to look up legislative issues related to other issues such as global warming, fair trade (in agricultural goods), and conflict-free diamonds. 1-32 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

5. Provide examples of companies that are actively trying to increase the amount of empowerment in the strategic management process throughout the organization. Do these companies seem to be having positive outcomes? Why? Why not? Response: Students may come up with numerous examples of empowerment. A Google search of ―employee empowerment‖ will yield more than 800,000 hits, and lots of good examples. Most of the information is positive, but for the negative side, check the infamous stories of Nick Leeson, who brought down Barings Bank, and Jerome Kerviel, who hurt Societe Generale. And the recent downfall of AIG has been linked to the poor monitoring, and excess empowerment, of its division that get involved in credit default swaps and collateralized debt obligations. In these cases, lower-level managers were empowered but not supervised, made poor decisions, and cost their firms dearly. The lesson is that empowerment has associated risks, and managers have to strive for a most effective balance between empowerment and control. 6. Look up the vision statements and/or mission statements for a few companies. Do you feel that they are constructive and useful as a means of motivating employees and providing a strong strategic direction? Why? Why not? (Note: Annual reports, along with the internet, may be good sources of information.) Response: Students will likely come up with a few examples. An interesting exercise is to first ask students if they are excited by the statements. If not, then ask how the statements should be changed to increase interest. It would then be useful to steer students into a discussion of what the firm is all about—what does the firm do that is interesting. Then to how a firm can back up its claims. The result of the discussion is that mission and vision statements relate to firm policies. Ethics Questions 1. A company focuses solely on short-term profits to provide the greatest return to the owners of the business (i.e., the shareholders in a publicly held firm). What ethical issues could this raise? Response: Short-term focus may result in long-term loss. For example, look at Arthur Anderson. That company is alleged to have increased short-term profits by linking consulting contracts with favorable auditing opinions. The increase in short-term profits was balanced by bankruptcy in the longer run. Other examples are the banking industry‘s focus on exploiting the home mortgage industry in the 2000s, and the Bernie Madoff scandal.

2. A firm has spent some time—with input from managers at all levels—in developing a vision statement and a mission statement. Over time, however, the behavior of some executives is contrary to these statements. Could this raise some ethical issues? Response: From the perspective of lower-level managers, the inconsistency between the mission and vision statements—and the behavior of the executives—will cause cognitive dissonance. The lowerlevel managers will wonder what the firm really values and will possibly lose motivation, identification with the firm, pride, and desire to stay with the firm.

CONNECT RESOURCES Case Analysis. Coming from Behind, Lego Becomes Number One. Suntory—A Japanese Beer Company Tesla: A 21st Century Success Story

Chapter 2 Analyzing the External Environment of the Firm: Creating Competitive Advantages 2-37 Enhancing Awareness of the External Environment .............. 2-Error! Bookmark not defined. The Role of Scanning, Monitoring, Competitive Intelligence, and Forecasting.......................................................................................... 2-39 SWOT Analysis.......................................................................................... 2-44

The General Environment ......................................................... 2-44 The Demographic Segment ...................................................................... 2-45 The Sociocultural Segment ....................................................................... 2-45 The Political/Legal Segment ..................................................................... 2-47 The Technological Segment ...................................................................... 2-47 The Economic Segment ............................................................................. 2-49 The Global Segment .................................................................................. 2-49 Relationships among Elements of the General Environment ............... 2-50

The Competitive Environment .................................................. 2-51 Porter’s Five Forces Model of Industry Competition............................ 2-51 Using Industry Analysis: A Few Caveats ................................................ 2-57 Strategic Groups within Industries ......................................................... 2-58

Issue for Debate ........................................................................... 2-59 1-35 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Reflecting on Career Implications ............................................ 2-60 Summary ...................................................................................... 2-62 End-of-Chapter Teaching Notes................................................ 2-68 Connect Resources ...................................................................... 2-76

Chapter 2

Analyzing the External Environment of the Firm: Creating Competitive Advantages Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead The purpose of this chapter is to familiarize students with techniques for evaluating a firm‘s external environment. This chapter focuses on the value managers add when they have a sense of events outside the company. By focusing on external events, managers are able to stay a step ahead of competitors by accurately anticipating and promptly responding to actions that can impact the organization. The chapter is organized into three sections. 1. The environmentally aware organization. Emphasize that managers use scanning, monitoring, and competitive intelligence to develop forecasts. Also, the role of scenario planning is discussed. 2. The influence of the six broad segments (demographic, sociocultural, political/legal, technological, economic, global) of the general environment of the firm. 3. The role of the competitive (also called the task or industry) environment and its analysis through the application of Porter‘s five-forces model. We address how industry and competitive practices are being affected by digital technologies. We also address the concept of strategic groups. Managers use strategic groups to identify who its main competitors are and how a company fits in with the overall industry in which it competes.

Lecture/Discussion Outline We lead off the chapter with the opening case of Airbus in LEARNING FROM MISTAKES. Here‘s a firm that had a different vision of how to exploit an opportunity than its closest competitor, Boeing. Airbus did misjudge this particular market opportunity. Ask: Discussion Question 1: Given that it is difficult to predict future market needs and trends in industries with long product life-cycles (such as jetliners), how should managers deal with this uncertainty? Response guidelines: Students should understand that effective strategy is often an opportunity-driven process, meaning effective strategy starts with identifying changes in the environment. Airbus saw a market opportunity for extra-large jumbo jets and focused on ―perks‖ 1-37 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

(such bars and beauty salons) while Boeing saw a market opportunity for smaller jumbo jets and focused on efficiency and comfort. While both companies made a bet on an uncertain future, Boeing better predicted the needs of customers and airlines. Specifically, filling a large A380 with passengers is a daunting task for airlines, while filling a fuel-efficient Boeing Dreamliner is much more manageable for airlines. Students should understand that it is not only the endconsumer that determines the success of a product or service (passengers loved the A380) but also the service providers (airlines) must be able to operate the airliner effectively and efficiently. Companies must therefore consider a broad range of important stakeholders and use effective strategy tools (such as the tools we introduce in Chapter 2) to predict changes in the general and competitive environment. Students should also realize that strategic analysis of the general and competitive environment becomes increasingly important when the life-cycle of the product or service is very long as changes or adjustment become infeasible. Discussion Question 2: How should Airbus compete against Boeing going forward? Response guidelines: Students may come up with a few intriguing suggestions. After they do, instructors may want to group the responses into external and internal categories. It is expected that some students focus on perceived internal strengths and weaknesses (such as improving Airbus‘ R&D competence) while others focus on opportunities (such as investing in the market for short-haul airplanes or space travel). The instructor should illustrate that competition between two large (and in many aspects similar) competitors is often driven by taking a position and seize external opportunities effectively. Of course, taking a position is uncertain and risky (as we saw with the A380) so the key is not to avoid uncertainty and risk, but to manage it effectively (with the tools we introduce in Chapter 2). The instructor may also point out that if executives want certainty and clarity, they can just wait for other firms to take a position and see how they do. Then they will know what works, but it will be too late to profit from the knowledge.

Enhancing Awareness of the External Environment

PowerPoint Slide 4: The Importance of External Environment PowerPoint Slide 5: Enhancing Awareness of the External Environment PowerPoint Slide 6: Environmental Scanning and Monitoring PowerPoint Slide 7: Competitive Intelligence PowerPoint Slide 8: Environmental Forecasting PowerPoint Slide 9: SWOT Analysis We address three important processes—scanning, monitoring, and gathering competitive intelligence—which managers use to develop environmental forecasts. EXHIBIT 2.1 depicts relationships among these activities. Also, we address scenario analysis and its role in anticipating future major changes in the external environment as well as the role of SWOT analysis. We lead off the section with a discussion of Ram Charan‘s concept of ―perceptual acuity‖—the ability to sense what is coming before the fog clears. We give three examples of 1-38 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

what three CEOs have done to improve their perceptual acuity: met with key managers periodically to discuss what is going on, met with the CEOs of other organizations four times a year, and asked outsiders to critique their firm‘s strategy. Teaching Tip: Most students in your class will not likely be CEOs or top executives. So, one way to help them apply this idea is to ask them how they could apply it in their present position—or in a job to which they immediately aspire. Hopefully, they will come up with ideas such as spending time with people in their organization to address issues outside of their immediate job, describing how their efforts affect other areas/departments in the firm, and seeking perspectives of colleagues and friends who work in a different organization. The key point, of course, is to encourage them to look at issues from a broader perspective instead of focusing on their immediate work responsibilities. A.

The Role of Scanning, Monitoring, Competitive Intelligence, and Forecasting 1.

Environmental Scanning

Environmental scanning involves surveillance of the firm‘s external environment to predict environmental changes to come and detect changes that are already underway. We discuss the example of how Procter & Gamble, with its wide range of household products, can be a good barometer of household spending. Discussion Question 3: Would these “tips” be equally appropriate for all industries? Why? Why not? Discussion Question 4: Could such an approach be used in other industries? What investments would be required? Environmental scanning can also involve obtaining information from your customer base. The SUPPLEMENT below provides an example of how this was effectively used by an online contact-lens retailer, Coastal Contacts. Extra Example: Ask Your Customers for Ideas Coastal Contacts, one of the largest online contact-lens retailers in North America, came out of its two-day planning session with few ideas about how to spur growth. Thus, over the next six months CEO Roger Hardy and his senior team called customers each week to see whether they had any ideas. To the company‘s surprise, one recurring theme emerged—customers wanted to get their lenses the next day. ―We started overnighting everything,‖ he reports. Sales in the U.S., where he recently made the change, were up 41 percent for the year, bringing company sales to $155 million. Source: Harnish, V. 2011. Five ways to get your strategy right. Fortune. April 11: 42.

Discussion Question 5: What are some other examples of firms that got excellent ideas by simply asking their customers for input?

Environmental Monitoring

Environmental monitoring tracks the evolution of trends, events, or streams of activities in the external environment. In this section, we present some of the factors monitored by three organizations: Motel 6, Pier 1 Imports, and Johnson and Johnson Medical Products. Such factors are vital for managers in determining their firm‘s strategic direction and resource allocations. The SUPPLEMENT below represents the factors that the Director of Planning of Vought Aircraft considered critical. You may initially ask the students: Discussion Question 6: What indicators do you believe a firm should monitor that produces both (1) weapon systems for the military, and, (2) key components for the commercial aircraft industry? Extra Example: Factors to Monitor—Vought Aircraft Commercial Aircraft: 1. Oil prices 2. Age of fleet of airlines 3. Profitability of airlines Defense Department: 1. Where weapons are in the life cycle 2. Mission requirements of the military Source: Authors‘ interviews.

The SUPPLEMENT below discusses how Cisco, the networking giant, learned from its mistakes during the Internet bust in 2001—and now carefully it monitors its inventory levels. It points out that managers must monitor key aspects of the firm‘s internal environment—as well as the firm‘s external environment. Extra Example: How Cisco Learned from Its Mistakes In April 2001, Cisco made one of the more painful confessions of the Internet bust: It had so much networking gear piled up that it had to take a $2.5 billion write-off for equipment that it figured nobody would ever buy. It has been working hard ever since to make sure that such a thing never happens again. Supply chain chief Angel Mendez is grilled at monthly reviews by CEO John Chambers and other top executives. Now, Cisco has half the inventory it did in 2001—even though its revenues are twice as large. Says Mendez: ―It didn‘t take John eight years to start asking questions (about inventory levels). He asks about every eight minutes.‖ Source: Burrows, P. 2009. Tech: Lean and Ready to Spring. BusinessWeek. April 27: 14–16.

Discussion Question 7: Are you aware of other firms that have failed to effectively monitor key aspects of their internal environment (e.g., excessive numbers of employees and layers of management; high levels of inventory that became obsolescent; insufficient 1-40 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

sales, marketing, engineers, etc. to meet increasing demand for goods/services and innovations, etc.)? The SUPPLEMENT below discusses why Caterpillar may serve as a macroeconomic early-warning system. Extra Example: Caterpillar—A Macroeconomic Early-Warning System? Although it is hard to confuse a 40-ton excavator with a crystal ball, forecasters could do worse than tracking retail sales of the huge, yellow machines sold by Caterpillar Inc. Being the largest seller of equipment used to build stuff or extract the stuff from the ground used to build that stuff, Caterpillar‘s customers‘ appetite is sort of a macroeconomic early-warning system. Two big worries—the slowdown in China‘s property market and a related slump in demand for commodities from crude oil to iron ore—show up quickly in its monthly sales reports, helpfully broken down by region and type of machinery. The year 2014 has, not surprisingly, been a tough year for the firm‘s shareholders. Its stock price trailed the S&P 500 by 31 percent. Source: Jakab, S. 2015. Caterpillar is stuck in its cocoon. Wall Street Journal. April 23: C1.

Competitive Intelligence

Competitive intelligence helps firms define and understand their industry and identify rivals‘ strengths and weaknesses. Done properly, competitive intelligence helps a company to avoid surprises by effectively anticipating and responding to competitors‘ moves. We briefly address the importance of competitive intelligence to firms in the banking, airline, and automobile industry. Discussion Question 8: What are other industries where competitive intelligence is extremely important? How might such information be collected? We address how the Internet has accelerated the speed at which firms can find competitive intelligence. We discuss in the text also some of the ethical guidelines that United Technologies has implemented. Discussion Question 9: Are you aware of ethical guidelines that other companies have developed? Were they effective? Why? Why not? Teaching Tip: The discussion of Competitor Intelligence provides the instructor with an opportunity to introduce the subject of ethics into the classroom. We suggest presenting scenarios that are not ―black and white.‖ For example, a firm advertises a position in order to get a chance to interview employees of a rival company with no intention to hire them. While this may not be illegal, clearly it is difficult to justify morally. The ensuing discussion will help to clarify the distinction between illegal and unethical behavior. 1-41 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Environmental Forecasting

Environmental scanning, monitoring, and competitive intelligence are important inputs for analyzing the external environment. However, they are of little use unless they provide raw material that is accurate enough to help managers make accurate forecasts. We address the twin problems of either assuming that the world is certain and open to precise predictions, or the assumption that it is uncertain and totally unpredictable. And, we provide the famous example of poor forecasting by Digital Equipment Corp., which caused it to ignore the potential of personal computers. We also provide several other predictions about the future of technology which did not pan out. Discussion Question 10: What are some other errors in forecasting with which you are familiar? It should be interesting to ask students to provide a few more examples of technology forecasts that really missed the mark—some of them go farther back in time than the ones listed in the text. A few of them are listed in the SUPPLEMENT below. You might even ask them what forecasts/predictions for the future of technology that they have. Extra Example: Technology Forecasts That Missed the Mark 1946: ―Television won‘t be able to hold on to any market it captures after the first six months. People will soon get tired of staring at a plywood box every night.‖ —20th Century Fox Studio executive Darryl Zanuck 1959: ―Before man reaches the moon, your mail will be delivered within hours from New York to Australia by guided missiles. We stand on the threshold of rocket mail.‖—U.S. Postmaster General Arthur Summerfield 1961: ―There is practically no chance communications space satellites will be used to provide better telephone, telegraph, television, or radio service inside the United States.‖—Federal Communications Commission (FCC) commissioner T.A.M. Craven 1966: ―Remote shopping, while entirely feasible, will flop.‖ —Time Magazine Source: Dunn, M. 2016. 20 tech predictions that failed. www.news.com.au. March 8: np.

The SUPPLEMENT below provides an intriguing example for the importance of forecasting trends in the general environment. Extra Example: Focusing on what most businesses do is a big mistake When analyzing the general environment, strategists are well advised to focus on the long-term future rather than the present. Strategies that disregard this advice are often destined to underdeliver. It is easy to understand why companies may base their strategy on the present: It is easy to understand and presents little uncertainty. Yet, focusing on the present is like developing a strategy based on what you see in a rearview mirror. If you develop a strategy this way, you implicitly assume that the future will look like the present. Yet, this may only be true in very 1-42 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

static industries. The majority of industries are increasingly dynamic and change is the rule rather than the exception. For instance, at one point, most movies were rented on something physical (like VHS or DVD), yet the growth was in ―new‖ distribution channels such as streaming. Companies that do not focus on the small but growing market may quickly become a ―dead man walking‖. Andrew Winston, the founder of Winston Eco-Strategies and an adviser to leading companies, highlights that this advice is particularly important when companies try to forecast environmental and social issues. It is easy to understand current environmental conditions but developing business models on what most companies do in the environmental space likely leaves opportunities on the table. Take Amazon for example. While many delivery companies presently rely on conventional delivery trucks, Amazon aggressively replaces its delivery trucks fleet with electric delivery vans from Rivian to achieve its goal to be carbon neutral by 2040. Focusing on the future of general environmental factors will likely give companies a first mover advantage. Sources: Winston, A. 2018. Focusing on what 90% of businesses do now is a big mistake. MIT Sloan Management Review, 59(3): 80–84.

Scenario Analysis

Scenario analysis provides a set of tools that enable managers to imagine threats and opportunities the future may bring. As a general rule, scenarios should be used by businesses whose external environments are prone to fundamental or sudden change and whose anticipation of such change is of vital strategic importance. It is important to note that scenario analysis draws on a wide range of disciplines and interests, among them economics, psychology, sociology, and demographics. Discussion Question 11: Why must scenario analysis and scenario planning draw on a variety of disciplines and interests? We provide an example of how PPG Industries has benefited from the use of scenario analysis and planning. We address the value of a firm in creating an environmentally aware organization— which includes environmental scanning and monitoring, as well as competitive intelligence, forecasting, and scenario planning. In contrast, the late Steve Jobs (Apple‘s former Chairman) took a far different approach to determining what customers really wanted. We discuss Jobs‘ distaste for sophisticated approaches to market research. Discussion Question 12: Would such a mindset work for other organizations? Why? Why not? (Firms in commodity industries—which experience much less uncertainty than technology industries have less need for such “intuition” since these industries face much less dramatic change in market demand and technologies. And, of course, very few firms have the visionary genius of a Steve Jobs! Also, you might point out how Ron Johnson (who was fired as CEO of J.C. Penney in early April 2013) relied too much on his intuition and drove the firm into the ground—and almost into bankruptcy.

SWOT Analysis

We briefly address SWOT Analysis at this point. SWOT stands for strengths, weaknesses, opportunities, and threats. SWOT analysis provides a framework for analyzing these four elements of a company‘s internal and external environment. It is important to note that SWOT analysis provides the ―raw material,‖ that is, a basic listing of conditions and factors inside and outside of a company. Discussion Question 13: What do you consider to be some of the major advantages and disadvantages of SWOT analysis? (This issue is addressed in more detail in Chapter 3, but you should point out that a key disadvantage is that strengths may not necessarily convert to sources of competitive advantage that are sustainable in the marketplace.)

II.

The General Environment

PowerPoint Slide 11: The General Environment PowerPoint Slide 12: The Demographic Segment PowerPoint Slide 13: The Social Segment PowerPoint Slide 14: The Political/Legal Segment PowerPoint Slide 15: The Technological Segment PowerPoint Slide 16: The Economic Segment PowerPoint Slide 17: The Global Segment PowerPoint Slide 18: General Environment: Relationships among Elements The general environment consists of factors that can have a dramatic effect on a firm‘s strategy. Typically, a firm has little ability to predict trends and events in the general environment, and even less ability to control them. We divide the general environment into six segments: demographic, sociocultural, political/legal, technological, economic, and global. EXHIBIT 2.2 provides examples of key trends and events in each of the six segments of the general environment Discussion Question 14: How will the factors in Exhibit 2.3 affect specific industries? Discussion Question 15: Which factors are more difficult to predict than others? (e.g., macroeconomic changes are typically more difficult to predict than demographic changes) Discussion Question 16: How are these factors interrelated? Discussion Question 17: What factors that are not listed in this exhibit do you feel are important? 1-44 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The Demographic Segment

Demographics are the most easily understood and quantifiable elements of the general environment. Demographics include elements such as the aging population, rising or declining affluence, changes in ethnic composition, geographic distribution of the population, and income level disparities. Discussion Question 18: What are the implications of ethnic diversity for the work place? Discussion Question 19: What implications does the migration to the South and West in the United States have for individual businesses? Discussion Question 20: How does the “graying of America” affect U. S. companies? Among the trends we discuss are the aging of the population and how it may differentially affect a wide variety of industries. We also discuss the increasing number of older Americans and its importance for attracting and retaining older workers. Ask: Discussion Question 21: It might be interesting to ask what the implications (of the aging of the population) are for today’s organization (e.g., how can firms attract and retain older workers, changes in financial and non-financial incentives, etc.) as well as for public policy (e.g., changes in tax policies, increasing the number of immigrants, etc.). We also provide INSIGHTS FROM RESEARCH: New Tricks: Research Debunks Myths about Older Workers (in text, The General Environment section). Here, results from a metaanalysis points out some findings about older workers many people would find counterintuitive. The findings concluded older workers are NOT less motivated, more resistant to change, less trusting, less healthy, or more valuable to work-family issues. The only ―myth‖ supported by the data was older workers are less willing to participate in training and career development. Discussion Question 22: What are the practical implications of these findings As noted in the IFR: provide more opportunities for younger and older workers to work together; promote positive attributes of older workers; and, engage employees in open discussions about stereotypes. The broader learning point would be to encourage students to always question their assumption bases—they might be wrong, at times! B.

The Sociocultural Segment

Sociocultural forces influence the values, beliefs, and lifestyles of a society. Examples include a higher percentage of women in the workforce, dual-income families, increases in the 1-45 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

number of temporary workers, greater concern for healthy diets and physical fitness, greater interest in the environment, and families postponing having children. Discussion Question 23: Name two industries that have benefited from the growing awareness about health and fitness. Also name two that have been adversely affected by this trend. Discussion Question 24: What must firms do to attract and retain women employees? Why are such efforts becoming increasingly important? The section also addresses how values and beliefs shaped changes in consumer preferences. Traditionally, values and beliefs affect the demand for types of products (e.g., more environmentally friendly products), but values and beliefs may also influence the amount of products and services customers demand. Younger generations often have different attitudes towards owning products, leading to more cautious and frugal consumer spending. Ask: Discussion Question 25: Can you think of an industry that may need to respond to the values and beliefs (such as environmental concerns and product ownership) of younger customers? The SUPPLEMENT below provides some perspective on the consumer preferences of the Generation Z. Extra Example: Consumer Preferences of the Gen Z Consumers of the Generation Z (born in the mid-1990s and early-2000s) are about to become the most sought-after target market in countries around the world. However, these consumers may be more frugal than earlier generations because their early life experiences shaped their values and beliefs when it comes to consuming. Specifically, kids of the Gen Z experienced economic downturns or saw their parents struggle during recessions (such as the global financial crisis of 2008). These early life experiences have shaped the consumer attitudes of Gen Z consumers and imprinted a thrifty attitude. For example, Japan had five recessions in the past 20 years, transforming Japanese consumers into one of the most frugal consumers in the world. These frugal attitudes learned at a young age also persist and hardly change when economic conditions brighten. In Japan, recent economic conditions are more positive and wages are growing. Fast Retailing Co. (the owner of the fashion company Uniqlo), for instance, is raising entry level pay by 20% to win the war for talent in the tight Japanese labor market. However, young Japanese are not increasing their spending, but stick to buying necessities. Executives around the world adjust their strategies to effectively address frugal consumer attitudes and broader preferences for sustainable consumption. For instance, fashion company ―Urban Outfitters‖ recently started a subscription clothing rental business called Nuuly. For a fee of $88 dollars per month, consumers get six clothing pieces, a reusable bag, and a prepaid return envelope to return the clothes (or pay full price in case you love and want to keep them). The hope is that young consumers will find this new clothing business model not only attractive for its reduced environmental impact but also for meeting the broader values of beliefs regarding product ownership of Gen Z consumers.

Sources: Du, L., & Milligan, E. 2019. In regions hit by recession, Gen Z is turning out to be frugal. Bloomberg.com. April 25: np. Naughton, K., Dawson, C., Welch, D., & Coppola, G. 2019. Gen Zero. Bloomberg BusinessWeek. April 29: 18–19; Safdar, K. 2019, May 21. Urban Outfitters to start renting clothes. Wall Street Journal. June 21: np.

The Political/Legal Segment

Political processes and legislation influence the regulations with which industries must comply. Some important elements of the political/legal arena include tort reform, the Americans with Disabilities Act (ADA), deregulation of utilities and other industries, and increases in the federally mandated minimum wage. Discussion Question 26: What do you see as some of the pros/cons of the Americans with Disabilities (ADA) Act? We close this section with a brief discussion of how legislation in the U.S. has restricted the number of H-1B visas for highly skilled professionals. Discussion Question 27: Should the U.S. Congress increase the number of H-1B visas? Why? Why not?) STRATEGY SPOTLIGHT 2.1 addresses how advocacy groups and public opinion can put pressure on companies to address environmental sustainability concerns such as waste reduction in a proactive manner. Discussion Question 28: What are some of the challenges associated with companies facing increasing pressure for sustainable business practices? Do you have ideas about how companies could use eco-friendly business practices and models to differentiate themselves in the market? D.

The Technological Segment

Developments in technology lead to new products and services and improve how they‘re produced and delivered to the end user. Innovations can create entirely new industries and alter existing industries. Discussion Question 29: Ask students to speculate on the impact of the following technologies on American industry: (1) the Internet, (2) manufacturing innovations (e.g., robotics), (3) genetic engineering/designer genes. (The last items may provoke some heated discussion regarding the ethical implications.) We also address a fascinating issue: some of the promising future applications of nanotechnology and how it will impact some industries. STRATEGY SPOTLIGHT 2.2 addresses how data privacy concerns helped Apple to gain a competitive edge over its closest competitors.

The SUPPLEMENT below discusses how SkyMall, the inflight magazine was forced into bankruptcy by technology—smartphones and tablets.

Extra Example: It Seems That Technology Killed SkyMall The firm behind the inflight catalog, SkyMall, filed for bankruptcy protection. It is clearly a victim of evolving rules and technology that now permit airline passengers to keep their smartphones and tablets powered up during flights. For 25 years it sold quirky products like a Darth Vader toaster or a paper-towel holder with USB ports. However, SkyMall is now seeking a court supervised sale of its assets, according to papers filed on January 22, 2015 with the Phoenix Bankruptcy Court. CEO Scott Wiley cited a ―crowded, rapidly evolving and intensely competitive‖ retail environment as the reason for the firm‘s recent struggles. And, he said, ―With the increased use of electronic devices on planes, fewer people browsed the SkyMall inflight catalog.‖ SkyMall had revenue of $33.7 million in 2013. But, its sales sank to only 15.8 million for the nine months ending on September 28, 2014. Source: Corrigan, T. 2015. SkyMall Succumbs to a New Jet Age. Wall Street Journal. January 24–25: B3.

Discussion Question 30: Are you aware of other cases where technology is a key factor that is reshaping—or adversely affecting—an industry? What industries are most likely to be influenced by technological changes? E.

The Economic Segment

The economy has an impact on all industries, from suppliers of raw materials to manufacturers of finished goods and services, as well as all organizations in the service, wholesale, retail, government, and nonprofit sectors of economies. Key indicators include interest rates, unemployment rates, the consumer price index (CPI), the Gross Domestic Product (GDP), and net disposable income. Discussion Question 31: Compare the impact of rising (or declining) interest rates on the overall demand for the following industries: (1) housing (will have a significant impact), (2) automobiles (will have a significant impact), (3) fast food (will have very little effect). F.

The Global Segment

Globalization provides both opportunities to access larger potential markets and a broad base of factors of production such as raw materials, labor, skilled managers, and technical professionals. However, such endeavors carry many political, social, and economic risks. Examples of important elements in the global segment include currency exchange rates, increasing global trade, the economic emergence of India, and China‘s admittance to the World Trade Organization.

Discussion Question 32: Provide examples of firms that have succeeded (stumbled) in their efforts to expand into international markets. What factors can explain their success (failure)? We also address the rising middle class in emerging countries and how it has led to increased employment in those countries by multinationals.

Discussion Question 33: What are the risks associated with accessing a larger potential market overseas as a result of the process of globalization? Do the risks of globalization outweigh its benefits? G.

Relationships among Elements of the General Environment

In our discussion of the general environment, we have addressed many relationships among the various elements. EXHIBIT 2.3 provides many examples of how the impact of trends or events in the general environment can vary across industries. The SUPPLEMENT below provides some insights on how many elements of the General Environment are interrelated. It is a rather interesting context—Cairo, Egypt after the Arab Spring. Extra Example: Entrepreneurship in Cairo after the Arab Spring A different type of grassroots revolution has begun in the aftermath of the Arab Spring. According to Ramez Mohamed, CEO of Flat6Labs, a Cairo-based startup accelerator, entrepreneurship has thrived over the past two years. He contends that Egypt‘s youth feel empowered to make a difference, one venture at a time. Here are some of his firm‘s most promising startups and the opportunity that they are tackling:    

Ekshef: With an Arabic-only platform and Yelp-like rating system, the service enables Egyptians to search, review, and recommend doctors from the directory. Opportunity: The country has more than 75,000 health care clinics, but it is hard for patients to find the right physician. Nafham: The service condenses the country‘s public-school curriculum into online, crowdsourced lessons. Users can vote up or down based on quality. Its staff also produces video content. Opportunity: Egypt‘s rising population is putting a squeeze on classroom space. Eshtery: The utility lets users shop by scanning codes on signs around town and having the items delivered to them. The business was inspired by Home Plus, a supermarket that offers a similar service in South Korea. Opportunity: It is hard to buy groceries if you work two hours from the market. Ogra: A mobile app, a la Uber, which connects passengers with reliable drivers. Opportunity: With social tensions spilling onto the street, public transportation that is dependable is hard to find. Source: Anonymous. 2013. Emerging tech scene: Cairo. Fast Company. March: 31.

The ―Digital Economy‖ is an important aspect of an effective strategy. We introduce the topic and provide examples of how it can be applied in practice. Specifically, corporations are increasingly collecting and analyzing data on their customers, including data on customer characteristics, purchasing patterns, employee productivity, and physical asset utilization. Such 1-50 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

efforts have the potential to help firms better customize their product and service offerings to customers as well as more efficiently use the resources of the company. We provide examples of Pepsi and Kaiser Permanente as well as some figures on how its use has dramatically increased in recent years—as well as how it can improve a firm‘s performance. STRATEGY SPOTLIGHT 2.3 provides an example of how the short-video app TikTok uses AI to create successful digital offerings. Discussion Question 34: How can firms effectively use AI to improve their competitive position? What other products or services may also benefit from the use of AI?

III.

The Competitive Environment

PowerPoint Slide 19: Digital Economy, A Fundamental Shift in the Business Environment PowerPoint Slide 20: The Competitive Environment PowerPoint Slide 21: Porter’s Five Forces Model of Industry Competition PowerPoint Slide 22: The Threat of New Entrants PowerPoint Slide 24: The Bargaining Power of Buyers PowerPoint Slide 25: The Bargaining Power of Suppliers PowerPoint Slide 26: The Threat of Substitute Products and Services PowerPoint Slide 27: The Intensity of Rivalry among Competitors in an Industry PowerPoint Slide 28: Using Industry Analysis: A Few Caveats PowerPoint Slide 29: The Value Net PowerPoint Slide 30: Doing a Good Industry Analysis PowerPoint Slide 31: Strategy Groups within Industries PowerPoint Slide 32: Strategy Groups as an Analytic Tool PowerPoint Slide 33: Example: Strategic Groups within Industries Here, we draw upon a well-known analytic tool, Michael Porter‘s five-forces model of industry competition. We introduce this model and discuss examples of each force. We then address the strategic groups concept and its implications for studying rivalry and competition. A.

Porter’s Five-Forces Model of Industry Competition EXHIBIT 2.4 illustrates Porter‘s five-forces model of industry competition

When introducing this model, it is useful to show how the model provides insight into an industry‘s dynamics and expected profit levels. The SUPPLEMENT below provides such an analysis on the paint and allied products industry. The analysis is restricted to the trade sales (i.e., house paint) segment of the industry. The competitive forces are very different for other segments such as the specialized high-tech automobile finishes. Note: For our purposes of illustrating the “basics” of the “five forces,” the analysis has been simplified. We assume buyers to be consumers, although there are, of course, other distinct groups such as hardware stores, and large discounters such as Walmart. Obviously firms’ 1-51 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

bargaining power vis-à-vis paint manufacturers vary significantly. Similarly, our analysis assumes the industry’s products to be commodity products. However, there are exceptions, such as Olympic Stain, that have successfully differentiated their products on the basis of quality. Extra Example: The Paint and Allied Products (PAP) Industry An analysis of the Paints and Allied Products industry (SIC 2851), using the five-forces model, demonstrates why this industry has traditionally been caught in a price-cost squeeze and is unable to pass on rising raw material costs to its customers. To illustrate the price-cost squeeze that this industry is facing, consider that between the years 1995 to 2000, the PPI (producer price index—the price for which it sells its output) of the PAP industry increased an average of only 2 percent. The PPI for petroleum refining and related products—a key supplier to this industry—increased at a rate of 6 percent over this same period of time. Hence the price of this key raw material was roughly twice the rate of inflation (about 3 percent); whereas, the PAP industry was lower than the rate of inflation. Thus, the PAP industry has been unable—due to unfavorable industry competitive forces—to pass on cost increases to their suppliers; thus eroding profitability. Consider the PAP industry in terms of each of Porter‘s Five Forces: Threats of Entry: Very High (minimal capital investment needed, little proprietary technology, regional firms can compete in local markets due to high transportation costs, little brand identification of existing competitors) Buyer Power: Very High (low brand loyalty, relatively little product differentiation, relatively low switching costs) Supplier Power: High (especially for petroleum derivative raw materials—a key input in industry) Substitute Products: High (plastics, wood paneling, wallpaper coverings, etc.) Rivalry: High (competition is based mostly on price competition, because of little brand loyalty and product differentiation; easy entry and exit from the industry gives rise to frequent price wars; little price leadership exhibited by larger firms) Sources: www.bls.gov (Bureau of Labor Statistics); www.ita.doc.gov (International Trade Administration)

It is useful to point out that there can also be very profitable opportunities to compete in industries that have overall low profits. For example, in the paint industry, Olympic Stain has typically been a very successful and highly profitable firm because they have found an attractive niche in the market and developed a differentiated product (through product development and advertising). We also provide a brief discussion of some of the competitive forces affecting the hotel industry. 1. Threat of New Entrants After summarizing the major barriers to entry, ask students to provide examples of industries characterized by each of these entry barriers. This may help them to understand what initially may appear to be rather complex ideas. 1-52 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

We discuss the concept of ―the era of Lego innovation.‖ Here, valuable advances in technology can be attained by imaginatively combining components and software available to everyone. Clearly, this serves to lower entry barriers. Teaching Tip: The chapter explains how economies of scale and economies of experience (learning curve) erect significant entry barriers. In the auto industry, U.S. manufacturers such as Ford and G.M. have high economies of scale (being the large producers) and all the benefits of learning curve (having been in the business for almost a century). Despite these advantages, foreign auto producers have entered the U.S. market and have increasingly gained market share over the past few decades. Ask the students why this happened? Does this prove that the concepts we discussed are wrong? Or does it point out that additional factors have to be considered? Point out that foreign producers have the benefits of lower labor costs and/or have developed better manufacturing technologies (such as Toyota‘s lean manufacturing). 2. Bargaining Power of Buyers It may be interesting to discuss when a group of buyers becomes powerful. For instance, organizations that produce ―talent‖ (i.e., business schools) may have varying power against groups of organizations that hire business school graduates. For instance, large employers may require changes to the curriculum or shift talent production in house (see Apple University). Moreover, Apple uses its buyer power to negotiate very low rental rates—compared to other stores—for its stores in shopping malls. This is because its powerful brand/products can help drive customers to the mall and increase overall sales in a mall by as much as 10 percent. Roughly speaking, Apple pays 2 percent of sales—compared to other tenants who may pay as much as 15 percent of sales. Discussion Question 35: Can you think of other tenants that would be able to negotiate low rental rates? Why? STRATEGY SPOTLIGHT 2.4 addresses how Nike created a ―Connected Strategy‖ to circumvent traditional retailers, which reduced the bargaining power of one of Nike‘s buyer groups. The SUPPLEMENT below explains that many huge consumer product firms are going to cut the amount of money they will spend on advertising. Clearly, this will enhance their buyer power. Extra Example: Large Consumer Product Firms Cut Advertising Budgets Procter & Gamble is planning to make deep cuts in its number of advertising agencies. It hopes to save up to half-abillion dollars in fees that it now pays to outside firms to help pitch its wide variety of everyday items—from Gillette razors, to Tide detergent, to Pantene hair care, to Bounty paper towels.

Needless to say, this worries Madison Avenue. P&G is joining other companies—such as Unilever, L‘Oreal SA, Coca-Cola Co, S.C. Johnson, and Visa—that are all trying to force advertisers to either lower prices or risk losing the business altogether. These firms are striving to offset slow growth with cost cuts. P&G CFO Jon Moeller said the household-products giant plans to ―significantly simplify and reduce‖ the number of agencies it works with on ads, media buying, public relations, package design and in-store marketing. Similarly, Unilever, which spent about $7 billion on advertising and marketing in 2014, is currently reviewing its global media-buying business. A person familiar with the issue said the process is driven in part by the need to find ―cost savings and efficiencies.‖ Such pressures have prompted extensive industry consolidation. For example, giants Publicis Groupe SA and Omnicom Group Inc. tried—but failed—to merge in 2014. The agencies remain at the behest of clients that are in an increasingly frugal mood. Source: Tadena, N. & Ng, Serena, A. S. 2015. P&G Joins the Movement to Reduce Costs. Wall Street Journal. April 27: B1–B2.

3. Bargaining Power of Suppliers Briefly discuss some of the conditions under which a supplier group may become powerful. The bargaining power of suppliers can be presented as the mirror opposite of the bargaining power of suppliers. For example, the relative sizes and concentrations largely determine the bargaining power of the two parties involved in the transaction. The section discusses how catfish farmers in Mississippi increased their power by forming a cooperative—Delta Pride Catfish. The SUPPLEMENT below discusses how hotel companies in ―tight‖ housing markets such as San Francisco raise their profits by exploiting the limited supply of housing, highlighting potentially negative consequences of supplier power. Clearly, raising prices benefits hotel firms in the short run, but is it prudent in the long run? Extra Example: Risk your reputation if you have strong bargaining power? J.P. Morgan organizes one of the leading annual healthcare conference in San Francisco, which attracts thousands of attendees who are linked to 450 companies every year. It is no secret that San Francisco‘s housing market is one of the most expensive in the world. But that is not all. San Francisco is also famous for a lack of hotel rooms, meaning hotels operate in a seller‘s market. It is therefore no surprise that the arrival of around 9,000 travelers leads to exorbitant hotel rates because hotels flex their muscles and exploit their powerful supplier position. In 2018, for instance, a room at a Holiday Inn Express close to the conference venue was $527 a night. Other hospitality providers such as restaurants also join in on the high-price game. For instance, cold lunch buffets at some establishments close to the conference venue were offered for more than $70 dollars a head and came with a mandatory 25% service charge. While these high prices are a consequence of market principles such as ―supply and demand,‖ hotels and other hospitality firms should also consider the wider consequences of excessively high prices. For instance, smaller healthcare and biotech startups may not be able to attend the conference, which may be perceived as stifling entrepreneurship. In addition, people living in close proximity to the conference venue or travelers that visit San Francisco for unrelated business reasons may protest against the high costs of hospitality services. The media may have an open ear to these outcries over high prices. 1-54 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Overall, hospitality providers may expose themselves to reputational penalties if they charge the highest possible price. While these reputational penalties are likely to be lower than price gauging in events of natural disasters (e.g., Hurricane Harvey destroying much of the Houston metropolitan area in 2017), hotel chains and other hospitality providers may be well-advised to consider ways to address any potential backlash. Source: Grant, C. 2018. The real winners in biotech. Wall Street Journal. December 28: np.

4. The Threat of Substitute Products and Services Emphasize that the viability of a substitute product depends largely on its relative priceperformance trade-off, i.e., more value for the same price or the same value for a lower price. Examples are electronic security systems versus security guards, and the use of steel versus plastic for components in the manufacture of automobiles. We discuss substitutes and give the example of how the use of teleconferencing poses a threat to the airline industry. 5. The Intensity of Rivalry among Competitors in an Industry After discussing the factors that lead to intense rivalry in an industry, provide an example of an industry in which competition has recently been intense. For example, most students are familiar with the recurring price wars in the U. S. airline industry. Ask them to explain this using the factors discussed (e.g., undifferentiated service, low switching costs, slow industry growth, numerous competitors, etc.) You might point out that this industry was expected to report huge losses in 2001 even before the September 11, 2001 terrorist attack. Beginning in late 2005, the airlines‘ problems were further aggravated by extremely high fuel costs. The SUPPLEMENT below is Michael Porter‘s response to a question as to whether or not he would add a ―sixth force‖ if he were developing his framework today. Extra Example: Should There Be a ―Sixth Force?‖ Michael Porter‘s Perspective ―There have been two nominees for the sixth force. One is government. After much further work using and teaching the framework, I have reaffirmed my original conclusion that government is not a sixth force because there is no monotonic (direct linear) relationship between the strength and influence of government and profitability of an industry. You can‘t say that ‗government is low, industry profitability is high.‘ It all depends on exactly what government does. Also, there are many different parts of government, each with its own distinct impacts. And, how do you assess the consequence of what government does? Well, you look at how it affects the five forces. ―The other, more recent, candidate for a sixth force involves organizations whose products and services are complementary to the primary organization‘s products and services. Again, there is no monotonic relationship between the extent of complements and profitability. Sometimes having many complements is consistent with high industry profitability, sometimes with low profitability. It has to do with how complements affect the five forces.… Clearly, complements have much to do with the size of the pie, but their role in the division of the pie is independent of other factors.‖ Source: Argyres, N. & McGahan, A. M. 2002. An interview with Michael Porter. Academy of Management Executive. 16 (2): 43–52.

EXHIBIT 2.5 provides a summary of key points from the discussion of industry fiveforces analysis.

Using Industry Analyses: A Few Caveats

This section was written as a ―caveat‖ to address some limitations of Porter‘s five-forces model. First, managers should not always avoid low profit industries. We provide the example of WellPoint Health Networks (now Anthem, Inc.). Teaching Tip: Even when industry analysis shows that an industry is unattractive, there are a few firms that seem to be able to earn high returns. For example, Southwest Airlines has been consistently profitable in an otherwise unattractive industry over the past several years. Does this mean that industry analysis is misleading? You may point out that industry analysis is useful to predict an industry‘s average profitability, but not necessarily, a single firm‘s profitability. This is a good opportunity to introduce the role of the strategist in outperforming industry norms. Second is the idea that business is not always a zero-sum game—which is an assumption that is implicit in Porter‘s five-forces model. We discuss how companies can collaborate with suppliers for mutually beneficial outcomes. The SUPPLEMENT below provides a rather counterintuitive perspective on rivalry in an industry. With examples from Yoplait and McDonald‘s, sometimes a firm can benefit from a rival‘s new product. Extra Example: Firms Can Benefit from a Rival‘s New Product Conventional wisdom that a rival‘s launch can hurt a firm‘s profits is often correct. But not always. Research has shown that companies sometimes see profits increase after a rival‘s rollout—even when they don‘t aggressively seek ways to undermine the new product‘s sales. The underlying mechanism is rather straightforward: When a firm extends a product line, it often raises the prices of its existing products. These hikes may be designed to make the new product look cheaper and thus more attractive by comparison or to capture the value customers place on a broader line of offerings. As the company adjusts its pricing, its competitors can follow suit without risking customer defections over price. For example, consider what happened with Yoplait became the first major producer to market low-fat yogurt in the United States. Although Dannon took a 5 percent hit in units sold during the new product‘s initial year, the vast majority of its customers did not defect to Yoplait. Instead, they preferred Dannon‘s style of yogurt. And, since Yoplait had raised prices across its product line, Dannon raised its prices as well, by more than 10 percent. Thus, despite the 5 percent decrease in volume, Dannon‘s revenue increased by 5 percent. A similar dynamic plays out in fast food. My research shows that McDonald‘s franchisees who open additional outlets (a type of horizontal product extension) often price the menu items in all their locations higher than before. This allows competing Burger Kings to raise their prices as well. At independent Burger Kings in Silicon Valley, this has led to increase margins more than 10 percent of the time. Source: Thomadsen, R. 2013. You can benefit from a rival‘s new product. Harvard Business Review. 91(4): 24.

The third issue we raise is that the five-forces analysis has often been criticized for being a static, rather than a dynamic, analysis. Brandenberger and Nalebuff introduced the concept of the value net, which we include in EXHIBIT 2.6. 1-57 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The concept of complementors is often considered to be the single most important contribution of value net analysis. Complements typically are products or services that have a potential impact on the value of the firms‘ own product and services. We provide the examples of complements (software and microprocessors) in the personal computer industry and the video game industry. (As we noted in an earlier supplement, Professor Michael Porter would not add complements to the ―five forces‖ because they don‘t have a direct linear relationship to industry profitability. However, they clearly can have an impact on an industry‘s profitability.) C.

Strategic Groups within Industries

Most of your students are probably very interested in the automobile industry. EXHIBIT 2.7 provides a strategic grouping of the worldwide automobile industry. It is rather clear from the discussion in the text that the intensity of competition within strategic groups is much more intense than competition across groups. Point out four benefits of strategic groups as an analytical tool: 1.

Strategic groupings help a firm identify mobility barriers that protect a group from attacks by other groups.

It helps a firm to identify groups whose competitive position may be marginal or tenuous.

It helps chart the future directions of firms‘ strategies.

It helps in thinking through the implications of each industry trend for the strategic group as a whole.

It may be interesting to ask the students what dynamics they envision in the automobile industry, i.e., how membership in strategic groups may change and if new strategic groups may emerge. Discussion Question 36: What are some of the strategic groups in other industries with which you may be familiar? What are the implications? (e.g., retailing) We close with an example with an industry closely related to the one addressed in this section—motorcycles. The SUPPLEMENT below discusses the two major clusters in this industry and how the basis for competition is quite different.

Extra Example: The Two Key Strategic Groups in the Motorcycle Industry In most industries, firms cluster around a relatively small number of strategic positions and within each cluster hold similar ideas about how to compete. In the motorcycle industry, there are two major clusters of firms. The Japanese producers—Honda, Yamaha, Suzuki, and Kawasaki—compete on technical innovation and lower costs. The Harley-Davidsons and Ducatis, in contrast, view their business through a very different lens—as entertainment. Here‘s how Federic Minoli, the CEO and chairman of Ducati from 1996 to 2007 described his decision to build a museum celebrating the firm before he repaired a damaged factory: ―Ducati is not, or not only, a motorcycle company. We sell something more: a dream, passion, a piece of history.‖ Analyze most industries, and you will find a similar situation: two or three groups of firms jostling for position upon the same two or three competitive mountaintops. Now consider the major U.S. airlines. They all struggled for many years in cutthroat competition around the same position until Herb Kelleher of Southwest Airlines saw a different, low-cost way to compete. Source: Gavetti, G. 2011. The new psychology of strategic leadership. Harvard Business Review. 89 (7/8): 118–125.

IV.

Issue for Debate

The topic should be of great interest because many students are familiar with drones (or perhaps own a drone or use drones for fun). What may be less well known is that drones are also extremely prevalent and effective in commercial applications such as building inspections. In effect, this is a good example of a new technology that has great potential for business (e.g., reducing costs) and workers (e.g., improving safety), but also faces challenges (e.g., privacy concerns). This tension between benefits and costs is certainly not unusual when new technologies get introduced into established markets. The instructor can point to other industries that have seen great efficiency benefits but also faced much opposition from various stakeholders (such as ridesharing). Discussion Question 1: If you were a local regulator, would you permit the use of drones? Response Guideline: The benefits of drones seem to outweigh potential costs. In 2016, the White House estimated that drones could lead to $82 billion in economic growth by 2025 and support up to 100,000 jobs. Less obvious benefits include increased safety in many professions such as building inspectors (less risk for slipping on roofs or ladders). Drones also have a lot of potential to assist first responders. This question can direct the discussion to the risk aversion of regulators. It also pushes students to think about how to balance the costs and benefits of new technologies that have the potential to revolutionize a range of commercial applications. Discussion Question 2: How should regulators respond to drone accidents? Response guideline: This would be a good application of stakeholder management and can be tied to the commercialization of other novel technologies. For instance, Elon Musk 1-59 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

tweeted in 2013 following media coverage of a Tesla on fire: ―Why does a Tesla fire [with] no injury get more media headlines than 100,000 gas car fires that kill [hundreds] of people per year?‖ A potential solution for regulators may be to allow commercial drone use (since the benefits are quite clear) and restrict private drone use (as the benefits are more experimental and uncertain). Discussion Question 3: Do you think drone use could be successful in other commercial applications such as package delivery? Response guideline: Students should think about how the nature of the business may affect adaptation. Building inspections are generally seen as a public service whereas the ―package delivery‖ sector is mostly privately organized (USPS being the exception of course). Private companies such as Amazon that want to break into the ―drone delivery market‖ may engage in political strategies and sophisticated PR strategies (the following article illustrates nicely how Amazon tries to educate and lobby the public and politicians: https://goo.gl/1P5aUK).

Reflecting on Career Implications

PowerPoint Slide 34: Reflecting on Career Implications Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 2. 

Creating the Environmentally Aware Organization: Advancing your career requires constant scanning, monitoring, and intelligence gathering to find out not only about future job opportunities but also to understand how employers‘ expectations are changing. Consider using websites such as LinkedIn to find opportunities. Merely posting your resume on a site such as LinkedIn may not be enough. Instead, consider in what ways you can use such sites for scanning, monitoring, and intelligence gathering.

Students will likely be very interested in the topic of learning about new job opportunities and their associated skill requirements and compensation. Later in the course, there will be specific advice related to finding jobs through networking. Here, the point is to raise in students a general awareness of the types of career options available to them. On LinkedIn, job postings are grouped in various ways. Employers list desired skills and experience. Students should browse a number of these postings in order to identify trends concerning the types of skills that are currently in demand. To find compensation levels, students can join LinkedIn and ask experts. Compensation is a very tricky topic, though, because companies will tailor it to the specific skills of their chosen candidate. The point here is that students will gain from learning about the job market in their fields and how their specific skills and capabilities match up with what the market values. A related topic to consider is the value of experience. Ask students why employers value experience in addition to skills and training. The question does not have an obvious answer. Students should appreciate that as they progress through their careers, they will gain subtle and 1-60 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

powerful capabilities related to, for example, leadership, handling complex situations, and stakeholder relations 

SWOT Analysis: As an analytical method, SWOT analysis is applicable for individuals as it is for firms. It is important for you to periodically evaluate your strengths and weaknesses as well as potential opportunities and threats to your career. Such analysis should be followed by efforts to address your weaknesses by improving your skills and capabilities.

The SWOT analysis directly pertains to individuals, and students will usually grasp how it applies to them personally. A useful exercise is to have students complete a SWOT analysis on themselves and then pair with another and share reviews. As a check, ask student volunteers to share an element from each part to ensure that students are correctly classifying the elements. The next step is to ask students to make a plan to address their weaknesses. Plans may be of two types. One is to develop weak skills to the point they are not weaknesses. Two is to make a plan to avoid the weakness. For example, if a student were weak at quantitative analysis, then he or she could pursue a career, such as copywriting, that does not rely on that skill so much. The point here is that students should be aware of their SWOT profile and plan their careers accordingly. 

General Environment: The general environment consists of several segments, such as the demographic, sociocultural, political/legal, technological, economic, and global environments. It would be useful to evaluate how each of these segments can affect your career opportunities. Identify two or three specific trends (e.g., rapid technological change, aging of the population, increase in minimum wages) and their impact on your choice of careers. These also provide possibilities for you to add value to your organization.

When students choose a segment, they should identify a trend within that segment. Then they should be able to identify an industry that would benefit from that trend. This industry is therefore likely to be a growth industry that may provide good career opportunities. It also may be useful to identify some weaknesses in this logic, such as reversal of a trend, or having an industry become a magnet for workers, such as computer programming, where the labor supply may exceed demand. Within industries, there may be specific functions that will offer growth in areas that firms can exploit. An example may be e-business, where firms in many industries are revolutionizing their distribution channels in response to the increasing acceptance by consumers of e-tailing. 

Five-Forces Analysis: Before you go for a job interview, consider the five forces affecting the industry within which the firm competes. This will help you to appear knowledgeable about the industry and increase your odds of landing the job. It also can help you to decide if you want to work for that organization. If the ―forces‖ are unfavorable, the long-term profit potential of the industry may be unattractive, leading to fewer resources available and—all other things being equal— fewer career opportunities.

It is good advice to do due diligence of a firm and its industry prior to a job interview. It helps job candidates to appear knowledgeable about their prospective employers, which may be a differentiator. In class discussions, it is probably less important to make a general conclusion of ―favorableness‖ vs. ―unfavorableness.‖ Better is to identify the specific forces that are the strongest threats to the industry. Then develop an argument as to how students, the candidates, can help firms to address these threats. Later, provided that students have offers from firms in multiple industries, students may use the assessment of industry overall attractiveness in their decision as to which offer to accept. In discussions of this issue, it may be useful to remind students that firm characteristics are a stronger explanation of firm success than industry environment. It may be better to work for a strong firm in an unattractive industry than for a weak firm in an attractive industry.

VI.

Summary

Managers must analyze the external environment to minimize or eliminate threats and exploit opportunities. This involves a continuous process of environmental scanning and monitoring, as well as obtaining competitive intelligence on present and potential rivals. These activities provide valuable inputs for developing forecasts. In addition, many firms use scenario planning to anticipate and respond to volatile and disruptive environmental changes. We identified two types of environment: the general environment and the competitive environment. The six segments of the general environment are demographic, sociocultural, political/legal, technological, economic, and global. Trends and events occurring in these segments, such as the aging of the population, higher percentages of women in the workplace, governmental legislation, and increasing (or decreasing) interest rates, can have a dramatic effect on your firm. A given trend may have a positive impact on some industries and a negative or neutral impact, or none at all on others. The competitive environment consists of industry-related factors and has a more direct impact than the general environment. Porter‘s five-forces model of industry analysis includes the threat of new entrants, buyer power, supplier power, threat of substitutes, and rivalry among competitors. The intensity of these factors determines, in large part, the average expected level of profitability in an industry. A sound awareness of such factors, both individually and in combination, is beneficial not only for deciding what industries to enter but also for assessing how a firm can improve its competitive position. We also addressed some of the limitations of Porter‘s five-forces model, including its zero-sum perspective and its omission of the key role of complements. Although we discussed the general environment and competitive environment in separate sections, they are quite interdependent. A given environmental trend or event, such as changes in the ethnic composition of a population or a technological innovation, typically has a much greater impact on some industries than on others. The concept of strategic groups is also very important to the external environment of a firm. No two organizations are completely different nor are they exactly the same. The question is how to group firms in an industry on the basis of similarities in their resources and strategies. The strategic groups concept is valuable for determining mobility barriers across groups, 1-62 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

identifying groups with marginal competitive positions, charting the future directions of firm strategies, and assessing the implications of industry trends for the strategic group as a whole.

Chapter 2: Analyzing the External Environment of the Firm Explain the profitability of an industry (of your choice) by applying the tools that you learned in this chapter (five-forces analysis). How can the five-forces zero-sum perspective be a disadvantage? Teaching Suggestions: You can organize the discussion on this topic around the following sub-questions:  What are the five forces that drive the profitability in an industry? The five forces are: 1. The threat of new entrants 2. The bargaining power of suppliers 3. The bargaining power of buyers 4. The threat of substitute products and services 5. The intensity of rivalry among competitors in an industry  What are the barriers to entry into a particular industry? Are they high or low? What are the implications? Six major sources of entry barriers as outlined in the text are: 1. Economies of scale 2. Product differentiation 3. Capital requirements 4. Switching costs (one-time costs that the buyer faces when switching from one supplier‘s product or service to another) 5. Access to distribution channels 6. Cost disadvantages independent of scale (These derive from: proprietary product, favorable access to raw materials, government subsidies and, favorable government policies)  Who are the buyers in this industry? Are they powerful? What makes the buyers powerful (not powerful)? Are the buyers likely to engage in backward integration?  What are the implications of buyers bargaining power?  Who are the suppliers to your industry? Do you think the suppliers are powerful? What makes the suppliers powerful (not powerful) in your industry? Are there any ‗switching costs?‘ What are the implications of high bargaining power of the suppliers in the industry?  If you are a firm in this industry, how would you define competition? Would you consider all firms operating in the industry as your competitors? Why/why not?

 What are ―strategic groups?‖ How would you know the ―strategic groups‖ in your industry? What kind of dimensions should you choose when mapping the ―strategic groups‖? Why is it important to understand ―strategic groups‖? (We provide the example of the worldwide automobile industry.) The concept of ‗strategic groups‘ is important because competition would be more intense among firms within the same strategic group as compared to competition with other firms in the industry. Some dimensions that can be used for mapping strategic groups are: breadth of product and geographic scope, price/quality, degree of vertical integration etc. You should emphasize that for strategic group mapping to serve any meaningful purpose, the dimensions should be chosen in a manner that they reflect the variety of strategic combinations in the industry. For example, in an industry where there is severe price-base competition, price may not be the right dimension to choose. Similarly, if all firms have the same level of product differentiation, then choosing product differentiation as a dimension would not serve the purpose.  What are the substitutes to your products or services? How do substitutes impact the profitability of your industry? You might want to make a point here that identifying substitutes can be quite a difficult task sometimes. Firms in seemingly unrelated industries may be providing products or services that act as substitutes to each other. The example given in the text on the substitution between airline industry and teleconferencing would help highlight this point. Some more interesting questions to ask would be the following:  If two industries have the same profitability levels, can you employ a common strategy in both the industries? Even though two industries might have the same profitability levels, the underlying industry structures can be entirely different. For example, in both the automobile industry and in the Internet-based businesses, profit margins are quite low. However, while the entry barriers into the automobile industry are very high, the barriers are very low into the Internet-based businesses. Competition is intense in both the industries, whereas supplier and buyer bargaining powers are quite low. On the other hand, threat from substitutes such as the ‗brick-and-mortar‘ stores, is very high in the Internet-based businesses, whereas the threat from substitutes is low in the automobile industry. (Some students might argue that the airline industry is a strong substitute and you would have to deal with that objection.) Thus, even if a firm operates in both these industries, it needs to formulate quite different strategies to suit the particular industry situation.  Why is the five-force analysis important?

It is important to understand these five forces because they affect a firm‘s ability to compete in a given market. This analysis helps in deciding whether or not to remain in a particular industry and also in choosing industries to enter. A sound understanding of the forces operating in an industry helps in assessing how to improve the firm‘s competitive position with regard to each of the five forces. You can ask students to give their own ideas on what strategies they would employ in the particular industries they have chosen for analysis.  Is the five-force analysis ―zero sum‖ in perspective? Is that a disadvantage? It would often be the case that students, in the position of a company, think about counteracting the effects of each force and blunting it. This is the essence of the zero-sum perspective. You can explain the importance of thinking ―win-win‖ and establishing collaborative partnerships with suppliers and customers. For example, establishing longterm mutually beneficial relationships with suppliers improves a firm‘s ability to implement just-in-time (JIT) inventory systems, which let it manage inventories better and respond quickly to the market demands.  Do the competitive forces remain the same over a period of time? What impact will it have on profitability? The key point is that in the five-force analysis, we are essentially taking a point in time and trying to understand the industry situation at that point in time. This is a static approach to understanding the competitive environment. However, these external forces and the strategies of the firms within industries change over time and thus change the structure of the industry itself. In order to understand how the profitability changes over time, game theoretic approaches are being used.  What is ―Value Net?‖ Who are on the vertical and horizontal dimensions? How are those on the vertical dimension different from those on the horizontal dimension? Who are complementors?‖ How are complements different from substitutes? (We provide the example of the video game industry.) The value net represents all players in the game and analyzes how their interactions affect a firm‘s ability to generate and appropriate value. Suppliers and customers form the vertical dimension of the value net and the firm engages in transactions with them. Substitutes and complements are on the horizontal dimension of the value net. These are the players with who the firm interacts but does not necessarily transact. Substitute products or services serve the same purpose that the products and services from a chosen industry serve. Substitutes accentuate competition.

Complements are typically products or services that have a potential impact on the value of a firm‘s own products or services. The firms that produce complements are referred to as ―complementors.‖ For example, very sophisticated cameras may be useless if we do not have high-quality film to produce quality pictures. Powerful hardware might prove useless without software to make it work and highly sophisticated software may be useless if there is no hardware to support its working. Thus, complements in essence help to increase the performance and efficiency of products or services of a particular industry and thus improve their competitive situation vis-à-vis other products and substitutes.

End-of-Chapter Teaching Notes Chapter 2: Analyzing the External Environment of the Firm Summary Review Questions 1. Why must managers be aware of a firm’s external environment? (in the text, Enhancing Awareness of the External Environment, LO 2-1) Response: Being responsive to the external environment enables firms to avoid strategic mistakes. It is possible for firms to become internally focused, efficient producers of obsolete goods and services (e.g. buggy whips, carbon paper). Rather, managers need to respond to opportunities and threats from the external environment in order to develop the most successful products and services. 2. What is gathering and analyzing competitive intelligence and why is it important for firms to engage in it? (in the text, Enhancing Awareness of the External Environment, LO 2-2) Response: Competitive intelligence is a firm‘s activities of collecting and interpreting data on competitors, defining and understanding the industry, and identifying competitors‘ strengths and weaknesses. It is not spying, fortune-telling, simple data collection, or an isolated activity within a firm. The purpose of competitive intelligence is to increase management‘s awareness of developments in the external environment, thereby increasing the quality of strategic decisions. 3. Discuss and describe the six elements of the external environment. (in the text, The General Environment, LO 2-4) Response: The six elements of the general environment are the demographic segment, the sociocultural segment, the political/ legal segment, the technological segment, the economic segment, and the global segment. The demographic segment refers to the statistics of a population, such as age, income characteristics, ethnic groups, and geographic distribution. The sociocultural segment refers to the values, beliefs, and lifestyles of a country. The political/legal segment refers to the creation and use of power within a country, including the effect of various regulations, including the areas of environmental protection, employment discrimination protection, and taxes.

The technological segment refers to new products and services derived from advances in engineering, applied science, and/or pure science. These new products and services can change manufacturing processes, create new industries, and alter the boundaries between industries. The economic segment refers to the level and change in monetary and macroeconomic factors such as unemployment, inflation, interest rates, and economic growth. The global segment refers to effects on a country‘s business environment from abroad, and include factors such as foreign competition, foreign market opportunities, foreign supply opportunities, legal changes due to international treaties, and regional economic integration. 4. Select one of these elements and describe some changes relating to it in an industry that interests you. (in text, The Competitive Environment, LO 2-5) Response: The answer will vary according to segment and industry chosen. Exhibit 2.5 may summarize some of the possible findings. The purpose of this question is to get students to classify various environmental changes into the segments and articulate why a change belongs in a particular segment. 5. Describe how the five forces can be used to determine the average expected profitability in an industry. (in text, The Competitive Environment, LO 2-5) Response: The five-forces model consists of the threat of new entrants, the bargaining power of buyers, the bargaining power of suppliers, the threat of substitute products and services, and the intensity of rivalry among competitors in an industry. Each force can be looked at as a way that the industry environment limits a firm‘s ability to earn profits through either raising prices or lowering costs. The threat of new entrants limits a firm‘s ability to raise prices because then a new entrant may decide to enter the industry and offer a lower price. The bargaining power of buyers directly limits a firm‘s ability to raise prices. The bargaining power of suppliers directly limits a firm‘s ability to lower costs. The threat of substitute products and services limits a firm‘s ability to raise prices because customers would then buy the substitutes. The intensity of rivalry among competitors in an industry limits a firm‘s ability to raise prices because then customers would buy from a competitor.

6. What are some of the limitations (or caveats) in using five-forces analysis? (in text, The Competitive Environment, LO 2-5) Response: Three limitations of the five-forces analysis are 1) the implication that low-profitability industries should be avoided may not be optimal. Low-profitability industries may be profitable opportunities for firms with innovative business models that change the competitive landscape. 2) The five-forces model assumes a zero-sum game, with a firm‘s loss of profitability associated with another firm‘s gain. However, through strategic alliances or other forms of collaboration with suppliers, buyers, or other industry players, firms can gain both profitability and competitiveness. 3) The five-forces model is static and does not account for constant changes in competitive position that characterize many industries. Included in the dynamic analyses is the effect of complements, or other products and services that affect the value of a firm‘s own products and services. For example, software is a complement to hardware. Dynamic interactions between firms and complements can affect the profitability prospects for a firm outside of the five-forces model. 7. Explain how the general environment and industry environment are highly related. How can such interrelationships affect the profitability of a firm or industry? (in text, The General Environment and The Competitive Environment, LO 2-4 and LO 2-5) Response: The general environment can affect all of the five forces in various ways. A growing economy can reduce the intensity of rivalry within the industry because firms will be scrambling to meet growing demand. There is a detailed explanation of how the Internet, a development in the technological segment, affects each of the five forces. 8. Explain the concept of strategic groups. What are the performance implications? (in text, The Competitive Environment, LO 2-7) Response: Strategic groups are groups of firms, usually within an industry, that share similar strategies. The performance implications are that firms can group themselves with close competitors and 1) identify barriers between groups, 2) identify positions within the industry that are marginal or tenuous, and 3) chart directions for future strategic development. Strategic group analysis is a more fine-grained way to conduct competitor analysis, as the competitive environment of an industry may differ from the competitive environment of the strategic group.

Experiential Exercises and Application Questions

1. Strategy Spotlight 2.1 discusses the growing importance of environmental concerns and illustrates how companies in different industries deal with plastic waste issues. Many other environmental problems such as greenhouse gas emissions and the resulting climate change issues are major concerns for today’s businesses and governments. Pick an industry with high greenhouse gas emissions such as electric utilities, air transportation, or livestock agriculture and identify the threats and opportunities facing the industries. Do you think companies with substantial greenhouse gas emissions should proactively address their environmental impact? Response: This question should result in a lively discussion. Many students will agree that companies should address environmental concerns related to climate change. What may be more controversial is how companies should be compelled to become more environmentally sustainable. Some students may favor a regulatory approach. The instructor can point out that this may be an effective way to compel industries to become greener since this may overcome collective action problems and free rider issues in an industry. The strategic drawback of this approach is that it will be very difficult for any company to differentiate its business if regulatory action triggers resource commitments to green technologies for all companies in an industry. Other students may favor a more proactive approach by individual companies. In other words, companies proactively and voluntarily search for ways to reduce greenhouse emissions. The instructor may point to the strategic benefit of this approach: Given that environmental concerns regarding climate change are here to stay, companies that proactively invest in green technology may establish a first-mover advantage and differentiate their image and brand from the competition. The instructor may offer some examples of companies that have taken a proactive approach. Good examples can be found in the book ―Green to Gold‖ by Daniel Esty and Andrew Winston. 2. Select one of the following industries: personal computers, airlines, or automobiles. For this industry, evaluate the strength of each of Porter’s five forces as well as complementors. Response: This exercise is very useful for helping students understand the value of the five-forces model. For undergraduate and even graduate classes, it might be useful to work with only one force at a time. In general, students may identify a number of firms and organizations for each of the five forces. To evaluate the strength of each force, it is important to refer to relevant characteristics. The list below shows these: 1-71 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

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 

Threat of new entrants—you can look at the barriers to entry for the industry, as indicated by economies of scale, product differentiation, capital requirements, and switching costs, as well as other types of cost disadvantages to new entrants, such as proprietary products, favorable access to raw materials, government subsidies, and favorable government policies. Bargaining power of buyers—identify buyers who are large or in concentrated buyer industries, standard or undifferentiated products, few buyer switching costs, buyer with low profits, buyer has a credible threat of backwards integration, or the buyer views the firm‘s products or services as undifferentiated. Bargaining power of suppliers—it is often a challenge to find suppliers, but to the extent you can, look for suppliers that are large and concentrated (few in number), suppliers with few substitutes, suppliers that view the firm‘s industry as a minor proportion of its sales, suppliers that provide an important input, suppliers with differentiated products, and suppliers that pose a credible threat of forward integration. Threat of substitute products and services—identify substitutes that are a) outside the industry, and b) that are an economical and feasible alternative for buyers. Intensity of rivalry—identify rivals within the industry and evaluate each rival‘s product offerings for being lower priced or of higher quality than the firm‘s offerings.

Then have students put them all together and provide a summary evaluation of the overall ability of the firm to set prices and control costs. 3. Imagine yourself as the CEO of a large firm in an industry in which you are interested. Please (1) identify major trends in the general environment, (2) analyze their impact on the firm, and (3) identify major sources of information to monitor these trends. (Use Internet and library resources.) Response: Students should respond with a variety of industries and approaches. It may be useful to have students justify their classification of trends into segments of the general environment. It may also be useful to have students justify why the trends they have identified are major trends and not minor trends. And you can ask students to classify their chosen trends as threats or opportunities. If students have focused on one, say, opportunity, then ask them to consider threats. As for sources of information, there are many good sources from the government. Try the census department, the Bureau of Economic Analysis, Department of Commerce, Department of Labor, and the Central Intelligence Agency. Many of these sources are freely available directly from the government or through libraries. Some libraries of institutions of higher education subscribe to industry analysts reports, which often include analyses of the business environment. In addition, company websites often include information about potential market size and trends, although note that company websites are inherently a biased source of information. 1-72 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

4. Analyze movements across the strategic groups in the U.S. retail industry. How do these movements within this industry change the nature of competition? Response: We suggest following these five steps. First, develop a list of retailers. The list may include only local retailers that the students are familiar with, or the stores within a local mall or shopping area, or even a comprehensive list of all retailers in the region. Second, choose two dimensions for mapping the firms. Depending on the type of stores chosen, we suggest breadth of product line, degree of vertical integration, average store size, pricing strategy, or target market (broad versus niche). Third, for each store assign a value for each dimension and plot it on the strategic group space. For example, Wal-Mart would have a broad product line, high vertical integration (it often buys directly from suppliers, not wholesalers), large size, low pricing, and broad target market. These assessments will determine its location on the two chosen dimensions. In addition, for at least one firm get a sense of how it has changed in the past year or so. Fourth, after putting your firms on the strategic group space, look for clusters and spaces between clusters. Evaluate each cluster. Ask students which clusters would be more profitable and which less so. And most important, ask why. Students should be able to articulate the desirability of each cluster, and link their reasoning to the dimensions used for mapping the firms. For the spaces, ask students if any of the spaces would be desirable places. Often, the groupings do not make sense. If that were the case, then challenge students to come up with dimensions that do make sense. You should help students to understand that they have control over how the strategic space is defined. Fifth, for the firm that has changed in the past year, chart that movement on the strategic group space. No matter what dimensions you use, this firm will be moving away from some competitors and toward others. Ask students how this movement affects the competition between this firm and others. The purpose of the discussion is to get students to appreciate that increasing distance associates with less competition and decreasing distance between firms represents a threat. 5. What are the major trends in the general environment that have impacted the U.S. pharmaceutical industry? Response: The U.S. pharmaceutical industry consists of firms that manufacture and market medicines for people. All segments impact this industry. The demographic segment affects demand, as the aging baby-boomers require age-specific medicines and marketing approaches. Also, older people tend to require more medicines than younger people, so market demand in the U.S. is growing. The sociocultural segment affects medicinal preferences. People value their health and trust their doctors rather than use traditional medicines. 1-73 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The political/legal segment is extremely important due to the regulatory approval process for new medicines, intellectual property right protection, government insurance programs, and price controls. Regulatory approval of new medicines is extremely rigorous and costly. To recoup the costs of obtaining approval, pharmaceutical firms exploit their monopoly power that stems from the patents and trademarks on the medicines. And this monopoly power enables pharmaceutical companies to charge high prices. The recent trend in government support for prescription drugs through Medicare, and the recent and ongoing implementation of near-universal health care and prescription programs has two impacts: 1) more patients will be getting prescriptions, which increases revenues, and 2) more patients will be covered by insurance, which will increase buyer power and decrease revenue to pharmaceutical companies. The technological segment affects the new product development process. Biotechnology involves the use of living organisms to develop new drugs and has created an explosion in potential new medicines. Other technologies developed by these companies are the ability to test thousands of substances at a time and to map the human genome, which helps us to understand the causes and potential cures of many ailments. The economic segment affects the industry, as general economic growth affects market potential. The recent recession has therefore hurt the industry. In addition, expected interest rates affect the financial prospects of many biotech firms. These firms often take decades to develop new drugs and bring them to the market. Lower interest rates enable them to make their investors‘ capital last longer. The global segment affects the industry in a number of ways. Foreign markets offer sales opportunities. Foreign labs are effective partners for collaboration. However, foreign countries often put price controls on medicines, which limit profit potential from foreign sales. And foreign competitors often do not respect the intellectual property of U.S. firms, giving rise to loss through piracy. 6. Go to the Internet and look up www.kroger.com. What are some of the five forces driving industry competition that are affecting the profitability of this firm? Response: A couple of clicks first to the ―about the Kroger company‖ at the bottom of the home page, then to the Kroger Fact Books on the right side of the page will get you to the fact books. These include information on the following topics. The first step is to define Kroger‘s industry. While Kroger does have jewelry stores and houseware stores, its primary activity is in supermarkets. We will focus on supermarkets. For the threat of new entrants, this force is weak. Kroger notes that the industry is consolidating. There are very large barriers to entry due to capital requirements and economies of scale. The bargaining power of buyers is weak. The buyers are the general public, which is an aggregation of very small customers. No customer is a very large part of the market, and customers will not have an information advantage over Kroger. The primary source of buyer power is the ability of customers to shop at the competition. The bargaining power of suppliers is moderate. Some of 1-74 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Kroger‘s stated competitive advantages stem from the brand equity of suppliers‘ products, such as Kitchen Aid, Levis, Dockers, and Nikon. However, Kroger counters supplier power by developing a series of corporate brands, and by backwards integrating into the suppliers‘ industries. The threat of substitute products and services is limited, as customers have developed a habit of doing most of their food shopping at supermarkets as opposed to farmers‘ markets, convenience stores, or general stores (although students may note the growing food offerings at retailers such as Wal-Mart or Target). And note that Kroger includes a number of other types of store formats, like marketplace stores and convenience stores, to compete in substitute industries. Alternatives do not have a very high market share. The intensity of rivalry among competitors in the industry is very strong. Kroger competes with Walmart, Meijer, and other chains of supermarkets in every part of the country. These competitors are large, successful, and aggressive. Kroger limits rivalry by acquiring smaller stores and chains where possible. One of Kroger‘s strategies for dealing with rivalry is to encourage customer loyalty through various programs such as shopper cards and a customer relations management system in conjunction with London-based dunnhumby. Ethics Questions

1. What are some of the legal and ethical issues involved in collecting competitor intelligence in the following situations? a. Hotel A sends an employee posing as a potential client to Hotel B to find out who Hotel B’s major corporate customers are. Response: The scheme risks exposure. Hotel B might find out who the employee is and find out that he or she represents Hotel A. Hotel B‘s list of major corporate customers is likely to be a trade secret, and Hotel A‘s use of fraud to gain the trade secret is, depending on state law and the specific circumstances, likely to be a crime. It is likely that Hotel B will share this information with the press, trade publications, or other media. It is also possible that Hotel B will use this information to tarnish Hotel A‘s reputation. Hotel A‘s business could be affected and shareholders embarrassed. The cost to Hotel A of overcoming these shortcomings is likely to exceed whatever gain was possible. b. A firm hires an MBA student to collect information directly from a competitor while claiming the information is for a course project. Response: It is possible that this action would be a crime, although doubtful. The competitor is not likely to share trade secrets, because the course project is not likely to be kept confidential, but that depends on the circumstances. 1-75 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

However, the scheme is certainly fraudulent and therefore unethical. The firm is using the MBA student as a spy, which is abusive to the MBA student. The student‘s college or university, though perhaps not directly involved, will have its name associated with the scheme. In addition, the competitor can use the scheme to discredit the firm and embarrass its shareholders. c. A firm advertises a nonexistent position and interviews a rival’s employees with the intention of obtaining competitor information. Response: The scheme is fraudulent. Advertising a position without an intention of hiring is unethical. If the scheme succeeds in obtaining trade secrets, then it is probably a violation of law. And the coercive treatment of the rival‘s employees is a problem. The possibility of criminal violations occurs within the purview of many states‘ trade secret laws. If any individual suffers any harm, then civil damages are possible. But the unethical nature of this scheme is likely to be the largest problem. The rival can use the firm‘s actions to discredit the firm and embarrass its shareholders. 2. What are some of the ethical implications that arise when a firm tries to exploit its power over a supplier? Response: A monopsonist, or a firm that is the only buyer in a market, has great power over suppliers. It might try to exploit this power by forcing the supplier to reduce prices or provide extra services. In the extreme, suppliers will be forced to cut costs, lay off employees, cut salaries, and forego investments in new technologies or capabilities. The downside of these actions is that the supplier is less capable of contributing to industry development by infusing it with innovations.

CONNECT RESOURCES Comprehension Case Mayo Clinic’s Transformation and Adaptation Case Analysis Mayo Clinic’s Pursuit of a Health Care-Centric Platform Gas versus Hybrids versus Electric: A Battle of Substitutes Video Case Analyzing Industry Forces Analyzing the Macro-Environment SWOT Analysis

Assessing the Internal Environment of the Firm 3-78 Value-Chain Analysis ................................................................. 3-Error! Bookmark not defined. Primary Activities...................................................................................... 3-81 Support Activities ...................................................................................... 3-83 Interrelationships among Value-Chain Activities within and across Organizations .............................................................. 3-85 Applying the Value Chain to Service Organizations ............................. 3-86

Resource-Based View of the Firm ............................................. 3-87 Types of Firm Resources .......................................................................... 3-87 Firm Resources and Sustainable Competitive Advantages .................. 3-88 The Generation and Distribution of a Firm’s Profits: Extending the Resource-Based View of the Firm .................................. 3-92

Evaluating Firm Performance: Two Approaches ................... 3-93 Financial Ratio Analysis ........................................................................... 3-93 Integrating Financial Analysis and Stakeholder Perspectives: The Balanced Scorecard.................................................... 3-94

Issue for Debate ........................................................................... 3-96 Reflecting on Career Implications ............................................ 3-97 Summary ............................................................................................... 3-99 End-of-Chapter Teaching Notes ....................................................... 3-103 1-77 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Connect Resources ............................................................................. 3-110

Chapter 3

Assessing the Internal Environment of the Firm Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead The purpose of this chapter is to help students understand the importance of the internal environment of the firm. Chapter 2 focused on assessing the external environment; we turn our attention in this chapter to managing value-creating activities within the company. This chapter discusses value-chain analysis, the resource-based view of the firm, and the balanced scorecard as methods for analyzing the firm‘s internal environment. The chapter is organized into three sections. Value-Chain Analysis: The firm‘s activities are divided into a series of value-creating steps. Both individual activities as well as the interrelationships among activities within the firm—and between the firm and its suppliers, customers, and alliance partners—add value to the firm. Resource based view of the firm: We analyze the firm as a collection of tangible and intangible resources and organizational capabilities. The key to the sustainability of advantages is the creation of bundles of activities that satisfy four criteria: rare, valuable, difficult to imitate, and difficult to substitute. We also discuss how value can be appropriated by an organization‘s stakeholders, such as employees. Two approaches to evaluating firm performance: We emphasize both the inclusion of the analysis of financial resources, as well as the interests of multiple stakeholders. Central to our discussion is Kaplan and Norton‘s concepts of the ―balanced scorecard.‖

Lecture/Discussion Outline In LEARNING FROM MISTAKES, we begin the chapter with the example of Quibi, a short form video firm, that aimed to attract subscribers by offering high-quality videos created by Hollywood stars. The firm attracted prominent and wealthy investors and compiled a strong financial foundation. It also enlisted Hollywood A-listers to create and act in short-form Quibi video series. But it all came apart and the service failed within six months.

The failure of Quibi was surprising given the quality of the set of resources the firm had compiled, but it found that due to changes in consumer preferences and technology, their resource set didn‘t create sufficient value for consumers. Quibi also lacked a key resource that would have driven consumer demand—bankable franchise shows. Discussion Question 1: Why were high profile executives, actors, and producers attracted to being part of Quibi? Response guidelines: Essentially, there was little downside for these individuals. They invested no capital. Some were paid up front for signing on to be part of Quibi. Others were promised hefty paydays if their shows became hits. Also, their personal brands received free marketing as Quibi promoted their involvement as it tried to draw in customers. Their lack of ―skin in the game‖ may have even limited their commitment to try to make Quibi succeed. Once Quibi started to sputter, many of these individuals worked to distance themselves from the failing firm. The key insight from this is that human capital can be fairly mobile and not highly committed to the firm. Thus, while human capital is potentially valuable and hard to imitate, firms are more likely to benefit if key employees are loyal to the firm and committed to working to make the firm successful. Discussion Question 2: Is there promise in developing new short-form video services? Why or why not? Response guidelines: There is likely to be differences of opinion here. Students may argue that, yes consumers are often open to new platforms that replace old platforms. See TikTok gaining in prominence relative to Instagram, which did the same to Facebook. Thus, there is potential that a new short-form service could catch on. Others may argue that this is unlikely since other video services can easily add on short-form videos onto their existing platform, as they have already begun to do. The key question is whether a new provider could develop a resource set that would be hard to imitate. Discussion Question 3: What actions should the backers of future services take to increase their likelihood of success? Response guidelines: Students should look to the reasons for the failure of Quibi and develop ways to avoid those pitfalls. Three resource issues with Quibi stand out. First, their key human capital was not fully committed to the success of the venture. Future services should look to investment and incentives as a means to build this. They could look to see if stars will commit their own financial resources to buy a stake in the firm. As owners and with some of their own wealth at risk, they are likely to feel greater commitment to its success. They also should not pay the stars up front. Instead, firms could use longer term incentives where the stars would only benefit once the service finds success. Second, the human capital they brought in did not resonate with their target consumers. Younger consumers look to TikTok and Instagram influencers and YouTubers more than Hollywood A-list celebrities. Future services should look to lock up content developers that are most desired by the target market the service is aiming to 1-80 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

draw in. Finally, Quibi lacked franchise shows. Future services may look to license the right to develop short-form content for established franchises from movies and existing shows.

VII. Value-Chain Analysis PowerPoint Slide 4: The Importance of the Internal Environment PowerPoint Slide 5: Value-Chain Analysis PowerPoint Slide 6: Value-Chain Analysis Primary Activities PowerPoint Slide 8: Value-Chain Analysis Support Activities PowerPoint Slide 9: The Value Chain PowerPoint Slide 10: Primary Activity: Inbound Logistics PowerPoint Slide 11: Primary Activity: Operations PowerPoint Slide 12: Primary Activity: Outbound Logistics PowerPoint Slide 13: Primary Activity: Marketing and Sales PowerPoint Slide 14: Primary Activity: Service PowerPoint Slide 15: Support Activity: Procurement PowerPoint Slide 16: Support Activity: Technology Development PowerPoint Slide 17: Support Activity: Human Resource Management PowerPoint Slide 18: Support Activity: General Administration PowerPoint Slide 19: Interrelationships Among Value-Chain Activities PowerPoint Slide 20: Example: The Value Chain in Service Organizations Value-chain analysis views the organization as a sequential process of value-creating activities. Such an approach is very useful for understanding the building blocks of competitive advantage. In competitive terms, value is the amount that buyers are willing to pay for what a firm provides for them. A firm is profitable to the extent that the value that it receives exceeds the total costs involved in creating the product or service. Value-chain analysis is described in Michael Porter‘s seminal book, Competitive Advantage. EXHIBIT 3.1 illustrates Porter‘s value chain—which consists of both primary and support activities. Discussion Question 4: What changes in the value chain would be necessary if the CEO of a manufacturing firm decided to dramatically improve the delivery time of his or her products? Discussion Question 5: What are some examples of organizations that perform “very well” or “very poorly” with respect to the items in this exhibit? Point out that when using value-chain analysis one needs to view the concept in its broadest context, i.e., without regard to the boundaries of a given organization. It should include suppliers, customers, and alliance partners. The balance of this section will address primary activities, support activities, and the importance of relationships among activities—both inside and outside the boundaries of a firm. 1-81 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Primary Activities

There are five categories of primary activities in an organization that is competing within any industry. These are included in EXHIBIT 3.2, along with examples of each activity. Discussion Question 6: What are some examples of firms with which you are familiar that are successful (or unsuccessful) in each of the primary activities? Why? Now, we will address each of the five primary activities. 1.

Inbound Logistics

Inbound logistics are associated with receiving, storing, and distributing inputs to the product. It includes material handling, warehousing, inventory control, vehicle scheduling, and returns to suppliers. We discuss how the COVID pandemic showed how brittle some supply chains were. Discussion Question 7: What changes can firms make to ensure their supply chains are more resilient? 2.

Operations

Operations include all activities associated with transforming the final product form, such as machining, assembly, equipment, testing, printing, and facility operations. We discuss how Shaw Industries (now part of Berkshire Hathaway), the world‘s largest carpet manufacturer, became known for its strong concern about the natural environment. They have received numerous awards for their recycling efforts. Discussion Question 8: What other companies are you aware of that have distinguished themselves by becoming known for their concern about the natural environment? The SUPPLEMENT below discusses how Peloton has pivoted recently in its drive to build in-house operations. Extra Example: Peloton Sprints Away from Manufacturing Peloton is one of the most recognizable brands in the at home fitness market. In selling stationary bikes, treadmills, and other fitness equipment that allow users to participate virtually in classes, compete with others, and get personalized training advice, Peloton has tapped into the sociocultural drive for better fitness and trends to both work from and workout at home. The firm generates revenue in two key ways: the sale of equipment that starts at about $1500 and subscription services that start at about $45 per month. In an effort to better control its operations and seize more of end customer value, Peloton launched an effort to build a strong in-house production unit. Up to this point, Peloton had relied on contract manufacturing for all its equipment. It launched its effort to get into the production business with the $47 million dollar purchase of its longtime supplier Tonic Fitness Technology in 2019. The firm then went on to buy Precor for $420 million in 2020. It also commenced building a $400 million factory in Ohio. 1-82 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

It undertook these efforts partly in response to exploding demand for its products during the advent of the COVID pandemic. The growing demand, along with supply chain distributions undermining the ability of Asian contract manufacturers to fulfill order requests, left Peloton unable to meet burgeoning demand. The firm anticipated an enduring shift in consumer behavior, where demand for at-home workout equipment would continue to flourish. However, demand dropped off as people returned to pre-pandemic behaviors, including returning to commercial gyms. Hemorrhaging cash with quarterly losses exceeding $750 million and holding a glut of inventory of nearly $1.5 billion of equipment, the firm switched course and get out of the operations end of the business. It announced it would sell its partially built Ohio factory, suspend its Tonic Fitness operations, and rely on Rexon Industrial Corporation as its primary contract manufacturing supplier. Source: Terlep, S. 2022. Peloton to Stop Making Bikes Itself. wsj.com. July 12: np.

Discussion Question 9: Was it the right decision for Peloton to close its manufacturing operations and rely on outside manufacturers? What are the benefits and risks of using contract manufacturers? Discussion Question 10: Looking forward, how should Peloton manage its manufacturing and other links in the value chain? 3.

Outbound Logistics

The activities of outbound logistics are associated with collecting, storing, and distributing the product or service to buyers. They include finished goods warehousing, material handling, delivery vehicle operations, order processing, and scheduling. We present the example of Costco‘s $1 billion purchase of Innovel to show how firms are willing to spend large sums to ensure that they have effective logistics systems to meet customer needs. Discussion Question 11: Why is it so important for Costco to have an efficient and effective delivery system to get large, big-ticket items into customers’ homes? The driving point here is competition. As the retailing environment evolves, Costco wants to build a value chain that allows it to compete effectively against key competitors. Since Costco increasingly competes with online retailers, such as Amazon, that have been developing their own delivery and installation systems, Costco needs to build that into its value chain. 4.

Marketing and Sales

Marketing and sales activities are associated with the purchase of products and services by end users and the inducements for them to make purchases. These include advertising, promotion, sales force, quoting, channel selection, channel relations, and pricing. We provide the example of how InBev, the beer manufacturer who owns Budweiser, Stella Artois, Shock Top, and many other beer brands, struck a deal to provide its products to Netflix to use as props in its shows. 1-83 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 12: How does InBev benefit from such product placement? The SUPPLEMENT below provides an interesting insight on compensation systems for sales professionals. Extra Example: Insights on Compensating Sales Professionals Andris Zoltners is the founder of one of the world‘s largest sales consultancies, ZS Associates, with 3,500 employees worldwide. He is an authority on the best ways to manage and pay a sales force—and author of six books on the subject, including The Power of Sales Analytics, published in 2014. Below is his response to a question posed by a Harvard Business Review editor: Do most companies have the right degree of “leverage” or risk-at-pay in their incentive plans? Some companies don‘t really understand how leveraged their plans are, because of ―free sales‖—sales that occur this year but are due to past effort in the territory. In many product categories, if you sell something one year, there‘s a high probability you‘ll make residual sales the next year without any effort. If a salesperson is paid a commission or bonus for free sales, we call that a ―hidden salary‖ because it‘s an incentive paid for something that‘s nearly automatic. Many companies don‘t account for hidden salaries when they design their comp plans and set goals. A company may think that it‘s paying salespeople 60 percent in salary and 40 percent in commissions, so people have strong incentives to sell. But, if the salespeople have a lot of free sales, they may really be earning 85 percent in salary and 15 percent in commissions, which is a lower incentive. Source: McGinn, D. 2015. Getting beyond ―Show me the month,‖ Harvard Business Review. 93(4): 78–79.

Service

This includes all activities associated with providing service to enhance the value of products, such as installation, repair, training, parts supply, and product adjustment. We discuss the importance of service for online retailers (e-tailers). In particular, we discuss the exemplar examples of Sephora.com and a more established, traditional retailer, Nordstrom‘s. Discussion Question 13: What has your experience been with online retailers’ customer service? How can/should it be improved? STRATEGY SPOTLIGHT 3.1 discusses how Tesla faces a challenge in that its service network and systems seems out of step with European corporate car buyers. E.

Support Activities

Support activities in the value chain involve competing in any industry, and can be divided into four generic categories, as shown in EXHIBIT 3.3. Discussion Question 14: What firms are you familiar with that excel in some of the items included in Exhibit 3.3? How does such excellence enhance their competitive position in their industry? How hard would it be for competitors to copy? We will now discuss each of the four support activities. 1-84 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Procurement

Procurement refers to the function of purchasing inputs used in a firm‘s value chain, not the purchased inputs themselves. Purchased inputs include raw materials, supplies, and other consumable items as well as such assets as machinery, laboratory equipment, office buildings, and other buildings. We discuss the example of how Microsoft improved their procurement operations by providing formal reviews of its suppliers. The example points out the value of constructive feedback and evaluation. Discussion Question 15: What are some of the benefits of such evaluation for both Microsoft and its suppliers? STRATEGY SPOTLIGHT 3.2 discusses how Coke responded to growing concerns about the use of plastics to move to recyclable packaging and greater use of recycled plastic in its bottles.

Technology Development

Every value activity embodies technology. The array of technologies employed in most firms is very broad, ranging from technologies used to prepare documents and transport goods to those embodied in processes and equipment or the product itself. Technology that is related to the product and its features supports the entire value chain, while other technology development is associated with particular primary or support activities. 3.

Human Resource Management

Human resource management consists of activities involved in the recruiting, hiring, training, development, and compensation of all types of personnel. It supports both individual, primary, and support activities (e.g., hiring of engineers and scientists) and the entire value chain (e.g., negotiations with labor unions). In this section, we address JetBlue Airlines‘ innovative ―family friendly‖ initiative and the firm‘s program for attracting new employees. Discussion Question 16: What are the advantages of JetBlue Airlines’ innovative approach to human resource management? Could this type of program be used at companies with which you are familiar? Why? Why not? We also introduce how some firms are using ―program hiring,‖ where recruiters have the option to offer high potential college students without knowing exactly what position they will move into. Later matching interviews with managers in different units of the corporation are used to find the best fit for the new hires.

Discussion Question 17: What would be your reaction to a program-hiring offer? Would you be comfortable accepting a job offer when you wouldn’t know the specific job role you’d have? Why? Why not? Teaching Tip: While discussing the various support activities, ask those students who have some work experience (or organizations they are familiar with) whether or not the Human Resource Management function at their organization was well integrated with other value-creating activities such as operations, marketing, and procurement. Then you can address the issue of whether or not such relationships help to create value for the organization. (Interestingly, some students may point out that there were indeed interactions, but these were negative and bureaucratic in nature and eroded value.) 4.

General Administration

General Administration consists of a number of activities, including general management, planning, finance, accounting, legal, government affairs, quality management, and information systems. General administration (unlike other support activities) typically supports the entire value chain and not individual activities. This section addresses how general administration can be used as a source of competitive advantages—not merely as ―overhead expenses.‖ We provide examples of the symbolic leadership of CEOs such as Jack Ma and Jeff Bezos. F.

Interrelationships among Value-Chain Activities within and across Organizations

Up to now, we have addressed value-chain activities separately. Here, we discuss: (1) interrelationships among activities within the firm, and, (2) relationships among activities with other organizations, such as suppliers and customers. In this section, we introduce the concept of connected strategies, where firms move from episodic interactions with suppliers and customers to having ongoing relationships with them. We use Disney as an example of connected strategies. STRATEGY SPOTLIGHT 3.3 discusses how Rolls Royce is using a connected strategy to better connect with its customers. The SUPPLEMENT below addresses Timberland‘s detoxification initiative. It serves to show how an energy efficient supply chain can both enhance environmental sustainability and improve efficiency. It serves to illustrate the importance of viewing one‘s firm as part of a valuechain system composed of a focal firm as well as its suppliers, customers, and alliance partners. Extra Example: Timberland‘s Detoxification Initiative Making shoes is a surprisingly toxic business. Both the materials and the adhesives that connect them are made of chemicals that are known dangers to the cardiac, respiratory, and nervous systems. One pair of running shoes will hardly harm you. However, workers in the industry face real risks.

Timberland, the second largest company in the outdoor industry with $1.8 billion in revenues, realized that it needed to rethink the industry‘s traditional reliance on toxic chemicals. It became the first footwear company to test new water-based adhesives on non-athletic shoes. (Nike and others had already taken the initiatives in the ―white shoe,‖ or athletic, part of the industry). Making such a change required the firm to work very closely with Asian suppliers. According to Timberland‘s website, the company released its long-term strategy in 2008, which included its goal to create products at lower cost and with less harm to the environment. The strategy included the elimination of polyvinylchloride (PVC) from its product line and increasing the use of water-based adhesives in its footwear in order to reduce the use of solvents. Common sense would suggest that Timberland‘s detoxification efforts would be very costly for its suppliers. During the test phase it was quite expensive. The new adhesives cost more because economies of scale hadn‘t yet been achieved. However, over time, Timberland found the process to be cost neutral for its business and a money saver for the full value chain. Why? Water-based adhesives eliminate almost entirely the supplier‘s expense for handling hazardous materials, including waste disposal, insurance, and training. Manufacturing expenses had already declined during the testing phase because water-based adhesives go on with one coat instead of two, and the application equipment requires less cleaning. Thus, suppliers can run longer without interruption. The change also improves worker safety as well as reduces both labor costs and time. This sounds good. But was Timberland able to capture these supplier savings down the road? Probably not, but over time this strategy may have helped the firm win market share and drive revenues. Sources: Esty, D. C. & Winston, A. S. 2009. Green to Gold. Hoboken, NJ: Wiley, p: 112–113; http://community.timberland.com/; Whaba, P. 2015. Re-Tooled: How Timberland got back on its feet. fortune.com. October 13: np; and www.finance.yahoo.com.

Discussion Question 18: In considering green initiatives like that undertaken by Timberland, how should firms balance the desire to be responsible with making a hard business case for the initiative? G.

Applying the Value Chain to Service Organizations

We briefly discuss how to apply the value-chain concept to service organizations in order to help show how it can be applied to firms other than manufacturing firms (which is where Porter‘s generic value-chain concept can be most directly applied). We provide Nordstrom‘s (retail) and Beca (technology-based consulting company) as illustrations. EXHIBIT 3.4 includes a depiction of the primary activities for each of these firms. Ask: Discussion Question 19: What would be some of the important support activities for these two firms? Discussion Question 20: What are the key relationships among the primary and support activities to create value for these firms?

VIII. Resource-Based View of the Firm PowerPoint Slide 21: Resource-Based View of the Firm PowerPoint Slide 22: Types of Tangible Firm Resources PowerPoint Slide 23: Types of Intangible Firm Resources PowerPoint Slide 24: Types of Firm Resources: Organizational Capabilities PowerPoint Slide 26: Firm Resources and Sustainable Competitive Advantages PowerPoint Slide 27: Sources of Inimitability PowerPoint Slide 28: Criteria for Sustainable Competitive Advantage PowerPoint Slide 29: Example: Building Sustainable Competitive Advantages Through Data PowerPoint Slide 30: The Generation and Distribution of the Firm’s Profits The resource-based view of the firm (RBV) combines two perspectives: (1) the internal analysis of phenomena within a company, and (2) an external analysis of the industry and its competitive environment. It extends SWOT analysis by combining internal and external perspectives and provides a useful framework for exploring why some firms are more successful than others. EXHIBIT 3.5 addresses the types of resources that firms possess: tangible resources, intangible resources, and organizational capabilities. Discussion Question 21: What are some examples of firms that are particularly strong (or weak) with regard to the items in Exhibit 3.5? Discussion Question 22: Can you provide examples of firms that have effectively (or ineffectively) integrated their strengths regarding some of the items in Exhibit 3.5? Throughout this section we focus on the importance of integrating value-creating activities, i.e., on how competitive advantages are created (and sustained) through the bundling of several resources in unique combinations. Types of Firm Resources This rather brief section discusses each of the three types of resources—tangible, intangible, and capabilities—and provides examples from business practices. Tangible resources are assets that are relatively easy to identify and include financial, physical, organizational, and technological resources that an organization uses to create value for its customers. We provide the example of FedEx‘s computer-based job competency tests. Intangible resources are much more difficult for competitors to account for or imitate. These include human resources, innovation resources, and reputation resources. The example of Harley-Davidson‘s strong brand image is addressed. At the end of this section, we discuss how various social networking sites can severely damage a firm‘s (Comcast) reputation. 1-88 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 23: What are some examples of other companies whose reputation was damaged when a product failure or other mishap became public knowledge? What were the strategic implications for those companies? Discussion Question 24: In general, what steps should companies (as well as students!) take to protect their reputations? Organizational capabilities are not specific tangible or intangible assets. They are competencies or skills that a firm employs to transform inputs into outputs. STRATEGY SPOTLIGHT 3.4 discusses how Zara is incorporating new technologies to develop new capabilities to meet evolving customer needs. H.

Firm Resources and Sustainable Competitive Advantages

For a firm to earn a sustainable competitive advantage, a resource must be valuable, rare, difficult for competitors to imitate, and difficult to substitute. EXHIBIT 3.6 addresses these four criteria and their implications. We will now discuss each of the four criteria. 1.

Is the Resource Valuable?

Resources are valuable when they enable a firm to formulate and implement strategies that improve its efficiency or effectiveness. The SWOT framework suggests that firms improve their performance only when they either exploit opportunities or neutralize (minimize) threats. Discussion Question 25: What are some other examples of resources that were once valuable, but are now less valuable (or a liability)? 2.

Is the Resource Rare?

If competitors or potential competitors also possess the same valuable resource, it is not a source of competitive advantage because all of these firms have the capability to exploit the resource in the same way. Common strategies based on such a resource would give no one firm an advantage. For a resource to provide a competitive advantage, it must be uncommon, that is, rare relative to other competitors. 3.

Can the Resource Be Imitated Easily?

Inimitability is a key to value creation because it constrains competition. If a resource is inimitable, then any profits generated are more likely to be sustainable. We discuss the example of Iowa Beef Processors (IBP). Although this firm was the first to modernize its facilities and capabilities, competitors easily duplicated its efforts. This drove down their profitability. We also discuss Groupon—a firm that the students are likely familiar with. 1-89 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The SUPPLEMENT below discusses the way In-N-Out tries to make it difficult for other firms to imitate its resources. Extra Example: In-N-Out Pushes Out Imitators At first blush, it doesn‘t seem that there is much about a fast-food burger chain that would be hard to imitate. But InN-Out, one of the most successful burger chains, works hard to protect its core resources. In 2007, an entrepreneur entering the fast-food burger market in Utah decided he had a clear recipe for success. He would simply imitate everything In-N-Out did, other than its name. While he named the chain Chadder‘s, he copied In-N-Out‘s color scheme, its menu, and even adopted In-N-Out‘s secret menu—all elements of the business In-N-Out had trademarked. Even though In-N-Out didn‘t operate in Utah at the time, they got wind of what Chadder‘s was up to and filed a lawsuit claiming trademark infringement. The court forced Chadder‘s to change its look, the names of items on its menu, and how people could order their food. In-N-Out got its ultimate revenge when it entered the Utah market. Chadder‘s quickly went out of business. Source: Moyer, J. 2015. The In-N-Out effect: Trademark mistakes you need to avoid. business.com. March 16: np.

Discussion Question 26: Why is In-N-Out able to keep other firms from imitating its resources? What can other firms learn from In-N-Out? For imitation to be avoided, one of four conditions need to be satisfied: Physical uniqueness. By definition it is inherently difficult to copy. Examples would include a beautiful resort location, mineral rights, or Pfizer‘s pharmaceutical patents. In STRATEGY SPOTLIGHT 3.5, we examine how T-Mobile is working to leverage the value of its 5G bandwidth to change the competitive balance in the mobile phone service industry. Path dependency. This means that resources are unique and therefore scarce because of all that has happened along the path followed in their development and/or accumulation. We provide the examples of Gerber Products Co. and Ashley Furniture. Discussion Question 27: What are other examples of firms that rely on resources that have the benefit of path dependency? The SUPPLEMENT below points out an important caveat regarding path dependency and competitive advantage. That is, tight interrelationships among value-chain activities that have been built up over time can often represent a strong fortress to ward off competition. However, the downside is that if industry conditions change, or if the firm desires to make a major change in its strategy, what is often considered a strength can become a severe handicap. We give the example of Liz Claiborne, an apparel firm.

Extra Example: When a Competitive Advantages Built on Path Dependency Becomes a Handicap Changing a tightly linked system of value-creating activities means dismantling the very synergies that management worked so hard to build and putting the organization at risk during the transition to a new strategy. For this reason, many managers either ignore change or make changes at the margin. However, neither approach works. Once stable markets change, entrenched strategic positions tend to falter. Change forces managers to dismantle their existing resource systems to reassemble them in new strategic positions. This is difficult and time consuming—a combination that can potentially be lethal because performance may not improve until the pieces are reassembled and linked. Consider Liz Claiborne, an apparel company. It relied on a strategy in which production, distribution, marketing, design, presentation and sales resources were all tightly linked. However, when the industry changed, the firm‘s relationships with department stores were disrupted. In an effort to adapt, Claiborne executives changed resources such as their ―no reordering‖ process that had antagonized department stores. But since this process was synergistically entwined with other resources like overseas logistics and distant manufacturing locations, the ―no reordering‖ process could not be undone without damaging system coherence. Financial performance sank precipitously. Only after Claiborne executives dismantled their existing resources and started reconnecting new ones did positive performance begin to return. Source: Bingham, C. B., Eisnehardt, K. M. & Furr, N. R. 2011. Which strategy when? Sloan Management Review, Fall: 71–78.

Causal ambiguity. This means that would-be competitors may be thwarted because it is impossible to disentangle the causes (or possible explanations) of either what the valuable resource is or how it can be created. We discuss 3M‘s process of innovation as well as Yahoo and Twitter‘s inability to match Google‘s ability to innovate and launch products. Amazon Prime has been seen as a key driver in the dramatic growth for Amazon—at the expense of many online and ―brick-and-mortar‖ rivals. Although competitors have tried to imitate this service, Amazon has been able to exploit many elements of its strategy—wide selection, low prices, network of third-party merchants, and superb distribution system—to create what would seem to be a nearly perfect ―sustainable competitive advantage.‖ Discussion Question 28: Have you used Amazon Prime? Are you satisfied with it and has it caused you to increase your purchases through Amazon? Do you see how some firms could successfully imitate this service? Why? Why not? Social complexity. These include ―soft‖ issues such as culture, trust, and leadership. Examples include interpersonal relations among the employees and managers of a firm, its culture, and its reputation among suppliers and customers. Although complex physical technology is not included in this category of imperfect inimitability, the exploitation of physical technology in a firm typically involves the use of socially complex resources. The SUPPLEMENT below discusses how Trader Joe‘s uses a combinations of resources that results in the firm having a resource set that is both causally ambiguous and socially complex.

Extra Example: The Unique Set of Resources of Trader Joe‘s The grocery business is notorious for its level of competition and its low profit margins. Trader Joe‘s, a Californiabased grocery retailer, has found a way to avoid the perils of this industry. Trader Joe‘s focuses on health-conscious, educated customers. This market focus leads the firm to make specific choices on where to locate its stores, the design of its stores, its product mix, the suppliers it works with, and the types of employees it hires. All of these choices reinforce each other to provide a unique and valuable shopping experience for its customers. The interdependence of these resource choices makes it difficult for established competitors to compete with Trader Joe‘s. If they cherry pick one or two elements of Trader Joe‘s resource base, such as the physical layout of the stores or the reliance on private label products, they wouldn‘t match up well against Trader Joe‘s. To compete effectively, a rival would need to replicate a full set of Trader Joe‘s interrelated choices. But even then, they‘d have to match the firm‘s culture and reputation. Source: Sull, D., Turconi, S., Sull, C., & Yoder, J. 2018. Turn Strategy into Results. MIT Sloan Management Review. Spring: 12–23.

Are Substitutes Readily Available?

The fourth requirement for a firm to be a source of sustainable competitive advantage is that there must be no strategically equivalent valuable resources that are themselves not rare or inimitable. Substitutability may take at least two forms. First, although it may be impossible for a firm to imitate another firm‘s resource exactly, it may be able to substitute a similar resource that enables it to develop and implement the same strategy. We provide the example of roughly equivalent top management teams. Second, very different firm resources can become strategic substitutes. We provide the example of Amazon as offering online ordering as a substitute to brick-and-mortar retailers, and ride-share services, such as Uber and Lyft, as developing a substitute fleet of vehicles to taxi services. EXHIBIT 3.7 illustrates the relationship among the four criteria of sustainability and shows the competitive implications. Discussion Question 29: What may be example(s) of companies that illustrate each of the four conditions? 5.

Leveraging Artificial Intelligence to Increase the Sustainability of an Advantage

We discuss how firms are increasingly using big data and artificial intelligence to better understand customer preferences and build a sustainable advantage. The key is that by leveraging data earlier and more aggressively than rivals, firms seek to build knowledge resources that are both path dependent and socially complex – leading to a sustainable advantage. We provide several examples of firms that are leveraging the power of big data to enhance their knowledge. The SUPPLEMENT below discusses how Wayfair, an internet retailer, is using data analytics to enhance their resource set and pull in customers. 1-92 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Extra Example: Wayfair Leverages Science to Offer Attract Customers Wayfair has grown from a bedroom business called RacksandStands.com to become the world‘s 12th largest online retailer. The firm generated nearly $9 billion in sales in 2019 and employs nearly 15,000 people. It offers a nearly unlimited range of products for its customers, over 14 million products from 11,000 suppliers, but the firm strives to continue to improve its ability to develop personalized marketing to pull in customers. How does it accomplish this? It‘s done with the help of the firm‘s data scientists. In recruiting their staff, Wayfair doesn‘t weight the applicant‘s experience heavily. Instead, it tests and hires on analytical ability, mental dexterity, and a strategic orientation. The firm has a staff of 130 data scientists dedicated to better target market potential online customers. They have built and regularly update a proprietary bidding algorithm that allows them to become more efficient and effective with their product recommendations. The algorithm links 20 million keywords and combinations of words to develop a dynamic targeting platform that analyzes customers‘ browsing history, thus providing more enticing product recommendations. Bob Sherman, Wayfair‘s VP of marketing, puts it this way: ―Our machine learning platform will also determine the ideal set of products to show any new customer.‖ The firm also uses data to improve its marketing efficiency. Sherman states, ―We do media buying like a portfolio manager makes stock-buying decisions.‖ For example, the firm found that media rates drop predictably at certain times of the year, and it leverages these arbitrage opportunities by focusing their media buys during these periods. In short, the firm looks to use the power of data to improve both the efficiency and effectiveness of its marketing efforts. Sources: O‘Brien, J. 2019. It‘s all clicking for Wayfair. Fortune. June 1:124–131.; finance.yahoo.com.

Discussion Question 30: What are some additional examples of companies that are leveraging the power of big data and analytics to build stronger knowledge resources? I.

The Generation and Distribution of a Firm’s Profits: Extending the Resource-Based View of the Firm

The key point in this section is that even though a firm may have a source of competitive advantage that appears to satisfy the four criteria for sustainability, some (or a good deal) of its profits may be retained (or ―appropriated‖) by its employees or managers—instead of going to the owners (i.e., shareholders). We address four conditions that explain the extent to which managers and employees will be able to extract a proportionately high level of the profits they generate:    

Employee bargaining power Employee replacement cost Employee exit cost Manager bargaining power

Teaching Tip: The discussion of the generation and distribution of a firm‘s profits between the firm and individual employees is a good opportunity to discuss some of the career implications for students and enable them to realize the practical applicability of the concepts covered. In this section, we address the four conditions that enable managers and employees to extract a disproportionate share of the profits that they 1-93 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

generate. You may ask them to remember people they have known in organizations who were either very successful or very unsuccessful, and if their success (or lack thereof) could be explained by these four criteria. The career implications become rather self-evident.

IX.

Evaluating Firm Performance: Two Approaches

PowerPoint Slide 31: Evaluating Firm Performance PowerPoint Slide 32: Financial Ration Analysis PowerPoint Slide 33: The Balance Scorecard PowerPoint Slide 34: Customer Perspective vs. Internal Business Perspective PowerPoint Slide 35: Innovation and Learning Perspective PowerPoint Slide 36: Financial Perspective PowerPoint Slide 37: Limitations of the Balanced Scorecard Here, we address two major approaches to evaluating firm performance. The first is financial ratio analysis. in which we assess how a firm is doing compared to its balance sheet, income statement, and market valuations. Second, we address performance from the perspective of a broader stakeholder perspective. Kaplan and Norton‘s concept of the balanced scorecard is central to our discussion. Financial Ratio Analysis We address five different types of financial ratios:     

Short-term solvency or liquidity Long-term solvency measures Asset management Profitability Market value

(All of your students have been exposed to this information in their accounting and finance classes, but it is worthwhile to spend some time in review.) EXHIBIT 3.8 provides a summary of five types of financial ratios. The Appendix to Chapter 13 (on Case Analysis) provides detailed definitions for discussions of each of these types of ratios, as well as examples of how each is calculated. Next, we address some issues that must be taken into account in order to make financial analysis more meaningful: historical comparisons, comparisons with industry norms, and comparisons with key competitors. 1.

Historical Comparisons

Comparing a firm‘s performance over time helps to provide a means of evaluating trends. We provide the example of Apple‘s performance over a period of years to point out the importance of looking at historical trends and their implications. EXHIBIT 3.10 illustrates a tenyear period of return on sales for a hypothetical company. As indicated by the dotted trend lines, the rate of growth (or decline) differs substantially across time periods. 2.

Comparisons with Industry Norms

When evaluating a firm‘s financial performance, it is important to compare it with industry norms. That is, a firm‘s current ratio or profitability may be impressive at first glance. However, it may pale when compared to industry averages. EXHIBIT 3.10 compares financial ratios for three different industries—semiconductors, grocery stores, and skilled nursing facilities. Although the text provides a brief discussion of why there is such variation among these industries, it may still be useful to pose this question—to reinforce learning and obtain additional insights. 3.

Comparisons with Key Competitors

Referring back to Chapter 2, firms with similar strategies are considered members of strategic groups in a given industry. Furthermore, competition tends to be more intense among competitors within groups than across groups. Thus, one can gain valuable insights into a firm‘s financial and competitive position if comparisons are made between a firm and its most direct competitors. We use the example of the pharmaceutical industry. Here, large firms such as Pfizer and Merck have enormous investments in R&D—which would discourage new firms from competing ―head to head.‖ J.

Integrating Financial Analysis and Stakeholder Perspectives: The Balanced Scorecard 1.

The Balanced Scorecard: Description and Benefits

The balanced scorecard helps to provide a meaningful integration of many issues that come into play when evaluating a firm‘s performance. It is a set of measures that provide top managers with a fast but comprehensive view of the business. In a nutshell, it includes financial indicators, operational measures of customer satisfaction, internal processes, and the organization‘s innovation and improvement activities. The balanced scorecard enables managers to consider their business from four key perspectives:    

How do customers see us? (customer perspective) What must we excel at? (internal perspective) Can we continue to improve and create value? (innovation and learning perspective) How do we look to our shareholders? (financial perspective)

EXHIBIT 3.11 depicts the balanced scorecard‘s four perspectives. a.

Customer Perspective

Managers must translate their general mission statements on customer service into specific measures that reflect the factors that really matter to customers. There are four primary categories of customer concerns: time, quality, performance and service, and cost. b.

Internal Business Perspective

Customer-based measures are important. However, they must be translated into indicators of what the firm must do internally to meet customers‘ expectations. The internal measures should reflect business processes that have the greatest impact on customer satisfaction. These includes factors such as cycle time, quality, employee skills, and productivity. c.

Innovation and Learning Perspective

Given the rapid rate of change in markets, technologies, and global competition, the criteria for success are constantly changing. Accordingly, a firm‘s ability to improve, innovate, and learn ties directly to its value. That is, only by developing new products and services, creating greater value for customers, and increasing operating efficiencies, can a company penetrate new markets, increase revenues, and grow shareholder value. d.

Financial Perspective

Such measures indicate whether the company‘s strategy, implementation, and execution are, in fact, contributing to bottom-line improvement. Typical financial goals include profitability, growth, and shareholder value. Periodic financial statements remind managers that improved quality, response time, productivity, and innovative products benefit the firm only when they result in improved service, increased market share, reduced operating expenses, or higher asset turnover. In the INSIGHTS FROM RESEARCH 3.1, we discuss research that highlights the longer term performance benefits associated with taking a balanced view in managing the firm. Teaching Tip: During the discussion of the Balanced Scorecard, it is important to bring to the class‘ attention that there are inevitable tradeoffs between the elements in the balanced scorecard. What are the challenges involved in balancing these tradeoffs? You may point out that at a given time a firm may focus on a goal that is more pressing at that point in time. You may also point out that a firm can focus on different elements at different points in time, building on the success in one area to improve in another. 2.

Limitations and Potential Downsides of the Balanced Scorecard

One criticism of the balanced scorecard is that executives will believe that implementing it provides a ―quick fix‖ to organizational problems. The balanced scorecard takes time to 1-96 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

implement effectively, and performance problems can be linked to poor execution of the system rather than the balanced scorecard itself. Commitment to improve issues addressed by the balanced scorecard—such as learning and improving the internal culture—is also essential to its successful application. Teaching Tip: You might consider asking the following question prior to discussing the material in the supplement above: What do you think are some of the problems that can potentially be expected with the use of the Balanced Scorecard. Or, if your students, as a group, have a relatively large amount of business experience, you may ask them: What has been your experience with the use of the Balanced Scorecard in your organization? Has it worked well? Why? or Why not?

Issue for Debate

Firms often face the decision of whether to invest in a range of products or technologies or focus primarily on one. In the Issue for Debate, we look at Merck, a major pharmaceutical firm, that historically invested in a wide range of products. More recently, the firm has concentrated its energies on one particular drug. This raises questions about the short- and long-term consequences the firm will face with this decision. QUESTIONS: Why is Merck investing so heavily in one drug? What are the risks and opportunities? They are focusing in this area primarily because it brings together a valuable and rare resource and an attractive market. Cancer treatment is a huge and growing business. For years, progress in treatment was slow. In recent years, researchers have found that drugs that enhance a patient‘s own immune system can improve the effectiveness of treatments dramatically. Merck‘s drug, Keytruda, is in this class of new drugs and has been effective in treating a range of cancers. Merck is investing heavily to leverage the value of this resource to serve a massive and growing market. This drug could become the dominant medicine used to treat a range of cancers. This value is reflected in the fact that it now accounts for $17 billion in sales annually for the firm. Also, the profit potential is great since Merck has the ability to put a very high price premium on this type of drug. However, there are also risks. First, Merck is pinning all of its hopes on this one drug. If the ongoing drug trials are not as positive as the firm hopes, they will struggle to succeed in the market. Second, since the potential for this market is huge, the firm will certainly face a number of competitors developing similar treatments, some of which may turn out to have greater effectiveness than Keytruda. Third, the firm is investing in the current generation of treatment. Other treatments may emerge that use different mechanisms to treat cancer, undercutting the value of Keytruda. Merck‘s intense focus on Keytruda lessens their focus on finding the next great blockbuster cancer treatment. Finally, focusing on cancer treatment lessens the firm‘s ability to identify and develop blockbusters to treat other ailments. This makes them more 1-97 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

reliant on this specific market and also may lead valuable human capital to leave the firm if they feel their expertise and particular disease focus is not valued. What are the long-term implications for Merck’s culture, its human resources, and its knowledge base? The firm is likely to become more conservative and competitive in its culture. As it looks to further exploit the value of this one drug, it will become less willing to take on the risks associated with developing bold, new treatments. The quote from Merck‘s R&D head also suggests that there will be greater conflict about and competition for research resources. Researchers working on non-Keytruda drugs will be left fighting with each other for limited resources and will likely perceive competition with the Keytruda teams. Even within the Keytruda research teams, they may perceive competition with each other to be seen as the most promising treatment area. Over time, researchers who are not focused on Keytruda will likely leave the firm, resulting in a narrower knowledge base. This has positive and negatives in that the firm will develop very strong expertise in one area. However, it limits the flexibility of the firm to incorporate new insights, reinforcing the narrow, exploitation orientation of the firm. Is this a good “bet the company” decision? How do you think Merck should move forward from here? Students could fall on either side of this issue. The key is to see both the shorter-term market and financial benefits from this focus as well as the longer-term risks. For longer-term success, there should be some discussion of how the firm can use the resources from the success of this product to fund more exploratory research initiatives. You can even foreshadow later chapters, such as Chapter 12, by discussing how the firm can stimulate innovative thinking within focused entrepreneurship units or in dispersed entrepreneurship activities.

XI.

Reflecting on Career Implications

PowerPoint Slide 38 Reflecting on Career Implications Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 3. 

The Value Chain: It is important that you develop an understanding of your firm‘s value chain. What activities are most critical for attaining competitive advantage? Think of ways in which you can add value in your firm‘s value chain. How might your firm‘s support activities (e.g., information technology, human resource practices) help you accomplish your assigned tasks more effectively? How will you bring your value-added contribution to the attention of your superiors?

Students should appreciate that the value chain helps to identify where within the firm that competitive advantage is created. To make this concept more concrete, instructors may need to us a real-world example. Consider a firm such as Whole Foods. Ask students which activity may be most responsible for its competitive advantage. There are multiple possible ―right‖ answers, but one option can be procurement. Whole Foods develops relationships with suppliers that can provide a wide variety of high-quality organic food that is GMO-free. Competitors would find it difficult to imitate this supplier network. Assuming that students agree with this logic, ask them how they might contribute to Whole Foods‘ success in procurement. One way may be to survey customers and find out what types of products they would be open to buying. There are many possibilities for linking the process of discovering these consumer preferences to a support activity. Perhaps information technology could be used to survey customers. There are many possible directions this discussion could go in, but the point is to link competitive advantage to a value-chain activity and then to an interrelationship with a support activity. As for bringing the value-added contribution to the attention of superiors, the best technique depends on the environment within firms and the student‘s relationship with the superior. Ask students for suggestions and identify the possible costs and benefits of various methods. Many superiors will be open to suggestions if there is not much risk to current operations or a major change in routines. So, a suggestion for an incremental improvement with a high upside potential is most likely to be successful. The Value Chain: Consider the most important linkages between the activities you perform in your organization with other activities both within your firm and between your firm and its suppliers, customers, and alliance partners. Understanding and strengthening these linkages can contribute greatly to career advancement within your current organization. The goal of this discussion is to get students to appreciate the wider context of their current position. Ask students who have jobs, or a select few ―volunteers,‖ to consider this context by identifying the value-chain activity in which they currently work, its internal linkages with other value-chain activities, and external linkages with suppliers, customers, and alliance partners. For each linkage, ask students to identify the range of resources exchanged within the relationship, such as information, goods, people, or intellectual property. Instructors could write this information on the board. Now ask students to rank these linkages by importance and identify the most important one. The logic behind this choice should be related to the firm‘s competitive advantage. Now ask how an employee can strengthen this linkage so that the competitive advantage is enhanced. Normally, employees who strengthen these linkages will be helping their careers. The goal here is to get students to appreciate how any manager within a firm can contribute to its success. The value chain helps to focus these efforts. Resource-Based View of the Firm: Are your skills and talents rare, valuable, difficult to imitate, and do they have few substitutes? If so, you are in the better position to add value for your firm—and earn rewards and incentives. How can your skills and talents be enhanced to help satisfy these criteria to a greater extent? More training? Change positions within the firm? Consider career options at other organizations? 1-99 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The RBV can apply to individuals as well as firms, which is analogous to SWOT analysis. Ask students to identify their individual skills and capabilities that differentiate them from other employees and give them a sustainable ―competitive advantage‖ over others. Then ask students why these skills and capabilities are difficult for others to imitate. Ideally, students will quickly learn to identify intangible characteristics such as the ability to motivate others, the ability to work hard to meet deadlines, or communication ability. It may be useful to extend the discussion and ask students how their academic degree program enhances their ability to add value to their firm. (There is no correct answer here, but it may be useful to mention that students gain subject matter knowledge as well as the tenacity to complete the program.) The next step in the discussion is to ask how work experience helps students to enhance their skills and talents. Students should also appreciate that different work experiences vary in their ability to enhance students‘ skills and talents. Students can then be asked which experiences would be most beneficial to them in their efforts to develop competitive resources. The point here is to help students look at themselves as strategic assets to their firms, to appreciate how they add value to their firms, and to think about how to sustain and develop that value. 

Balanced Scorecard: Can you design a ―balanced scorecard‖ for your life? What would be the perspectives that you will include in it? In what ways would such a ―balanced scorecard‖ help you attain success in life?

A useful way to start this discussion is to ask students to devise measures for their personal professional success. Money can be only one measure, and students will have to think beyond this dimension. A brainstorming approach is appropriate, and the range of suggestions may include long life, satisfaction, new innovations developed, number of people helped, and status. Using inductive reasoning, try to group the resulting measures into ―perspectives.‖ If money is included, that could be a ―financial‖ perspective. Other perspectives may include ―influence,‖ ―entrepreneurship,‖ ―service,‖ or ―satisfaction.‖ To make the discussion have a lasting impact, ask students to develop their own ―balanced scorecard‖ and keep track of their life ―performance.‖ At the end of the semester, ask students how they are doing.

XII. Summary We identified two frameworks that serve to complement SWOT analysis in assessing a firm‘s internal environment: value-chain analysis, and the resource-based view of the firm. In conducting a value-chain analysis, you first divide the firm into a set of value-creating activities. These include primary activities such as inbound logistics, operations, and service, as well as support activities such as procurement and human resources management. Then you analyze how each activity adds value, as well as how interrelationships among value activities in the firm and among the firm and its customers and suppliers add value. Thus, instead of merely determining a firm‘s strengths and weaknesses per se, we analyze them in the overall context of the firm and its relationships with customers and suppliers, the value system. The resource-based view of the firm considers the firm as a bundle of resources: tangible resources, intangible resources, and organizational capabilities. Competitive advantages that are sustainable over time generally arise from the creation of bundles of resources and capabilities. 1-100 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

For advantages to be sustainable, four criteria must be satisfied: rareness, valuable, difficulty in imitation, and difficulty in substitution. Such an evaluation requires a sound knowledge of the competitive context in which the firm exists. The owners of a business may not capture all of the value created by the firm. The appropriation of value created by a firm between the owners and employees is determined by four factors: employee bargaining power, employee replacement cost, employee exit costs, and manager bargaining power. An internal analysis of the firm would not be complete unless you evaluated its performance and made the appropriate comparisons. Determining a firm‘s performance requires an analysis of its financial situation as well as a review of how well it is satisfying a broad range of stakeholders, including customers, employees, and stockholders. We discuss the concepts of the balanced scorecard and strategy map, in which four perspectives must be addressed: customer, internal business, innovation and learning, and financial. Central to the balanced scorecard is the idea that the interests of various stakeholders can be interrelated. We provide examples of how indicators of employee satisfaction lead to higher levels of customer satisfaction, which in turn lead to higher levels of financial performance. Thus, improving a firm‘s performance does not need to involve making tradeoffs among different stakeholders. Assessing the firm‘s performance is also useful if it is evaluated in terms of how it changes over time, compares with industry norms, and compares with key competitors. Chapter 3: Assessing the Internal Environment of the Firm Map the value chain for an organization with which you are familiar. Assess each of the activities in the value chain as to whether they are a strength or a weakness. What are the important relationships among the activities? Teaching suggestions: You might want to ask the following questions in order to organize the discussion on this topic. 

What is ―value‖? Why is this mapping called ―value chain‖? Value, in competitive terms, means the amount the buyers are willing to pay for a firm‘s products or services. Value is measured by total revenue. A firm is profitable when the value it receives exceeds its costs of production. The mapping is called a ―value chain‖ because, in this analysis, the organization is viewed as a sequential process of ―value-creating activities.‖



What are the primary and support activities? Primary activities: Inbound logistics: Activities associated with receiving, storing and distributing inputs to the product. These are activities such as material handling, warehousing, inventory control, vehicle scheduling and returns to the suppliers. 1-101 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Operations: Activities connected with transforming inputs into outputs. These are machining, assembly, packaging, testing etc. Outbound logistics: Activities associated with collecting, storing and distributing the product or service to buyers. These include finished goods warehousing, material handling, order processing etc. Marketing and sales: Activities associated with purchases of products and services by the buyers including activities to induce them to purchase. Advertising, promotion, channel selection, channel relations, pricing, etc., come under this category. Service: Includes all activities associated with providing service to enhance or maintain the value of the product, such as installation, repair, training, parts supply and product adjustment. Support activities: Procurement: It is the function of purchasing inputs used in the firm‘s value chain. Technology development: Refers to a number of technologies from those used to prepare documents and transport goods, to those embodied in processes and equipment, or the product itself. Human resource management: Consists of activities involved in the recruitment, hiring, training, development and compensation of all types of personnel. It supports both primary and support activities (e.g., hiring of scientists) and the entire value chain (e.g., negotiations with labor unions). General administration: General management, planning, finance, accounting, legal, government affairs etc., are all general administration activities. Unlike other support activities, this activity supports the entire value chain and not individual activities. You might want to ask the students to describe the primary activities of the organization they have chosen for analysis. Some of the factors to consider when assessing the primary and secondary activities are provided in the exhibits in the chapter. 

Are the components of the value chain independent of each other? What are the interrelationships? The components of the value chain are described and understood separately for the purpose of clarity. Clearly, there are interrelationships among the various activities. For example, excellence in technology development will benefit almost all the primary activities. Efficient operations leading to high-quality products reduce the need for repair services.

You can ask the students to map the interrelationships among the various value-chain activities. A template for such mapping is provided in the experiential exercise section of this chapter. 1-102 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

It is also important to recognize that one has to look at the ―value chain‖ in the broader context of the firm‘s relationships with its suppliers and customers i.e., the extended value chain. For example, Dell has excellent supply chain linkages that lower the inventory holding costs for both its suppliers and itself. However, Dell‘s competitive position has eroded. 

How does ―value-chain analysis‖ help? The purpose of the analysis is to understand which activities help in creating value for the customer and, therefore, are sources of sustainable competitive advantage. Activities with which a firm is able to create value for its customers can be viewed as ―strengths,‖ and those activities that become bottlenecks in the value chain and erode value can be viewed as ―weaknesses.‖ It would be useful to bring in the ―resource-based view‖ of the firm According to the resource-based view, there are additional qualifications for a resource (bundles of resources) to be a source of sustainable competitive advantage, i.e., the resource or resource combination must be valuable, rare, difficult to imitate and, difficult to substitute.

You might also want to ask the students to assess each of the value-chain activities and their combinations on these four attributes to determine whether the activity or the combination can be a source of sustainable competitive advantage. The template to help in this analysis is provided at the end of the chapter as part of an experiential exercise.

End-of-Chapter Teaching Notes Chapter 3: Assessing the Internal Environment of the Firm

Summary Review Questions 1. Briefly describe the primary and support activities in a firm’s value chain. (In text, Value-Chain Analysis, LO 3-1) Response: A firm‘s value chain consists of a firm‘s value-creating activities. Primary activities are sequential activities that pertain to the physical creation of the product or service, its sale and transfer to the buyer, and its service after sale, including inbound logistics, operations, outbound logistics, marketing and sales, and service. Support activities either add value by themselves or through important relationships with both primary and other support activities, including procurement, technology development, human resource management, and general administration. 2. How can managers create value by establishing important relationships among the value-chain activities both within their firm and between the firm and its customers and suppliers? (In text, Value-Chain Analysis, LO 3-2) Response: Relationships among value-chain activities can improve firm operations, leading to better quality products or lower costs. For example, the human resource management practice of encouraging transfer of employees across divisions can improve employee morale and foster transfer of information and ideas across divisions, thereby improving operations. A relationship between inbound logistics and suppliers can lead to implementation of just-in-time management, which can reduce inventory cost and improve product quality. 3. Briefly explain the four criteria for sustainability of competitive advantages. (In text, Resource-Based View of the Firm, LO 3-3) Response: Strategic resources that lead to firms‘ sustainable competitive advantages must be valuable, rare, costly to imitate, and costly to substitute. Resources must be valuable in order to give the firm competitive advantages. They must be rare, or else competitors will be able to obtain the advantages too. The resources must be costly to imitate, and costly to find substitutes, or else 1-104 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

competitors will be able to replicate the competitive advantages. Four factors that limit resource imitation are physical uniqueness, path dependency, causal ambiguity, and social complexity. They must be costly to substitute, or competitors will be able to create a similar competitive advantage that serves the same function. 4. Under what conditions are employees and managers able to appropriate some of the value created by their firm? (In text, Resource-Based View of the Firm, LO 3-4) Response: Employees and managers sometimes have the capability to consume a firm‘s earnings in the form of salary and perks. Four conditions that determine their ability to do so are 1) employee bargaining power, due to their unique skills and abilities; 2) employee replacement cost, due to the rareness of employee skills; 3) employee exit cost, which is the ability of the employee to find alternative employment, and associates with lower ability to appropriate earnings; 4) manager bargaining power, due to managers‘ information about the integrated understanding of the firm‘s total operations. 5. What are the advantages and disadvantages of conducting a financial ratio analysis of a firm? (In text, Evaluating Firm Performance, LO 3-5) Response: Financial ratios enable a firm to obtain a quick assessment of its overall performance. There are three comparisons that lend themselves to financial ratio analysis: historical comparisons, or the trend in various financial ratios over time; comparison with industry norms, which enables a firm to determine whether or not it looks competitive within the industry; comparison with competitors, which provides a set of benchmarks that track the firm‘s competitiveness. Financial ratio analysis has limitations. First is the quality of the accounting data on which the ratios are calculated. Second, the ratios do not provide any direction on how managers should invest resources to generate future sustainable competitive advantages. 6. Summarize the concept of the balanced scorecard. What are its main advantages? (In text, Evaluating Firm Performance, LO 3-6) Response: The balanced scorecard is a method of evaluating a firm‘s performance using performance measures from internal, innovation and learning, financial, and the customers‘ perspectives. These measures include the financial perspective from financial ratio analysis, but also include measures of other firm processes that should pertain to developing sustainable competitive advantage. The customers‘ perspective includes measures of customer satisfaction. The internal perspective includes the ability of the firm‘s organization to efficiently and effectively create products and services that satisfy customers‘ needs. The innovation perspective includes measures of the firm‘s ability to change operations in order to keep up with the dynamic business 1-105 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

environment. The advantages of the balanced scorecard are that it incorporates more information about firm operations than financial ratio analysis about a firm‘s basis for sustainable competitive advantage. Therefore, it should be a better indicator of future organizational success. Experiential Exercises and Application Questions: 1. In Learning from Mistakes at the beginning of the chapter, we saw how Quibi compiled a number of valuable resources but failed spectacularly. Imagine you are advising Netflix on a new service they were considering to offer short-form videos. Your task is to lay out the value chain for this potential business unit and discuss how each step is critical to creating customer value. Response: Briefly, their primary activities include the inbound logistics of warehouse facilities to house equipment, sets, and other materials needed to produce shows. Operations include filming facilities and the technology needed to incorporate special effects into the shows and edit the product down to digestible short segments for the platform. Outbound logistics involves the development and management of an online platform through which users can access the videos. Marketing and sales is central to the success of such a platform since the ability to draw in subscribers to the new service is key to its viability. Quibi‘s support activities include corporate management needed to provide vision and leadership; finance to ensure the firm manages its initial capital and expenses as it builds its subscriber base; a human resource team that brings in the talent needed to create, produce, edit, and sell the firm‘s products; and a technology development team that maintains the production and distribution systems the firms use in the ever-advancing technology frontier. 2. Caterpillar, the world’s leading manufacturer of construction and mining equipment, diesel and industrial gas turbines and diesel-electric locomotives, had 2021 revenues of $51 billion. The company consists of three product segments: construction industries; resource industries; and energy and transportation. Its financial products segment provides financing and related services. The three questions will help the student incorporate two core concepts in internal analysis— value chain and the resource-based view of the firm. The first question will center on identifying important value-creating activities, the second question will focus on addressing important relationships among the activities, and the third question will address how these activities and interrelationships help a firm attain a competitive advantage (by addressing the 4 criteria for sustainable advantages). Students can attain a good deal of information rather quickly by accessing the Caterpillar‘s most recent Annual Report, as well as other sources that are easily obtained via the Internet. (The sources used for this response are listed end of the third question.) 2a. Where in Caterpillar’s value chain is the firm creating value for its customers? 1-106 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Response: Briefly, Caterpillar‘s primary activities create value with its wide product line, creative marketing to enhance brand identification/awareness, lean manufacturing practices to enhance operational efficiency and product quality, extensive dealer network, superb logistical operations, and excellent customer service (which is extremely important given the high cost of downtime associated with its expensive equipment). Caterpillar‘s support activities create value with its excellent IT operations (part of firm infrastructure), its financial products and corporate services unit that provides financing for both its dealers and customers, extensive R&D operations to develop new products, and sound procurement practices. As noted by Stu Levenick, Group President (Customer and Dealer Support): ―I think our designers and manufacturers are the best in the industry, but what really sets us apart is the dealer organization.‖ 2b. What are the important relationships among Caterpillar’s value-chain activities? What are the important interdependencies? For each activity, identify the relationships and interdependencies. Response: This question builds on the first question. It is very important to not only consider what activities add value but also to explore what are the important interrelationships among activities. (Such interrelationships are critical in creating competitive advantages that would be hard for rivals to imitate or duplicate.) Below are some important interrelationships among both primary and support activities: 7. The Global Supply Network joins procurement and logistics to focus on supply excellence, visibility, and driving efficiencies from order to delivery. 8. According to Stu Levenick, former Group President (Customer and Dealer Support), the firm made progress on dealer enterprise resource planning and data sharing. He stated, ―We‘re becoming one of the leading e-commerce practitioners in the industry.‖ Also, Caterpillar has made advances in ―telematics and the distribution aspect of technologyenabled solutions.‖ 9. Caterpillar‘s ―Across the Table‖ initiative has led to deeper collaborations with its 178 dealers, which enhance the sharing of best practices across many value activities. 10. Caterpillar‘s Enterprise System Group brings together critical process and support groups to further improve holistic manufacturing and value-chain capabilities worldwide. 11. Caterpillar has become more ―mainstream‖ and creative in its marketing and advertising strategies. Its ―Let‘s Do the Work‖ tagline has served to leverage the brand, including well-received videos (one has had over 500 thousand views, which has put Caterpillar in 1-107 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

conversations beyond any ―hardhats.‖) Interestingly, Renee Richardson, former head of Global Brand Marketing, asserted that such efforts attract not only customers but also potential employees, with content that engages and excites them. As she noted: ―We have the brand for our customer, but we‘re a very large company and we like to attract the best and the brightest, so it serves different purposes.‖ Therefore, effective marketing can enhance human resource procurement. 12. In 2021, Caterpillar was honored by both the Wall Street Journal and Dow Jones as one of the world‘s leading firms for sustainability. Such success is a reflection of a coordinated effort that includes a number of primary and support activities. In the exhibit below, we note what could be considered the most important relationships among value-creating activities.

Inbound logistics Inbound logistics Operations Outbound logistics Marketing and sales Service Procurement Technology development Human resource management General administration

Operations X

Outbound logistics X

Marketing and sales

Service X X X

Procurement X X X

Technology development X X X X

Human resource management X X X X X X

General administration

X X

2c. What resources, activities, and relationships enable Caterpillar to achieve a sustainable competitive advantage? Response: As noted in the above two questions, there are many value-chain activities and important relationships among them that help Caterpillar attain competitive advantages that are difficult for rivals to imitate. Key among these are:

1. Close relationships between logistics, operations, and service to build brand loyalty. 2. Excellent downstream service activities—in particular quick response to customer needs (very important given the high costs of downtime). 3. Human resource practices that enhance all value-creating activities. For example, new employees begin a 3-year program with a variety of complex assignments, are provided peer mentors, participate in monthly virtual team meetings, and undertake visits to various facilities. 4. Superior product quality and service enhances brand identification and strengthens market position. 5. Financial Products and Corporate Services provide critical financing for both dealers and customers.

Resource/Activity Inbound logistics Operations Outbound logistics Marketing and sales Service Procurement Technology development Human resource management General administration

X X X X

Is it valuable? X X X X

Is it rare? X X X X

Are there few substitutes? Is it difficult to make? X X X

X X

Sources: Company records; 2015 Caterpillar Annual Report; Anonymous. 2015. NYSE Governance Services Announces 2015 Leadership Award Winners. www.finance.yahoo.com: June 19: np.; and, Beer, J. 2015. Behind the Brand: Caterpillar Went from Conservative to BuzzBuilding Content Marketing. www.fastcocreate.com. June 20: np; caterpillar.com. 3. Using published reports, select two CEOs who have recently made public statements regarding a major change in their firm’s strategy. Discuss how the successful implementation of such strategies requires changes in the firm’s primary and support activities. Response: Most company websites publish new releases that include CEO statements. Many corporate annual reports include a statement to shareholders from the CEO. The purpose of this exercise is for students to learn how to classify changes in strategy and also to consider how these changes lead to changes in activities on the value chain. 4. Select a firm that competes in an industry in which you are interested. Drawing upon published financial reports, complete a financial ratio analysis. Based on changes over time and a comparison with industry norms, evaluate the firm’s strengths and weaknesses in terms of its financial position. 1-109 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Response: Most annual reports include the relevant accounting data. In addition, some common services, such as D&B Hoovers, Yahoo Finance, and Lexis/Nexis, include financial ratios for many corporations. Data on industry norms may require industry-level reports, and that data is available from industry analysts, which may require a library subscription. The goal is to have students appreciate the value and limitations of financial ratio analysis. Students can quickly tell if a firm‘s ratios are above or below industry norms, which directly indicates strengths and weaknesses. However, an important step is to ask students, ―What investments does the firm need to make to improve its financial performance?‖ Usually, the financial ratios analysis itself turns out to provide little guidance for answering this question. 5. How might exemplary human resource practices enhance and strengthen a firm’s valuechain activities? Response: Exemplary human resource practices can enhance and strengthen every value-chain activity. Such human resource practices can place people in jobs they are best suited for, improve morale by supporting their efforts, and enable them to transfer to other positions within the company to further their professional development. 6. Using the Internet, look up your university or college. What are some of its key valuecreating activities that provide competitive advantages? Why? Response: Universities and colleges have support activities that are similar to other firms. For primary activities, the value chain is different. The ―raw material‖ is students. The activities may include moving-in support, educational offerings, recruitment, career services, and alumni relationships. Ask students why they chose your college, and you‘ll usually have your answer. In our experience, students usually mention the great academic programs, great faculty, good reputation from alumni, convenient location, or low cost. Of these, only convenient location and low cost do not translate directly to an activity on the value chain. Low cost is often related to financial support from alumni, donors, or state legislatures, so the interrelationship story applies.

Ethics Questions 1. What are some of the ethical issues that arise when a firm becomes overly zealous in advertising its products? Response: A firm may advertise its products with inaccurate claims. If so, then it opens itself up to claims of false advertising, which can result in legal action and embarrassment. In addition, brand equity will suffer as consumers discover that the actual product is not as good as advertised. The solution is to have marketing and sales closely linked with technology development and operations. Marketing should therefore only advertise products and services realistically. And technology development and operations should work together to develop and produce products that live up to marketing‘s (and customers‘) expectations. 2. What are some of the ethical issues that may arise from a firm’s procurement activities? Are you aware of any of these issues from your personal experience or businesses you are familiar with? Response: Ideally, procurement involves an agreement with a supplier that specifies, in part, the product to be delivered, the timing of delivery, the place of delivery, the price, and the timing of payment. Malfeasance can occur along any of these dimensions. Malfeasance by suppliers may include shipping an inferior product or a lower quantity of product, delivery delay, or delivery to the wrong place. Malfeasance by the buyer may include delay of payment or underpayment. Other malfeasance may include miscommunication or misunderstanding of any of the terms of the agreement. Any issue that arises requires a negotiation and resolution. In extreme cases, legal action is a last resort. All types of resolution require that someone incur a cost.

CONNECT RESOURCES Comprehension Case Competitive Analytics at CarMax Case Analysis Competitive Analytics at CarMax Amazon Prime: Difficult to Copy

Chapter 4 Recognizing a Firm‘s Intellectual Assets: Moving beyond a Firm‘s Tangible Resources 113-2 The Central Role of Knowledge in Today’s Economy ............ 4-4 1-111 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Human Capital: The Foundation of Intellectual Capital ........ 4-4 Attracting Human Capital ........................................................................ 4-6 Developing Human Capital ....................................................................... 4-8 Retaining Human Capital ......................................................................... 4-11 Enhancing Human Capital: Redefining Jobs and Managing Diversity 4-13

The Vital Role of Social Capital ................................................. 4-125 How Social Capital Helps Attract and Retain Talent ............................ 4-14 Social Networks: Implications for Knowledge Management and Career Success ......................................................................................................... 4-15 The Potential Downside of Social Capital................................................ 4-16

Using Technology to Leverage Human Capital and Knowledge . 4-17 Using Networks to Share Information ..................................................... 4-17 Virtual Teams: Using Technology to Enhance Collaboration............... 4-18 Codifying Knowledge for Competitive Advantage ................................. 4-18

Protecting the Intellectual Assets of the Organization: Intellectual Property and Dynamic Capabilities ...................... 4-19 Intellectual Property Rights ...................................................................... 4-19 Dynamic Capabilities ................................................................................. 4-20

Issue for Debate ........................................................................... 4-20 Reflecting on Career Implications ............................................. 4-21 Summary ...................................................................................... 4-24

End-of-Chapter Teaching Notes ............................................ 4-28 Connect Resources ...................................................................... 4-33

Chapter 4 Recognizing a Firm‘s Intellectual Assets: Moving beyond a Firm’s Tangible Resources Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead One of the key trends today is the emergence of the importance of the knowledge worker in today‘s economy. It is critical for managers to not only recognize the importance of top talent but also the need to leverage human capital in order to innovate and, in the end, to develop products and services that create value. This chapter is divided into four sections. The first section focuses on the increasing role of knowledge as the primary means of wealth generation in today‘s economy. After all, in the knowledge economy, a firm‘s value is based much more on knowledge—know-how, and intellectual assets—than on the traditional factors of production (i.e., labor and capital). The second section addresses the key resource itself—human capital—the foundation for the creation of intellectual capital. We explore ways in which the organization can attract, develop, and retain human capital, as well as the importance of recognizing the interdependence of these three activities. We also address how the effectiveness of human capital can be increased by redefining jobs and the value of a diverse work force. Third, we discuss the critical role of social capital, that is, the network of relationships among individuals. We address both social capital within organizations as well as across organizations. We also discuss social networks— and their implications for knowledge management and career success. The final section focuses on the role of technology in leveraging human capital. This can range from such basic technologies as email to more complex forms such as sophisticated knowledge management systems. We also discuss how technology can play a key role in electronic teams (or e-teams) and enhance the retention of knowledge in an organization. And, we address the importance of protecting an organization‘s intellectual assets. Here, the roles of intellectual property and dynamic capabilities become salient.

Lecture/Discussion Outline We open the chapter in LEARNING FROM MISTAKES with the example of Dewey & LeBoeuf LLP bankruptcy. Here we had a very successful law firm with a ―storied history‖ which failed due to a failed strategy and huge missteps with their human capital. At the core of the problem was the merger of two law firms—insurance- and energy-focused LeBoeuf, Lamb, Greene & McRae LLP, and Dewy Ballantine LLP. The merged partnership promised new partners guaranteed lucrative contracts, sometimes over $5 million a year. Not surprisingly, the legacy partners did not take kindly to such largess— and many left the firm. The firm‘s performance continued to suffer—in part the result of numerous failed merger attempts, and eventually the firm liquidated. It became the largest law firm failure in U.S. history. (And, the Great Recession of 2008 and 2009 hit the firm hard and big problems came to the surface.) Discussion Question 1: How could these problems have been avoided at Dewey & LeBoeuf? Discussion Question 2: What practices should firms such as Dewey & LeBoeuf implement to attract and retain top talent? Response guidelines: (Given the interrelated nature of the two questions an integrated response will be provided.) At the end of the vignette it is made rather clear that the firm was run by a core of administrators and lawyers who were not transparent in their actions. In effect, it would appear that there was an ―ingroup‖ and an ―outgroup.‖ This led to tremendous resentment when some of the legacy lawyers discovered that the compensation packages of the newly hired partners were much higher than theirs. And, subsequently when the Great Recession hit, there was clearly not a sense of ―shared sacrifice‖ in order to help the firm weather the storm. Dewey & LeBoeuf LLP could have benefitted by implementing more transparent and fair human resources practices—both in terms of the ―content‖ as well as ―processes‖ which would make the practices more transparent. And, the firm was far too aggressive with its growth prospects—fueled in part by its over optimism regarding future growth opportunities. And, given the ―insular‖ nature of its key decision makers, the firm could have benefitted by soliciting input from a wider variety of partners—instead of relying on those who were making key decisions and resource allocations in a very opaque manner.

IX.

The Central Role of Knowledge in Today’s Economy

PowerPoint Slide 4: The Importance of Intellectual Assets PowerPoint Slide 5: The Central Role of Knowledge 1 PowerPoint Slide 6: The Central Role of Knowledge 2 We begin by providing some figures on how wealth is increasingly dependent on knowledgebased assets in today‘s economy. Human capital is growing more valuable in virtually every business. To provide some additional ―quantitative support‖ for our arguments, we investigate the tremendous ―gaps‖ between market value and book value—a difference that is considered by many to be an indicator of a firm‘s ―intellectual capital.‖ EXHIBIT 4.1 shows the ratio of market-to-book value for a selected set of companies. It is useful to pose the following question. It should elicit some interesting responses: Discussion Question 3: What are the implications of EXHIBIT 4.1 for today’s organizations? We then define some of the basic concepts in the chapter: 

Human capital is the ―individual capabilities, knowledge, skills, and experience of the company‘s employees and managers.‖



Social capital can be defined as ―the network of relationships that individuals have throughout the organization.‖



Knowledge comes in two different forms: explicit (easily documented, stored, etc.) and tacit (in the minds of employees and shared only with their consent).

It is important to point out that the creation of new knowledge involves the continual interaction of explicit and tacit knowledge. We provide the example of engineers working on computer code. This is also a point at which you may wish to address the critical role of socially complex processes (leadership, trust, culture) in leveraging human capital.

Human Capital: The Foundation of Intellectual Capital

PowerPoint Slide 8: Human Capital PowerPoint Slide 9: Attracting Human Capital PowerPoint Slide 10: Developing Human Capital PowerPoint Slide 11: Retaining Human Capital PowerPoint Slide 12: Enhancing Human Capital: Redefining Jobs and Managing Diversity 1-116 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Organizations must recruit talented people—employees at all levels with the proper set of skills and capabilities coupled with the right values. In this section, we address the hiring/selection, development, and retention processes. EXHIBIT 4.2 illustrates these processes. We suggest the imagery of the three-legged stool. We provide the rather humorous perspective of Professor Jeffrey Pfeffer (the San Francisco law firm) to illustrate the interdependent nature of these three activities. It may be useful to ask: Discussion Question 4: Why do many firms devote more efforts to attracting human capital than they do to developing or retaining talent? STRATEGY SPOTLIGHT 4.1 discusses the importance of a firm‘s ―green‖ or environmental sustainability strategy in attracting and retaining young talent. Ask: Discussion Question 5: How important is a firm’s “green strategy” in your job search? The SUPPLEMENT below presents the overall characteristics of the labor markets in the United States, Japan, and France. The author argues that today‘s college graduates would not remain unemployed for long because of the relative structural dynamism of American capitalism, that is, its extraordinary labor flexibility. Extra Example: Labor Flexibility in the United States, Japan, and France The World Bank Group ranks the United States as ―first‖ in the world in ―employing workers‖ (that is, labor flexibility). What puts the United States on the top of the list? American companies have a lot of freedom to hire and fire, payroll taxes are relatively low by international standards, and people are free to move to new jobs when the economy is better. In contrast, Japan ranks 40th. Lifetime tenure at many companies remains the norm, and it is difficult to get a job except immediately after leaving school. In France, which ranks 155th, many labor contracts severely limit hours and flexibility, high payroll taxes fund workers‘ benefits, and social policy makes layoffs very difficult. A strong economy needs entrepreneurs to start companies and absorb new workers entering the labor market, and such risktakers do not appear in a vacuum: Such entrepreneurial activity flourishes typically only in countries with business climates that are conducive to entrepreneurial efforts. Source: Vanderkam, L. 2010. Why recession won‘t mean lost generation Dallas Morning News. February 28: 5

Discussion Question 6: Do you agree with the idea that “higher labor flexibility eases unemployment”? Discussion Question 7: From the perspective of this article, would employees or employers in the United States be happy that it is first in the rankings? Why? INSIGHTS from Research 4.1 focuses on an increasingly useful approach to recruiting— hiring former employees. From the perspective of employers, it is important to have, among other practices, a solid exit interview process whereby management can obtain insights on why 1-117 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

an employee is leaving (e.g., unhappy or taking advantage of a position with great potential for their career)—as well as an ―alumni program‖ to keep in touch with valued employees who have departed. And, this has implications for employees, of course: be sure to heave on good terms in order to keep one‘s options open! Another key benefit of ―boomerang employees‖ for the firm is that there is less need for socialization and training. And, perhaps even more important, these people are already well known, so the chances of making a ―poor hire‖ are substantially reduced. A.

Attracting Human Capital

We begin by questioning the traditional ―lock and key‖ approach to employee selection and emphasize the importance of employee mindsets, attitudes, and social skills. (It is useful to reemphasize that in today‘s knowledge economy, the leveraging of human capital is critical— thus, such ―soft skills‖ become more important.) 1.

“Hire for Attitude, Train for Skill”

This is a phrase that has become more predominant in today‘s business environment. This point is driven home with the example of Southwest Airlines. It may be interesting to pose the following question: Discussion Question 9: Do you think the approach used by Southwest Airlines is a good idea? For other companies with which you are familiar? We discuss the ―Bozo filter‖ that Cooper Software, Inc. uses to screen employees. Discussion Question 9: What are the advantages (and disadvantages) of the “Bozo Filter”? Would it work in other organizations with which you are familiar? The SUPPLEMENT below should be very useful to students—it should ―personalize‖ some of the discussion on the development and evaluation of human capital. It summarizes the four qualities that Larry Bossidy (former CEO of Allied Signal) looks for when evaluating job candidates. You might consider asking your students: Discussion Question 10: Can these qualities be developed or are they typically inherent in an individual (i.e., a nature/nurture argument)? If so, how can they be developed and nurtured? Extra Example: Key Leadership Qualities for Future Leaders: Larry Bossidy Below are the four key qualities that Larry Bossidy considers when evaluating job candidates: THE ABILITY TO EXECUTE: Ideas, analytical capacity, and education are important parts of a leader‘s makeup. However, just as important is being able to implement those ideas. There are people who are fulfilled by expressing big thoughts, but you will be better served by hiring people with boundless energy who can execute the thoughts.

A CAREER RUNWAY: Good leaders have plenty of runway left in their careers. I like to hire someone for this job and also the next job, never for the person‘s final position. People with perspective on their jobs give me an indication that they have not only the interest but also the ability to go further. A TEAM ORIENTATION: If someone is able to work through and with other people, he‘s got better potential then if he is essentially an individual contributor. MULTIPLE EXPERIENCES: I‘ve learned to consider carefully the dynamics of a candidate‘s past work experiences. People who come from quasi-monopolistic areas often have great difficulty moving into more competitive environments. You have to understand the environment from which you‘re hiring; some kinds of companies are better than others at developing leaders. To make sure our future leaders have the right experience, I look for candidates who have operated real Profit & Loss units in two or three different industries or companies. That‘s how great leaders are grown. Source: Bossidy, L. 2001. The job of the CEO. Harvard Business Review, 79 (3): 47–49.

Teaching Tip: The adage ―hire for attitude, train for skill‖ can generate some interesting discussion in the class. Some students may argue that in jobs that require high levels of skill, such as software development, skills may be more important than attitude. This may be an opportunity to point out that even in jobs that require high skills and relatively low levels of interdependence with others, poor attitude can lead to lack of effort as well as a lack of willingness to learn, excel, experiment, and, importantly—collaborate. 2.

Recognizing the Geographical Preferences of Talent

Here, we address a problem that many firms face—the willingness of top talent to uproot their life for a job in a new location has decreased among young professionals. This is particularly relevant in ―hot areas‖ like software and advanced technologies such as robotics. We provided the example of how Toyota Corporation has opened up the Toyota Research Institute in three locations to attract talent. These locations are near top universities which enables the firm to maintain formal relationships with these research institutions. 3.

Using Algorithms for Selection

We discuss how firms often use algorithms to deal with the deluge of applications they often receive for positions. This can include simple screening criteria winnowing the applicant pool down to a manageable set of applicants who have the set of skills and experience for the posted position. It can also include online exercises to test their creativity, personality, and decision-making skills. STRATEGY SPOTLIGHT 4.2 discusses promises and perils of using algorithms in the identification of candidates for positions. Discussion Question 11: How can the use of algorithms in recruiting help reduce bias, and how does it potentially increase bias?

Discussion Question 12: Are you comfortable with the idea that, when you apply to firms, the initial screening of your application is done by an algorithm? Does it concern you that no human may ever see your resume? The following SUPPLEMENT provides an interesting perspective on an issue that is critical in attracting, developing, and retaining talent: How job satisfaction is influenced by whether or not a boss is a real expert in the core business of the organization. This information may be of interest to many students because they may feel that there is often too much emphasis on ―soft skills‖! Extra Example: When Are Technical Skills More Important Than Emotional Intelligence? Often people fear that promoting a strong individual performer to a managerial role will backfire because they believe that technological proficiency isn‘t a predictor of people skills. However, a study of 35,00 employees in the United States and Britain finds that an employee‘s job satisfaction is deeply influenced by whether or not the boss is a real expert in the core business. The research posed three questions: Could the supervisor properly do the employee‘s job if necessary? Had the supervisor worked her way up in the firm? How did the employee rate the supervisor‘s tech competence? The researchers found that employees are far happier when they are led by people with deep expertise. The study concludes that although there is an awareness that emotional intelligence and organizational skills are important— technical expertise can give a leader essential credibility. Perhaps, hospitals should be led by doctors and universities by researchers—rather than general administrators? Source: Anonymous. 2017. When technical skill beats emotional intelligence. Harvard Business Review, May–June 2017: 36. The research was based on ―Boss competence and worker well-being‖ by Benjamin Artz, Amanda H. Goodall, and Andrew J. Oswald (Industrial and Labor Review, forthcoming).

Developing Human Capital

Organizations must do more than merely hire top-level talent and expect the skills and capabilities of those employees to remain current throughout their employment. Rather, training and development must take place. We provide the example of Solectron and Duke Energy. The following SUPPLEMENT provides some guidelines/suggestions for enhancing one‘s career success. Although these points are directed at women managers, they should also apply to men. In addition, these issues may spur some lively discussion (such as how much risk one should take, work/life balance, and so on). Extra Example: Three Suggestions for Enhanced Career Success The following suggestions are drawn from Warren Ferrell, author of Why Men Earn More: The Startling Truth Behind the Pay Gap—and What Women Can Do About It (AMACOM, January 2005). 1.

Kathy Vrabeck, president of Activision Publishing, the video-game producer behind Shrek 2 and the Tony Hawk series, believes that this is the advice she could give anyone seeing to earn more money. She had an early glimpse of how this works while at Eli Lilly, when she noticed that R&D was the driving function in pharmaceuticals. At Activision, she‘s responsible for game development—the function on which the company‘s success largely depends. According to Vrabeck, ―In any company, it‘s the operating jobs, not the staff jobs, that generate revenue. A company‘s always willing to pay more for people who are willing to take on the responsibility of a line job and the risk it entails. 2.

Find a field that entails financial or emotional risk taking Most venture capitalists can expect to earn between $100,000 and $300,000 a year, according to Salary.com. (Many, of course, earn far more!) Of course, if they bet the farm on an online pet-food supplier, they also risk losing everything. Currency traders, real-estate speculators, and many sales executives all gamble that they can use their drive and smarts to make a good living. If they‘re right, they can clean up. If not, they have only themselves to blame. The market pays a premium for such chutzpah.

Work more hours, more weeks, and more years Many may declare: ―Enough! Americans already work more hours per year than the rest of the planet!‖ So true. But if you are willing to be the alpha dog of wage slaves in your industry, you can expect to be rewarded handsomely. The U.S. Bureau of Labor Statistics (BLS) reports that the average person working 45 hours per week earns 44 percent more than someone who works only 40 hours. Why? The willingness to work more often leads to jobs that pay more per hour. At the upper reaches of a corporation, this can be significant. Top CEOs generally command pay in the 7-digit range—but they have also typically paid their dues with 15-hour days, six days a week, for an average of 20 years. The road to higher pay is a toll road with no EZ-Pass for the fast lane! Source: Tischler, L. 2005. Bridging the (gender wage) gap. Fast Company, January: 85–87.

Encouraging Widespread Involvement

The development of human capital requires the active involvement of leaders at all levels. We discuss the broad-based involvement at General Electric and Procter & Gamble. 7.

Mentoring

We believe that this is a very important topic to address. (To clarify the difference between mentoring and sponsoring—they are not, of course, synonymous. In effect, a mentor will talk with you and provide career guidance, but a sponsor will talk about you—and ―use up chips‖ for their protégé. We also provide insights form Intel‘s approach to mentoring. The following SUPPLEMENT provides some thoughts on mentoring of Gen Z employees. Extra Example: Gen Z Employees Respond More to Mentoring than Management Mike Tinney is CEO of a firm, FIX Health, that has a largely Gen Z employee base. His experience of working with these younger workers led him to the following perspective. ―One clear difference between my younger team members and older ones is that they tend to flourish when mentored as opposed to being managed.‖ He also said, ―I‘ve worked with some people and generations who wanted stricter parameters. My ‗new gen folks‘ want compass directions and stories, then they want to do their thing and add their own chapter.‖ 1-121 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Having grown up with the internet at their fingertips, Gen Z workers are used to finding solutions and filling in knowledge gaps on their own. However, ―coming directly out of college, younger employees don‘t fully understand company needs and need management to play a large part in tying together both concept and expectations,‖ according to Kristen Fowler, an executive recruiting expert. Knowing their experiences and skills, she argues that managers should not micromanage Gen Z workers. Instead, they should lead by example, publicly displaying the desired behaviors. They should look to coach or mentor Gen Z workers, explaining the values and goals of the firm as well as general expectations and then leave these younger employees to ―analyze their own behavior and explore new ways to achieve more.‖ This allows the firm to be more creative and efficient and more effectively engage younger workers. Source: Lashbrooke, B. 2019. Want more from generation Z? Mentor, don‘t manage them. Forbes.com. June 21: np.

Discussion Question 13: Do you agree with the above observations and suggestions? Is it reasonably “representative” of how members of Gen Z act and respond? Why? Why not? 8.

Monitoring Progress and Tracking Development

Whether a firm uses on-site formal training, off-site training (e.g., universities) or on-thejob training, tracking individual progress—and sharing this knowledge with both the employee and key managers—becomes essential. We provide the example GlaxoSmithKline. It may be particularly interesting to mention GlaxoSmithKline‘s ―two-plus-two-plus-two‖ (two business units, two functional units, and two countries) formula for developing people for top management positions. Ask: Discussion Question 14: Should the 2+2+2 approach be used for other large multinational firms? Why? Why not? We also discuss Alcoa‘s ―Talent Marketplace.‖ The following SUPPLEMENT addresses how Procter & Gamble uses technology to track talent. Extra Example: How P&G Uses Technology to Monitor and Track Its Talent At P&G, people and positions are tracked via its technology-based talent management system. It accommodates all the firm‘s 135,000 employees. However, it is primarily used to track 13,500 middle- and upper-management employees. The system captures information about:    

succession planning at the country, business category, and regional levels; career histories and capabilities, as well as education and community affiliations; top talent and their development needs; and, achieving diversity objectives.

It also makes in-house talent visible to business leaders, who no longer have to scour the company to find candidates by themselves. To keep the system relevant, P&G has instituted a global talent review. This is a process by which every country, every function, and every business is assessed for its capacity to find, develop, deploy, engage, and 1-122 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

retain skilled people, in light of specific performance objectives. For example, if the company has stated diversity in hiring objectives, the review is used to audit diversity in hiring and promotions. Determinations made in these reviews are captured in a global automated talent development system and can be assessed by decision makers through their HR managers. Source: Ready, D.A. & Conger, J.A. 2007. Make your company a talent factory. Harvard Business Review, 85 (6): 68–77.

Discussion Question 15: What are some of the benefits of P&G’s system for attracting, developing, and retaining talent? 9.

Evaluating Human Capital

The primary issue that this section addresses is the 360-degree evaluation system. Such an evaluation approach is becoming more critical given the importance of collaboration and interdependence in today‘s knowledge intensive organizations. Traditional ―top down‖ evaluation systems evaluate performance from a single perspective and typically do not address the ―softer‖ issues such as social skills, values, beliefs, and attitudes. The SUPPLEMENT below discusses the trend for companies to ditch the annual employee reviews—and move toward reviews that are much more frequent. Extra Example: The Trend Toward More Frequent Employee Performance Reviews Many companies such as Adobe Systems Inc. and General Electric have revamped and rethought the detested annual review. In its place, they have put new evaluations designed to give employees more frequent feedback. Firms are trying to stay current with younger workers who are accustomed to instant gratification—in the form of Facebook likes. Both managers and employees claim that it is difficult learning to receive—and give—constant critiques. As Noted by Deloitte LLP Consultant Cashel Discepola, who transitioned from twice-annual reviews to talking about performance with her managers every other week: ―You really have to put your ego aside.‖ And, a software company manager now gives her team bite-sized feedback, and lots of it. She uses a system that tracks goals—such as meeting client targets—which keeps staff accountable. Source: Feintzeig, R. 2017. Your manager wants to see you. Again. Wall Street Journal, May 10: B7.

Retaining Human Capital

We use the rather colorful imagery of ―frogs in a wheelbarrow‖ to drive home the point that top talent may bolt at any time. Managers have the option of either forcing top talent to stay with the organization via non-compete clauses, golden handcuffs, etc., or providing the type of environment wherein top talent will desire to stay. (We recognize, of course, that employment contracts have their place—but should not be the primary means of the retention of talent.) Identifying with an Organization‘s Mission and Values

People who identify with and are more committed to the core mission and values of the organization are less likely to stray or bolt to the competition. We provide a perspective by Apple‘s Steve Jobs on values and commitment. We also mention the importance of the emerging trends to a ―relationship first‖ set of values—in contrast to a ―task first‖ value—in the workplace. Discussion Question 16: What are other examples of firms that have successfully strengthened an employee’s identification with their firm’s mission and values? Challenging Work and a Stimulating Environment The motivation to work on something because it is interesting, exciting, or personally challenging underlies the importance of intrinsic motivation. We provide a quotation from Arthur Schwawlow, the 1981 Nobel Prize winner in physics, on the intrinsic value of challenging work. We discuss how Novo Nordisk brings meaning to its pharmaceutical employees by having them interact with patients how have benefited from their products. In addition, some leading-edge firms have kept highly mobile employees motivated and challenged by lowering the barriers to an employee‘s mobility within a company. For example, Shell Oil Company has created an ―open sourcing model‖ for talent. The following SUPPLEMENT below addresses findings from a survey of Glassdoor, which lists the factors that have the greatest impact on employee satisfaction—clearly an important factor in enhancing the retention of human capital in an organization. Extra Example: What Factors Make a Company Among the Best to Work for? Companies have a vested interest in keeping their talent happy and satisfied and numerous studies find that employee satisfaction is tightly linked to a wide variety of performance measures. While employee satisfaction should be a key cornerstone in a firm‘s business model, few companies actually excel at maintaining high morale throughout the firm. Based on reviews posted by Glassdoor, an online platform for former and current employees to review companies, 24/7 Wall Street identified the best U.S. firms to work for. Only 18 large companies—out of a universe of hundreds—received a score of more than four out of five starts. Sarah Stoddard, a community expert with Glassdoor, listed factors that have consistently had the largest impact on employee satisfaction. She notes, ―Glassdoor research has found the top three indicators of employee satisfaction: career opportunities, trust in senior leadership, as well as culture and values.‖ Consistent with her comments, employee testimony suggests most companies on this list offer growth and development opportunities, have trusted and respected chief executives, and cultures described as fun, motivating, and supportive. Half of the companies on the list (of 18) are technology and software firms based on the West Coast. The other companies included staffing agencies, management consulting firms, and grocery stores. Source: Stebbins, S. 2018. Did your company make the list of best U.S. companies to work for? usatoday.com. September 18: np. 1-124 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

10.

Financial and Non-Financial Rewards and Incentives

Clearly, financial rewards are a vital organizational control mechanism (as we will also discuss later in Chapter 9). After all, top talent is a highly mobile asset, and such individuals are likely to always be able to attract competing offers—even in relatively tight labor markets. STRATEGY SPOTLIGHT 4.3 discusses how firms have found that using benefits and perks to help keep employees healthy and motivated. Discussion Question 17: What are some non-financial benefits you think firms can offer that would help keep employees engaged and motivated? The following SUPPLEMENT provides some interesting examples of how data analytics can address some very relevant personnel issues—and help detect signs of when people might quit! Extra Example: Big Data Can Help Stop People from Quitting If one of your star employees is about to jump ship—isn‘t it a good idea to know ahead of time? Today firms such as Walmart, Credit Suisse, Yahoo, and Nissan rely on big data and a statistical discipline called ―predictive analytics‖ to determine who‘s likely to leave the firm. Specialists in the rapidly growing field include Workday, VoloMetrix, and Visier. These firms have identified dozens of telltale signs that people are about to quit. Some of the most significant:   

A recent promotion. Beware: Many people leverage that exciting new title and bigger paycheck for an even better job elsewhere. Avoiding meetings with people not on their immediate team: Why should one make the effort if they already have one foot out of the door? Opting out of company benefits: If an employee has found an alternative to the company health plan, that reduces their need for the job as well. Source: Anonymous. 2015. Nearly departed. Forbes. May 4: 24.

Enhancing Human Capital: Redefining Jobs and Managing Diversity

First, we discuss how some progressive firms are redefining the jobs of their experts and transferring some of their tasks to lower-skilled people inside or outside their companies—as well as outsourcing work that requires less scarce skills and is not as strategically important. We provide examples of a San Francisco-based law firm, public schools in the United Kingdom, and a large hospital in Bangalore, India. Second, we address diversity in today‘s workforce today. This has become more vital due to demographic trends and the accelerating globalization of business. We address some of the emerging demographic trends that have created a more diverse society. We then address six areas in which a diverse workforce can improve an organization‘s effectiveness. These are: 1-125 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

6. 7. 8. 9. 10. 11.

Cost Argument Resource Acquisition Argument Marketing Argument Creativity Argument Problem-Solving Argument System Flexibility Argument

Ask: Discussion Question 18: Are you aware of organizations that have exemplary (or ineffective) diversity programs? If so, what makes them successful (or unsuccessful)? In the INSIGHTS FROM EXECUTIVES, Kelly Sepcic Pfeil discusses the importance of building diversity in STEM. She discusses how achieving higher gender diversity in STEM will require changes in educational systems and in how women are mentored and promoted in organizations. She also discussed the benefits of gender diversity for organizations.

XI.

The Vital Role of Social Capital

PowerPoint Slide 13: Social Capital PowerPoint Slide 14: How Social Capital Helps Attract and Retain Talent PowerPoint Slide 15: Social Networks PowerPoint Slide 16: Example: Social Network Analysis PowerPoint Slide 17: Social Network Analysis PowerPoint Slide 18: Social Networks: Implications for Career Success PowerPoint Slide 19: Social Capital: Potential Downside Successful firms are well aware that the attraction, development, and retention of talent are necessary but not sufficient conditions for creating competitive advantages. In the knowledge economy, it is not the stock of resources that is important, but rather the extent to which it is combined and leveraged. Thus, the development of ―social capital‖—friendships and working relationships among talented individuals, helps to tie knowledge workers to a given firm. We provide the hypothetical example of two Nobel Prize-winning scientists. The point, of course, is that the situation in which there are strong ties among the professionals is the one in which retention is more likely to occur. Another way to view these perspectives is drawn from the resource-based view of the firm. Here, competitive advantages that are harder for competitors to duplicate are those that are based on ―unique bundles‖ of resources—which occurs when individuals are actively collaborating and sharing knowledge. A.

How Social Capital Helps to Attract and Retain Talent

The importance of social ties among talented professionals is creating an important challenge (and opportunity) for organizations today. The phrase: ―Pied Piper Effect‖ has been coined to depict the phenomena in which teams or networks of people are leaving one company for another. Thus, a trend is evolving to recruit job candidates at the crux of social networks in organizations, particularly if they are seen as having the potential to bring with them a raft of colleagues. We provide the example of an electronic commerce company called Third Millennium Communications. Here, social capital certainly played a key role in attracting talent to the firm. We also discuss how firms can strive to maintain relationships with former employees. These ―alumni employees‖ can potentially benefit the firm by mentoring current employees, return as boomerang employees, suppliers to the company, and/or ambassadors for the firm. We discuss how HubSpot, eBay, LinkedIn, and Nestle all take steps to retain some connection with alumni employees. B.

Social Networks: Implications for Knowledge Management and Career Success

We included this section because we feel that it has very important implications for business school graduates‘ career success. Much of their education focuses on developing ―human capital,‖ i.e., their skills and competences. However, consistent with the resource-based view of the firm, success in the business world depends on how well one can ―combine and leverage resources‖ or ―create unique bundles‖—not just the output from one‘s individual efforts. Social network analysis depicts the pattern of interactions among individuals and helps to diagnose effective and ineffective patterns. Group members‘ ties within and outside the group affects the extent to which members connect to individuals who  convey needed resources,  have the opportunity to exchange information and support,  have the motivation to treat each other in positive ways, and,  have time to develop trusting relationships that might improve the groups‘ effectiveness. EXHIBIT 4.3 is a simplified network analysis that should provide students with a grasp of key concepts. It depicts informal relationships among individuals that involve communication flows, personal support, and advice networks. The exhibit serves to illustrate two salient social network concepts: closure and bridging relationships (in addition to ―isolates‖—those individuals who are not connected to anyone). Closure involves a situation in which members have relationship ties to other members in a given network. Through closure, members develop a high level of trust and solidarity. However, groups that become too closed can become insular and cut themselves off from the rest of the organization.

Bridging relationships, in contrast to closure, stresses the importance of ties connecting heterogeneous people. People who bridge relationships tend to receive timely, diverse information because of their access to a wide range of heterogeneous information flows. We briefly review the study that Ron Burt conducted at Raytheon, a $64 billion U. S. electronics company and military contractor. He found that managers who discussed ideas outside of their group consistently had the best suggestions. The SUPPLEMENT below provides more information on the results of Burt‘s study at Raytheon from the perspective of career success. Extra Example: Burt‘s Raytheon Study—Evidence of Career Success For executives educated in the network structure of social capital—performance improved. The effects turned out to be substantial—relative to a control group of untrained, but otherwise comparable peers. Graduates from the Business Leadership Program (BLP) were 36 percent to 42 percent more likely to receive top performance evaluations, 43 percent to 72 percent more likely to be promoted, and 42 percent to 74 percent more likely to be retained by the Raytheon. It is important to point out that performance did not improve equally for all graduates. Executives who were quiet spectators in the program cannot be distinguished from the careers of people in the control group—that is, people who did not attend the program. Clearly, there are significant career benefits from actively participating in the BLP Program. Source: Miller, R. A. (abridgement). 2006. Teaching executives to see social capital: An ROI study of a four-year executive education custom program at Chicago GSB. International Executive Development Programmes.

Discussion Question 19: Why do you think that the BLP Program graduates had higher subsequent career success? (You would want to stress the importance of social networks/social capital and suggest that students spend time on developing diverse networks instead of solely directing their efforts at enhancing their skills, and capabilities in performing specific tasks. Also, the importance of bridging diverse networks can be addressed.) Implications for Career Success We close our discussion of social network analysis with a summary of the implications for career success. These are  Private Information.  Access to Diverse Skill Sets.  Power. We discuss a topic that many students should be very interested in: Women and Networking. Some of the challenges faced by women are that there are fewer women than men in executive positions and the ―likes attract‖ principle means that women will have to work harder to build relationships with decision makers and influential stakeholders. C.

The Potential Downside of Social Capital

To provide balance to the discussion, it is useful to address some of the downsides of social capital. There are primarily two issues: 1-128 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

First, when people identify strongly with a group they sometimes support ideas that are suboptimal or simply wrong. If there are strong social pressures (such as ―groupthink‖), people may be hesitant to challenge each other with tough questioning. This prevents them from engaging in ―creative abrasion‖—a termed coined by Harvard‘s Dorothy Leonard-Barton—a key means to innovative activity. Second, if there are deep-rooted mindsets, dysfunctional human resource practices may develop. For example, the hiring of like-minded people may heighten inertia and erode innovation. Third, the socialization process whereby individuals are socialized in the norms and values of an organization can be potentially expensive—both in terms of financial resources and managerial commitment. Such expenses should be evaluated in terms of anticipated benefits. Fourth, individuals may use their contacts solely for personal gain.

XII. Using Technology to Leverage Human Capital and Knowledge PowerPoint Slide 20: Using Technology to Leverage Human Capital and Knowledge PowerPoint Slide 21: Networks and Electronic Teams: Share Information and Enhance Collaboration Here, we discuss how technology can be used to leverage human capital and knowledge in organizations, as well as beyond their boundaries to include customers and suppliers. We will address both simple and more complex applications of technology. We also discuss the challenge of protecting a firm‘s intellectual property and the importance of a firm‘s dynamic capabilities. A.

Using Networks to Share Information

Clearly, information is easily shared across a variety of technology platforms, such as email, social network cites, blogs, and vlogs. These communication channels are quick, easy, and almost costless. They can, of course, become a problem if it is used inappropriately, but they have benefits. We discuss how firms can use these communication channels to share vision and values, to provide mentoring, and to facilitate collaboration. The following SUPPLEMENT addresses some of the other challenges and limitations associated with the use of email. Extra Example: E-mail—Challenges and Limitations Some well-known problems associated with the use of e-mail include the distraction of spam and stuffed in-boxes as well as the potential for legal liability. However, an additional concern is misinterpreted messages, as well as the degree to which e-mail becomes a substitute for the nuanced conversations that are critical in the workplace. Business has undervalued the social dimension of communication,‖ says Daniel Goleman (of Emotional Intelligence ―fame‖), whose book, Social Intelligence, examines the science behind interpersonal connections.

Research suggest that the perils of e-mail are greater than many assume. Justin Kruger, of New York University‘s Stern School of Business, has found that as few as 50 percent of users grasp the tone or intent of an e-mail. Further, most people vastly overestimate their ability to relay and comprehend messages accurately. Smiley faces and exclamation points add another layer of confusion. Misinterpretation is highest, studies have found, when the e-mail comes from a boss. Source: Brady, D. 2006., *!?@ the e-mail. Can we talk? BusinessWeek, December 4: 109.

Teaching Tip: Clearly, email can be a double-edged sword. In the chapter we talk of its productivity-enhancing properties. Ask the students how email can end up consuming organizational resources, leading to miscommunications, and erode productivity. Further, ask them for suggestions on how an organization can cope with some of these negative aspects and realize the positive potential of email. B.

Virtual Teams: Using Technology to Enhance Collaboration

Technology has also enabled professionals to work as part of virtual teams to enhance the speed and effectiveness with which products and services are developed. For example, Microsoft has used virtual teams to facilitate the incorporation of new technologies into the firm‘s business ventures in a range of markets. Two major advantages of virtual teams parallel the first two sections of this chapter. First, it enables the firm to access a broader range of human capital (i.e., skills necessary for complex assignments). Second, it‘s effective in generating ―social capital‖ the quality of relationships and the networks that leaders and members form. The two key challenges of making virtual teams effective include: members must identify with who among them can provide knowledge and resources; and leaders must be able to know how to combine individual contributions. Discussion Question 20: Have you participated in virtual teams? Have they been successful? What advantages and disadvantages have you experienced with virtual teams? C.

Codifying Knowledge for Competitive Advantage

There are two different types of knowledge: tacit (embedded in personal experience) and codified (knowledge that can be documented, widely distributed, and easily replicated). A challenge of knowledge-intensive organizations is to capture and codify the knowledge and experience that, in effect, resides in the heads of their employees. We discuss the knowledge management system used by Access Health, a call-in medical center. Although it was very expensive to develop, the company‘s paying customers—insurance companies and provider groups—save money because many callers would have made expensive trips to the emergency room or the doctor‘s office had they not been diagnosed over the telephone.

STRATEGY SPOTLIGHT 4.4 discusses how SAP uses crowdsourcing to tap knowledge well beyond its organization‘s boundaries. The SUPPLEMENT below provides some guidelines on making knowledge management systems effective. Prior to discussing the supplement, you may pose the following question: Discussion Question 21: What are some guidelines on making knowledge management systems effective? (It will be interesting to see what issues are brought up and how they compare and contrast with the supplement.) Extra Example: Making Knowledge Management Systems Effective Persuading people to empty their brains into a knowledge management system isn‘t easy. Fortune magazine asked some experts how to make it effective. Here are some of their perspectives: 1. 2. 3. 4. 5. 6.

Create heroes: Build a system that rewards those who share knowledge. Follow through: Hire someone to manage and update the system. Don‘t let it be in vain: Make sure employees get something out of it. Bring in the boss: Involve upper management to emphasize the system‘s importance. Make it a no-brainer: Design a tool that is easy to use. Focus on culture: Foster an environment where sharing information is in vogue. Source: Koudsi, S. 2001. Actually, it is like brain surgery. Fortune, March 20: 234.

EXHIBIT 4.4 provides a series of questions that managers should consider in determining (1) how effective their organization is in attracting, developing, and retaining human capital, and (2) how effective they are in leveraging human capital through social capital and technology.

XIII. Protecting the Intellectual Assets of the Organization: Intellectual Property and Dynamic Capabilities PowerPoint Slide 23: Codifying Knowledge for Competitive Advantage PowerPoint Slide 24: Protecting Intellectual Assets PowerPoint Slide 25: Protecting Intellectual Assets Through Dynamic Capabilities PowerPoint Slide 25: Summary: Creating Value Through Intellectual Assets The management of intellectual property involves  patents,  contracts with confidentiality and noncompete clauses,  copyrights, and,  development of trademarks. A.

Intellectual Property Rights

The protection of intellectual rights raises unique issues, compared to physical property rights. Much of the production of intellectual property is characterized by significant 1-131 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

development costs and very low marginal costs. Indeed, it may take a substantial investment to develop a software program. However, once developed, its reproduction and distribution costs may be almost zero—especially if the Internet is used. Effective protection of intellectual property is necessary before any investor will finance such an undertaking. We discuss and intellectual property dispute between IBM and Groupon that relates to IBM‘s aggressive protection of its patented technologies. B.

Dynamic Capabilities

Developing dynamic capabilities is the only avenue providing firms with the ability to reconfigure their knowledge and activities to achieve a sustainable competitive advantage. Dynamic capabilities include the ability to challenge the conventional wisdom within a firm‘s industry and market, learning and innovating, adapting to a changing world, and adopting new ways to serve the evolving needs of the market. Dynamic capabilities can be seen as consisting of three primary activities:   

Identifying, developing, and assessing technological opportunities (and threats) that relate to customer needs (the ―sensing‖ of uncertain futures) Mobilizing resources to focus on needs and opportunities in order to capture value from doing so (―seizing‖); and, Continuing the ongoing process of renewal (―transforming‖ or ―shifting‖).

Such activities are essential if organizations want to sustain themselves in the longer term as customers, competitors, and technologies change.

XIV. Issue for Debate Non-disclosure agreements are a controversial issue. They protect firms from having valuable proprietary information being shared by employees who leave with competitors, reporters, or anyone else. But they also limit the ability of employees to find employment at other employers or the ability of former employees to set up their own entrepreneurial firms. NDAs may also limit the ability of employees to identify and correct inequities in pay and career advancement or even harassment by employers. Discussion Question 1: Do you agree or disagree with firms requiring employees to sign NDAs? Why or why not? Students may have an emotional reaction to this. They may see NDAs as simply wrong since they take away the rights of employees. Other students may see it from the perspective of the firm and argue that the firm has the right to protect its interests. The first view may be more earnest and framed from a view of individual justice, reflecting a skepticism toward corporations. The role of the instructor is to push back on that if 1-132 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

needed, and ask if the interests of individual employees and investors in a firm that may be harmed by someone bringing key information to a competitor matter. Discussion Question 2: What boundaries, if any, should be placed on NDAs? I would suggest taking this question from two perspectives. First is the question of which type of information should be covered by NDAs? We might think of the types of factors covered in three buckets: technology assets, strategic knowledge and plans, and HR policies and decisions. Students may have different views, with protecting technology a more logical set of information to protect, and HR policies and decisions being more controversial or difficult to justify. Second, the issue could be looked at from the perspective of who is covered by NDAs. Students may find it logical to have scientists and engineers at the firm being covered by NDAs, but it is a bit harder to justify them for other employees, such as administrative staff who have limited knowledge of highly sensitive proprietary information. Discussion Question 3: Would your view change if you were the founder and CEO of an entrepreneurial technology firm? This likely will shift the view a fair bit. The founder likely has his or her life savings invested in the firm. Additionally, they likely feel personally connected to the firm and also have their standing in the community associated with the business. The action of someone walking off with valuable technology or other information is a more emotional and tangible risk in this situation.

XV. Reflecting on Career Implications PowerPoint Slide 27: Reflecting on Career Implications Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 4. Human Capital: Does your organization effectively attract, develop, and retain talent? If not, you may have fewer career opportunities to enhance your human capital. Take advantage of your organization‘s human resources programs such as tuition reimbursement, mentoring, etc. At least some students in the class are likely to be taking advantage of their firm‘s human capital developments programs like tuition reimbursement. Getting them to discuss why the firms are doing so would be an interesting classroom experience. Some would attribute it to altruism on the part of corporations. while others would argue that they are helping themselves while helping their employees. Human Capital: Does your organization value diversity? What kinds of diversity seem to be addressed (e.g. age-based or ethnicity-based)? If not, there may be limited 1-133 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

perspectives on strategic and operational issues and a career at this organization may be less attractive to you. Getting the students to expand the notion of diversity beyond just race-based diversity would be an interesting experience. Issues such as age, disability, physical appearance, religious beliefs also add to the consideration (and complexities) of managing diversity in the work place. Social Capital: Does your organization have effective programs to build and develop social capital such that professionals develop strong ―ties‖ to the organization? Alternatively, is social capital so strong that you see effects such as ―groupthink‖? From your perspective, how might you better leverage social capital toward pursuing other career opportunities? Social capital is often an abstract idea even after a lecture on the topic. Many students may be unable to fully grasp its importance. Getting them to see the connection between social capital and career opportunities can greatly help them to appreciate the role of social capital. Social Capital: Are you actively working to build a strong social network at your work organization? To advance your career, strive to build a broad network that gives you access to diverse information. Discuss with students the topic of developing relationships outside the organization. Networks of friendships and working relationships may have long-lasting benefits. The part of the chapter on social network analysis is particularly relevant. Important relationships may be those that link between groups. It is important to develop relationships within the organization, but it may be more important to develop interpersonal ties with those outside it. Such relationships may give students access to information about the general and industry environments, as well as employment opportunities. As an extension, ask students how many of their classmates they know, and what value they place on their school ties. Friendships with classmates can be an enduring professional asset over the course of their careers. Technology: Does your organization provide and effectively use technology (e.g., groupware, knowledge management systems) to help you leverage your talents and expand your knowledge base? Most students are very familiar with social networking websites. Some are likely members of professional networking websites as well. While these websites enable the instructor to illustrate the role of technology, the key is to go one step further and make them aware of the differences between simple social networking systems and more sophisticated knowledge management systems.

XVI. Summary Firms throughout the industrial world are recognizing that the knowledge worker is the key to success in the marketplace. However, we also recognize that human capital, although vital, is still only a necessary but not sufficient condition for creating value. We began the first section of the chapter by addressing the importance of human capital and how it can be attracted, 1-134 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

developed, and retained. Then we discussed the role of social capital and technology in leveraging human capital for competitive success. We pointed out that intellectual capital—the difference between a firm‘s market share and its book value—has increased significantly over the past few decades. This is particularly true for firms in knowledge-intensive industries, especially where there are relatively few tangible assets such as software development. The second section of the chapter addressed the attraction, development, and retention of human capital. We viewed these three activities as a ―three-legged stool.‖ That is, it is difficult for firms to be successful if they ignore or are unsuccessful in any one of these activities. Among the issues we discussed in attracting human capital were ―hiring for attitude, training for skill‖ and the value of using social networks to attract human capital. In particular, it is important to attract employees who can collaborate with others given the importance of collective efforts such as teams and task forces. With regard to developing human capital, we discussed the need to encourage widespread involvement throughout the organization, monitor progress and track the development of human capital, and evaluate human capital. Finally, some mechanisms for retaining human capital are employees‘ identification with the organization‘s mission and values, providing challenging work and a stimulating environment, the importance of financial and nonfinancial rewards and incentives, and providing flexibility and amenities. A key issue here is that a firm should not overemphasize financial rewards. After all, if individuals join an organization for money, they also are likely to leave for money. With money as the primary motivator, there is little chance that employees will develop firm-specific ties to keep them with the organization. We also address the value of a diverse workforce. The third section of the chapter discussed the importance of social capital in leveraging human capital. Social capital refers to the network of relationships that individuals have throughout the organization as well as with customers and suppliers. Such ties can be critical in obtaining both information and resources. With regard to recruiting, for example, we saw how some firms are able to hire groups of individuals en masse who are part of social networks. Social relationships can also be very important in the effective functioning of groups. We address social network theory and point out the relative advantages of two key concepts— closure and brokering relationships. Finally, we discussed some of the potential downsides of social capital. These include the expenses that firms may bear when promoting social and working relationships among individuals, as well as the potential for ―groupthink,‖ wherein individuals are reluctant to express divergent (or opposing) views on an issue because of social pressures to conform. The fourth section addressed the role of technology in leveraging human capital. We discussed relatively simple means of using technology such as email and networks where individuals can collaborate by way of personal computers. We also addressed more sophisticated uses of technology such as sophisticated management systems. Here knowledge can be codified and reused at very low cost, as we provided in the examples of firms in the consulting, health care, and high technology industries. We discuss how electronic teams can be effectively used.

The fifth section addresses key differences between the protection of physical property and intellectual property. The development of dynamic capabilities is clearly one of the best ways to ensure that a firm can protect its intellectual property.

Chapter 4: Recognizing a Firm’s Intellectual Assets Refer to Exhibit 4.4: Issues to Consider in Creating Value through Human Capital, Social Capital, and Technology. Ask students in a group to use this “checklist” to evaluate an organization that they are familiar with. (Obviously, the students won’t have a “common experience,” but they can select one of the group members’ organizations and use that as a point of reference.) Ask them how the company could improve their “score” on the items. Teaching suggestions: The checklist is rather self-explanatory to give detailed answers here. Key points to be emphasized are 3. Implementing improvements in the areas of human capital, social capital and technology can be expensive. There are trade-offs involved in making these investment decisions. 4. After the investments are made, what would be the implication when an employee leaves? How would the organization be able to retain the employees’ knowledge after they leave the firm? It is important to mention: developing ―firm-specific ties;‖ teams to disseminate knowledge to lessen the impact of employee turnover; and efforts to convert ―tacit‖ knowledge to ―explicit‖ knowledge through knowledge management systems. 5. Is it feasible or desirable to improve human capital, social capital and, technology, on all the items mentioned in the checklist? Is it possible to create a challenging work environment in all cases; for example, production-level jobs in a factory environment? 6. When is cooperation among members in an organization better than competition? Are there situations where competition among groups is better than cooperation? In several high technology industries, groups are encouraged to compete with one another in order to foster innovation and creativity. 7. In what kind of competitive environments is human capital more important than social capital or the other way around? 8. Do you always need the best technology? It is important to emphasize that technology is a ―means to an end‖ and not just an ―end in itself.‖ For example, obtaining expensive technology to maintain ―parity‖ with rivals without knowing how it can provide competitive advantages can be of no use. (You might find it helpful to refer to the HBR article, ―IT doesn‘t matter‖ 1-137 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

by Nicholas G. Carr, published in the May 2003 issue, to provide further insights on this topic.) The student should be made sensitive to the dilemmas and trade-offs involved in making these key decisions. After all, its business decision making and the impact on the bottom-line cannot be ignored.

End-of-Chapter Teaching Notes Chapter 4: Recognizing a Firm’s Intellectual Assets: Moving Beyond a Firm’s Tangible Resources Summary Review Questions 4. Explain the role of knowledge in today‘s competitive environment. (In text, The Central Role of Knowledge in Today‘s Economy, LO 4-1) Response: To understand the competition that a firm faces, it must understand competitors‘ (as well as buyers‘, suppliers‘, substitutes‘, and potential entrants‘) intellectual capital. Firms are no longer important because of how they manage things, but rather because of how they manage knowledge. Most of their market value is likely to be intellectual capital. Therefore, firms will have to understand competitors‘ human capital and social capital, as well as their explicit knowledge and tacit knowledge. 5. Why is it important for managers to recognize the interdependence in the attraction, development, and retention of talented professionals? (In text, Human Capital: The Foundation of Intellectual Capital, LO 4-2) Response: All three steps are important for efficiently and effectively developing intellectual capital. To illustrate, consider what happens if any one step is weak. If attraction were weak, then the firm would not be able to hire sufficient numbers of capable employees to replace retirees, grow intellectual capital, or select capable professionals for its organization. If development were weak, then the firm would not be able to increase the intellectual capital of its staff to compete effectively. If retention were weak, then the firm would be investing its scarce capital into selecting and developing replacements for the professionals who are leaving. 6. What are some of the potential downsides for firms that engage in a ―war for talent‖? (In text, Human Capital: The Foundation of Intellectual Capital, LO 4-2) Response: A war for talent implies that an organization focuses on attracting and retaining talented professionals by offering competitive salaries—usually at least slightly exceeding what the competition offers. This type of human capital development strategy is likely to be expensive and limiting. Professionals take a lot of factors into consideration when accepting a position, and salary is usually not the most important. Therefore, it makes sense to attract and retain human capital using appeals besides pay. An alternative to the war for talent is to encourage development of firm-specific characteristics, such as an attitude of team-orientation and identification with the organization‘s mission and 1-139 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

values. Such practices will help firms develop differentiated human capital and limit professionals‘ focus on finding alternative employment. 7. Discuss the need for managers to use social capital in leveraging their human capital both within and across their firm. (In text, The Vital Role of Social Capital, LO 4-3) Response: Social capital is the network of relationships and friendships among talented professionals both inside and outside the organization. Human capital can, in theory, be developed without any interaction between professionals in an organization. However, most activities in firms require professionals to work in combinations, each lending different types of expertise to completing projects. Social capital also recognizes that workplace interactions involve friendships and mutual respect that motivate professionals, encourage loyalty, and facilitate learning and human capital development. Social capital also helps to attract and retain talent. Because social capital also characterizes interpersonal relationships across firms, it helps the firm to work with suppliers, buyers, and other partners through joint projects and information exchange. Managers can take network theory into account when developing social capital. They can put key individuals in positions with high centrality. Specific groups can be managed with closure in order to limit the unwanted spread of sensitive information. And in cases where barriers prevent key groups from interacting, thus creating structural holes, managers can create bridging relationships that will give other groups access to an optimal range of information and talent. 8. Discuss the key role of technology in leveraging knowledge and human capital. (In text, Using Technology to Leverage Human Capital and Knowledge, LO 4-5) Response: Technology can be used to share information, increase collaboration, and codify knowledge. For sharing information, email has the advantage of being nearly costless and spanning geographical boundaries. Videoconferencing is increasingly being used to mimic face-to-face meetings across large distances. For increasing collaboration, email, videoconferencing, and internal networks enable formation of electronic teams, or teams that complete tasks primarily through electronic communications. Electronic teams can span geographic regions, departments within the organization, or even enable collaboration with suppliers or buyers. For codifying knowledge, technology enables the creation of in-house databases that can be used to solve problems. For example, if one professional develops a solution to a problem and then codifies it, then the codified solution can be used to help solve future problems of that type. All these practices enhance firms‘ knowledge and human and social capital. Experiential Exercise Pfizer, a leading health care firm with $81 billion in revenues, is often rated as one of Fortune’s “Most Admired Firms.” It is also considered an excellent place to work and has generated high return to shareholders. Clearly, Pfizer values its human capital. Using the 1-140 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Internet and/or library resources, identify some of the actions/strategies Pfizer has taken to attract, develop, and retain human capital. What are their implications? (Fill in the table at bottom of the page.) Response: (Note to instructor): The value of this exercise is to get students to classify various corporate policies into attracting, developing, or retaining human capital. For implications, it may be useful to ask students to differentiate between firm-specific policies and policies that create and develop transferable human capital. Also, it may be useful to tie these policies to the development of social capital. Students may come up with a wide variety of relevant action/strategies. For attracting human capital, possibilities may include advertising positions, offering pay and benefits, recruitment efforts, selection based on attitude, and use of networks to attract new recruits. For developing human capital, possibilities may include intra-firm transfer policies, mentoring programs, training programs, evaluation programs, and access to in-house data. For retaining human capital, possibilities include adoption of learning the corporate credo, rewards and incentives, and efforts to enhance the working environment. For example, the following insights can be gleaned from Pfizer‘s 2021 Annual Report: 



The firm emphasizes its values with a statement about its core values in regard to human capital. They are Courage, Excellence, Equity and Joy. o Courage: Breakthroughs start by challenging convention – especially in the face of uncertainty or adversity. This happens when we think big, speak up and are decisive. o Excellence: We can only change patients‘ lives when we perform at our best together. This happens when we focus on what matters, agree who does what and measure outcomes. o Equity: Every person deserves to be seen, heard, and cared for. This happens when we are inclusive, act with integrity and reduce health care disparities. o Joy: We give ourselves to our work, and it also gives to us. They then emphasize key human resource initiatives: o Diversity, Equity and Inclusion o Colleague Engagement. o Performance, Leadership and Growth. o Health, Safety and Well-Being. o Pay equity They discuss several key initiatives, including: o Annual survey employees on their commitment to and perceiving value in their work at Pfizer o Twice a year goal setting meetings to aid in career development o Active mentoring programs

o Non-traditional career paths o Public reporting of pay equity to build accountability Application Questions and Exercises Look up successful firms in a high-technology industry, as well as two successful firms in more traditional industries such as automobile manufacturing and retailing. Compare their market values and book values. What are some implications of these differences? Response: Typically, the exercise will result in higher market value: book value ratios in the high technology industries than in the more traditional industries. The implications are that the high technology industries rely more on intellectual capital than traditional industries. In addition, the more traditional industries have more fixed assets to manage than the high technology industries. Strategically, the high technology industries will have more of a unidimensional focus on developing intellectual assets. 9. Select a firm for which you believe its social capital—both within the firm and among its suppliers and customers—is vital to its competitive advantage. Support your arguments. Response: Social capital within the firm will be reflected in policies that promote rotation to different parts of the organization, collegiality among professionals, or perhaps retreats to discuss and develop corporate policies. Social capital among suppliers and customers may be indicated by close working relationships, such as task forces with membership from the firm and its suppliers to work out a just-in-time inventory system. Also, the board of directors may have membership from suppliers or customers, which suggests interrelationships between top managers from the related firms. A really strong answer would include evidence of bridging relationships. Perhaps a firm has a policy of forming cross-functional teams, where professionals who normally may not deal with each other that much come together to solve problems. Perhaps accountants and marketers would serve on these teams. The firm‘s stated rationale for this policy might be a very strong indicator of a commitment to developing social capital by establishing bridging relationships across structural holes. To show that the social capital is vital to the firm‘s competitive advantage, there should be an argument that the social capital helps in the development of a sustainable competitive advantage. 10. Choose a company with which you are familiar. What are some of the ways in which it uses technology to leverage its human capital? Response: 1-142 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Three possibilities are internal email systems, use of virtual teams, and the development of an internal database of useable firm-specific knowledge. The specifics will vary by company, but these efforts usually require a significant investment. Also, look for senior management positions with information technology (IT) responsibilities. A few firms have created positions such as a CIO (Chief Information Officer). 11. Using the Internet, look up a company with which you are familiar. What are some of the policies and procedures that it uses to enhance the firm‘s human and social capital? Response: Policies for enhancing human capital should be available in the employment section on the firm‘s web page. Policies can be classified into attracting, developing, and retaining. Some firms include information on evaluation policies, such as a mentoring program. Social capital has been discussed above (application question #2), but there may be policies related to the creation and use of teams, collaboration with suppliers or customers, or other evidence of recognition of social capital. (Note to instructor): We have found it interesting to ask students what questions they should bring to a job interview. What policies do they want to see in place regarding human capital attraction, development, and retention? How do they want to be evaluated? And what types of social capital policies would they find important both for themselves and their firms? Ethics Questions Recall an example of a firm that recently faced an ethical crisis. How do you feel the crisis and management‘s handling of it affected the firm‘s human capital and social capital? Response: Students are likely to respond with a wide variety of examples. For each, it may be useful to draw specific links between the firm‘s crisis and the stressors put on individual professionals within the firm. From the human capital perspective, it might be useful to reexamine the issue of retaining human capital. How would the crisis affect the firm‘s ability to retain its professionals? With regard to social capital, the crisis might have a profound effect on the interpersonal relationships between professionals at the firm and individuals in suppliers or customers. The firm‘s inter-organizational is likely to suffer. To emphasize the importance of the crisis, it may be useful to link all these issues to the firm‘s sustainable competitive advantage. 12. Based on your experiences or what you have learned in your previous classes, are you familiar with any companies that used unethical practices to attract talented professionals? What do you feel were the short-term and long-term consequences of such practices? Response: Such unethical practices usually take the form of promising something to attract the talent and then not delivering on the promise after hiring. Of course, the short- and long-term consequences 1-143 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

are likely to be negative, ranging from disappointment to sabotage. The talented professionals are likely to have high turnover. (Note to instructor) Because the students are sharing their experiences, the discussion may be emotional. So, the next question may be to ask why such unethical practices are so common? Students may respond with arguments such as that the practices are normal in the industry, that firms are facing cost pressures, or that the talented professionals were naïve. The last question, then, is to ask students if firms are aware of all the short- and long-term consequences of their unethical practices, and if these consequences could be reduced if the unethical practices were changed to more ethical ones. The end result of the discussion should be to raise issues with these unethical practices.

CONNECT RESOURCES Comprehension Case Diversity at Work: Reckitt Benckiser Case Analysis Diversity at Work: Reckitt Benckiser The Intelligent Enterprise at SAP: Turning Insights into Action Attracting and Retaining “Top Notch” Human Capital at Nationwide Insurance

part 2

Strategic Formulation

Chapter 5 Business-Level Strategy: Creating and Sustaining Competitive Advantages

5-145

Types of Competitive Advantage and Sustainability .............. 5-146 Overall Cost Leadership ........................................................................... 5-147 Differentiation ............................................................................................ 5-151 Focus ........................................................................................................... 5-154 Combination Strategies: Integrating Overall Low Cost and Differentiation ..................................................................................................................... 5-156

Can Competitive Strategies Be Sustained? Integrating and Applying Strategic Management Concepts .............................. 5-159 1-144 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Strategies for Platform Markets .............................................................. 5-159

Industry Life-Cycle Stages: Strategic Implications ................ 5-160 Strategies in the Introduction Stage ........................................................ 5-160 Strategies in the Growth Stage ................................................................. 5-161 Strategies in the Maturity Stage .............................................................. 5-161 Strategies in the Decline Stage ................................................................. 5-162 Retrenchment Strategies........................................................................... 5-163

Issue for Debate ........................................................................... 5-163 Reflecting on Career Implications ............................................ 5-164 Summary ...................................................................................... 5-166 End-of-Chapter Teaching Notes................................................ 5-171 Connect Resources ...................................................................... 5-177

Chapter 5

Business-Level Strategy: Creating and Sustaining Competitive Advantages Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead In the previous three chapters, we have focused on the analysis of the external (Chapter 2) and internal (chapters 3 and 4) of the firm. In this chapter, the emphasis is on the formulation of strategies at the business level. Since the business level is where competition takes place, a firm‘s performance at this level is vital to its overall success. The chapter is divided into two major sections: 5. The first section draws on Michael Porter‘s framework of generic strategies—overall cost leadership, differentiation, and focus. We describe each of these strategies and provide examples of firms that have successfully used them to outperform rivals. Then, we suggest some of the pitfalls that managers must avoid to successfully pursue these strategies. We include a discussion of how firms may combine generic strategies. We also discuss whether a strategy can be sustainable—using the example of a manufacturing firm. We close with a discussion of how competitive strategies should be revised and redeployed in light of changes caused by the Internet and digital technologies. 6. The second section addresses an important contingency in the effective use of business-level strategies—industry life cycles. The stages of the life cycle— introduction, growth, maturity, and decline—have important implications for a firm‘s relative emphasis on functional capabilities and value-creating activities. It also discusses ―retrenchment strategies‖ which enable a firm to reposition its competitive position in an industry and how such strategies can lead to sustainable advantages.

Lecture/Discussion Outline The introductory case in LEARNING FROM MISTAKES discusses the decline of LG in the mobile phone market and its eventual exit from this market. The example highlights the challenge of building a sustainable differentiated position in a fast-moving market. 1-146 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 1: Why did LG struggle so much in the mobile phone market? Response guidelines: LG strives to be a technological innovator in all of its markets in order to build out a differentiated position. However, this strategy faces key potential pitfalls, and LG experienced a number of those in this business. First, differentiation efforts will fail if the product‘s unique attributes are not valued by the market. This was the case with LG in the mobile phone market. They were very creative in their technology and design, such as with the curved screen and T-shape, but these were not valued by a large segment of the market. Second, when it did succeed with a product design, LG faced another pitfall of differentiation. Their innovative designs were easily imitated. As a result, they were unable to build a strong brand image that could command a premium price. They struggled as an unsuccessful differentiator, having a reasonably high cost structure without generating revenue to support it. They were ―stuck in the middle.‖ Discussion Question 2: Did they make the right choice to exit this market? Response guidelines: From a financial standpoint, it made a lot of sense. The firm had lost money for six years straight. With the mobile phone industry maturing and Apple and Samsung having strong, established positions, it would have been very difficult for LG to build a strong position at this point. The opportunity cost for the firm to continue to invest in R&D and marketing in this market was high since LG had plenty of other businesses it could invest in. However, there is at least one counter argument. Students could see the mobile phone market as a key product market to compete in that is worth the investment. Mobile phones are increasingly individuals‘ central device for communication, shopping, facilitating transactions, and controlling smart appliances. Thus, by exiting this market, LG may find that, in the long run, they could be left behind in other markets since LG will not be seen as a leading technologyoriented product manufacturer, and its other products will not be as integrated with a person‘s mobile phone as those of its key competitors. Discussion Question 3: Who benefits from LG’s exit from this market? Response guidelines: In the short run, the firms that benefit from LG‘s exit are lower cost mobile phone manufacturers that can soak up demand at the lower to mid level of the market where LG had most of its market share. In the longer run, Apple and Samsung may benefit the most since they face less risk of LG seizing a large part of the market with a winning innovation. Also, as mentioned in question 2, they may also benefit if they can exploit LG‘s loss in the mobile phone market by building more integrated smart suites of appliances that rely on their phones as the central processing device. This could be a means of differentiation to erode LG‘s position in other electronic, telecommunication, and appliance devices.

PowerPoint Slide 4: The Central Role of Competitive Advantage PowerPoint Slide 5: Sustaining a Competitive Advantage PowerPoint Slide 6, 7, and 8: Three Generic Strategies PowerPoint Slide 9 and 10: Overall Low-Cost Leaderships PowerPoint Slide 11: Improving Competitive Position vis-à-vis the Five Forces: Cost Leadership PowerPoint Slide 12: Pitfalls of Cost Leaderships PowerPoint Slide 13 and 14: Differentiation (1 of 2) PowerPoint Slide 15: Improving Competitive Position vis-à-vis the Five Forces: Differentiation PowerPoint Slide 16: Pitfalls of Differentiation PowerPoint Slide 17 and 18: Focus PowerPoint Slide 19: Improving Competitive Position vis-à-vis the Five Forces: Focus PowerPoint Slide 20: Pitfalls of Focus Michael Porter presented three generic strategies that firms can use to overcome the five forces and attain competitive advantage. The first, overall cost leadership, is based on creating a lowcost position relative to one‘s peers. The second, differentiation, requires that the firm (or business unit) create products and/or services that are unique and valued. Third, firms following a focus strategy must direct their attention (or ―focus‖) toward narrow product lines, buyer groups, or geographical markets. Firms emphasizing a focus strategy must attain advantages either through differentiation or a cost leadership approach. EXHIBIT 5.1 illustrates these strategies on two dimensions: competitive advantage and markets served. Discussion Question 4: What are some examples of businesses that follow each of the four strategies in Exhibit 5.1? Why are they successful (or unsuccessful)? Before moving on to the discussion of each of the generic strategies, it is useful to point out that a variety of research has supported the notion that firms that identify with one or more forms of competitive advantage typically outperform those that do not. EXHIBIT 5.2 provides evidence that businesses that combined multiple forms of competitive advantage were more successful than those using only a single form. And the lowest performers where those that were ―stuck in the middle‖; that is, they did not identify with a single type of strategy. Discussion Question 5: What are some examples of firms that have successfully combined multiple strategies? Does this seem to help their performance? Why? Why not? At this point, it is useful to point out that deciding what types of competitive advantage to select requires making hard choices (a point driven home by Michael Porter in his 1996 Harvard Business Review article: ―What is strategy?‖) In effect, a firm cannot be ―all things to all people.‖ We now discuss each of the types of generic strategies. K.

Cost leadership requires a tight set of interrelated tactics such as aggressive construction of efficient-scale facilities, vigorous pursuit of cost reductions from experience, tight cost and overhead control, avoidance of managerial customer accounts, and cost minimization in all activities in a firm‘s value chain.

EXHIBIT 5.3 uses the value-chain concept (from Chapter 3) to provide examples of how a firm can attain an overall cost leadership strategy in its primary and support activities. Discussion Question 6: What are some examples of firms that exemplify the items in Exhibit 5.3? How do they improve the firm’s performance? The SUPPLEMENT below discusses how a firm, Spirit Airlines, has been able to compete successfully in an intensely competitive industry by means of an effective cost leadership strategy. It serves to show how actions involve many primary and support activities in the value chain. Extra Example: Spirit Airlines‘ Successful Cost Leadership Strategy Spirit Airlines is a controversial and successful firm in the highly competitive and often unprofitable airlines industry. From 2012 to 2019, Spirit Airlines saw its sales grow by 150 percent, and its profits by 114 percent. Additionally, its stock grew in value by over 135 percent from December 2012 to December 2019. However, staying successful requires attention to every aspect of operations to continually squeeze out costs. This is especially true since Spirit‘s tickets average 30 percent less than its competition‘s. Below are some examples of how it employs a wide variety of value-chain activities in its efforts to cut costs: 

      

It keeps its firm infrastructure as small as possible. It operates from a simple, single story corporate headquarters building. Additionally, there is no receptionist at the headquarters to welcome visitors. Ben Baldanza, the firm‘s CEO, comments that he only buys pens for the office when needed and instructs employees to pick up pens at conferences to take back to the headquarters. It has limited marketing efforts, spending less than $10 million a year on advertising. It flies only two models of airplane, the Airbus 319 and 320, saving costs on employee training and tools. It has set up fast turnaround routines, often taking only 30 minutes to move from the landing of one flight to the takeoff of the next. It stocks water and food onto its planes only once a day. Spirit removed the reclining mechanism on the seats on its A320 planes allowing them to move the rows closer together, increasing the capacity of the plane to 178 seats, which is up to 40 seats more than its competitors. It removed in-flight magazines from the planes to cut the weight of the plane and save fuel. It charges customers for both checked and carry-on luggage. This serves as a source of revenue, but the airline has also found its flyers carry less luggage than passengers on other airlines, reducing plane weight and saving fuel.

While Spirit has grown and experienced strong profitability, it was the lowest ranked airline in 2017‘s American Customer Satisfaction Index of U.S. based airlines. Source: Nicas, J. 2012. A stingy Spirit lift‘s airline‘s profits. WSJ.com. May 11: np; Vasel, K. 2015. America‘s worst airline for customer satisfaction is… cnnmoney.com. April 21: np; cnnmoney.com; theasci.org; finance.yahoo.com.

Discussion Question 7: How does Spirit’s cost leadership strategy improve its competitive position vis-à-vis the five forces? Discussion Question 8: Is Spirit able to achieve parity on differentiation? 1-150 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

It is important to point out that in order to enjoy above-average performance, firms following a cost leadership position must attain parity or proximity on the basis of differentiation relative to competitors. Proximity to differentiation means that the price discount necessary to get an acceptable market share does not offset a cost leader‘s cost advantage. We next address two examples of how overall cost leadership strategies can help a firm to enjoy advantages in their industry: Aldi (a hard discount supermarket chain) and Zulily (an online retailer). STRATEGY SPOTLIGHT 5.1 discusses Primark, a clothing retailer that has built a successful cost leadership strategy while also striving for environmental sustainability. Discussion Question 9: Do you think that Primark’s sustainability efforts are an important element of its business? Does it help sustain or undercut its strategic position? 6.

Overall Cost Leadership: Improving Competitive Position vis-à-vis the Five Forces

After discussing how an overall cost leadership position improves a firm‘s position vis-àvis the five forces, we reintroduce the earlier examples of Aldi, Zulily, and Primark to illustrate the concepts. 7.

Potential Pitfalls of Overall Cost Leadership Strategies

This section addresses five pitfalls of following an overall cost leadership strategy: 1. 2. 3. 4. 5. 6.

Too much focus on one or a few value-chain activities Increase in the cost of the inputs on which the advantage is based The strategy is imitated too easily A lack of parity on differentiation Reduced flexibility Obsolescence of the basis of cost advantage

The SUPPLEMENT below describes how TJX is staking out a strong position in discount retailing.

Extra Example: Winning in the Tough Retail Market with an Overall Cost Leadership Strategy This firm is arguably the most successful low-cost retailer in the United States. Its sales have grown by over 25 percent over the last three years, rising to nearly $39 billion, and its profits have grown 36 percent over the same period, to nearly $3.1 billion in 2019. But the firm isn‘t Walmart or Target. It is TJX, the parent firm for T.J. Maxx, Marshalls, and HomeGoods. In the words of industry consultant and analyst Howard Davidowitz, ―It‘s the most consistent, most powerful apparel retailer in the United States.‖ 1-151 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

TJX has a relatively simple but powerful model to succeed in the competitive apparel business. First, it focuses on moving inventory through the firm and out its doors. TJX turns its inventory over every 55 days, compared to 85 for its competitors. It quickly moves its orders through its distribution centers and out to its stores. It puts product right out to its racks and shelves on the selling floor. Stores have very little backroom storage. As a result, TJX often sells its merchandise before the firm has even paid its vendors. Second, the firm emphasizes value with the products it sells. Rather than looking to sell the cheapest merchandise, it looks to buy good merchandise at a steeply discounted price. Shoppers at its chains may find low-priced graphic tshirts, but they also may find a Stella McCartney dress that would retail for $1250 at a mainline department store discounted to $499 at T.J. Maxx. Third, the firm extensively trains its buyers, builds their expertise in very narrow product areas, and gives them autonomy to make large purchases when they find attractive deals. Rather than buying for an entire season, TJX buyers search for bargains on a weekly basis. The firm‘s goal is to purchase products as late into the buying season as possible so that they can turn the inventory quickly and get a better sense of fashion trends. Additionally, rather than paying a wholesale price and then doubling it for the final retail price, TJX buyers estimate what price point TJX needs to be at in the retail store and then work backwards to a purchase price they are willing to pay to a supplier. Fourth, it serves as a reliable and discrete customer for apparel manufacturers. Unlike department stores that can be fickle and cancel or change the quantity of orders when product sales fall short of their projections or require advertising and markdown allowance from manufacturers, TJX offers straight forward and guaranteed deals with suppliers. With its scale and ordering processes, TJX can say manufacturers‘ favorite phrase, ―We‘ll take it all‖ and rarely looks to change the terms of a deal after it is initially made. Also, the firm doesn‘t advertise the brands it carries, leaving name brands, such as Ralph Lauren, more willing to work with the firm. These choices by TJX make it a favorite customer for apparel firms, resulting in more favorable pricing for the firm. Sources: Kowitt, B. 2014. Is T.J. Maxx the best retail store in the land? Fortune.com. July 24: np; finance.yahoo.com.

Discussion Question 10: Do you think TJX will be able to sustain its position over time? What are the greatest challenges the firm faces? L.

Differentiation

As the name implies, differentiation consists of creating differences in the firm‘s products or service offerings by creating something that is perceived industry-wide as being unique and valued by customers. Differentiation can take many forms, such as prestige or brand image, technology, innovation, features, customer service, or dealer networks. The SUPPLEMENT below provides an example of a firm that has found the ability to differentiate itself in a market where most of the time the product is free. Extra Example: Would You Pay for Sports News? Most people looking for sports news turn to Web sites, such as ESPN, Fox Sports, or Bleacher Report. These Web sites are mostly free for readers and generate their income from ads. But most of these Web sites are finding the market challenging and have laid off staff. One sports-news provider is taking a different tack. The Athletic aims to build a differentiated market position in the sports-news market. It is differentiating itself in three key ways. First, by offering a subscription-based, ad-free Web site, The Athletic is able to offer a clutter-free, clean Web site that is easy to navigate. Second, in writing articles, 1-152 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The Athletic has emphasized in-depth analysis over quotes from star athletes. Third, the site builds staff of local sportswriters in the cities in which it operates to provide true local sports news. In essence, customers are buying access to a local sports page. With a subscription cost of $60 per year, The Athletic only needs between 8,000 and 12,000 subscribers in a city to turn a profit. So far, The Athletic has built its business in Chicago, Cleveland, Detroit, and Toronto. As the other sports sites cut their staff, The Athletic is finding a ready pool of experienced sportswriters to choose from as it grows its business. Source: Anonymous. 2017. A New Sports Authority. Bloombergbusinessweek.com. July 31: np; www.bloomberg.com.

Discussion Question 11: Is there room for subscription services in today’s market of free news and information? Discussion Question 12: What types of customers are most likely to be attracted to The Athletic? What actions should The Athletic take to meet the wants of these customers? EXHIBIT 5.4 applies the value chain concept to illustrate how companies may differentiate themselves in primary and support activities. Discussion Question 13: What are some examples of companies that have successfully incorporated some of the elements in EXHIBIT 5.4 into their differentiation strategy? Discussion Question 14: What are some examples of companies that have been able to combine/integrate some of the items in EXHIBIT 5.4? As with overall cost leadership strategies, parity on the other dimension of strategy becomes very important. That is, firms following differentiation strategies must strive to attain a degree or level of parity on cost. In this section, we provide many examples of firms that have successfully implemented a differentiation strategy. These include Hotel Monaco and BMW automobiles (image and brand identification) and Nordstrom department stores (customer service). We also use Nike and Blizzard as exemplars of how differentiators can use technology to customize its offerings to meet the differentiated needs of customers. Still, differentiators must be clear to not send mixed signals to customers about whether their products or services are truly differentiated. Teaching Tip: Another important aspect of differentiation in today‘s markets is speed, or alternatively, quick response to changes in the marketplace/customer demands. You can provide examples like Amazon to show how companies can increase their competitive position through speed and quick response to customers. (This may also provide another example of how a seemingly ―commodity‖ service can be differentiated, and premium prices may be charged to customers.) Ask students what other companies use speed as a means of differentiation. The SUPPLEMENT below discusses how Anheuser-Busch is turning to sustainability to differentiate its products. 1-153 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Extra Example: Budweiser Goes Green As its core beer business faces challenging conditions, Anheuser-Busch is pushing heavily to turn its U.S. beer operations into sustainable ones. The firm stated that it is implementing sustainability efforts that, by 2025, will shift the firm to using 100 percent renewable energy to manufacturer all of its classics, including Budweiser and Bud Light. This will cut Anheuser-Busch‘s carbon footprint by 25 percent. This is part of an ongoing effort by the firm. As CEO Michel Doukeris stated, ―It's not something that is new for us. We've been working with sustainability goals for the last several years. As a matter of fact, we set some goals for 2020 which we achieved all of them ahead of schedule. So we are now raising the bar and coming up with these new 2025 sustainability goals,‖ Doukeris told FOX Business in an exclusive interview. As part of this push, the brewer announced that it has ordered 40 of Tesla‘s new electric semi-trucks at the estimated price tag of $150,000 to $200,000 each in an effort to reduce its supply chain emissions. While these efforts are socially responsible and are simply the right thing to do according to firm leaders, they also may help the firm position itself with younger consumers who are increasingly concerned about the environmental impact of products they purchase. Source: Sciopini, J. 2018 Anheuser-Busch to turn its beers ―green‖. foxbusiness.com. April 17: np.

STRATEGY SPOTLIGHT 5.2 discusses how working with platform providers can both help product sellers but also limit their ability to differentiate. Discussion Question 15: What actions can firms take to lessen the cost of working with platforms? Discussion Question 16: If you were starting up an entrepreneurial firm, would you work with one of these platforms? Why or why not? 1.

Differentiation: Improving Competitive Position vis-à-vis the Five Forces.

We discuss how a differentiation strategy helps a firm to improve its position vis-à-vis Porter‘s five forces. We use Porsche and Zappos to illustrate our points. 2.

Potential Pitfalls of Differentiation Strategies

Next, we address some of the pitfalls of a differentiation strategy:      

Uniqueness that is not valuable Too much differentiation Too high a price premium Differentiation that is easily imitated Dilution of brand identification through product-line extensions Perceptions of differentiation may vary between buyers and sellers

The SUPPLEMENT below discusses how Pharmaceutical firms are finding that additional differentiation of their products may not lead to market success. Extra Example: Pharma Finds Innovation Doesn‘t Always Pay Off Novo Nordisk, a Danish drug firm, has found over its corporate history that innovation can provide continued market leadership and financial success. The firm has specialized in diabetes treatment, and over the last several decades, has developed successive generations of more effective version of its core product—insulin. However, the firm has now found that customers don‘t appear to value additional innovation. With its latest drug, Tresiba, Novo Nordisk has found that, for many customers, it isn‘t worth the increased price over the last generation of its insulin product. At a cost that is 60 to 70 percent higher, ―the incremental improvements don‘t seem to justify the higher prices‖ according to Steve Miller, chief medical officer of Express Scripts. Other drug manufacturers have faced similar experiences. Sanofi SA and Amgen Inc. have found it hard to build business for new cholesterol-lowering drugs the firms have brought to market. Novartis AG has similarly struggled to grow the business for a new heart failure medicine. In some instances, insurers have incentivized doctors to prescribe older, cheaper drugs. Customers are also reluctant to pay higher co-pays for the new drugs. In countries where the government manages the healthcare system, some countries have refused to pay more for some newer drugs than they did for the older medicines already available on the market. The bottom line is that these new drugs are not seen as game changers. Though they offer incremental gains over prior generations of medicine, the increased benefit isn‘t large enough to convince a range of customers, including governments, insurers, doctors, and patients, that the benefits are large enough to justify large price increases. The effect is substantial on the pharmaceutical firms. Novo Nordisk has cut its long-term growth goal projection from 15 percent to 5 percent annually. It has also seen its stock price stay essentially flat from December 2015 to December 2019. Source: Roland, D. 2017. Pharma‘s new bind: Progress may not pay. Wall Street Journal. August 16: A1, A10; finance.yahoo.com.

Discussion Question 17: What pitfalls of differentiation are the pharma firms experiencing? How can they respond to this new reality? Discussion Question 18: What are some examples of firms that achieved a level of differentiation only to see it eroded? What pitfalls did these firms fall prey to? EXHIBIT 5.5 points out potential pitfalls of overall cost leadership and differentiation strategies. STRATEGY SPOTLIGHT 5.3 discusses how using environmental sustainability to differentiate is a challenging endeavor. M.

Focus

The third generic strategy is based on the choice of a narrow competitive scope within an industry. The focuser attains competitive advantages by dedicating itself to a segment or group of segments and tailors its strategy to serving them. 1-155 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 19: What are some companies that have successfully implemented a focus strategy? The focus strategy, as indicated in EXHIBIT 5.1, has two variants. In a cost focus, a firm strives to create a cost advantage in its target segment. In a differentiation focus, a firm seeks to differentiate in its target market. We provide an example of a successful niche firm in both a service industry (LinkedIn) and a manufacturing industry (Marlin Steel Wire Products). STRATEGY SPOTLIGHT 5.4 discusses how A. Lange & Sohne has created extreme differentiation with its perpetual calendar watches. 1.

Focus: Improving Competitive Position vis-à-vis the Five Forces

We next discuss how an effective focus strategy can improve a firm‘s position with regard to the industry‘s five forces. We draw on the previous examples of LinkedIn and Marlin Steel Wire. The SUPPLEMENT below points out how Hilton Hotels is developing a new chain that employs a focus strategy. Extra Example: Tru Hotels: Serving the Millennial and Gen Z Customer You might expect that a fast-growing hotel chain aimed at Millennial and Gen Z customers would be emphasizing trendy, urban neighborhoods. But the Tru Hotel chain is rapidly building new hotels near suburban freeway exits all across the country. The first Tru was opened by its parent firm, Hilton Hotels, in May 2017 in Oklahoma City. Hilton had 240 locations of the hotel operating by the middle of 2022. The chain is specifically aiming for Millennial and Gen Z customers. To keep costs down to meet the needs of budget conscious Millennials and Gen Zers, the chain has rooms 25 percent smaller than competing chains. Additionally, the rooms are designed to be quick and easy to clean, with vinyl floors, rather than carpet, and no inroom coffee makers or desks. This seems to fit the preferences of many younger customers. As one guest said, ―What do I do when I go into a room? I‘m usually just hopping into the bed, watching some TV and going to sleep. That‘s why it made sense.‖ But Hilton is adding amenities that it believes will be valued by younger customers. Tru‘s lobbies are 80 percent bigger than similar hotels. Lobbies include a gourmet coffee area, a self-serve snack area, and individual work pods with a fast Internet connection in case guests need a desk. When it‘s time to relax, customers can purchase craft beers to enjoy while they play on one of the pool tables or game systems in the lobby area. Time will tell if this new design draws Millennial and Gen Z customers from other chains and lodge-sharing sites, such as Airbnb. Source: Kirkham, C. 2017. Hilton sees room for growth with new low-price brand. wsj.com. July 6: np; hilton.com

Discussion Question 20: Are Millennial and Gen Z customers a group with specific hotel wants and needs? Does Tru have an effective business model to attract its targeted customers? 1-156 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Potential Pitfalls of Focus Strategies

The section closes by addressing some of the pitfalls of a focus strategy. These are:    N.

Erosion of cost advantages within the narrow segment Even product and service offerings that are highly focused are subject to competition from new entrants and imitators Focusers can become too focused to satisfy buyer needs

Combination Strategies: Integrating Overall Low Cost and Differentiation

There has been a great deal of evidence—in both observation of business practice as well as in research studies—about the strategic benefits of competitive positioning and resultant performance implications that are inherent in combining generic strategies. In the beginning of this section, we provided some evidence from nearly 2,000 strategic business units (EXHIBIT 5.2) to support this contention. In general, the key benefit to be enjoyed by firms that successfully integrate low cost and differentiation strategies is that it is generally harder for competitors to duplicate or imitate them. An integrated strategy enables a firm to provide two types of value to customers: differentiated attributes and lower prices. Furthermore, the benefits of combining advantages can be additive, instead of merely involving tradeoffs. We next address three approaches that combine overall cost leadership and differentiation. 1.

Automated and Flexible Manufacturing Systems

Given the advances in manufacturing technologies such as CAD/CAM, as well as information technologies, many firms have been able to manufacture unique products in relatively small quantities at lower costs. This is a concept known as ―mass customization.‖ We provide the example of Andersen Windows in Bayport, Minnesota—a $2.3 billion manufacturer of windows for the building industry. Among the benefits are that the system is virtually error free, the customers get exactly what they want, and the time to develop the design and price quotation is cut by 75 percent. 2.

Using Data Analytics

Firms are increasingly using the ability to analyze large sets of data on customer preferences and choices to simultaneously minimize cost and increase differentiation. We briefly discuss actions by Caterpillar to leverage the power of ―big data.‖ 3.

Exploiting the Profit Pool Concept for Competitive Advantage

A profit pool can be defined as the total profits in an industry at all points along the industry‘s value chain. The potential pool of profits will be deeper in some segments of the value chain than in others, and the depths will vary within an individual segment. Our discussion of the profit pool concept can be illustrated more compellingly to the class by emphasizing that this applies to virtually every industry. The SUPPLEMENT below describes how Rolls-Royce is placing more emphasis on downstream (i.e., marketing, sales, and service) profit opportunities.

Extra Example: Rolls-Royce Sells Services Rolls-Royce has traditionally been a maker of airline jet engines. Given the growth in long-haul plane orders, which use the firm‘s engines in Asia, as well as a rebound in jet orders in the United States, the firm has seen improved sales and strong earnings over the last few years. For example, its net income exceeded $1B a year from 2011 through 2015. The company is in a strong competitive position, supplying engines to both the major jet manufacturers, Boeing and Airbus. For some of these firms‘ models, they are the sole supplier of engines. But Rolls-Royce is changing the way it does business to extract more of the potential profit from the aircraft engine business. Profits used to come primarily from selling engines and replacement parts. Now, they come from providing long-term repair and maintenance. Rolls is steadily signing up customers for this sort of service. Margins are typically higher for service than for hardware sales. Customers value these services since they offer peace of mind that Rolls will keep the engines running. However, if the economy declines again and airlines cut flights and aircraft orders, Rolls-Royce could be in a tough position since this will cut the need for both new hardware and services. Source: Anonymous. 2010. Rolls-Royce: The jet engine maker is soaring above its troubles. The Economist. February 5: 76; hoovers.com.

Discussion Question 21: Can you think of other industries where firms can benefit by applying the profit pool idea? Discussion Question 22: By exploiting the profit pool along the industry’s value chain, is Rolls-Royce taking too high a level of risk? Do they have more control over how their engines are maintained, therefore lowering their risk and increasing profits? Support your answer. 4.

Unscaling to Create a Combination Strategy

Firms are increasingly identifying ways to build small-scale operations that allow them to be hyper-efficient while providing differentiated products or services to meet the needs of specific customer segments. STRATEGY SPOTLIGHT 5.5 discusses the specific example of Indochino, a menswear manufacturer that is using the unscaling concept to outcompete traditional retailers. Discussion Question 23: What are some other examples of firms that are using unscaling to create advantage with a combination strategy? 5.

Integrated Overall Cost Leadership and Differentiation Strategies: Improving Competitive Position vis-à-vis the Five Forces

We next address how an integrated overall cost leadership and differentiation strategy helps a firm to improve its position in regard to its industry‘s five forces. We introduce the Walmart example to illustrate these points. We discuss why its strategy is highly sustainable. 6.

Pitfalls of Integrated Overall Low Cost and Differentiation Strategies.

Firms that attain both types of competitive advantage enjoy high returns. However, as with each generic strategy taken individually, there are some pitfalls to avoid:   

Firms that fail to attain both strategies may end up with neither and become ―stuck in the middle‖ Underestimating the challenges associated with coordinating value-creating activities in the extended value chain Miscalculating sources of revenue and profit pools in your industry

XIV. Can Competitive Strategies Be Sustained? Integrating and Applying Strategic Management Concepts PowerPoint Slide 21: Combination Strategies: Integrating Low-Cost and Differentiation PowerPoint Slide 22: Combination Strategies PowerPoint Slide 23: Improving Competitive Position vis-à-vis the Five Forces: Combination PowerPoint Slide 24: Pitfalls of Combination Strategies In this section, we integrate many of the key concepts in the first five chapters: stakeholder analysis, external environmental analysis, five-forces analysis, value-chain analysis, resourcebased view of the firm (including the issue of sustainability). We provide the example of a manufacturing firm (Atlas Door—a ―real‖ company), which entered an industry and developed a strategy that earned it very high returns and a very favorable competitive position. The Atlas Door example provides an opportunity for students to get a more thorough understanding of the aforementioned key concepts, as well as provides some insights on whether or not a firm‘s advantage is sustainable over a long period of time (rather strong arguments are provided for both the ―pro‖ and ―con‖ positions) and offers potential sources of value appropriation. You might find it interesting to pose some very general questions to the class such as whether or not they believe that Atlas Door‘s advantages were sustainable, as well as any other sources of value appropriation. Strategies for Platform Markets We discuss strategic actions to build a sustainable advantage in platform markets, where the firm‘s primary purpose is to serve as an intermediary between buyers and sellers. We identify a number of prominent platform firms, including VISA, Amazon, Facebook, and Etsy. We discuss key four strategy elements for platform firms: 1. Draw in users. 2. Create easy and informative customer interfaces. 3. Facilitate the best connections between suppliers and customers. 4. Sequencing the growth of the business. 1-160 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

XV. Industry Life Cycle Stages: Strategic Implications PowerPoint Slide 26 and 27: Industry Life Cycle Stages PowerPoint Slide 28: Strategies in the Introduction Stage PowerPoint Slide 29: Strategies in the Growth Stage PowerPoint Slide 30: Strategies in the Maturity Stage PowerPoint Slide 31: Strategies in the Decline Stage PowerPoint Slide 33: Retrenchment Strategies The life cycle of an industry refers to the stages of introduction, growth, maturity, and decline that occur over the life of an industry. Why is it important to consider industry life cycles? The emphasis on various generic strategies, functional areas, value-creating activities, and overall objectives vary over the course of the industry life cycle. Managers must become even more aware of their firm‘s strengths and weaknesses in many areas to attain competitive advantages. EXHIBIT 5.6 depicts the four stages of the industry life cycle and how factors such as generic strategies, market growth rate, intensity of competition, and overall objectives change over time. Be sure to point out an important caveat regarding the key limitation of the industry life cycle concept. That is, products and services go through many cycles of innovation and renewal. And, for the most part, only fad products have a single life cycle. We provide the example of how the cereal industry got a boost in sales when medical research indicated that oat consumption reduced a person‘s cholesterol. Teaching Tip: In the textbook, we discuss what may be considered as the ―generic‖ industry life cycle. Ask students for examples of how technological or product market innovations have abruptly truncated or extended an industry‘s life cycle. (Examples would include how the technological innovation of subscription music services, such as Spotify, truncated the life cycle of digital music sales, and how Nike‘s product innovation enhanced the life cycle of the athletic shoe industry.) Next, we address each of the four stages of the industry life cycle. O.

Strategies in the Introduction Stage

In the introduction stage, products are unfamiliar to consumers. Market segments are not well defined and product features are not clearly specified. The early development of an industry typically involves low sales growth, rapid technological change, operating losses, and the need for strong sources of cash to finance operations. Since there are few players and not much growth, competition tends to be limited.

There‘s an advantage to being a ―first mover‖ in the market. We address the examples of Coca Cola‘s global brand and Caterpillar‘s ability to get a lock on overseas sales channels and service capabilities. Discussion Question 24: What are some other firms that benefited from being a “first mover” in their industry? However, there are also benefits to being a ―late mover.‖ We address how Target benefited from its delayed Internet strategy. P.

Strategies in the Growth Stage

The second stage of the industry life cycle, growth, is characterized by strong increases in sales. The potential for strong sales (and profits) attracts other rivals who also want to benefit. Whereas marketing and sales initiatives were mainly directed at spurring aggregate demand, defined as demand for all such products in the introduction stage, efforts in the growth stage are directed toward stimulating selective demand, in which a firm‘s product offerings are chosen with those of its rivals. Revenues in the growth stage increase at an accelerating rate because (1) new consumers are trying the product, and (2) a growing proportion of satisfied consumers are making repeat purchases. In general, new products and services often fail if there are relatively few repeat purchases. (We provide the example of Alberto-Culver‘s introduction of Mr. Sparklers, which were sold as solid air fresheners that looked like stained glass.) Discussion Question 25: What are some examples of products/industries in the growth stage of their life cycle? How long do you think the growth stage will last? Q.

Strategies in the Maturity Stage

In the third stage, maturity, aggregate industry demand begins to slow. Since markets are becoming saturated, there are few opportunities to attract new adopters. Because it is no longer possible to ―grow around‖ competition, direct competition becomes more predominant—and competition intensifies (often on the basis of price). We address the example of the intense competition between AB InBev and MillerCoors and Gamble in the beer business. This slow growth business in the maturity stage puts enormous pressure on both players to attack each other to grow sales. The SUPPLEMENT below provides examples of how General Mills continues to renew a very established brand with new versions of its flagship cereal, Cheerios. Extra Example: Cheerios New Flavors General Mills introduced the Cheerios brand of cereal in 1941 and has seen it take on a central position in the breakfast food market. The Cheerios brand accounts for 13 percent of all cold cereal sold in the United States, over twice the share of its nearest competitor. Although the brand is over 75 years old, General Mills has not accepted 1-162 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

that the growth potential for the mature brand is over, and it continues to spin out new variants of the venerable cereal to stoke up new demand. There are now 18 different varieties of Cheerios, with five new types of Cheerios introduced after 2007. The latest to arrive are Dulce de Leche and Multi Grain Peanut Butter Cheerios. By extending the brand with new flavors, General Mills has found a way to generate modest growth in a very mature market. For example, Chocolate Cheerios, introduced in 2010, has been a very successful launch and added to sales by adding a chocolate flavor to the family-cereal market. Prior to this launch, chocolate-flavored cereals were largely limited to the kids‘ cereal market. General Mills has even taken inspiration from Reese‘s candies and added another variant of this cereal, Chocolate Peanut Butter Cheerios in 2017. There is one additional benefit to launching new versions of established brands. Every new version of Cheerios on the shelf represents an inch of territory extracted from some other brand. Shelf space is so tight in retail stores these days that each Cheerios product has the potential to take the shelf space of competing cereal brands. Source: Hughlett, M. 2012. General Mills makes Cheerios a serial business. Startribune.com. March 3: np; cheerios.com.

Discussion Question 26: What are some industries in the maturity phase of the life cycle? How intense is the competition? How difficult is it to differentiate products and services? Two positioning strategies that managers can use in the maturity stage include: a) Reverse positioning—a change in industry tendencies to continuously improve products by offering products with fewer product attributes and lower prices. b) Breakaway positioning—a break in industry tendencies to incrementally improve by offering products that are still in the industry but are perceived by customers as being different. Discussion Question 27: What are some examples of companies that used breakaway or reverse positioning strategies to distinguish themselves from other companies in their industry? Discussion Question 28: What are some of the risks associated with breaking away from other similar companies in an industry? What are the benefits? R.

Strategies in the Decline Stage

Decisions in the decline phase of the industry life cycle become particularly important. Hard choices must be made, and firms must face up to the fundamental strategic choices of either exiting or staying and attempting to consolidate the industry. There are four basic strategies available in the decline phase: maintaining, harvesting, exiting, or consolidating. Maintaining refers to keeping a product going without significantly reducing marketing support, technological development, or other investments in the hope that competitors will eventually leave the market.

Harvesting involves obtaining as much profit as possible and requires that costs in the decline stage be decreased quickly. Exiting the market involves dropping the product from a firm‘s portfolio. Consolidating involves one firm acquiring the best of the surviving firms in an industry at a reasonable price. (We provide the example of Lockheed Martin, the giant in the defense industry.) Discussion Question 29: What are some examples of industries in the decline stage? What strategies are the incumbent firms following? We also address three ways in which old technologies can enjoy a ―last gasp‖ in the marketplace. These are: retreating to a more defensible ground, using the old to replace the new, and improving the price-performance trade-off. S.

Retrenchment Strategies We discuss three retrenchment strategies: 1. Asset and cost surgery 2. Selective product and market pruning 3. Piecemeal productivity improvements Discussion Question 30: Can you think of successful (or unsuccessful) retrenchment actions?

XVI. Issue for Debate The case discusses how an emerging segment of the egg market is striving to differentiate eggs using regenerative farming. The aim is to position the eggs as both organic and climate friendly. Discussion Question 31: Will consumers value regenerative farming and pay a premium for regenerative eggs? As a starting point, students should discuss why customers are willing to pay such a high premium for eggs that are certified organic and cage-free. The reason largely rests on two factors. One, the packaging and marketing of these eggs are clear and easy to understand. It speaks to the perceived healthiness of the eggs and the degree to which the treatment of the chickens is seen as humane. Second, while the eggs cost a fair bit more than traditional farm produced eggs, it has a very limited effect on the overall grocery cost for consumers, likely only raising their weekly food bill by two to four dollars. Thus, it is an easy decision to be socially conscious in egg purchases. Turning to the climate friendly eggs, students should examine if the same effects are at work. While the cost is a bit higher, it is not a steep jump from the organic, cage-free eggs. However, 1-164 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

there are two related questions at work here. Since there are already socially responsible eggs available, will customers want to pay an additional premium of any level? Also, is it really clear what the gain is? While it is easy to sell using marketing phrases such as organic and free range, it is not clear that ―regenerative farming‖ will resonate with customers on a broad scale. It may take a simpler marketing phrase to grab customer attention. If the students largely come down on the side that it won‘t work, you may want to push back a bit with the question of whether there is a viable niche market for this product. Is there a community of customers who are climate-change focused and likely to find great value with these eggs? Discussion Question 32: How should producers position these products to enhance consumer demand? There are several different angles the discussion can go here. First, the direction of the conversation likely differs depending on the student‘s answer to the prior question. If the target is a broad market, the conversation should be how to effectively differentiate the product from other premium eggs. This could include a discussion of how to market regenerative farming, including possibly a simpler tag line for them. If the discussion, goes toward this being a niche market, the discussion could center on defining the customer niche, the optimal distribution system to get the product to them, and ways of highlighting climate benefits to these particular customers. One additional angle to consider is whether these egg producers should coordinate with other climate-friendly food producers. For example, the term organic is broad but has defined characteristics and standards that are enforced on producers using the label. These egg producers, along with other climate-friendly food producers, could consider a trademark that signifies climate-friendliness and create a standards council that would define what is meant by the term. This would allow them to collectively promote the term and place it on all of their products, giving consumers a clear indicator of the desired climate-friendly attributes. Discussion Question 33: Is regenerative farming a beneficial action, or is it just a marketing slogan? This is likely to generate some differing opinions. While there clearly are differences in farming practices, some students may question whether the differences are meaningful to the eco-system. While this could be a lively debate, the important take-away is to inform and possibly lead to a revision of the assessment of the viability of this business model and how providers need to inform or convince consumers of its value.

XVII. Reflecting on Career Implications PowerPoint Slide 34: Reflecting on Career Implications

Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 5. 

Types of Competitive Advantage: Are you aware of your organization‘s business-level strategy? What do you do to help your firm either increase differentiation or lower costs? Can you demonstrate to your superiors how you have contributed to the firm‘s chosen business-level strategy?

This would be an opportunity for the student to see if his or her own actions at work are leading to competitive advantage for the firm. Although at first sight this might appear to be difficult for the student to figure out, it‘s easy to walk the student through his/her activities at work even if they are only entry-level employees. For example, you may have a student who is a waiter/waitress at an upscale restaurant and someone who has worked in a fast-food restaurant during their high school years. The instructor can help the class understand that their activities were very dissimilar because their organizations were attempting very different kinds of competitive advantage. 

Types of Competitive Advantage: What is your own competitive advantage? What opportunities does your current job provide to enhance your competitive advantage? Are you making best use of your competitive advantage? If not, what organizations might provide you with better opportunities for doing so? Does your resume clearly reflect your competitive advantage? Or are you ―stuck in the middle?‖

Since students are unlikely to stay with the same company or in the same position for their entire career, it is important for students to think about how they are positioning themselves. Specifically, push students to consider how their training and experiences can help them differentiate themselves from their peers or others with whom they will compete for positions. Students can also think about whether they are striving to focus their skill set on specific industries or types of positions or if they are striving to build a broader set of skills that will allow them to be a generalist employee, capable of handling a wider range of responsibilities or varying types of work and industry environments. 

Understanding your Differentiation: When looking for a new job or for advancement in your current firm, be conscious of being able to identify what differentiates you from other applicants. Consider the items in Exhibit 5.4 as you work to identify what distinguishes you from others.

Once you have walked the student through Question 2, this question would become more relevant. Students often assert they are differentiated from competing applicants and co-workers, but it is important that they can clearly articulate how they are different. 

Industry Life Cycle: Before you go for a job interview, identify the life cycle stage of the industry within which your firm is located. You are more likely to have greater

opportunities for career advancement in an industry in the growth stage than in the decline stage. This point is part of a larger issue of having students examine and assess firms with which they are interviewing. They should think of how the firm and its position provide opportunities for them. Also, they can determine if there is a good fit between them and the firms to which they are applying. 

Industry Life Cycle: If you sense that your career is maturing (or in the decline phase!), what actions can you take to restore career growth and momentum (e.g., training, mentoring, professional networking)? Should you actively consider professional opportunities in other industries?

This is an excellent opportunity for the instructor to get the student thinking about the short-term and long-term career implications of industry maturity and decline. It is important to emphasize that (a) even if an industry is declining, many of their skills can be transferred to other industries (with some ―switching costs‖ of course!), and (b) that there many avenues available to them to develop new skill sets.

XVIII.

Summary

How and why firms outperform each other goes to the heart of strategic management. In this chapter, we identified three generic strategies and discussed how firms are able not only to attain advantages over competitors, but also to sustain such advantages over time. Why do some advantages become long lasting, while others are quickly imitated by competitors? The three generic strategies—overall cost leadership, differentiation, and focus—form the core of this chapter. We began by providing a brief description of each generic strategy (or competitive advantage) and furnished examples of firms that have successfully implemented these strategies. Successful generic strategies invariably enhance a firm‘s position vis-à-vis the five forces of that industry—a point that we stressed and illustrated with examples. However, as we pointed out, there are pitfalls to each of the generic strategies. Thus, the sustainability of a firm‘s advantage is always challenged because of imitation or substitution by new or existing rivals. Such competitor moves erode a firm‘s advantage over time. We discussed the viability of combining (or integrating) overall cost leadership and differentiation generic strategies. If successful, such integration can enable a firm to enjoy superior performance and improve its competitive position. However, this is challenging, and managers must be aware of the potential downside risks associated with such an initiative. We also discussed the issue of the sustainability of a firm‘s competitive advantage. We used the example of a manufacturing firm—Atlas Door—to illustrate our key concepts in the first five chapters in the book.

The concept of the industry life cycle is a critical contingency that managers must take into account in striving to create and sustain competitive advantages. We identified the four stages of the industry life cycle—introduction, growth, maturity, and decline—and suggested how these stages can play a role in decisions that managers must make at the business level. These include overall strategies as well as the relative emphasis on functional areas and valuecreating activities. When a firm‘s performance severely erodes, retrenchment strategies are needed to reverse its situation and enhance its competitive position. We have discussed three approaches— asset cost surgery, selective product and market pruning, and piecemeal productivity improvements.

Chapter 5: Business-Level Strategy: Creating and Sustaining Competitive Advantages Select an industry (e.g., retail chain and restaurants). Identify an organization that competes on the basis of overall cost leadership and one that is a differentiator. Are their advantages sustainable? Why or why not? Are each of these organizations attaining parity on the other type of competitive advantage? Teaching suggestions: You will have students referring to examples from a wide variety of industries. You can use this question for stimulating discussion on the merits, demerits and the organizational implications of overall cost leadership and differentiation strategies. The ‗overall cost leadership‘ strategy is based on creating a low-cost position compared to the other competitors in the industry (You might want to refer to Exhibit 5.3 in this section of the text to look at how firms can achieve low cost in their value-chain activities). This strategy helps in improving the competitive position vis-à-vis the five-forces in the industry in the following manner:     

Protects against rivalry from existing competitors because lower costs allow a firm to earn profits even when its competitors are losing money Protects against powerful buyers because buyers can exert their power to drive down prices only to the level of the next most efficient producer and here there is none Protects against powerful suppliers by providing greater flexibility to cope with their demands for input cost increases Serves as a substantial barrier to entry and thus lowers the threat of new entrants Puts the firm in a favorable position with respect to substitute products

You can ask the students whether the firm pursuing overall cost leadership is realizing some or all of these benefits. Overall cost leadership also has some pitfalls that need to be avoided: 

Too much focus on one or a few value-chain activities Just focusing on one or a few value-chain activities for cost reduction might not help much. Managers need to explore all value-chain activities and the relationships between them for cost reduction.



The firm becomes vulnerable to price increases in the factors of production. The firm may not always be able to pass the price increases to the customers and could face serious problems. An example is the challenge experienced by manufacturing firms based in China. These firms rely on a common input—low labor costs. Given demographic factors (causing labor shortages) firms have been forced to raise wages.



The strategy can be imitated too easily if the activities contributing to cost reduction are easily imitable.

You might want to emphasize the importance of exploiting the linkages between various activities of the value chain so that the advantage cannot be easily imitated. 

When you lack parity on differentiation, buyers may be willing to pay more for the differentiated product and thus, cost leadership may not create a competitive advantage.

You might want to ask the students whether the firm pursuing the overall cost leadership strategy is facing any of these difficulties. The strategy of ―differentiation‖ means creating differences in the firm‘s product or service offering by creating something that is perceived industry-wide as unique and is valued by the customers (You might want to refer to Exhibit 5.4 in this section of the text to see how firms can achieve differentiation in their value-chain activities). Differentiation creates the following advantages:     

Provides protection against rivalry, since brand loyalty lowers customer sensitivity to price and raises customer switching costs Customer loyalty and the firm‘s ability to provide uniqueness in its products or services, creating higher entry barriers Provides higher margins and thus enables the firm to deal with supplier power Reduces buyer power because buyers lack comparable alternatives and therefore are less sensitive to price Lessens the threat from substitutes, and in some cases the product or service may be so unique that there are no substitutes at all.

You can ask the students whether the firm pursuing differentiation strategy is able to get any or all of these benefits. Differentiation comes with its own pitfalls such as the following:  Creating uniqueness that is not valuable  Too much differentiation that is too costly  Differentiation that can be easily imitated  Dilution of brand identification through product-line extension  The seller may consider it as differentiation whereas buyers do not perceive it the same way. You might want to ask the students whether the firm pursuing differentiation is facing any or all of these problems, and if so, how to address them.

You can also ask:  

Whether the firms pursuing either the cost leadership or the differentiation strategy are achieving competitive parity on the other strategy If it is possible to pursue a strategy in earnest on one hand and still achieve parity on the other

Attention should also be drawn to the ‗focus‘ strategy that is based on the choice of a narrow competitive scope within an industry.  

What are the merits and demerits of ―focus‖ strategy? Would high focus mean escaping imitation and competition from new entrants? Is there a danger of getting excessively focused? What is a combination strategy? A combination strategy means achieving both cost leadership and differentiation simultaneously. Discussion can be directed at whether it would be feasible for a firm to achieve both cost leadership and differentiation at the same time and sustain them. (You might also discuss the concept of the “profit pool”—and our example of the automobile industry to demonstrate that usually there is not a one-to-one relationship between revenues and profits along the value chain in an industry.)

Highlight the danger of getting ―stuck in the middle‖ if the firm cannot achieve both. On the other hand, if the firm is successful, it may be creating competitive advantages that cannot be easily imitated.

End-of-Chapter Teaching Notes Chapter 5: Business-Level Strategy: Creating and Sustaining Competitive Advantages Summary Review Questions 1. Explain why the concept of competitive advantage is central to the study of strategic management. (In text, Types of Competitive Advantage and Sustainability, LO 5-1) Response: Strategic management involves creating and sustaining competitive advantages. These competitive advantages need to be developed and maintained sufficiently to overcome the five competitive forces. Only through overcoming competitive forces can firms achieve aboveaverage returns. So, it‘s all about making the organization perform successfully. 2. Briefly describe the three generic strategies—overall cost leadership, differentiation, and focus. (In text, Types of Competitive Advantage and Sustainability, LO 5-2) Response: In each case, the generic strategies are defined by the type of competitive advantage, uniqueness perceived by the customer or low-cost position, and the strategic target market, industrywide or focused on a particular market segment. The overall cost leadership generic strategy involves developing a competitive advantage based on low-cost position while appealing to an industrywide market. The differentiation generic strategy involves developing a competitive advantage based on uniqueness perceived by the customer while appealing to industrywide market. The focus generic strategy involves focus on a narrow market segment while developing a competitive advantage of either uniqueness perceived by the customer or low-cost position. 3. Explain the relationship between the three generic strategies and the five forces that determine the average profitability within an industry. (In text, Types of Competitive Advantage and Sustainability, LO 5-3) Response: The five forces act to limit industry profitability. Research has shown that business units that identify with a generic strategy overcome the five forces and outperform business units that do not or are stuck in the middle. Further, business units that identify with multiple generic strategies will have higher performance than those that identify with just one generic strategy. The highest performing business units identified with differentiation and overall cost leadership have generic advantages.

4. What are some of the ways in which a firm can attain a successful retrenchment strategy? (In text, Industry Life-Cycle Stages: Strategic Implications, LO 5-7) Response: Retrenchment strategies reverse a firm‘s decline in performance and return it to growth and profitability. They are used by firms that are in industries in the decline stage of the industry life cycle. Research has shown there are three basic ways for retrenchment strategies to work. First is asset and cost surgery, where firms sell off unproductive assets and outsource any activities in which they are not competitive. Second is product and market pruning, which is the reverse of diversification. Firms will sell off products and businesses in which they are not competitive and focus on select products and markets. Third is productivity improvements, which may involve examination of many businesses processes. But small productivity improvements in many processes can add up to substantial improvement overall. 5. Describe some of the pitfalls associated with each of the three generic strategies. (In text, Can Competitive Strategies Be Sustained? Integrating and Applying Strategic Management Concepts, LO 5-5) Response: For overall cost leadership, firms will be scaling up production, learning to produce more efficiently, and minimizing costs on all activities of the value chain. The pitfalls include so much neglect on specific value chain activities that competitive parity is not reached, vulnerability to an increase in price on inputs, imitation by competitors, insufficient differentiation for buyers to get acceptable quality even at the low price, reduced strategic flexibility, and obsolescence of the basis of a cost advantage. For differentiation, firms tend to charge higher prices for their goods, but offer customers some quality or perceived quality advantage for the extra price. The pitfalls include providing a difference that is not perceived to be valuable by customers, differentiating more than customers desire, charging too high a price, imitation by rivals, dilution of brand image, and difference in quality perception between the firm and its buyers. For focus strategies, firms will appeal to a narrow segment of the market using either a low-cost or product uniqueness appeal. The pitfalls include an erosion of price advantages over competitors, imitation of product and service offerings, and loss of focus advantage as less focused competitors offer products and services at prices that the niche customers prefer. 6. Can firms combine the generic strategies of overall cost leadership and differentiation? Why or why not? (In text, Types of Competitive Advantage and Sustainability, LO 5-4) Response: Yes, there are examples of firms that serve the industrywide target market by providing products that are differentiated by, for instance, high quality or brand equity. Firms can do this by 1-173 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

providing unique value to customers efficiently. Methods include use of manufacturing systems that are flexible and automated, exploiting profit pools, seamlessly integrating operations with suppliers and customers, and exploiting profit pools. 7. Explain why the industry life-cycle concept is an important factor in determining a firm’s business-level strategy. (In text, Industry Life-Cycle Stages: Strategic Implications, LO 5-6) Response: The industry life cycle explains patterns of critical aspects of the industry and external environment, including market size, growth potential, characteristics of customers, establishment and volatility of the technology, and amount of competition. For each stage of the industry life cycle, there are associated strategies that have proved effective. Experiential Exercises and Application Questions 1. In Learning from Mistakes at the opening of the chapter, we discussed the struggles of LG in the mobile phone market. Choose a competing firm in this market (e.g., Apple, Samsung, Xiaomi, Huawei, Motorola) and analyze its strategy and value chain. Discuss how each activity in its value chain supports or does not support its generic strategy. What recommendations would you have regarding what generic strategy should be pursued and changes in the value chain needed to succeed with that strategy. The key in this analysis is to clearly identify the type of the strategy the firm is pursuing, including the bases of their strategy (ex. Differentiation based on service, cost leadership based on scale, etc.). Students should assess if this is the correct strategy for the firm or if they should migrate to a different strategy. This could include the change in generic strategy and/or changes in the bases for that strategy (an example is shifting from differentiation based on service to differentiation based on features). They should then analyze the value chain of the firm to see where the strong and weak elements of the firm are. Needed investments and changes will logically flow from this analysis. 2. What are some examples of primary and support activities that enable Nucor, a $36billion steel manufacturer, to achieve a low-cost strategy? (Fill in table below.) Response: Despite its size, Nucor is not the biggest steel manufacturer in the industry. What Nucor does do is to take as input primarily recycled products with steel in them. As a result, Nucor adapts its inbound logistics to taking in recycled steel, which is very different from taking in iron ore and other inputs associated with traditional steel manufacturers. Production operations focus on processing, or reprocessing, refined steel. It requires less energy to reprocess refined steel than to make steel out of iron ore, and the savings are passed on to customers. For technology development, Nucor focuses on steel refining technologies that are efficient and adapted to refining steel. 1-174 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

(Note to instructor) Students will probably come up with other examples than those listed above, which is fine. Nucor has refined its competitiveness in many ways across all activities of the value chain. For each student example, we suggest that the student first explain exactly what it is, where he or she found out about the example, and then in what activity of the value chain the example belongs. Value-Chain Activity Primary: Inbound logistics

Yes/No

How Does Nucor Create Value for the Customer?

Yes

Operations

Yes

Outbound logistics

Yes

Marketing and sales

Yes

Focus on deliveries in the form of scrap iron and other refuse made of steel. Focus operations on efficiently reprocessing steel, which requires specially adapted furnaces and other associated processes. Outbound logistics are adapted to efficient delivery of specialty steel products rather than less refined steel. Marketing focused on appeals to customers who require specialty steel products.

Service Support: Procurement

Technology development

Yes

Human resource management

Yes

General administration

Yes

Efficient procurement of scrap iron required developing relationships with various suppliers of recycled steel, specialized transportation equipment, and the like. Also, procurement of capital goods such as specialized furnaces contributes to Nucor‘s competitive advantage. Nucor has developed specialized and unique steel processing technologies that enable it to refine steel efficiently. Talent is needed for Nucor to develop and sustain its advantages in all activities. All activities listed above need to be organized, supported, and sustained through strategic investments and support systems.

3. Research Amazon. How has this firm been able to combine overall cost leadership and differentiation strategies? Response: The combination of cost leadership and differentiation strategies requires providing unique value to customers efficiently. Amazon is unique in its ability to develop proprietary technology to ease customers‘ purchasing processes, including its patented one-click ordering system, and the immense range of products available to customers along with the tremendous efficiencies built into its warehouse system. Amazon also uses its large size to develop other advantages related to buying power. It offers its suppliers large volume purchases but demands low prices. Note to instructor: Students may answer this question in a number of ways. Generally, students may be aware of Amazon as a low-price store for books and other staple products. Amazon is also well known for its ability to deliver quickly. You might challenge them to look a bit deeper into Amazon‘s operations to understand the full range of ways in which Amazon is both trying to improve its efficiency while also enhancing its customer service. Ask students what the brand 1-175 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

means to them and how this grows out of Amazon‘s actions to both cut costs and offer differentiated service. 4. Choose a firm with which you are familiar in your local business community. Is the firm successful in following one (or more) generic strategies? Why or why not? What do you think are some of the challenges it faces in implementing these strategies in an effective manner? Response: (Note to instructor) The following three steps might be useful for bringing out students‘ responses. Step 1 is to identify the firm and assess the five competitive forces that it faces. Step 2 is to ask the student to identify the firm‘s generic strategy. You need to get students to agree on the strategic target market, narrow or industrywide, and source of competitive advantage (lowcost or uniqueness). The answers will determine the generic strategy (or strategies) that the firm follows. Step 3 is to link the generic strategy(ies) to the five forces model. Are there competitive forces that remain strong threats? How could a competitor threaten the firm? And how should the firm respond to the threats? These are the basics. There are probably many challenges you can identify. Look at the challenges associated with the development of intellectual capital and the potential pitfalls of each of the generic strategies. 5. Think of a firm that has attained a differentiation focus or cost focus strategy. Are their advantages sustainable? Why? Why not? (Hint: Consider its position vis-à-vis Porter’s five forces.) Response: (Note to instructor) We suggest the following three steps. First, identify the sources of sustainable competitive advantage (valuable, rare, costly to imitate, and costly to substitute). Ask students to articulate these sources, with emphasis on the cost to imitate and cost to substitute. Second, consider the firms associated with each of Porter‘s five forces, including suppliers, buyers, potential entrants, substitutes, and rivals, especially rivals that follow other generic strategies. And third, assess the potential of each of these other firms for imitating or substituting the firm‘s product or service. Note that in a dynamic context, these other firms are constantly striving to imitate or substitute the advantages of any successful firm, so the challenge is making the right investments to maintain the advantages. It is therefore useful to ask students what kind of investments firms can make to leverage, extend, or otherwise maintain their advantages. 6. Think of a firm that successfully achieved a combination overall cost leadership and differentiation strategy. What can be learned from this example? Are these advantages sustainable? Why? Why not? (Hint: Consider its competitive position vis-à-vis Porter’s five forces.)

Response: (Note to instructor) Firms that have achieved a combination overall cost leadership and differentiation strategy usually have some sort of unique capability (discussed in the text and above in response to summary review question 6). Ask students to identify this capability and evaluate it with respect to the characteristics of a sustainable competitive advantage. Then, as for the above question, ask students to assess the ability of suppliers, buyers, potential entrants, substitutes, and rivals to imitate or substitute for this unique capability. Then ask them to assess the possibility for acquisition. Another line of questioning is to ask about other strategic capabilities the firm could be developing to sustain its competitive advantage. And ask students if the firm is maintaining its cost leadership and differentiation strategies equally. If one is weaker, then discuss how the firm can avoid becoming stuck in the middle. There are no right answers to these questions! The end result should be to raise students‘ awareness of the vulnerabilities and strengths of this combination strategy. Ethics Questions 1. Can you think of a company that suffered ethical consequences as a result of an overemphasis on a cost leadership strategy? What do you think were the financial and nonfinancial implications? Response: The ethical consequences of overemphasis on a cost leadership strategy may be associated with cost-cutting measures or reliance on experience curve effects. The strategy may not work because a competitor or substitute could offer a product or service more desirable to customers. Often, following a cost leadership strategy involves making a large investment to build scale efficient facilities, and the lag between investment and product delivery gives competitors an opportunity to enter the market with better products or services. Making such large-scale investments may involve substantial borrowing. The financial implications could be that cash flow is not sufficient to cover the interest and principle payments. Perhaps excessive borrowing to cover these financial costs could saddle the firm with an unsustainable debt burden. The nonfinancial implications may involve stress for top management. Such a situation has potential to cause unethical behavior, or wrong behavior according to business norms. Suppliers may not be paid on time. Customers may be promised unrealistic prices. Financiers could be promised payment or collateral fraudulently. And employees may be squeezed. 2. In the introductory stage of the product life cycle, what are some of the unethical practices that managers could engage in to enhance their firm’s market position? What could be some of the long-term implications of such actions? Response:

In the introductory stage, uncertainty abounds. Customers are uncertain about the value of the new product. The technology is not developed. Costs are not established. And product capabilities are not established. Unethical managerial practices may include misleading promises regarding product/service capabilities or cost. Of course, long-term implications include legal action for fraud, loss of reputation and brand equity, and loss of sales. All these can threaten the life of the firm and, by extension, the industry.

CONNECT RESOURCES Comprehension Case Renault: Challenge of Converging Calamities Case Analysis Renault: Electric Business Model Innovation Mini: Compact Car Niche Video Case Differences in Differentiation Strategy and Cost Leadership Strategy Chapter 6

Corporate-Level Strategy: Creating Value through Diversification ...............................6-2 Making Diversification Work: An Overview ................................... 6-5 Related Diversification: Economies of Scope and Revenue Enhancement ...................................................... 6-5 Leveraging Core Competencies ................................................................................ 6-6 Sharing Activities ...................................................................................................... 6-7

Related Diversification: Market Power ............................................. 6-8 Pooled Negotiating Power ........................................................................................ 6-8 Vertical Integration ................................................................................................... 6-8

Unrelated Diversification: Financial Synergies and Parenting ..... 6-10 Corporate Parenting and Restructuring ................................................................. 6-10 Portfolio Management ............................................................................................ 6-11 Caveat: Is Risk Reduction a Viable Goal of Diversification?................................. 6-12

The Means to Achieve Diversification .............................................. 6-11 1-178 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Mergers and Acquisitions ....................................................................................... 6-12 Strategic Alliances and Joint Venture ..................................................................... 6-15 Internal Development .............................................................................................. 6-17

How Managerial Motives Can Erode Value Creation .................... 6-16 Growth for Growth’s Sake ...................................................................................... 6-17 Egotism .................................................................................................................... 6-17 Antitakeover Tactics ................................................................................................ 6-18

Issue for Debate ................................................................................. 6-19 Reflecting on Career Implications .................................................... 6-20 Summary ............................................................................................. 6-21 End-of-Chapter Teaching Notes ....................................................... 6-24 Connect Resources ............................................................................. 6-30

Chapter 6 Corporate-Level Strategy: Creating Value through Diversification Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead

Whereas business-level strategy (Chapter 5) deals with the question of how to compete in a given industry, corporate level strategy addresses two related issues. These are: (1) what businesses should we compete in, and (2) how can these businesses be managed in a way to create ―synergy,‖ that is, more value by working together than if they were free-standing units. This chapter is divided into six major sections: 1.

We begin by posing the question of why some corporate-level strategic efforts fail, and others succeed? We emphasize the importance of diversification activities that create shareholder value, whether through mergers and acquisitions, strategic alliances and joint ventures, or internal development.

We address how related diversification can help a firm attain economies of scope through either leveraging core competencies or sharing activities (such as production facilities or distribution facilities).

We discuss how firms can benefit from related diversification through greater market power. Here, we address pooled negotiating power and vertical integration.

The fourth section discusses how firms can benefit from unrelated diversification. There are two key means to this end: corporate parenting and restructuring, as well as portfolio management.

The fifth section focuses on the means that firms can use to achieve diversification. The means include mergers and acquisitions, strategic alliances and joint ventures, and internal development. We discuss the advantages and disadvantages associated with each of these.

We close the chapter with a section on how managerial motives can erode value creation as firms pursue diversification initiatives. These include growth for growth‘s sake, egotism, and antitakeover tactics (e.g., greenmail, poison pills).

Lecture/Discussion Outline The Newell-Jarden case in LEARNING FROM MISTAKES discusses Newell‘s decision to acquire Jarden. The acquisition appeared to offer significant value creation potential, but it has not worked out the way the firms anticipated. Discussion Question 1: In what ways did Newell expect to generate value by acquiring Jarden? EXHIBIT 6.2 identifies the ways in which acquisitions can create value. Newell thought they could generate value in a number of ways. First, they saw opportunities in restructuring Jarden. Newell thought Jarden was not run as efficiently as possible, with the individual business units being run fairly autonomously. By applying Newell‘s more centralized business model on Jarden, the firm thought it could generate significant savings. Second, the firm thought it could improve efficiencies by sharing activities, such as having shared research and development, supply chain, and back office operations. Third, since they used some of the same inputs and sold their products through the same retailers, Newell likely anticipated that they could leverage pooled negotiating power. Discussion Question 2: Why was Newell so overly optimistic about the value it could generate? There were at least four reasons that made the firm overly optimistic about the value potential in this acquisition. First, the firm was likely overconfident in their ability to extract value from this acquisition. The firm had succeeded with a series of smaller acquisitions and had expected that they could impose their typical integration plan on Jarden. They hadn‘t considered how this acquisition differed in size and in the success of the target from their prior acquisitions. Second, and related, they hadn‘t considered cultural differences with Jarden that made integration difficult. This included the specialization and autonomy of employees, such as sales staff, that bristled in the Newell system. Third, they didn‘t account for strategic differences between the firms. Many of Jarden‘s products were more differentiated than Newell‘s, and Newell didn‘t understand that the normal sales, distribution, and promotion processes Newell used may not fit all of Jarden‘s products. Fourth, they didn‘t anticipate the challenges in the retail environment or the growing power of Amazon and Walmart that would put the squeeze on Newell‘s sales and profits. Discussion Question 3: What mistakes did Newell make in its pursuit and post-merger integration of Jarden? In its earnestness to buy Jarden, Newell did not appear to undertake or at least fully consider a full due diligence analysis of Jarden. Such an analysis allows firms to assess the financial and strategic value for and complementarity with the acquiring firm. This would have identified the cultural and strategic differences between the two firms that hampered postacquisition integration efforts. Additionally, the push for the acquisition may have been partly driven by the ego Michael Polk, the CEO of Newell. He saw tremendous value here and may have wanted to cement his legacy as a visionary CEO by bringing together two major manufacturers. In the post-acquisition period, the firm jumped in and made substantive changes before it fully understood the strategy and operating methods of Jarden. They also didn‘t appear 1-181 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

to do a great job of engaging with the employees of Jarden to understand their interests and concerns about the Newell way of operating The SUPPLEMENT below points out that even successful firms can struggle with acquisitions and that there are a number of reasons that acquisitions can fail. P&G went through a lengthy examination of its acquisition experiences to learn and improve.

Extra Example: Procter and Gambles Struggles with and Learns from Acquisitions When A.G. Lafley was the CEO of Procter and Gamble, he commissioned a study to assess the level of success and failure the firm had experienced with its acquisitions. He was shocked to find that, when they looked at the acquisitions P&G had undertaken from 1970–2000, less than 30 percent of them met the investment objectives of the acquisition and were deemed successful. They further found that failures typically resulted from one or more of the following five factors: (1) absence of a winning strategy for the combination, (2) not integrating the acquired unit well or quickly enough, (3) expected synergies didn‘t materialize, (4) cultures weren‘t compatible, and (5) leadership couldn‘t play well together. Thus, one of the root causes related to a lack of strategic logic. The other four revolved around the inability to make a potentially valuable acquisition work, often because of personal or cultural differences. However, Lafley didn‘t stop there. He was determined to have P&G learn from its mistakes. He and his team took the results of this assessment and changed their acquisition integration processes. They saw their success rate with acquisitions rose from 30 percent to 60 percent over the 2001–2010 time period, partly as a result of this exercise. Source: Dillon, K. 2011. I think of my failures as a gift. Harvard Business Review. 89(4): 86–89.

Some general questions to spur discussion and debate: Discussion Question 4: Why is it typically necessary to integrate the acquiring and acquired firm to have an acquisition succeed? Discussion Question 5: Why is it so difficult to integrate firms together after an acquisition?

Making Diversification Work: An Overview

PowerPoint Slide 4: Corporate-Level Strategy PowerPoint Slide 5: Reasons for Diversification Failures PowerPoint Slide 6 and 7: Making Diversification Work

Despite the gloomy performance of some M&As, not all deals erode profitability. Examples of successful mergers include British Petroleum‘s acquisition of Amoco and Arco, the ExxonMobile merger, and T-Mobile‘s acquisition of Sprint. The question becomes, why do some diversification efforts fail, and others succeed? At the end of the day, diversification initiatives—whether via mergers and acquisitions, strategic alliances and joint ventures, or internal development—must be justified by the creation of value for shareholders. Firms can either diversify into related or unrelated businesses. With related diversification, the primary benefits are to be derived from horizontal relationships—businesses sharing intangible resources (i.e., core competencies) and tangible resources (e.g., production facilities, distribution channels). For example, Procter & Gamble enjoys many synergies from having multiple businesses that share distribution resources. 1-182 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

With unrelated diversification, the primary benefits are derived largely from vertical relationships, that is, value that is created by the corporate office. This would include infrastructure activities such as information systems and corporate culture/leadership, sound businesses practices that have been honed by the corporation over time, and human resource practices.

EXHIBIT 6.2 provides an overview of how we will address the various means by which firms create value through both related and unrelated diversification. The exhibit also includes an overview of some of the examples that we have in this chapter.

II.

Related Diversification: Economies of Scope and Revenue Enhancement

PowerPoint Slide 8: Related Diversification PowerPoint Slide 10: Related Diversification: Leverage Core Competencies PowerPoint Slide 11: Related Diversification: Sharing Activities

Related diversification enables a firm to benefit from horizontal relationships across different businesses in the diversified corporation. There are two means for accomplishing this: (1) leveraging core competencies, and (2) sharing activities. Such horizontal relationships across businesses enable the corporation to benefit from economies of scope that refers to cost savings due to the breadth of operations. Additionally, a firm can enjoy greater revenues if two businesses attain higher levels of sales growth combined than either business could independently. The SUPPLEMENT below provides the example of John Deere—a firm whose diversification strategy is moving them from being an equipment manufacturer to a financial services company. Extra Example: John Deere Becomes a Bank to Keep Selling Tractors John Deere has been in business for over 180 years. Today, it does over $25 billion in business and is the world‘s largest manufacturer of agriculture equipment. Now, it has also become a major lender to farmers. With low prices for corn, soybeans, and wheat, farmers are finding their finances stretched and banks less willing to lend to them. John Deere has entered the gap. It has lent out billions of dollars to farmers to finance the purchase of equipment and also offers leasing programs to farmers who don‘t want to commit to the six figures it takes to buy a major piece of John Deere‘s equipment. With the challenge for farmers increasing, Deere now offers short-term credit to farmers to pay for the seed, fertilizer, and chemicals needed to produce a crop. Deere is taking these actions to prop up the sales of its products. Farm income has dropped by half in the last five years, and farm debt is the highest it‘s been in 30 years. Deere‘s efforts are making it possible for farmers to continue to replace their equipment and keep Deere‘s sales from falling through the floor. As Jayma Sandquist, VP of marketing at John Deere Financial said, ―our core mission is to support sales of equipment.‖ Even with its efforts, Deere‘s sales have fallen by over a third in the last five years but providing financing has kept the drop from being much worse. Also, Deere is able to leverage its relationship with farmers to grow its financing business which now accounts for over a third of the corporation‘s profits. Deere‘s actions also come at substantial risk for the firm. If crop prices remain low, the company and farmers are likely just delaying the pain that will come when farms fail. The firm is already starting to feel the pinch. The amount of overdue loans that Deere has on its books and the amount of loans the firm is writing off as bad debt have both doubled in recent years. If crop prices increase, this tide will turn, and farmers will be likely to get their debt under control. If not, there could soon be a debt crisis for the farming sector and for Deere.

In the end, by becoming the lender of last resort, Deere is keeping its factories humming and its sales at a decent level. What is unclear is whether this diversification will result in deeper and longer pain for the firm in the future. Source: Newman, J, & Tita, B. 2017. America‘s farmers turn to the bank of John Deere. Wall Street Journal. July 19: A1, A10.

Leveraging Core Competencies

We begin with the imagery of a tree to illustrate the concept of core competencies. Core competencies represent the root system (not the leaves) and competitors can make a big mistake if they believe a firm‘s strength is in their leaves (by analogy). Core competencies may be considered to be the ―glue‖ that binds existing businesses together or as the engine that fuels new business growth. Core competencies—to create synergy for a corporation—must satisfy three conditions:   

The core competence must enhance competitive advantage(s) by creating superior customer value. (Gillette) Different businesses in the corporation must be similar in at least one important way to benefit from the core competence. (Fujifilm) The core competencies must be difficult for competitors to imitate or find substitutes for. (Amazon)

STRATEGY SPOTLIGHT 6.1 discusses how Geely leveraged Volvo‘s core competencies to become a stronger player in the global auto market. Discussion Question 6: What are the ways Geely‘s acquisition of Volvo leveraged the value creating potential of acquisitions? If you were advising one of Geely‘s competitors, would you recommend they mimic Geely‘s actions? Why or why not? Teaching Tip: Although many companies have core competencies, not all seem to be able to leverage them. You may ask students to speculate why so many firms fail to leverage their core competencies. Possible reasons may include failure to recognize opportunities to leverage, lack of complementary competencies, or problems with culture, structure, and reward systems within the organization. This serves to reinforce the integrative nature of strategy formulation and implementation and the interconnections among the various aspects of organizational strategies, structures, and systems. B. Sharing Activities Synergy can also be achieved by sharing tangible activities across business units. These include value-creating activities such as common manufacturing facilities, distribution channels, and sales forces. Sharing activities provide two potential benefits: cost savings and revenue enhancements. 1.

Deriving Cost Savings through Sharing Activities

Cost savings come from many sources such as eliminating jobs, facilities, and related expenses that are no longer needed when functions are consolidated. We provide the examples of Shaw Industries, a leading player in the carpet industry, and General Motors. 2. Enhancing Revenue and Differentiation through Sharing Activities At times, an acquiring firm and its target may attain a higher level of sales growth together than either company could do on its own. We provide the example of Starbucks‘ acquisition of several small food and drink firms that the firm then expands throughout its store network to ramp up sales growth of these small brands. Firms can also increase the effectiveness of their differentiation strategies via sharing activities among business units. The SUPPLEMENT below discusses how Mattel is trying to enhance its revenues by diversifying into feature films.

Extra Example: Mattel is Trying to Use Movies to Enhance its Sales Mattel owns some of the most iconic toy brands in the world, including Barbie, Hot Wheels, American Girl, and Fisher-Price. Generations of kids have grown up playing with Mattel toys, but the firm has hit a hard stretch in recent years. Its sales declined by 27 percent from 2013 to 2018, and its stock price fell by 75 percent over the same period. Ynon Kreiz, the firm‘s CEO has a plan for reinvigorating the firm. His plan is to transform the firm into a media company that leverages the value of its characters and toys. Kreiz eyes the success of other firms that have appropriated the value of their characters. Disney has shown the path for decades by leveraging the value of its characters across a range of media platforms. Closer to home, Kreiz sees Hasbro‘s success bringing Transformers and G.I. Joe to the big screen. Hasbro has seen increased income directly from the movies, but more importantly, movies stoke up demand for what would otherwise be seen as mature products with limited growth potential. While Mattel has considered movie opportunities with its characters for years, it has significantly ramped up its efforts on this front under Kreiz‘s leadership. The company has announced eight film projects with four studios. It‘s working with Warner Bros on a Barbie film that will star Margot Robbie as well as a Hot Wheels movie. MGM is working on an American Girl film. Paramount, in cooperation with Tom Hanks, is developing an adventure movie focusing on Major Matt Mason, a Mattel astronaut action figure. Mattel is working with multiple studies to accelerate their move into film. As Robbie Brenner, Mattel‘s executive championing the movie effort, stated working with multiple studios allows the firm to ―progress concurrently on a number of projects at scale.‖ If they‘d signed on with one studio ―it would have taken years to do eight projects. Time will tell if Mattel can succeed like Disney and Hasbro in having strong businesses in movies and in related products.

Source: Lashinsky, A. 2019. Rewriting a toy story. Fortune, December: 99–103.

III.

Related Diversification: Market Power

PowerPoint Slide 12: Related Diversification: Market Power PowerPoint Slide 14: Related Diversification: Vertical Integration, Issues PowerPoint Slide 15: Related Diversification: Vertical Integration, Transaction Costs 1-185 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Here, we address two principal means by which firms attain synergy through market power: pooled negotiating power and vertical integration. Note that managers have limits on their ability to use market power for diversification—government regulations can sometimes restrict the ability of a business to gain very large shares of a particular market. (Also, we discuss how Walgreens wanted to acquire all of Rite Aid, but regulators Walgreens limited the deal to less than half of Rite Aid‘s stores before it was willing to approve the deal.) A.

Pooled Negotiating Power

Similar businesses working together or the affiliation of a business with a strong parent can strengthen an organization‘s bargaining power in relation to suppliers and customers as well as enhance its position vis-à-vis its competitors. We provide the comparison of an independent food producer with the situation in which the same business is part of a giant player such as Nestlé. B. Vertical Integration Vertical integration represents an expansion or extension of the firm by integrating preceding or successive productive processes. That is, the firm incorporates more processes toward the original source of raw materials (backward integration) or toward the ultimate consumer (forward integration). STRATEGY SPOTLIGHT 6.2 provides the example of Costco forward integrating by buying a distribution and delivery firm. EXHIBIT 6.3 depicts the stages of vertical integration, using Shaw Industries as an example. We address the benefits and risks of vertical integration. They are summarized in EXHIBIT 6.4. In making decisions associated with vertical integration, five issues need to be considered: 1. Is the company satisfied with the quality of the value that its present suppliers and distributors are providing? 2. Are there activities in the industry value chain that are presently being outsourced or performed by others independently that are viable sources of future profits? 3. Is there a high level of stability in the demand for the organization‘s products? 4. Does the company have the necessary competencies to execute the vertical integration strategies? 5. Will the vertical integration initiative have potential negative impacts on the firm‘s stakeholders? We discuss how vertical integration can be analyzed from the transaction cost perspective. We note that every transaction involves transaction costs: search costs, negotiating, contracting, monitoring, and enforcement. Another problem—transaction—specific investments—occurs when purchasing a specialized input from outside. Vertical integration, on the other hand involves a different set of costs—administrative. Thus, if transaction costs are higher than administrative costs, vertical integration should occur.

IV.

Unrelated Diversification: Financial Synergies and Parenting

PowerPoint Slide 16: Unrelated Diversification PowerPoint Slide 17: Unrelated Diversification: Parenting and Restructuring PowerPoint Slide 18: Unrelated Diversification: Portfolio Management PowerPoint Slide 19: Unrelated Diversification: Portfolio Management, BCG PowerPoint Slide 20: Unrelated Diversification: Portfolio Management, Limitations PowerPoint Slide 21: Example: Goal of Diversification = Risk Reduction?

We now address unrelated diversification. Here, unlike related diversification, there are few benefits to be derived from horizontal relationships, that is, the leveraging of core competencies or the sharing of activities across business units in a corporation. In unrelated diversification, the benefits are to be gained from vertical (or hierarchical) relationships, i.e., the creation of synergies from the interaction of the corporate office with the individual business units. There are two main sources of such synergies:  The corporate office can contribute to ―parenting‖ and restructuring of (often acquired) businesses.  The corporate office can add value by viewing the entire corporation as a family or ―portfolio‖ of businesses and allocating resources to optimize corporate goals of profitability, cash flow, and growth.

Corporate Parenting and Restructuring

The positive contribution of the corporate office has been referred to as the ―parenting advantage.‖ Many parent companies, like Berkshire Hathaway and Virgin Group, create value through management expertise. We provide the example of KKR, a private equity firm, whose parenting approach is used to improve the performance of multiple segments of the acquired firms‘ value chains. Restructuring is another means by which the corporate office can add substantial value to a business. Here, the corporate office tries to find either poorly performing firms with unrealized potential or firms in industries on the threshold of significant, positive change. We address three types of restructuring: Asset Restructuring, Capital Restructuring, and Management Restructuring. For restructuring strategies to work, corporate management must have both the insight to detect undervalued companies (otherwise the cost of acquisition would be too high), or businesses competing in industries with high potential for transformation. Also, they must have the requisite skills and resources for turning the businesses around—even if they are new and unfamiliar businesses. B. Portfolio Management Here, the key concept is the idea of a balanced portfolio of businesses. This consists of businesses whose profitability, growth, and cash flow characteristics complement each other and add up to satisfactory overall corporate performance. 1. Description and Potential Benefits 1-187 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The Boston Consulting Group‘s growth/share matrix is among the best known of these approaches. Each of the firm‘s strategic business units (SBUs) is plotted on a two-dimensional grid, in which the axes are relative market share and industry growth rate. EXHIBIT 6.5 illustrates the BCG matrix. We describe the labels for each of the four quadrants of the matrix— stars, question marks, cash cows, and dogs. In using a portfolio strategy approach, a corporation tries to create synergies and shareholder value in a number of ways. Since the businesses are unrelated, synergies that develop are the result of the actions of the corporate office interacting with the individual units, i.e., vertical relationships, instead of across business units, i.e., horizontal relationships. Discussion Question 7: What are the main advantages of portfolio approaches? (e.g., provides good snapshot to help allocate resources, helps determine attractiveness of acquisitions, can provide funds to business units at favorable rates, corporate office can provide high-quality review of business units, and, provides a basis for developing strategic goals and reward and evaluation systems) The SUPPLEMENT below provides an example of how VF used portfolio logic when it decided to exit the jeans business. Extra Example: VF Spins Off Lee and Wrangler VF is one of the world‘s biggest apparel maker and was widely known for the iconic jeans brands, Lee and Wrangler. But in 2019, VF spun off the jeans brands as a new business called Kontoor. With this spin off, VF concentrated its efforts on its other businesses, including Vans shoes and North Face outerwear. What led VF to decide to get out of the jeans business? The short answer is that the business looked more like a dog than a star. The growth rate in the basic jeans business is very low, driven by the maturity of the market and the shift from jeans to athleisure clothing as an everyday wear choice. Additionally, Wrangler and Lee‘s market share has been declining as major retailers, such as Walmart, increasingly push store brands. Not surprisingly, the jeans business experienced a 13 percent drop in profits in 2018. ―(Jeans) has been the weak link in the portfolio,‖ Jane Hali, head of investment research firm Jane Hali & Associates, said. ―Now they can concentrate on the outdoor coalition and Vans, a much more unified and strong stable of brands.‖ Source: Kumar, U. 2018. VF to spin off Lee and Wrangler jeans into public company. reuters.com. August 13: np.

Discussion Question 8: What do you think are some of the benefits (drawbacks) of VF‘s spin off of the jeans businesses? 2. Limitations We then provide some of the limitations and disadvantages of portfolio approaches such as the BCG matrix. Discussion Question 9: What are the primary limitations of portfolio approaches? (too simplistic—only two dimensions, ignores potential synergies across businesses, process can become too mechanical, may rely on overly strict rules to allocate resources, and, the imagery may lead to overly simplistic prescriptions) We close out the section with the example of how one company, Cabot Corporation, experienced erosion in its market position when it ―blindly‖ adopted the portfolio approach. 1-188 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Caveat: Is Risk Reduction a Viable Goal of Diversification?

In this section we briefly address the issue of whether or not diversification should be undertaken in order to reduce risk that is inherent in a firm‘s variability in revenues and profits over time. While it may make sense at ―first glance,‖ there are some limitations to such an approach. First, a firm‘s stockholders can diversify their portfolio at much lower cost than a corporation. And, second, economic cycles, as well as their impact on a given industry (or firm) are very difficult to predict with any degree of accuracy.

The Means to Achieve Diversification

PowerPoint Slide 22: Means of Diversification PowerPoint Slide 23: Mergers and Acquisitions PowerPoint Slide 24: Mergers and Acquisitions: Motives PowerPoint Slide 25: Mergers and Acquisitions: Limitations PowerPoint Slide 27: Mergers and Acquisitions: Divestment Objectives PowerPoint Slide 28: Mergers and Acquisitions: Divestment Success PowerPoint Slide 29: Strategic Alliances and Joint Ventures: Motives PowerPoint Slide 30: Strategic Alliances and Joint Ventures: Limitations PowerPoint Slide 31: Internal Development

In the first three sections of the chapter, we addressed the types of diversification (i.e., related and unrelated). Now we address the means to attain diversification. These include:    A.

mergers and acquisitions strategic alliances and joint ventures internal development

Mergers and Acquisitions

Discussion Question 10: What are the major advantages and disadvantages of mergers and acquisitions? Growth through mergers and acquisitions (M&A) has played a critical role in the success of many corporations in a wide variety of high technology and knowledge-intensive industries. Here, market and technology changes can occur very rapidly and unpredictably. In addition to speed, M&A can also be a valuable means of obtaining resources that can help an organization to expand its product offerings and services. M&A also can help companies enter new market segments. EXHIBIT 6.6 illustrates the enormous volume in global mergers and acquisitions since 2011. While there are ebbs and flows in the level of M&A activity that relate to economic conditions, there are billions of dollars worth of deals every year. The track record of acquisitions is less than stellar as described in the text. There are a number of reasons why acquisitions fail most of the time. The SUPPLEMENT below describes Parker Hannifin‘s extraordinary track record with acquisitions and the reasons behind their success. 1-189 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Extra Example: Parker‘s Successful M&A Strategy Parker, the Cleveland-based industrial products manufacturer makes an average of ten acquisitions every year. What is truly impressive is not just the number but the remarkable success they have had with these acquisitions. What do they do right?       

Parker works very hard to retain the employees of the acquired organization by communicating frequently with employees and implementing an orderly integration process. The company assigns an ―integration manager‖ to each acquired firm to get to know its employees at all levels and to make sure that they understand Parker‘s goals. They acquire only firms that they understand very well. Acquisition targets are often their former competitors. This way they already know the customers, the markets, and even the margins. They send a team of supply-chain and sales managers to each acquired firm so that they can share the best practices to get the lowest prices from their suppliers and the highest prices from their customers. They send an innovation team to acquired companies to help them launch new products. They make sure that they don‘t ram their practices down the throats of acquired firms. Instead, the emphasis is on making the managers of these firms even more successful than before. If the managers can‘t get the results they want, they don‘t hesitate to replace them. Source: Hymovitz, C. 2008. In deal-making, keep people in mind. Wall Street Journal. May 12: np.

Discussion Question 11: Do you think the above strategies will work if the acquisitions are in unrelated industries? 1. Motives and Benefits In this section, we address the potential advantages of mergers and acquisitions. These include:  Obtaining valuable resources that can help an organization to expand its product offerings and services (examples: Alphabet and Apple)  Provide the opportunity for firms to attain the three bases of synergy—leveraging core competencies, sharing activities, and building market power (examples: eBay‘s acquisitions of GSI Commerce, StubHub, Gmarket, and Shutl)  Lead to consolidation within an industry and can force other players to merge (example: the airline industry)  Enter new segments STRATEGY SPOTLIGHT 6.3 discusses how Hitachi purchase of GlobalLogic allows it to expand into the technology services market. The SUPPLEMENT below outlines how Dollar Tree benefitted by acquiring one of its key competitors Family Dollar. Extra Example: Consolidation in the Dollar Store Market The dollar store industry is dominated by three major players: Dollar General, Dollar Tree, and Family Dollar. In early 2015, Dollar Tree, the second largest player in this market, acquired Family Dollar, the industry‘s third largest firm, to create the largest dollar store firm. In completing this consolidation merger, Dollar Tree extracted value in multiple ways. First, the market became less competitive since there are now fewer competitors in the market space. Second, the combined firm will have increased market power with its suppliers. Finally, the firm shares warehouse and distribution facilities to improve firm efficiency. 1-190 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

From 2015 to 2012, the firm‘s revenue tripled, its net income nearly tripled, and its stock price rose nearly doubled. Source: Tully, S. 2015. How the dollar store war was won. fortune.com. May 1: np; finance.yahoo.com.

One of the problems with acquisitions is that acquirers tend to overpay. Acquisition premiums are often in the range of 30 percent–60 percent in normal times. The SUPPLEMENT below discusses why economic downturns are a good time to make acquisitions. Extra Example: Parker Continues to Acquire in Down Times From 2008 until 2012, economic conditions were very weak across the globe. While the United States moved out of its recession fairly quickly, other countries, especially in Europe, remained mired in recession. For Parker, this spelled opportunity. Parker, a global firm in motion and control technologies, is a serial acquirer, a firm that undertakes acquisitions regularly as a part of its normal business operations. It found the economic turbulence of recent years to provide an opportunity. The economic troubles in a number of countries resulted in significant declines in the market value of potential acquisition targets, increasing their attractiveness as acquisition targets. These troubles have also reduced the number of potential acquiring firms competing with Parker as many firms have shifted their attention to shoring up their own core operations rather than undertaking acquisitions. Parker used this period to acquire a number of companies in geographic regions in which Parker wanted to grow. For example, in 2012, Parker acquired a number of firms in India, including PIX Transmissions and John Fowler PLC. Parker also acquired Olaer Group, a British-based firm that manufacturers hydraulic system parts. While this firm is U.K.-based, it sells its products in fourteen countries. These acquisitions allow parker to diversify its product portfolio and geographic reach. By undertaking these acquisitions during a down economic time, Parker was able to achieve its strategic goal to become a broad-based, global player at attractive prices. Source: Anonymous. 2012. Parker completes acquisition of the Olaer Group in the United Kingdom. Prnewswire. July 2: np. Anonymous. 2012. Proactive acquisitions by Parker. Finance.yahoo.com. July 13: np.

Discussion Question 12: The clothing retailing industry is going through a massive downturn in recent years. Do you think this is a good time for leading firms to acquire weaker players? EXHIBIT 6.7 summarizes the potential benefits of M&As. We also discuss M&A integration practices that McKinsey Consulting has concluded facilitate integration success. 2. Potential Limitations Here, we discuss some of the possible drawbacks of mergers and acquisitions. These include:  The takeover premium can be very high (examples: Household International‘s acquisition of Beneficial an 83 percent premium; and, Conseco paid an 82 percent premium to acquire Green Tree Financial).  Competing firms can often imitate any advantages realized or copy synergies that result from the M&A.  Managers‘ credibility and ego can sometimes get in the way of sound business decisions.  Cultural issues can doom the intended benefits from M&A endeavors (example: merger between SmithKline and Beecham Group). The SUPPLEMENT below discusses a troubled merger of two major media companies. 1-191 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Extra Example: A Tragic Corporate Marriage in the Cable TV World On paper, the acquisition of Scripps Networks Interactive by Discovery Communications seemed to make a lot of sense. The two cable TV channel firms offered a complementary set of channels specializing in reality-based programming. The combined firm could generate efficiencies by combining corporate functions, with Discovery estimating it will reap $350 million in efficiency gains. The two systems could share best practices to improve the efficiency and capabilities of their networks. Finally, the combined entity has stronger bargaining power relative to cable and satellite TV service providers than each of the firms had on their own. However, below the surface, the logic for the acquisition appears less compelling. Rather than building strength, the combination brought together a large set of struggling channels that are losing out as customers change their TV habits. As customers move to smaller cable or satellite packages or to small bundles of streamed channels, the networks owned by the combined firms, such as the Discovery Channel, TLC, HGTV, and the Food Network, find their viewer base declining. With this trend, it is hard to justify the 34 percent premium Discovery agreed to pay for Scripps. Source: Gottfried, M. 2017. Reality bites for Discovery and Scripps. wsj.com. July 31; np.

EXHIBIT 6.8 summarizes the potential limitations of M&As. 3.

Divestment: The Other Side of the “M&A Coin”

Corporate managers often find it necessary to divest businesses from their portfolios. Divesting can enhance a firm‘s competitive position by reducing costs, freeing up resources, enabling management to focus on core business activities, and raising cash to fund existing businesses. We also draw on research by the Boston Consulting Group to identify seven principles for successful divestitures. B.

Strategic Alliances and Joint Ventures

Discussion Question 13: What are the major advantages and limitations of strategic alliances and joint ventures? Strategic alliances and joint ventures are assuming an increasingly prominent role in the strategy of leading firms, both large and small. Such cooperative relationships have many potential advantages. Among these are (our text examples are included): 1.

Entry into new markets (the partnership of Zara‘s alliance with Tata to enter the Indian market)

Reducing manufacturing (or other) costs in the value chain (the alliance between the PGA and LPGA to market golf and negotiate with networks)

Developing and diffusing new technologies (Alcoa and Rio Tinto to produce green aluminum)

STRATEGY SPOTLIGHT 6.4 discusses how Honda is using alliances to incorporate new technologies into its automobiles. The SUPPLEMENT below discusses how Koch Industries, a major oil firm, is using alliances to expand into the battery industry. Extra Example: Big Oil Gets Electrified Koch Industries is an energy conglomerate that has long fought environmental regulation and has funded groups that have questioned climate change. The firm has long been a pariah for environmental groups and the founders of the firm have been staunch supporters of Republican political candidates. However, the firm has switched its focus, and rather than fighting against green energy, it has become a major investor to and partner with battery technology firms. The firm has become the major stockholder in a range of battery startups and has created joint ventures with these firms to produce batteries together. For example, they have invested in Standard Lithium, a producer of Lithium, a key component of batteries. They‘ve also partnered with Freyr Batteries and Solid Power Inc., two battery manufacturers using different battery technologies. The firm‘s drive appears to be to build up the supply of battery components and manufacturing capacity for batteries in the United States. Source: Ramkumar, A. 2022. Koch Industries, built on oil, bets big on U.S. batteries. wsj.com. March 22; np.

Discussion Question 14: What is Koch Industries trying to gain by buying into the battery industry? Discussion Question 15: Why are they allying with a range of firms using different battery technologies? There are also many potential limitations associated with strategic alliances and joint ventures. Problems often arise when there is low trust among the partners and minimal attention given to nurturing close working relationships, there are limited opportunities for developing synergies, and there are not complementary strengths.

Internal Development

Firms can also diversify via corporate entrepreneurship and new venture development. In today‘s economy, internal development (or intrapreneurship) is such an important topic by which companies expand their businesses that we dedicate a major portion of an entire chapter to it (Chapter 12—which also addresses corporate entrepreneurship). Among the advantages of internal development is the ability to capture all of the value of innovative endeavors (as opposed to sharing with partners). Generally, firms may be able to accomplish it at a lower cost than relying on external funding. There are also potential disadvantages such as the time-consuming nature of intrapreneurship—which is particularly important in fast-changing competitive environments. Discussion Question 16: How can internal development endeavors be made more effective?

VI.

How Managerial Motives Can Erode Value Creation

PowerPoint Slide 32: Managerial Motives PowerPoint Slide 33: Managerial Motives: Antitakeover Tactics

In this section, we address some of the managerial motives that can erode, rather than enhance, value creation. These include ―growth for growth‘s sake,‖ excessive egotism, and the creation of a wide variety of antitakeover tactics. A.

Growth for Growth’s Sake

There are huge incentives for executives to grow the size of the firm. These include extra prestige (such as higher rankings in the Fortune 500) and compensation as well as the excitement that is generated by making the ―big play.‖ B.

Egotism

As we all know, a healthy ego makes a leader more confident and able to cope with change. However, sometimes pride is at stake, and individuals will go to great lengths to win—or at least not back down. Such behavior is often detrimental to the firm. We provide several examples of rather hostile interactions among executives after their merger. Such clashes can certainly lead to the erosion of some of the intended benefits of diversification. We also discuss ―lessons learned‖ by GE‘s Jack Welch—situations in which ego got in the way of better judgment. The SUPPLEMENT below discusses how egotism caused Mattel to fail miserably with an acquisition. Extra Example: Mattel Falls Prey to Egotism with the Learning Company In 1999, Mattel found itself in a difficult situation. Its growth was slowing, its flagship product, Barbie, was losing market share, and it did not have a strong position in computer-based games. Mattel CEO, Jill Barad, thought that the solution was for Mattel to shift its attention to the faster growing computer-based interactive games market. To move aggressively in this market, she decided to acquire the Learning Company, a maker of interactive and educational games. The price was steep—$3.5 billion which was 4.5 times the Learning Company‘s annual revenue. It turned out to be a very expensive move. Mattel found that the Learning Company was generating little free cash flow and had a stable of aging brands. To make matters worse, Mattel didn‘t have the skills to renew the product portfolio of the Learning Company. Mattel lost two-thirds of its market value after the acquisition. Jill Barad lost her job, and the Learning Company was sold off for a paltry $27 million. One of the key mistakes with this acquisition was that Mattel was overconfident in its ability to run the Learning Company. They thought that their managerial talent and knowledge could be easily transferred to run the Learning Company. What they found, instead, was that the skills needed to run a computer software company were very different from those needed to run a toy company. Also, they had little appreciation for the differences in the market dynamics of the software business. Mattel would have been much better served by focusing its attention on being the strongest competitor possible in their core market, a market where they should have had the competencies needed to build a competitive advantage. Source: Hirsch, E. & Rangan, K. 2013. The grass isn‘t greener. Harvard Business Review. 91(1): 21–23. 1-194 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 17: How can such egotistic behavior be minimized? (e.g., reward and control systems, executive selection, culture, etc.) C.

Antitakeover Tactics

Antitakeover tactics are rather common. These are efforts by management to prevent hostile or unfriendly takeovers by unwelcome suitors. Often, it is in management‘s best interests to undertake such actions—but typically they are not in the interests of the firm‘s shareholders. We discuss three types of antitakeover tactics: greenmail, golden parachutes, and poison pill. Teaching Tip: Ask the students how the managerial behaviors that erode shareholder value can be minimized. This provides you with an opportunity to reintroduce the underlying concepts of corporate governance that we introduced in Chapter 1 and will be discussed at length in Chapter 9. The core elements of corporate governance are a committed and well-informed board of directors, shareholder activism, and effective incentive and reward systems for executive officers.

VII. Issue for Debate The case examines Walmart‘s move into healthcare. Discussion Question 18: Is Walmart making the right decision to build healthcare clinics into their stores? The discussion may start with whether or not the healthcare industry is a good one to be in; if there is the potential for sales and profits in this industry. However, the key is to get students to think about whether it makes sense for Walmart to be in this industry. First, they need to determine if it is related or unrelated diversification so that you can focus on the ways to create value. While it would likely be considered unrelated if they bought an existing healthcare firm, since they are co-locating the clinics in their stores, they have made it related diversification. They are structuring it so they share the tangible resource of the store space. But where is the value in this diversification? The avenue for value would appear to be generating greater store traffic and related product sales. When patients come into Walmart for healthcare, they are likely to take the opportunity to shop, especially for health products associated with their visit. Since most Walmart stores already have pharmacies and health product sections, there is significant potential for related sales. Walmart could also conceivably use data from their healthcare unit to identify products to add to their stores or insights on how to market their products to consumers. Additionally, while the business is very different than Walmart‘s core business, students may argue that Walmart has developed strong competencies in managing efficient operations and may be able to leverage those competencies to improve the efficiency of the healthcare industry. However, students may also note that by creating somewhat separate health facilities, with external signage and entrances, the firm may be undercutting the degree to which it will drive incremental foot traffic in its stores.

Discussion Question 19: What are the risks of this effort? Most directly, the firm potentially opens itself up to medical malpractice risks. This could potentially lead to significant financial risk for the company. More broadly, any issues in its healthcare operation could damage the reputation of the firm. 1-195 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

There are also potential operational risks and costs. The significant financial investment that Walmart is making in its healthcare operations, from construction costs, to hiring costs, to purchasing medical equipment. If the business unit struggles or fails, the firm could lose these investment dollars. The firm also risks losing sales since these clinics take up store space that could otherwise be used to sell other products.

Discussion Question 20: How do you think this will change healthcare in the United States? There is no way to know for sure what ultimate outcome will be. If Walmart is able leverage its efficiency competencies in this market, they may play a significant role in forcing other healthcare providers to significantly improve their efficiency. It might also result in a two-level healthcare system, where wealthier individuals with generous healthcare plans continue to go to high-cost providers and those with limited healthcare coverage go to low cost facilities, such as those run by Walmart. However, if Walmart struggles with this venture, the effects on the healthcare system will be very minor.

VIII. Reflecting on Career Implications PowerPoint Slide 34: Reflecting on Career Implications

Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 6. 

Corporate-Level Strategy: Is your current employer a single business firm or a diversified firm? If it is diversified, does it pursue related or unrelated diversification? Does its diversification provide you with career opportunities, especially lateral moves? What organizational policies are in place to either encourage or discourage you from moving from one business unit to another?

Students are often far removed from the corporate level of their organizations; many will have only vague notions about their firm‘s corporate strategy. This would be a good opportunity to make them think about corporate strategy and how that relates to the career options they have. 

Core Competencies: What do you see as your core competencies? How can you leverage them both within your business unit as well as across other business units?

It would be a good idea for the instructor to make connection to the personal SWOT that the students performed earlier. The challenge is to make each individual think in terms of their core competency. Once they have identified their core competency, the discussion can move on to how that competency can be leveraged. This part is sometimes tricky because a student may identify his/her musical or artistic skill as their core competency. At that point, either the instructor can ask them, if indeed that is the case, why they did not leverage that in their life, or instead, ask them to identify their core competency strictly within their professional context. 

Sharing Infrastructures: Identify what infrastructure activities and resources (e.g., information systems, legal, training) are available in the corporate office that is shared by various business units in the firm. How often do you take advantage of these shared resources? Identify ways in which you can enhance your performance, taking advantage of these shared infrastructures resources.

Students will rarely have a good handle on this issue. The key point to make is that employees can enhance and demonstrate their value to their firms by leveraging the value-enhancing possibilities of the corporate office. It also may help employees build their social networks by coordinating actions with corporate officers and employees and managers in different units in the firm. 

Diversification: From your career perspective, what actions can you take to diversify your employment risk (e.g., coursework at a local university, obtain professional certification such as a C.P.A., networking through professional affiliation, etc.)? In

periods of retrenchment, such actions will provide you with a greater number of career options. While students can often easily talk of risk in terms of a financial portfolio, they have difficulty identifying and evaluating risk in the context of their own employment. The key is to make them see the parallels between investment decisions and employment choices. That is, they are investing their time, effort, and money in building human capital. Although they have thought about the returns from that investment, most have never recognized the need to diversify the employment risk. This could lead to a lively discussion.

IX.

Summary

A key challenge of today‘s managers is to create ―synergy‖ when engaging in diversification activities. As we discussed in this chapter, corporate managers do not, in general, have a very good track record in creating value in such endeavors when it comes to mergers and acquisitions. Among the factors that serve to erode shareholder values are paying an excessive premium for the target firm, failing to integrate the activities of the newly acquired businesses into the corporate family, and undertaking diversification initiatives that are too easily imitated by the competition. We addressed two major types of corporate-level strategy: related and unrelated diversification. With related diversification, the corporation strives to enter into areas in which key resources and capabilities of the corporation can be shared and leveraged. Synergies come from horizontal relationships among business units. Cost savings and enhanced revenues can be derived from two major sources. First, economies of scope can be achieved from the leveraging of core competencies and sharing of activities. Second, market power can be attained from greater, or pooled, negotiating power and from vertical integration. When firms undergo unrelated diversification, they enter product markets that are dissimilar to their present businesses. Thus, there is generally little opportunity to either leverage core competencies or share activities across business units. Here, synergies are created from vertical relationships between the corporate office and individual business units. With unrelated diversification, the primary ways to create value are corporate restructuring and parenting, as well as the use of portfolio analysis techniques. Corporations have three primary means of diversifying their product markets. These are mergers and acquisitions, joint ventures/strategic alliances, and internal development. There are key trade-offs associated with each of these. For example, mergers and acquisitions are typically the quickest means to enter new markets and provide the corporation with a high level of control over the acquired business. However, with the expensive premiums that often need to be paid to shareholders of the target firm and the challenges associated with integrating acquisitions, they can also be quite expensive. Strategic alliances among two or more firms, on the other hand, may be a means of reducing risk since they involve the sharing and combining of resources. But such joint initiatives also provide a firm with less control (than it would have with an acquisition) since governance is shared between two independent entities. Also, there is a limit to the 1-198 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

potential ―upside‖ for each partner because returns must be shared as well. Finally, with internal development, a firm is able to capture all of the value from its initiatives (as opposed to sharing it with a merger or alliance partner); however, diversification by means of internal development can be very time consuming—a disadvantage that becomes even more important in fast-paced competitive environments. Finally, some managerial behaviors may serve to erode shareholder returns. Among these are ―growth for growth‘s sake,‖ egotism, and antitakeover tactics. As we discussed, some of these issues —particularly antitakeover tactics—raise ethical considerations because the managers of the firm are often not acting in the best interests of the shareholders. Chapter 6: Corporate-Level Strategy: Creating Value Through Diversification For a company with which you are familiar, select a potential area of diversification. Provide supporting arguments for this diversification move (e.g., if it is related diversification it might involve leveraging core competences or sharing activities). Would you recommend internal development, strategic alliances/joint ventures, or acquisition as the means to achieve this diversification? Clarify your rationale. Teaching Suggestions: Key points to be highlighted in this exercise are: 

What businesses should a corporation compete in? How can a corporation create ―synergy‖ among the various business units? You can discuss the merits and demerits of related vs. unrelated diversification. Related diversification:  Synergies are realized from the horizontal relationships among businesses.  Firm creates economies of scale and scope by: o leveraging core competencies o sharing activities

You might want to explain the concepts of ―core competencies‖ and ―economies of scope‖ here.



Synergies are also realized from market power through pooled negotiating power and vertical integration.

Here you can raise questions related to the merits and demerits of vertical integration and introduce the ―transaction costs perspective,‖ which is very important in vertical integration decisions. You must also mention that creating market power would draw the attention of regulatory authorities and therefore, there are limits on creating and using market power.

   

Unrelated diversification Creates value by exploiting vertical relationships Corporate office can add tremendous value in terms of parenting and restructuring the businesses



Corporate office can add value by viewing the corporation as a family or ―portfolio‖ of businesses and allocating resources to optimize corporate goals and profitability. Value can also be added by creating appropriate support structure in terms of human resource practices and financial controls for each of its business units. Should a corporation necessarily diversify? Which method of diversification should a firm employ?

Profit maximization as a goal propels a firm to grow, and diversification becomes a means of achieving such growth. However, diversification, whether related or unrelated, comes with its own problems and therefore raises the question of whether a firm needs to diversify at all. You might want to give examples of some diversification efforts that failed. You can then discuss whether internal development, i.e., through corporate entrepreneurship and new venture development, is better than external growth through mergers and acquisitions or strategic alliances and joint ventures. This is an opportunity to discuss the merits and demerits of each of these methods of diversification.



Does diversification create value at all?

A very important question to raise: research shows that high levels of diversification, on average, destroys rather than creates value. Why, then, do firms pursue a diversification strategy? The issue of incentive structure in the U.S. corporations that rewards CEOs on the size of the firm rather than its profitability and shareholder wealth maximization needs to be discussed. You might also want to mention that egotism and antitakeover tactics encourage CEOs to go to any length to protect their ―turfs.‖ They may engage in diversification that does not create any value for the shareholders at all and, instead, destroys shareholder value. You can raise these questions regardless of the method of diversification the students come up with. This discussion will develop their ability to think critically about issues involved in diversification decisions.

End-of-Chapter Teaching Notes

Chapter 6: Corporate-Level Strategy: Creating Value through Diversification Summary Review Questions 1. Discuss how managers can create value for their firm through diversification efforts. (In text, Making Diversification Work: An Overview, LO 6-2) Response: Diversification is often costlier for firms than for investors, so firms are not doing their shareholders a favor if they diversify without creating new value. Managers can create new value by combining their operations with the new business in a way that increases the diversified firm‘s value relative to the combined value of the pre-diversified firm(s). The two primary methods for creating value are lowering costs and increasing revenue. For lowering costs, firms are able to operate in multiple businesses and generate a given level of total revenue more efficiently than if there were separate firms in each business. These lower costs are due to a number of factors, including economies of scale, leveraging core competence, shared activities, and/or vertical integration. For increasing revenue, diversified firms are able to generate more revenue than if there were separate firms in each business. The increased revenue can be due to processes such as pooled negotiating power and possibly vertical integration. 2. What are some of the reasons that many diversification efforts fail to achieve desired outcomes? (In text, Learning from Mistakes, LO 6-1) Response: Managers of diversification efforts often fail to do the very difficult job of effectively combining operations in different businesses. According to the text, diversifiers:  ―failed to effectively integrate their acquisitions‖  ―paid too high a premium for the target‘s common stock‖  ―were unable to understand how the acquired firm‘s assets would fit with their own lines of business‖  had top executives who ―may not have acted in the best interests of shareholders. That is, the motive for the acquisition may have been to enhance the executives‘ power and prestige rather than to improve shareholder returns.‖ 3. How can companies benefit from related diversification? Unrelated diversification? What are some of the key concepts that can explain such success? (In text, Related Diversification: Economies of Scope and Revenue Enhancement, LO 6-3) Response:

Related diversification is a firm entering a different business where it can benefit from leveraging core competencies, sharing activities, or building market power. Companies can benefit from related diversification through economies of scope (leveraging core competencies or sharing related activities among businesses), or market power. Market power can be exercised through pooled negotiating power, where a diversified firm can restrict or control supply to a market, or vertical integration into the buyer or supplier industry. Vertical integration enables a firm to have secure access to strategic inputs and to gain efficiencies through coordinating delivery of inputs and outputs. Unrelated diversification is a firm entering a business that uses different core competencies and operates in different markets. Companies can benefit from unrelated diversification by improving the target businesses. Two ways to improve these businesses are parenting, where the company will provide expertise and support such as improving planning, budgeting, management performance evaluation and procurement practices. The second way to improve the target business is through restructuring, which involves substantially changing the assets, capital structure, and/or management. Portfolio management is a method of assessing a corporation‘s entire portfolio of businesses, and it helps managers to determine the strategic options and contribution of each business to the corporate overall performance. For corporations with multiple unrelated businesses, portfolio management helps to develop restructuring strategies. 4. What are some of the important ways in which a firm can restructure a business? (In text, Unrelated Diversification: Financial Synergies and Parenting, LO 6-4) Response: Three types of restructuring are asset restructuring, capital restructuring, and management restructuring. Asset restructuring involves selling off unproductive assets and product lines and acquiring complementary assets needed to improve the business. Capital restructuring involves improving the debt/equity ratio, adding different classes of debt and equity. Management restructuring involves changing the composition of top management and the firm‘s organization, as well as changes to the reporting relationships and management performance evaluation criteria. 5. Discuss some of the various means that firms can use to diversify. What are the pros and cons associated with each of these? (In text, The Means to Achieve Diversification, LO 6-5) Response: Firms can diversify using mergers and acquisitions, strategic alliances and joint ventures, or internal development. Mergers and acquisitions involve joining two separate firms into one. Mergers and acquisitions enable firms to fully integrate operations; acquiring valuable resources and exploit them through leveraging core competencies, sharing activities, and building market power; consolidating the industry, and entering new market segments. The cons of mergers and acquisitions include the financial costs of the diversification, which is especially true for acquisitions. The resulting benefits may be easily imitated by the competition. Managers‘ 1-202 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

credibility may be associated with mergers and acquisitions, which may result in escalating commitment to making the diversification work and thereby suboptimal decision making. Mergers and acquisitions involve the combination of two corporate cultures, which may lead to issues that are costly to resolve. Strategic alliances and joint ventures are a method of diversification that involves collaboration with partner firms. They are a method of gaining the advantages of mergers and acquisitions without the financial costs. The benefits of strategic alliances and joint ventures are that they enable firms to achieve strategic objectives such as entering new markets, reducing manufacturing (or other) costs in the value chain, and developing and diffusing new technologies. The cons of strategic alliances and joint ventures include working with a partner who is unwilling or unable to invest adequate resources to achieve the objectives, the necessary investment in nurturing close working relationships with partner executives, and the investment in human and social capital needed to forge a successful partnership. Internal development is another way for firms to diversify, through corporate entrepreneurship. Internal development enables firms to achieve the benefits of mergers and acquisitions without the financial cost premium or the costs of combining two corporate cultures. The cons of internal development include the potential time lag to enter the new business. 6. Discuss some of the actions that managers may engage in to erode shareholder value. (In text, How Managerial Motives Can Erode Value Creation, LO 6-6) Response: Managers have engaged in diversification efforts that do not increase shareholder value. They place their own self-interest ahead of shareholders‘. The actions that managers take can be in the form of growth for growth‘s sake, egotism, and antitakeover tactics. Growth for growth‘s sake results from managers‘ desires to work in larger, more powerful organizations, which offer more challenges, excitement, recognition, power, and prestige to their managers. Egotism refers to managers‘ self-interest and greed. Managers‘ competitive nature may lead them to acquire businesses for personal satisfaction. Related to egotism is the personal largesse of some executives. Antitakeover tactics include greenmail, golden parachutes, and poison pills. These tactics can erode shareholder value, especially for existing shareholders, by either making a large payment to a potential acquirer (greenmail), making a large payment to executives (golden parachutes), or reducing share price through dilution (poison pills). Each of these diverts value from shareholders to other parties. Experiential Exercises and Application Questions 1. What were some of the largest mergers and acquisitions over the past two years? What was the rationale for these actions? Do you think they will be successful? Explain. Response: 1-203 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

(Note to instructor) The Wall Street Journal announces mergers and acquisitions on a regular basis. A quick Internet search can yield a number of major acquisitions that have been announced, along with news articles analyzing the reasons for and challenges of these acquisitions. So getting information on large acquisitions should be a straightforward exercise. As for the rationale, ask students to identify a shared core competence, shared activity, enhanced negotiating power, or vertical integration that characterizes the merger or acquisition. If these are present, then it is a related diversification. The characteristic identified above will indicate the potential benefits of the diversification. Ask students to estimate the likely costs of the merger or acquisition, including the financial cost to the acquiring firm, and compare that to the benefits. We have found it useful to refer back to the potential for imitation and the other three sources of sustainable competitive advantage (rare, valuable, costly to imitate, and costly to substitute). Are these advantages of diversification sustainable? If there is no identified shared core competence, shared activity, enhanced negotiating power, or vertical integration, then the merger or acquisition is unrelated. Ask students to identify the likely benefits from corporate parenting or restructuring. For this, students could look at the recent financial performance of the acquired firm relative to the industry averages. In addition, you can ask students to examine the portfolio of businesses of the acquired firm and conduct a portfolio analysis. 2. Discuss some examples from business practice in which an executive’s actions appear to be in his or her self-interest rather than the corporation’s well-being. Response: (Note to instructor) The business sections of most major newspapers are full of examples of executives who are greedy and in legal trouble. In addition, some students are likely to be aware of business practices in their own experience. For each identified instance, we suggest that you ask the student to describe the questionable practice and classify it as growth for growth‘s sake, egotism, antitakeover tactics. Also, identify the groups or individuals who are hurt by the executive(s). To extend the exercise, ask students if there are any modifications to corporate governance and the legal system that would limit the damage from the executives‘ actions. 3. Discuss some of the challenges that managers must overcome in making strategic alliances successful. What are some strategic alliances with which you are familiar? Were they successful or not? Explain. Response: Strategic alliances involve a number of processes, including agreement on goals of the alliance, agreement on the investment or contribution that each partner gives, agreement on the distribution of benefits and learning that the alliance generates, and agreement on a system for 1-204 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

monitoring partners‘ efforts. As strategic alliances evolve and conflicts arise, these processes may have to be renegotiated between senior managers. The success of a strategic alliance is also not obvious. Strategic alliances are not all supposed to last a long time. It may be possible for an alliance to fulfill its objectives fairly quickly and then be dissolved. Also, some alliances are successful for one partner and not the other. (Note to instructors) Students will usually be aware of the agreements for goals, investments, and distribution of earnings. But they will tend to be less aware of the need for monitoring. To prompt them, try asking about how one partner knows that the other is making sufficient investments in the alliance. In the cases where an alliance is successful for one partner but not the other, ask students how a partner can avoid this outcome. Often, the answer involves partners developing a capacity to learn from the alliance. 4. Research a company that has recently undertaken diversification into new product markets. What do you feel were some of the reasons for this diversification (e.g., leveraging core competencies, sharing infrastructures)? Response: (Note to instructors) Students should be able to identify the core competency or shared infrastructure. Ask students to identify the likely costs and benefits of the diversification in order to determine how successful it was. In addition, ask students what other products or markets the firm should diversify into in the future. 5. The Newell-Jarden merger has not generated value for shareholders. Imagine you were advising firm managers on how they could best leverage the businesses they have. Identify the key business units in the firm. Evaluate how the firm can leverage opportunities for (1) building on core competencies, (2) sharing infrastructure, and (3) increasing market power across business units. Also, evaluate if the firm should divest any of its remaining business units. Response: This is a challenging issue since Newell, like many firms, has struggled to identify where to try to create value through corporate operations without destroying value of the individual business units. To get insight on these questions, students should review Newell‘s Annual Reports and/or 10-K filings to see both an identification of the business units of the firm and how they are currently organized into larger strategic business units. Students can also research key products and brands within the firm to identify potential core competencies and areas of commonality in their value chains that could be seen as sharing opportunities. 1-205 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

6. AT&T is a firm that follows a strategy of related diversification. Evaluate its success (or lack thereof) with regard to how well it has (1) built on core competencies, (2) shared infrastructures, and (3) increased market power. (Fill answers in table below.) Response: AT&T is a diversified telecommunications services provider. It is the largest landline telephone service provider, the second largest mobile telephone company, and largest satellite TV firm in the United States. For the table below, we provide some quick notes on these diversifications. Rationale for Related Diversification 1. Build on core competencies

Successful/ Unsuccessful? Successful

2. Share infrastructures

Successful

3. Increase market power

Successful

Why? Leveraged brand name across landline and mobile telephone businesses. Use relationships with end customers to cross-sell services. Shared technology development unit across business units. Using the same cell phone tower network to support multiple mobile telephone brands (AT&T Mobile and Cricket Wireless). Combined units have better bargaining leverage with suppliers for telecommunications equipment and other supplies.

(Note to instructor) Students should be able to come up with a number of examples of how AT&T is attempting to leverage value with its diversification efforts. We suggest you take one at a time and ask students to demonstrate how it has contributed to shareholder value. For the first method—build on core competencies—ask students to first identify the core competence. This question will often be a challenge, as core competencies are complex and abstract, and therefore difficult to articulate. But it is important to do so. For the second method—shared infrastructure—ask students to identify the infrastructures. For the third method—increased market power—ask students to identify the type of market power, such as bargaining power or vertical integration. Finally, ask students to evaluate the cost of the diversification and to argue whether the benefits exceed the costs. We suggest that you ask students to defend their diversification decision to a room full of shareholders. Ethics Questions 1. It is common for firms to undertake corporate downsizing and layoffs. Do you feel that such actions raise ethical considerations? Why or why not? Response: Relevant ethical considerations might include whether the individuals laid off were treated fairly, and whether management acted to maximize firm value. At the individual level, the question would be whether those laid off received adequate severance, training, and other services to help 1-206 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

with the transition to a new job. Note that the ethical obligation to those laid-off individuals may differ from the legal requirement. At the corporate level, the question revolves around the restructuring effort. Effective strategies of unrelated diversification and then restructuring will result in a new business unit that is worth more than the cost of acquisition. If so, then we can infer that managers acted in the best interests of shareholders. If not, then we can suspect that managers acted in self-interest. 2. What are some of the ethical issues that arise when managers act in a manner that is counter to their firm’s best interests? What are the long-term implications for both the firms and the managers themselves? Response: Managers have an obligation to their shareholders or, more broadly, their stakeholders. To the extent that managers neglect stakeholders and make business decisions that serve their selfinterest, they are behaving unethically. In the chapter, we reviewed such behavior and classified three types as growth for growth‘s sake, egotism, and antitakeover tactics. These activities tend to reduce firm value, especially shareholder value, while protecting the interests of managers. The long-term implications for the firm are that firm value is reduced. The ability of the firm to compete effectively and to otherwise fulfill its corporate mission are likely to be eroded. And if a firm has managers who conducted a diversification for reasons of self-interest, and those managers were not held accountable, then it is likely that such tactics will be repeated. As a result, firm value will be further eroded. As for the managers themselves, there are two possibilities. One is that the managers will stay with their firms. In this case, the managers may continue to make diversification decisions that erode firm value. In a classical agency problem situation, the managers may be appropriating shareholder value. The second is that the managers will leave their firms, such as through a golden parachute. While these managers will receive a payoff, they are not likely to ascend to the stature they previously had. Of course, there are exceptions. Managers who diversify in self-interest once may not repeat the act. They may also be held accountable either by their board, the shareholders, the press, or through legal action. It is not likely that any manager who has faced serious censure will return to the stature he or she enjoyed.

CONNECT RESOURCES Comprehension Case IBM: New Healthcare Experts—Part 1 Case Analysis IBM: New Healthcare Experts—Part 2 Apple Maps 1-207 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Video Case Disney’s Corporate Strategy Disney's Strategic Move Dilemma: Internally Invest, Ally, or Acquire?

Chapter 7 International Strategy: Creating Value in Global Markets .................................................................................... 7-2 The Global Economy: A Brief Overview.................................. 7-4 Factors Affecting a Nation’s Competitiveness ......................... 7-5 Factor Endowments .................................................................................. 7-5 Demand Conditions ................................................................................... 7-5 Related and Supporting Industries .......................................................... 7-6 Firm Strategy, Structure, and Rivalry .................................................... 7-6 Concluding Comment on Factors Affecting a Nation’s Competitiveness ..... 7-7

International Expansion: A Company’s Motivation and Risks 7-7 Motivations for International Expansion................................................ 7-7 Potential Risks of International Expansion ............................................ 7-10 Global Dispersion of Value Chains: Outsourcing and Offshoring ....... 7-13

Achieving Competitive Advantage in Global Markets ........... 7-13 Two Opposing Pressures: Reducing Costs and Adapting to Local Markets7-14 International Strategy ............................................................................... 7-14 Global Strategy .......................................................................................... 7-15 1-208 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Multidomestic Strategy ............................................................................. 7-16 Transnational Strategy ............................................................................. 7-17 Global or Regional? A Second Look at Globalization ........................... 7-19

Entry Modes of International Expansion ................................. 7-20 Exporting .................................................................................................... 7-20 Licensing and Franchising........................................................................ 7-21 Strategic Alliances and Joint Ventures ................................................... 7-22 Wholly Owned Subsidiaries ..................................................................... 7-22

Issue for Debate ........................................................................... 7-23 Reflecting on Career Implications ............................................ 7-24 Summary ...................................................................................... 7-26 End-of-Chapter Teaching Notes................................................ 7-28 Connect Resources ...................................................................... 7-36

Chapter 7

International Strategy: Creating Value in Global Markets Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead The global marketplace provides many opportunities for firms to increase their revenue base and profitability. Also, in today‘s knowledge-based economy there are opportunities to create advantages by leveraging firm knowledge across national boundaries. However, along with the potential benefits there are pitfalls that all firms must avoid in order to be successful. After some introductory comments on the global economy, we address this topic in four major sections: 3.

We draw on Porter’s “diamond of national advantage” as a framework to explain the level of success for an industry in a given country.

We address some of the motivations as well as the risks (or pitfalls) associated with international expansion, including the emerging trend toward greater offshoring and outsourcing.

We address how firms can attain a competitive advantage in the global marketplace. Here, we focus on the two opposing forces that firms face when entering international markets—cost reduction and local adaptation. Depending on the intensity of these forces, firms should select among four basic (or generic) strategies: international, global, multidomestic, and transnational.

The final section addresses the four entry strategies that firms typically choose from when entering foreign markets. These vary along a continuum from lowinvestment/low-control (exporting) to high-investment/high-control (wholly owned subsidiaries and greenfield ventures).

Lecture/Discussion Outline The opening case in LEARNING FROM MISTAKES discusses the challenges the American auto manufacturer Ford Motor Company faces in the Chinese market. Although Ford is a successful company in the U.S. and in many other markets around the world, it recently struggled to gain traction in the Chinese market. One of the key issues in this case is that Ford builds cars that are similar around the world (a so-called world car approach). However, Chinese 1-210 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

consumers seek out cars with technological innovations such as internet connectivity and best-inclass fuel economy. Moreover, China is the largest market for electric vehicles, making a world car approach in terms of design, engineering, and marketing less feasible. Discussion Question 1: How should executives manage the tensions between attention to local tastes and the desire to cut costs in multinational companies? Response guidelines: Consider asking students about their experience in shopping for a new car in the United States (and in other countries if international students are present). Then ask them how important local adaptation is in the car sector. For instance, some students who shopped for cars in the United States may have bought cars from foreign car companies such as Volkswagen, Toyota, or BMW. Ask them about their experiences with these cars: Are there any product features that they were missing or did these companies effectively adapt their cars to the U.S. market. Can they think of any product feature that may be common in overseas markets that would differentiate these cars in the United States? A key takeaway from this question should be that some customers place great emphasize on localization while others are much more comfortable with a ―world product.‖ In the case of China, some car companies may believe that Chinese consumers are unsophisticated, and that U.S. manufacturers do not have to adapt their cars to the market. However, Chinese car consumers already have become more sophisticated and demand products that meet their idiosyncratic needs (which may be different from European and American car consumer needs). Discussion Question 2: How should Ford compete against local Chinese car manufacturers such as Geely who are uniquely positioned to understand and satisfy local customer tastes? Response guidelines: Much of the discussion should revolve around competitive intelligence (understanding Chinese car companies) and environmental scanning/monitoring. The case already hinted at Ford becoming more attune to the local Chinese market by separating the Chinese business from the broader Ford operation in the Asia Pacific region. This action of course adds cost to Ford‘s Chinese operations, but may be necessary to effectively address the needs of more sophisticated Chinese consumers (and to compete against Chinese companies such as Geely who primarily focus on serving Chinese consumers). The instructor can also point out that the need to localization is more urgent when the country has an active and competitive car industry (such as Japan with Toyota and Honda and Korea with Hyundai and Kia, and now China with Geely and BYD). This is because local car companies will put the needs of their local population first, which increases the localization pressure for foreign car companies.

The Global Economy: A Brief Overview

PowerPoint Slide 4: International Strategy PowerPoint Slide 5: International Strategy: Globalization As the title indicates, our objective here is to provide a brief summary of some key issues in the global economy. We emphasize the increase in global trade and point out that recently the trade across nations exceeded the trade within nations. We also point out that globalization has led to tremendous growth opportunities in emerging markets, with over half the world‘s output now coming from emerging markets. One of the areas of focus in emerging markets is the issue of meeting the needs of the ―bottom of the pyramid,‖ the low-income population in emerging markets. Collectively, this market of 5 billion people represents $14 trillion in purchasing power. The SUPPLEMENT below illustrates the importance of estimating demand for customers in the bottom of pyramid. Extra Example: What Do People Need and Demand at the Bottom of the Pyramid? Confusing need with demand is a common problem among organizations serving the bottom of the pyramid. Many firms have wasted time and resources trying to market products that are designed for the poor but that consumers do not actually want. A research with microfinance customers in rural India showed that when given a choice between beneficial products, such as solar-powered lanterns and low-energy stoves, and aspirational products like mobile phones and gold coins, 85 percent of customers opted for the latter. It is usually difficult to make the economics work for a product if demand must be generated, because marketing costs typically swamp efforts to keep prices extremely low. Companies should focus on areas where they can meet existing demand, with either lower-cost and better-quality products than the existing options, or simply with cheaper ones. Safaricom‘s hugely successful M-Pesa, for example, offered money transfers by mobile phone in Africa at 33 percent of the cost of Western Union—and at 20 percent of the cost of (and much greater security than) longdistance bus companies, the customary provider. Source: Karamchandani, A., Kubzansky, M. & Lalwani, N. 2011. Is the bottom of the pyramid really for you? Harvard Business Review. 89(3): 107.

Discussion Question 3: What is the implication of the example stated above? Discussion Question 4: Can the bottom of the pyramid prove to be a profitable, long-term market? The next section discusses ―Porter‘s diamond‖ and sets forth a useful context for explaining competitiveness at the national level. (This provides a framework to address how firms can create competitive advantages in the balance of the chapter.)

XI.

Factors Affecting a Nation’s Competitiveness

PowerPoint Slide 6: Factors Affecting a Nation’s Competitiveness PowerPoint Slide 7: Factors Affecting a Nation’s Competitiveness: Factor Endowments PowerPoint Slide 8: Factors Affecting a Nation’s Competitiveness: Demand Conditions PowerPoint Slide 9: Factors Affecting a Nation’s Competitiveness: Related and Supporting Industries PowerPoint Slide 10: Factors Affecting a Nation’s Competitiveness: Firm Strategy PowerPoint Slide 12: Example: Factors Affecting a Nation’s Competitiveness After conducting a four-year study, Michael Porter concluded that there are four broad attributes of nations that individually, and as a system, constitute what is termed ―the diamond of national advantage.‖ These attributes collectively determine the playing field that each nation establishes for its industries. These factors are    

Factor conditions Demand conditions Related and supporting industries Firm strategy, structure, and rivalry

The balance of this section will briefly address each of these factors and then provide an integrative example—the Indian software industry. Discussion Question 5: How do these factors—individually or jointly—affect industries in countries with which you are familiar? D.

Factor Endowments

Factors of production include not only labor, capital, and natural resources (e.g., land and minerals) but also factors that can be created. The latter are more relevant to developed nations that are seeking competitive advantage over firms in other countries. These include a skilled human resource pool, in addition to the supporting infrastructure of a country, e.g., communication and transportation systems, as well as a stable banking system. We give the example of Japan‘s expertise in JIT Systems—in part necessary because of Japan‘s expensive land costs. E.

Demand Conditions

Demand conditions refer to the demands that consumers place on an industry for goods and services. Consumers who demand highly specific, sophisticated products and services force firms to be more innovative to meet such demand. Such consumer pressure presents challenges to a country‘s industries to also make it more competitive in international markets. 1-213 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

We provide the example of Denmark‘s world-class position in water pollution control equipment. This is, in part, due to the nation‘s environmental awareness and demands for environmentally safe products. The SUPPLEMENT below discusses the growth of the international box office as the demand for imported movies grows when more fancy cinemas opened overseas. Extra Example: Hollywood Films Need Foreign Viewers Hollywood has always been an international business. In recent years, it has become dramatically more so. In the past decades, total international box office has more than doubled. The growth of box office spending overseas is a result of a cinema boom in the emerging world, a concerted effort by the major studios to make films that might play well outside the United States and a global marketing push to make sure they do. Russia‘s efforts to build superior domestic film production has helped create demand. However, the big Hollywood studios muscle domestic filmmakers aside. The imported films made more than five times as much as the home-grown products in Russia in 2010. Source: Anonymous. 2011. Hollywood goes global; Bigger abroad. The Economist. February 19: 69.

Discussion Question 6: Would the growth of the international box office alter the strategy of big Hollywood studios? How so? Discussion Question 7: How can local producers successfully compete with Hollywood? What can Hollywood do to successfully compete with local producers? F.

Related and Supporting Industries

Related and supporting industries enable firms to more effectively manage inputs. For example, countries with a strong supplier base benefit by adding efficiency in downstream activities. That is because a competitive supplier base helps a firm obtain inputs using costeffective, timely methods it contributes to reducing manufacturing costs. We provide the example of the Italian shoe manufacturing industry and the Swiss pharmaceutical industry. G.

Firm Strategy, Structure, and Rivalry

Firms develop strategies and structures to compete with other firms in the same country that are trying to capture the same customer market. Rivalry is particularly intense in nations with strong consumer demand conditions, strong supplier bases, and high new entrant potential from related industries. Such rivalry provides a strong impetus for firms to innovate and find new sources of competitive advantage. The example that we provide is the European grocery retail industry with competitors such as Aldi and Tesco.

STRATEGY SPOTLIGHT 7.1 and EXHIBIT 7.1 provide the integrative example of the Indian software industry. (This should be a rather interesting example to students because many of them may think that most of the software development is in the developed countries in North America, Europe, and Asia). Discussion Question 8: What do you believe will be the implications of the intensifying global competition in the Indian software industry? Discussion Question 9: How can India maintain its position as a leading provider of software services as the labor costs in India continue to rise? H.

Concluding Comment on Factors Affecting a Nation’s Competitiveness

Porter‘s conclusions were based on case histories from more than 100 industries. A common theme did emerge: Firms that succeeded in global markets had first succeeded in intense competition in home markets. Thus, successful global firms often result from relentless, continuing improvement, innovation, and change. We will now turn to the level of the individual firm. In the next section, we‘ll discuss a company‘s motivations and risks associated with international expansion.

XII. International Expansion: A Company’s Motivations and Risks PowerPoint Slide 13 and 14: International Expansion: Motivations PowerPoint Slide 15 and 16: International Expansion: Risks PowerPoint Slide 17 and 18: International Expansion: Managing Risks Motivations for International Expansion There are many motivations for a firm to pursue expansion into global markets. The most obvious one is to increase the size of potential markets. We note the explosive growth in middleclass consumers in Asian markets, with one estimate projecting that 60 percent of global middleclass consumption will come from Asia by 2020. Discussion Question 10: What are the implications of the growth in middle-income consumers for consumer goods and services producers? The SUPPLEMENT below illustrates how NTT is striving to enhance its growth potential and competitiveness by expanding outside the Japanese market. Extra Example: NTT Moves Boldly Beyond Its Home Market Japan‘s biggest telecommunications group is making a strong push to grow in overseas markets. As part of this push, Nippon Telegraph & Telephone Corporation (NTT) is committing billions of dollars on acquisitions, primarily 1-215 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

in the United States. The firm spent $2.4 billion on investments outside of Japan in 2014 alone. This included the establishment of a research center in California‘s Silicon Valley. NTT is taking on this effort for three primary reasons. First, the Japanese market, where NTT generates 90 percent of its $100 billion in annual revenue, is stagnant. Its goal is to grow non-Japanese sales to 23 percent of total revenue by 2016. Going overseas provides NTT with enhanced growth opportunities. Second, NTT is trying to plug into markets where cutting edge, user-centered communications technology is being developed. Building a presence in Silicon Valley offers NTT the opportunity to recruit talent and incorporate knowledge that will allow the firm to design more advanced and user-friendly systems. Finally, having operations in a given country makes it easier to build relationships and sales with customers based in that country. For example, after the firm began to build its operations in the United States, NTT won contracts with Yum Brands, the parent firm of KFC and Pizza Hut, as well as the Texas Department of Transportation. NTT also sees one additional potential benefit of growing its operations outside of Japan. The firm has long been known as having a very cautious and conservative culture. Executives hope that its foreign operations will be more competitively aggressive and risk tolerant, attributes that will help the firm thrive in the dynamic, competitive global communications industry. Source: Negishi, M. 2014. NTT makes renewed overseas push. wsj.com. August 30: np.

Discussion Question 11: What should NTT do to ensure that it seizes the benefits and minimizes the risks of growing rapidly outside of its home market? The SUPPLEMENT below illustrates an even more extreme shift in demand, the dramatic increase of demand for luxury goods in China. Some big brands adapt well in the Chinese market, as the Chinese culture somehow promotes the demand for luxury goods both in the casual and business setting. Extra Example: The Demand for Bling in China The term ―luxury‖ may mean different things to people in China nowadays. Sales of luxury goods exploded and a forecast conducted by broker CLSA estimates that sales of luxury goods will grow rapidly by as much as 25 percent per year. CLSA also predicts that China‘s share of the global luxury market will triple, to 44 percent, by 2020. Richemont, the world‘s biggest jeweler, captured a 57 percent increase in Asian sales in the last quarter of 2010. The long queues of ―bling-hungry‖ mainlanders outside big brand stores in Hong Kong paints a picture of prosperous Chinese who are less shy to show off their wealth than people in other countries. The business culture in China agrees that gifts lubricate business and many Chinese believe that the more something costs, the better it is. Source: Anonymous. 2011. China‘s luxury boom: The Middle Blingdom. The Economist. February 19: 71–72.

Discussion Question 12: What are some of the pros/cons of the growing market of luxury goods in China? Discussion Question 13: Should luxury goods producers focus a large portion of their marketing goods on China? What are some of the risks and/or benefits? Potential benefits of international expansion include (with examples we discuss):

1. 2. 3. 4.

Increased market size (Boeing‘s commercial aircraft; Microsoft; Hollywood films) Take advantage of arbitrage opportunities (financial services firms) Enhance a product‘s growth potential (soft drink producers PepsiCo and CocaCola; Procter & Gamble‘s personal care products) Optimize the location of every value chain activity (Microsoft)

The last item—optimize the location of every activity in its value chain—can yield three strategic advantages: a.

Performance Enhancement

We provide the example of Microsoft‘s decision to locate a corporate research facility in Cambridge, U.K. in order to draw upon superb technical and professional talent. b.

Cost Reduction

We discuss Nike‘s decision to source the manufacture of athletic shoes from Asian countries such as China, Vietnam, and Indonesia; and the decision of Volkswagen to build a production facility in Chattanooga, TN. c.

Risk Reduction

Here, we address the risks associated with erratic swings of exchange ratios of the U.S. dollar and other currencies (such as the Japanese yen and the Euro). Firms can cope with such risks by spreading high-cost elements of their manufacturing operations across a few carefully chosen locations around the world. Such decisions can help lower the overall risk profile of a firm with regard to currency, economic, and political risk. The SUPPLEMENT below discusses Airbus‘ logic for building an aircraft production plant in Alabama to both cut costs and reduce currency risks. Extra Example: Airbus in Alabama Airbus, the European aircraft manufacturer, announced in 2012 that it was going to begin manufacturing jets in North America. Its chosen location for this plant was Mobile, Alabama. The logic for moving production to the United States was multi-faceted. First, it gets Airbus closer to its customers. By having these planes ―made in the USA,‖ Airbus believed it would lessen the concerns of U.S. airlines and military defense buyers regarding buying from a foreign manufacturer. This decision also allowed Airbus to cut costs and minimize currency risks. Labor costs in Alabama are significantly lower and work rules are much more flexible than they are in Airbus‘ European plants. Also, Airbus lessened its currency risk. When it builds planes in Europe to sell in the United States, a currency shift can wipe out all of the profits associated with the sale of the planes. However, with parts being procured in the United States and labor costs being in dollars, Airbus is not nearly as affected by currency fluctuations. Sources: Anonymous, 2012. Coming to America. The Economist. July 7: 63. 1-217 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

4. Learning Opportunities Going global also allows firms to learn about different market conditions, R&D skills, marketing skills, organizational processes, and managerial practices. Firms can then translate that knowledge back into their home markets. We discuss how L‘Oreal, a French personal care product manufacturer, translated learning from one market into other markets in which it competed.

Discussion Question 14: What are some other examples of firms that help to illustrate the benefits from international expansion? 5. Explore Reverse Innovation Reverse innovation has become a recent important motivation for international expansion. Here, companies such as GE have committed significant resources to developing products that meet the needs of developing nations—and such innovations provide opportunities for success in wealthier companies. We discuss the potential for $3,000 cars, $300 computers, and $30 mobile phones— which are now reaching the emerging middle class in developing economies. We also address many of the implications of reverse innovation. STRATEGY SPOTLIGHT 7.2 highlights how reverse innovation can help reduce health care costs in the United States. Discussion Question 16: Can you think of other industries where there is a significant potential for reverse innovation? What would be some of the challenges? Potential Risks of International Expansion There are also many potential risks associated with international expansion. To help companies assess such risks, rating systems have been developed. EXHIBIT 7.2 depicts a sample of country risk ratings from AM Best. In the EXHIBIT, note that the lower the score, the higher the country‘s expected level of risk. Next, we address the four main types of risk: political, economic, currency, and management. 1.

Political and Economic Risk

As indicated in EXHIBIT 7.2, countries vary significantly in their level of political risk. Such risk can lead to such problems as the destruction of property, nonpayment of goods and services, and the appropriation of a firm‘s assets in a country. We also address the enforcement of laws associated with the protection of property rights and discuss how Renault was threatened with the loss of its investment in Russia if it didn‘t transfer valuable technology to its Russian alliance. We also discuss how Microsoft has lost billions of dollars in potential revenue through the piracy of its software products in many countries such as China. STRATEGY SPOTLIGHT 7.3 discusses how companies manage their overreliance on a single country during the COVID-19 pandemic by improving their supply chain resilience 1-219 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

through supply chain regionalization and screening the international business environment for early warning signs. In addition, the SUPPLEMENT below shows how some companies—such as Apple—are diversifying their supply chain to avoid overreliance on any country or region. Extra Example: Apple reduced dependence on China Apple was traditionally heavily dependent on China for the manufacturing of its iPhone. Yet, with the introduction of the iPhone 14, Apple shifted significant manufacturing capacity to India in an effort to lessen dependence on China. Part of the reasons why Apple felt the need for this manufacturing shift are Covid-related shutdowns and geopolitical tensions with China. Yet, Apple still manufactures more than 90% of Apple products in China, which may result in costly production delays if tensions between Washington and Beijing escalate anytime soon. India saw this dependence as an opportunity and made a push to get global firms such as Apple to switch high-end manufacturing from China to India. The Indian government has worked to create an open and predictable regulatory regime and a simpler corporate tax structure for Apple. One challenge Apple faces in India is the lack of skilled labor compared to what is available in China. In addition, Indian infrastructure also lacks behind those in China. Notwithstanding these challenges, Apple is determined to reduce its manufacturing dependence, planning to shift about 5%–7% of its manufacturing capacity to India. Source: Rajesh, R., & Purnell, N. 2022. Apple to cut new iPhone 14 production lag between India and China. Wall Street Journal. August 23: np.

Discussion Question 16: What actions should Apple executives take to further reduce the manufacturing dependence on China? 2.

Currency Risks

Currency fluctuations can pose substantial risks. A company with operations in several countries must constantly monitor the exchange rate between its own currency and that of the host country. We provide a hypothetical example of negative implications for an American company with overseas operations. 3.

Management Risks

Management risks may be considered the challenges and risks that managers face when they must respond to the inevitable differences that they encounter in foreign markets. These take a variety of forms: culture, language, income levels, customer preferences, distribution systems, and so on. As an example, we discuss problems that Coca-Cola had with the Greeks when they ―insulted‖ the Acropolis. The SUPPLEMENT below addresses a topic that is always interesting (and often humorous to students), i.e., when a company fails to properly adapt its marketing strategies—and slogans—to local markets. 1-220 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Extra Example: Fails in Global Branding Companies should always check whether their name, logo, or tagline means something different in the regions where they are expanding their footprint. Here are some examples of companies that have neglected this critical marketing step: 

Coca-Cola‘s brand name, when it first marketing in China, was sometimes translated as ―Bite the Wax Tadpole.‖ Coors translated its slogan, ―Turn It Loose,‖ into Spanish, where it is a colloquial term for having diarrhea. Gerber marketed baby food in Africa with a cute baby on the label without known that, in Ethiopia, for example, products usually have pictures on the label of what‘s inside because many consumers can‘t read. KFC made Chinese consumers a bit apprehensive when ―finger-licking good‖ was translated as ―eat your fingers off.‖ Mercedes-Benz entered the Chinese market under the brand name ―Bensi,‖ which means ―rush to die.‖ Nike had to recall thousands of products when a decoration intended to resemble fire on the back of the shoes resembled the Arabic word for Allah.

    

Source: James, G. 2014. Epic fails in global branding. inc.com. October 29: np.

The SUPPLEMENT below addresses some additional protocol issues that multinational firms doing business in Hong Kong must be aware of in order to be successful. Note how they vary from customs in the United States. Extra Example: Protocol Issues in Hong Kong Gestures:  

Members of the same sex may hold hands to signify friendship, but members of the opposite sex may not. Although women may cross their legs, men should keep their feet on the floor. Place your hands in your lap while sitting. The Chinese may communicate in closer proximity than is common in the United States. Do not pat people on the shoulder or initiate any physical contact. It is not appreciated. ―Come here‖ is signified by turning the palm face down and waving the fingers.

   Gifts: 

Gift giving is an intricate and important custom in Hong Kong. The best-intentioned businessperson can offend counterparts by giving

1. 2. 3. 4. 5.

Clocks (they connote death) Books (they represent a ―Curse to Lose‖ for gamblers) Blankets (they stifle the recipient‘s prosperity) Unwrapped gifts (this is rude) Gifts wrapped in blue (the color of mourning) Source: Morrison, T., Conaway, W. & Borden, G. 2000. Kiss, Bow, or Shake Hands. Diane Publishing Company: 159.

Discussion Question 17: Can you think of a situation in which firms entering foreign markets should not adapt their management practices to local conditions?

Teaching Tip: Cross-cultural examples are typically very interesting to students. Although we provide examples in this section, as well as in the SUPPLEMENT above, it is always useful to ask students what examples they can come up with—both from their business courses as well as from personal experience. It also provides an opportunity to get some insights from the international students in the class.

Global Dispersion of Value Chains: Outsourcing and Offshoring This section addresses two of the emerging trends in international business—outsourcing and offshoring. Outsourcing occurs when a firm decides to utilize other firms to perform valuecreating activities that were previously performed in-house. Offshoring takes place when a firm decides to shift an activity that they were previously performing in a domestic location to a foreign location. It is important to point out that the movement of jobs offshore in the manufacturing sector was repeated by the service sector as well in the mid-1990s. However, the trend that began with low-level programmers and data entry work to countries such as India has grown many-fold to include a wide variety of white collar and professional activities ranging from call centers to R&D. To survive, companies have to locate each stage of the value chain in places where factor conditions are most conducive. The SUPPLEMENT below addresses a ―global delivery‖ approach, which is indicative of the extent to which outsourcing and offshoring have become part of global commerce. Extra Example: Outsourcing‘s global delivery model The use of offshore providers of information technology, human resource management, and other services is central to today‘s global expansion. In fact, many service providers are pursuing a global delivery model that permits them to fulfill their outsourcing obligations from offices around the world. For example, BT (formerly British Telecom), the UK telecom giant, outsourced its human resources operation to Accenture. To fulfill this task, Accenture used offices in India, the Czech Republic, and the United States, and the U.K. Dutch bank ABN Amro outsourced its IT operations to five companies. One of them is Tata Consultancy, which used employees in Mumbai, Bangalore, Budapest and Luxembourg to do the work. In another deal, Tata signed a joint agreement with Microsoft and a branch of the Chinese government to create a software joint venture to supply IT outsourcing services. Nearly half of the 5,000 employees Tata used for the job are employed in Latin America—Brazil, Uruguay, and Chile. Source: Dolan, K. A. 2006. Offshoring the Offshorers. Forbes, April 17: 74–76.

We also discuss the challenges of offshoring and why many firms are finding the realized cost benefits from offshoring to be much less than they anticipated. This has led a number of firms to re-shore their manufacturing.

XIII. Achieving Competitive Advantages in Global Markets PowerPoint Slide 19 and 20: International Strategies: Opposing Pressures PowerPoint Slide 21: International Strategies: Opposing Pressures, Chart PowerPoint Slide 22: International Strategy PowerPoint Slide 23: International Strategy, Strengths, Limitations PowerPoint Slide 24: Global Strategy PowerPoint Slide 25: Global Strategy: Strengths, Limitations PowerPoint Slide 26: Multidomestic Strategy PowerPoint Slide 27: Multidomestic Strategy: Strengths, Limitations PowerPoint Slide 28: Transnational Strategy PowerPoint Slide 29: Transnational Strategy: Strengths, Limitations PowerPoint Slide 31: International Strategies: Global or Regional? In this section, we begin by addressing the two opposing forces that firms face when they expand into global markets—cost reduction and adaptation to local markets. Then, we address the four basic types of international strategies that they may pursue—international, global, multidomestic, and transnational. A.

Two Opposing Pressures: Reducing Costs and Adapting to Local Markets

Approximately two decades ago, Ted Levitt advocated strategies that favored global products and brands that rested on three key assumptions.   

Customer needs and interests are becoming increasingly homogeneous worldwide. People around the world are willing to sacrifice preferences in product features, functions, design and the like for lower prices at high quality Substantial economies of scale in production and marketing can be achieved through supplying global markets.

We provide evidence that refutes each of the three assumptions. There are, of course brands such as Boeing and Coca-Cola that have developed products that are relatively unchanged throughout the world. Discussion Question 18: What are some other examples of global products and services that defy these assumptions? EXHIBIT 7.3 shows the conditions under which each of the strategies—international, global, multidomestic, and transnational—would be most appropriate. The strategies reflect their position on the two opposing forces—lowering costs and local adaptation. It is important to note that the following strategies are considered to be ―basic‖ or ―generic.‖ In practice, all firms will tend to have some elements of international, global, multidomestic, and transnational strategies. 1-223 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

International Strategy

As indicated in EXHIBIT 7.3, a firm without a strong emphasis on either differentiating their product and service offerings in order to adapt to local markets or on lowering costs is following an international strategy. An international strategy is based on diffusion and adaptation of the parent company‘s knowledge and expertise to foreign markets. Although country units are allowed to make minor adaptations to local markets, they have far less autonomy than local managers who operate under a multidomestic strategy.

Risks and Challenges Some of the risks of an international strategy include: 

The international strategy, with its tendency to concentrate most of its activities in one location, fails to take advantage of the optimally distributed value chain.



The strategy is susceptible to high levels of currency and political risks. Being too closely identified with a single country, an increase in the value of the currency may make the product or service unattractive abroad.

EXHIBIT 7.4 summarizes the strengths and weaknesses of international strategies in the global marketplace. C.

Global Strategy

As indicated in EXHIBIT 7.3, a firm whose emphasis is on lowering costs tends to follow a global strategy. A global strategy emphasizes economies of scale—due to the standardization of products and services as well as the centralization of operations in a few locations. We provide the example of Siebel Systems (now part of Oracle Corp.), the $2 billion developer of e-business applications software. Their CEO and founder, Tom Siebel, emphasizes global standardization. 1.

Risks and Challenges There are, of course, some risks associated with a global strategy. Including: 

 

A firm can enjoy scale economies by concentrating scale-sensitive resources and activities in one or a few locations. Decisions about locating facilities must weigh the potential benefits from concentration against higher transportation and tariff costs. The geographical concentration of any activity may also tend to isolate that activity from the targeted markets. Concentrating an activity in a single location also makes the rest of the firm dependent on that location.

EXHIBIT 7.5 summarizes the strengths and weaknesses of global strategies. Discussion Question 19: Can you think of other global strategies that failed? Why did they fail?

Multidomestic Strategy

As indicated in EXHIBIT 7.3, a firm whose emphasis is on differentiating their product and service offerings in order to adapt to local markets follows a multidomestic strategy. In contrast to a global strategy, which tends to be highly centralized, decisions are more decentralized to enable the firm to tailor its products and services to rapidly respond to changes in demand. To illustrate, we provide the example of how Kraft adapted the Oreo cookie and some of its other iconic brands to better match the tastes of customers in several countries. The SUPPLEMENT below discusses the changing views on bribery and its mixed consequences. Extra Example: The Economics of Bribery Managers of multinational firms often experience dilemmas when it comes to adjusting to the norms of foreign countries in which they operate. One especially difficult choice is whether or not to participate in bribery to get projects moving forward or to get approvals needed. According to a survey by Ernst & Young, 39 percent of businesses say that corruption is a common problem in the countries where they competed. Interestingly, the proportion of managers who believe it is justified to bribe an official to win business in difficult times rose from 9 percent in 2011 to 15 percent in 2012. From one perspective, this rise may be logical. One study looked at the costs and benefits of bribery and found some evidence that bribery pays off. This research found that firms who bribed public officials to win a contract experienced positive returns for its shareholders to the effect of 10–11 times the cost of the bribe. However, the payoff may be short lived. A second study found that when firms faced a bribery enforcement action, the stock price of the firm dropped by 9 percent. Source: Anonymous, 2012. You get what you pay for. The Economist. June 2: 89.

Discussion Question 20: Are their situations where it is justified to bribe an official to win a contract? Does it make it more acceptable if it makes economic sense? When companies cross national borders they typically encounter different cultures. STRATEGY SPOTLIGHT 7.4 illustrates some ways multinational companies such as Netflix adapt their product offerings to foreign markets. The SUPPLEMENT below illustrates related benefits and challenges in the global furniture industry. Extra Example: Ikea adapting their products to local markets In 2018, after years of planning and waiting, Ikea finally opened its first furniture store in India. When viewed from the outside, the new Ikea store looks remarkably similar to other stores around the world—huge footprint and blue exterior. However, a closer look into the Ikea store reveals subtle differences. For instance, Ikea changed the wood used for many of its furniture. While untreated pine furniture is very common in Europe and North America, the humid climate in India makes untreated wood a ―no-go‖. In addition, many Indians clean their floors using water, meaning the Swedish furniture giant needed to add risers to keep the furniture from getting wet.

Ikea applies the same general business idea and offers most products in all stores around the world, but the company makes sure to keep an ear to the market by sending Ikea representatives into the homes of foreign customers, asking about customer needs and how they shop. Take Ikea in China as an example: many Chinese homes have balconies, leading Ikea to showcase different furniture setups for balconies in its showrooms. Ikea even goes as far as to show different balcony setups for different Chinese regions: Southern Chinese Ikea stores show balconies used to dry clothes while northern Ikea stores show balconies used to store food—all in line with customer habits. However, even Ikea does not always get it right on the first try: In the United States, for instance, Ikea used to offer drinking glasses that were simply too small for U.S. households. The result: Its U.S. customers bought an uncommonly large number of vases (which were used to drink out of!). Source: Schwab, K. 2018. How Ikea quietly tweaks its design around the world. Fast Company. August 10: np.

Discussion Question 21: The Ikea example nicely illustrates that it is not just the product offering that needs to be adjusted around the world but also value chain activists such as store design. What risks do you see if companies would only adjust their products to foreign tastes but keep other value chain activities substantially similar around the world? 1.

Risks and Challenges

As one might expect, there are some risks associated with a multidomestic strategy. These include that   

Typically, local adaptation of products and services will increase a company‘s cost structure. At times, local adaptations, even well-intentioned, may backfire. Consistent with other aspects of global marketing, the optimal degree of local adaptation evolves over time.

EXHIBIT 7.6 summarizes the strengths and weaknesses of multidomestic strategies. E.

Transnational Strategy

Multinational firms following a transnational strategy strive to optimize the trade-offs associated with efficiency, local adaptation, and learning. It seeks efficiency not for its own sake, but as a means to achieve global competitiveness. It recognizes the value of local responsiveness, but as a tool for flexibility in international operations. Also, a core tenet of the transnational model is that a firm‘s assets and capabilities are dispersed according to the most beneficial location for a specific activity. We provide the perspective of Peter Brabeck, Nestle‘s former Chairman. He points out both the multidomestic and global aspects of his firm‘s strategy. It also illustrates whether or not to centralize or decentralize a value-chain activity. Generally speaking, activities that are ―downstream‖ (such as marketing and sales) tend to be decentralized because of the need to be closer to the customer. On the other hand, activities that are ―upstream‖ (such as logistics and 1-227 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

operations) tend to be centralized because there are generally few reasons to tailor them to local market conditions. STRATEGY SPOTLIGHT 7.5 discusses how Panasonic has balanced the tensions and leveraged the benefits of a transnational strategy. The SUPPLEMENT below discusses how firms need to respond to the contextual settings in which they operate—a key attribute of transnational firms. Extra Example: The Need for Contextual Intelligence Most entrepreneurs and managers agree, for example, that creating value and motivating talent are at the heart of what they do. But once you drill below the homilies, differences quickly emerge over what constitutes value and how to motivate people. That‘s because conditions differ enormously from place to place, in ways that aren‘t easy to codify—conditions not just of economic development but of institutional character, physical geography, educational norms, language, and culture. Successful managers understand that their experiences may not directly translate to other markets. Thus, they strive to develop contextual intelligence, which is defined as the ability to understand the limits of one‘s knowledge and to adapt that knowledge to an environment different from the one in which it was developed. Firms can develop contextual intelligence in a number of ways. First, the firm should work to build a human resource set that provides flexible and integrated knowledge. They can do this by hiring individuals ―fluent‖ in more than one culture, developing local talent in countries they wish to enter, rotate corporate employees into extended work roles in global locations, and align incentives with local expectations and motives for cultural norms. The firm should also take the time to research markets they are entering to better understand key cultural elements, the nation‘s institutions, the ways in which products are marketed and buying decisions are made, and how individual customers and employees interact. Source: Khanna, T. 2014. Contextual Intelligence. Harvard Business Review. September: 59–89.

Risks and Challenges

As with global and multidomestic strategies, there are some unique risks and challenges associated with transnational strategies: 

The choice of a seemingly optimal location cannot guarantee that the quality and cost of factor inputs (i.e., labor, materials, etc.) will be optimal. Managers must ensure that the relative advantage of a location is actually realized, not squandered because of weaknesses in productivity and the quality of internal operations.



Although knowledge transfer can be a key source of competitive advantages, it does not take place ―automatically.‖ It is important that business units and the headquarter office both recognize the potential value of such ―know-how.‖

EXHIBIT 7.7 summarizes the relative advantages and disadvantages of transnational strategies. 1-228 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The SUPPLEMENT below addresses how Johnson & Johnson successfully implements elements of a transnational strategy. With transnational strategies, some value creating activities are centralized (usually upstream and support activities) and some value creating activities are decentralized (generally downstream activities). However, with decentralization, control and coordination become major challenges. The SUPPLEMENT below discusses how Johnson & Johnson has successfully dealt with this challenge.

Extra Example: J&J‘s Decentralized Structure Johnson & Johnson today operates in 57 countries with 250 operating companies. How does one manage a company with so many different products and operations in so many different countries? Obviously, trying to concentrate all decision-making authority at the New Brunswick, NJ, corporate office would create a huge bottleneck. So what is J&J‘s solution? Decentralization. But at J&J, decentralization has been carried to an extent that most other companies would find impossible to replicate. Because of its extreme decentralization, the managing directors of operating companies have enormous freedom to run their businesses. But where do you find that many entrepreneurial managers to run its highly decentralized businesses? This is where management development plays a crucial part. Managers in their early years are rotated through different business segments systematically so that they become broadly developed. For example, Sheri McCoy, the incoming head of pharma, started in consumer R&D, and then served in the devices and diagnostics group before being promoted to the head of pharma. Decentralization of such a scale can potentially have two negative consequences. First, the corporate office can lose control. Second, efficiencies and scale advantages may be lost. How does J&J avoid these undesirable outcomes? They standardize processes in staff and support areas like procurement, human resources, and IT, but not in operations. The standardization of processes ensures control and cost reduction while decentralization facilitates operational freedom. Source: Colvin, G., & Shambora, J. 2009. J&J: Secrets of success. Fortune. May 4: 117–121.

Discussion Question 22: What are some of the control challenges J&J would face as they expand into more countries? F.

Global or Regional? A Second Look at Globalization

Full-scale globalization may not be the best strategic move for many types of firms. Recent research indicates that most companies are regional or, at best, bi-regional rather than global. Considering the advances in communication why is this so? Several reasons are suggested: distance still matters, despite improved communications; trading blocs exercise power over regions; and regional integration occurs faster than global integration. The SUPPLEMENT below extends the discussion of the importance of regional growth in the overall globalization trend.

Extra Example: Growth in Regional Trade Fuels Global Expansion In his Harvard Business Review article ―Regional strategies for global leadership,‖ Pankaj Ghemawat explains that regional strategies are not just a halfway measure between local strategies and global strategies but represent a unique set of strategies that leverage economic, cultural and administrative similarities to boost company performance. This is evidenced in part by the extent to which regional initiatives dominant cross-country activity during the second half of the 20th century. For example, increases in intraregional trade have outpaced global trade in Oceania and Asia for over forty years. In 1958, 35 percent of the trade in Asia and Oceania occurred between countries in that geographic region. By 2000, within-region trade exceeded 50 percent of the trade in the AsiaOceania region. Globally, between 1958 and 2000, the amount of trade within regions increased from 47 percent to 55 percent. These and other statistics led Ghemawat to conclude that ―increasing economic integration through international trade has been accompanied by increasing rather than decreasing regionalization‖ (p. 101). Source: Ghemawat, P. 2005. Regional strategies for global leadership,‖ Harvard Business Review, December: 97– 108.

XIV. Entry Modes of International Expansion PowerPoint Slide 33: International Strategies: Entry Modes PowerPoint Slide 34: International Strategies: Entry Modes, Chart A firm has many options available to it when it decides to expand into international markets. EXHIBIT 7.8 depicts a variety of modes of foreign entry that include exporting, licensing, franchising, strategic alliances, joint ventures, and wholly owned subsidiaries. As the exhibit indicates, these various types of entry form a continuum that ranges from exporting (low investment, low risk) to wholly owned subsidiaries (high investment and risk, high control). A.

Exporting

Exporting consists of producing goods in one country and selling them in another. This mode enables a firm to invest the least amount of resources in terms of product, its organization, and its overall corporate strategy. Not surprisingly, many host countries dislike this entry strategy because it provides limited opportunities for local employment. 1.

Benefits

Exporting has both advantages and disadvantages. Its advantages are that it is a low cost/risk way to enter foreign markets, and it may provide the firm with local distributors who can help them benefit from their valuable expertise and knowledge of local markets. After all, multinationals must recognize that they cannot immediately master local business practices, meet regulatory requirements, hire and manage local personnel, and gain access to potential customers.

Risks and Limitations

There are also some disadvantages associated with exporting. Firms have little ability to tailor their products to match the local market demands. Also, along with the lower cost/risk benefit comes less control. A firm‘s exporting partner may carry lines that compete with the firm‘s products and they may not be willing to share market information with the exporting firm. Furthermore, the exporting firm has little control over how their products are marketed or sold in the foreign market. We provide some insights from a study that explored factors that explained the differential rates of success that companies found in using distributors. The SUPPLEMENT below discusses Loctite‘s (a specialty adhesives company) insights on selecting partners to distribute their product. Extra Example: Loctite‘s Insights on the Selection of Distributors in International Markets ―We increasingly look for what we have come to call ‗company fit‘—a partner with a culture and a strategy we feel comfortable with, in terms of the investment they‘ll make, the training they‘ll give their people, and the support they‘ll ask from us,‖ says the Loctite executive. ―In many cases, this leads us to partners who have no experience with our market. The first couple of times, this felt risky, but our success with some of these partnerships made us bolder in choosing distributors.‖ In effect, this means bypassing the obvious choice—a distributor who has the right customers and can therefore generate quick sales—in favor of a partner with a greater willingness to invest and an acceptance of an open relationship that draws on the multinational‘s experience in marketing its own products. Source: Arnold, D. 2000. Seven rules of international distribution. Harvard Business Review, 78 (6): 135.

Discussion Question 23: What are some examples of successful (or unsuccessful) exporting? B.

Licensing and Franchising 1.

Benefits

Licensing and franchising are both forms of contractual arrangements. Franchise contracts typically include a broader range of factors in an operation and have a longer period during which the agreement is in effect. Franchising has the advantage of limiting the risk exposure that a firm has in overseas markets while expanding the revenue base of the parent company. 2.

Risks and Limitations

The other side of the coin, of course, is that the multinational firm receives only a portion of the revenues in the form of franchise fees instead of the entire revenue—as would be the case if they set up the operation themselves (such as a restaurant) through direct investment.

Strategic Alliances and Joint Ventures 1.

Benefits

Joint ventures and strategic alliances have become an increasingly popular way for firms to enter and succeed in foreign markets in recent years. These two forms of partnerships differ in that joint ventures entail the creation of a third-party legal entity, whereas strategic alliances do not. In addition, strategic alliances generally focus on initiatives that are smaller in scope than joint ventures. 2.

Risks and Limitations

In Chapter 6 (corporate-level strategy) we addressed some of the major advantages and disadvantages of these forms of collaboration. In addition to the usual issues, cultural differences can create additional challenges in making strategic alliances and joint ventures work. In the SUPPLEMENT below, we discuss Danone‘s successful joint venture with China Mengniu Dairy. Extra Example: Managing International Strategic Alliances ―Managing international alliances makes cultural differences especially salient. But my research…on foreign acquisitions of domestic companies made clear that national cultural differences are often less important sources of problems than company style differences. Those involved in alliances and partnerships must respect diverse cultural traditions and values, whatever their source. They must deal with fuzzy social variables such as trust and reputation and soft skills such as empathy and understanding to build relationships of mutuality. These fuzzy intangibles are increasingly recognized as having value for economies as well as businesses. The economic prosperity of nations, regions, and communities benefit from stocks of ―social capital‖ and trust in institutions.‖ Source: Kanter, R. M. 1999. Change is everyone‘s job: Managing the extended enterprise in a globally connected world. Organizational Dynamics, 28(1): 21.

We also discuss how some companies such as Hewlett-Packard have carefully documented alliance-management knowledge by creating guidelines and manuals to help them manage specific aspects of the entire alliance cycle. Discussion Question 24: What are some other examples of successful (or unsuccessful) strategic alliances and joint ventures? D.

A wholly owned subsidiary is a situation in which a multinational company owns 100 percent of the stock in the venue. There are two means by which a firm can establish a wholly owned subsidiary: acquisition of an existing company or developing a totally new operation, termed a ―greenfield venture.‖

Benefits

Wholly owned subsidiaries are most appropriate when a firm already has the appropriate knowledge and capabilities that can be readily leveraged through multiple locations. We provide the example of Intel‘s building of semiconductor plants overseas. Knowledge can be further leveraged by hiring managers and professionals from the home country. 2.

Risks and Limitations

While assuring the most control, wholly owned subsidiaries also are typically the most expensive and risky of the various modes of entry. Unlike strategic alliances and joint ventures, for example, the entire risk is borne by the corporation. The risks associated with doing business in a new country—such as the political, cultural, and legal nuances—may be mitigated by hiring local talent. Discussion Question 25: What are some other examples of successful (or unsuccessful) wholly owned subsidiaries?

XV. Issue for Debate This case focuses on the political strategy of Airbus—a major European airplane manufacturer. Many students may not be familiar with the heavy political influence in Airbus‘ operations not only in its European home market, but also in its international operations. This is particularly relevant now since Airbus sells most of its jetliners to airlines outside of Europe. The case illustrates some benefits of political influence, such as preferred access to loans and knowledge. In addition, Airbus‘ need to maneuver the political landscape in Europe led to hard to duplicate resources such as logistic skills and capabilities to lobby and influence the political process. On the negative side, Airbus may make itself vulnerable to foreign interferences, such as unwanted knowledge transfer and political holdup problems. Discussion Question 1: Should Airbus expand its investments and partnerships in China given the increasing competition from Chinese companies? Every American and European CEO eyes the Chinese market for its current potential and future growth. Many U.S. companies (eBay, Uber, and Facebook) admitted defeat and made room for Chinese versions of their business models (Taobao, Didi, and Weibo). How should Airbus manage the conflict between entering a lucrative market (the Chinese commercial aircraft market is projected to become the largest market for aircrafts in the world by 2022) and securing its future competitive position (given the risks of technology and knowledge transfers)? Boeing has chosen a risky approach and created a JV with Commercial Aircraft Corporation of China (Comac; a state-run Chinese aircraft manufacturer) in 2017. Discussion Question 2: Can you think of other areas in which Airbus can leverage its expertise in navigating political forces? 1-234 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Airbus‘s political capabilities may allow the European aerospace firm to gain an advantage in other markets that need government approval. One such market is the emerging mobility market in air taxis (see these WSJ articles: https://goo.gl/o1E8PP and https://goo.gl/ZbF8vb).

XVI. Reflecting on Career Implications PowerPoint Slide 35: Reflecting on Career Implications Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 7. International Strategy: Be aware of your organization‘s international strategy. What percentage of the total firm activity is international? What skills are needed to enhance your company‘s international efforts? How can you get more involved in your organization‘s international strategy? For your career, what conditions in your home country might cause you to seek careers abroad? The goal of this reflection is to raise students‘ awareness of the international scope of their firms‘ operations and how it may affect their careers. Students may not be aware of their firms‘ international activity, and therefore instructors may have to provide an example from a well-known firm. Specific data are not really needed. The first step would be to describe what is meant by ―total firm activity‖ that is foreign. Ask students what foreign activity is. Perhaps it refers to percent of sales in foreign markets, or percent of inputs obtained from abroad, or percent of new investments in foreign countries, or percent of competitors that are from foreign countries, or percent of stock owned by foreign residents. There are a great many ways that firms can be involved in international activity. The implication for students‘ careers is that there is much more to managing in an international environment than taking a foreign assignment. During their careers, students are likely to negotiate supply contracts with foreigners, conduct competitor analysis of foreign firms, and deal with foreign shareholders. Much of the future business world is likely to be international. In this international environment, students may have to develop a range of new skills. Ask students what these skills may be? They are likely to include more than language skills. Cultural awareness, international geography, and establishing intercultural interpersonal relationships come to mind. These skills will take time and effort for managers to develop. The point here is to increase students‘ awareness of the human capital requirements for the international business environment. Can students have a domestically focused career? Ask students if any of them plan to avoid the international business environment during their careers. For students who see their careers as involving foreign operations, ask how they plan to get involved. Taking a foreign assignment or handling a foreign account are possibilities. The sooner the students take these positions, the steeper their learning curve. There is much to learn, and these internationally1-235 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

focused students will get a head start. For the domestic students, instructors can remind them that foreign investment in the United States is increasing, as is trade as a percent of GNI. Why is the economy becoming international? Reasons include the need for low cost supplies, improved international trade, travel, communications, and financial infrastructures, and the growth of multinational corporations. The economy is becoming more international, and even ―domestic‖ firms may be impacted. Outsourcing and Offshoring: More and more organizations have resorted to outsourcing and offshoring in recent years. To what extent has your firm engaged in either? What activities in your organization can/should be outsourced or offshored? Be aware that you are competing in the global marketplace for employment and professional advancement. What is the likelihood that your own job may be outsourced or offshored? In what ways can you enhance your talents, skills, and competencies to reduce the odds that your job may be offshored or outsourced? Outsourcing and offshoring have been described in the chapter, as well as the conditions under which firms will engage in them. The goal of this discussion is to make the trends more relevant to students‘ careers. It would be nice if there were some students who worked for large organizations that have a large involvement in international outsourcing and offshoring. If this were not the case, then instructors can refer to a typical Fortune 500 firm. Now ask students if their jobs could be outsourced. Could foreigners do their jobs for less money? Given that firms have the option to outsource and offshore a growing variety of positions, how can students reduce the chance that their jobs get done by foreigners? In the discussion, it may be relevant to refer to the resource-based view of students‘ skills and capabilities. How can students make their skills rare, valuable, costly to imitate, and costly to substitute? In the discussion, note that technical skills, such as financial or accounting analysis, may be vulnerable. Less vulnerable are skills that are embedded in the firm‘s social system. Linking the discussion to the types of nuanced and complex capabilities that result from experience may be relevant. International Career Opportunities: Taking on overseas assignments in other countries can often provide a career boost. There are a number of ways in which you can improve your odds of being selected for an overseas assignment. Studying abroad for a semester or doing an overseas internship are two obvious strategies. Learning a foreign language can also greatly help. Anticipate how such opportunities will advance your short- and long-term career aspirations. One way to approach class discussion on this issue is to discuss the issue of moving. Some students may have moved away from home in order to go to college. Others may have travelled abroad for a period of 6 months or more. The experiences of international students may also be relevant. The point is that such moves are difficult. They involve loneliness, hardships, and personal adjustment challenges. However, there are benefits too. Learning to deal with moving can improve students‘ intercultural capabilities, ability to be effective in international management, and therefore add value to their firms. The point is to suggest to students that 1-236 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

experiences such as long-term travel, study abroad, or other international opportunities have merit and should be considered. Management Risks: Explore ways in which you can develop cultural sensitivity. Interacting with people from other cultures, foreign travel, reading about foreign countries, watching foreign movies, and similar activities can increase your cultural sensitivity. Identify ways in which your perceptions and behaviors have changed as a result of increased cultural sensitivity. In today‘s global culture, many students may already be exposed to international culture. To get them to appreciate this exposure, instructors can ask students about their activities such as visiting websites about foreign places; watching foreign-based media such as British television, Asian movies, and interviews with foreigners; and friendships with foreigners. Are they aware of the U.S. debate on immigration policy? Can students appreciate the challenges facing foreign nationals who are trying to succeed? It may also be useful to ask students to put themselves in the place of a foreigner. Can they understand what it feels like to be an ―outsider‖ in a foreign country? Usually, some students in class will relate to these issues and can identify how they have changed as a result of these activities that increase cultural sensitivity. A useful method for bringing out some of the issues may be to have an extended discussion of the U.S. immigration policy debate. Should there be an alternative ―path to U.S. citizenship‖?

XVII. Summary We live in a highly interconnected global community where many of the best opportunities for growth and profitability lie beyond the boundaries of a company‘s home country. Along with opportunities, of course, there are many risks associated with diversification into global markets. The first section of the chapter addressed the factors that determine a nation‘s competitiveness in a particular industry. The framework was developed by Professor Michael Porter of Harvard University and was based on a four-year study that explored the competitive success of 10 leading trading nations. The four factors, collectively termed the ―diamond of national advantage,‖ were factor conditions, demand characteristics, related and unrelated supporting industries, and firm strategy, structure, and rivalry. The discussion of Porter‘s ―diamond‖ helped, in essence, to set the broader context for exploring competitive advantage at the firm level. In the second section, we discussed the primary motivations and the potential risks associated with international expansion. The primary motivations included increasing the size of the potential market for the firm‘s products and services, achieving economies of scale, extending the life cycle of the firm‘s products, and optimizing the location of every activity in the value chain. On the other hand, the key risks included political and economic risk, currency risks, and management risks. Management risks are the challenges associated with responding to the inevitable differences that exist across countries such as customs, culture, language, customer preferences, and distribution systems. We also address the emerging trend of outsourcing and offshoring. 1-237 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Next, we addressed how firms can go about attaining competitive advantage in global markets. We began by discussing the two opposing forces—cost reduction and adaptation to local markets—which managers must contend with when entering global markets. The relative importance of these two factors plays a major part in determining which of the four basic types of strategies to select: international, global, multidomestic, or transnational. The chapter covered the benefits and risks associated with each type of strategy. The final section discussed the four types of entry strategies that managers may undertake when entering international markets. The key trade-off in each of these strategies is the level of investment or risk versus the level of control. In order of their progressively greater investment/risk and control, the strategies range from exporting to licensing and franchising, to strategic alliances and joint ventures, to wholly owned subsidiaries. The relative benefits and risks associated with each of these strategies are discussed.

End-of-Chapter Teaching Notes Chapter 7: International Strategy: Creating Value in Global Markets Summary Review Questions 3. What are some of the advantages and disadvantages associated with a firm’s expansion into international markets? (In text, International Expansion: A Company’s Motivations and Risks, LO 7-3) Response: Firms that expand internationally can gain revenue from selling abroad, can lower transportation and input costs by producing near those markets, and access knowledge from human capital worldwide. If managed effectively, know-how from various countries can be combined efficiently to form new sustainable competitive advantages. The international environment offers world-class suppliers, human resources, technology, and customers. The disadvantages include the challenges of dealing with governments that do not have business-friendly policies, with populations that are poor and illiterate, and with countries that do not have infrastructure or stable currencies. In addition, expansion internationally may subject firms to competition, which is both an advantage and a disadvantage. It is a disadvantage because competition may hurt profits in the shot-term. In the longer term, though, competition spurs firms to improve technology, products, services, and productivity, and therefore long-term survival prospects. 4. What are the four factors described in Porter’s diamond of national advantage? How do the four factors explain why some industries in a given country are more successful than others? (In text, Factors Affecting a Nation’s Competitiveness, LO 7-2) Response: The four factors are 1) factor endowments, 2) demand conditions, 3) related and supporting industries, and 4) firm strategy, structure, and rivalry. Together, these four factors, individually and collectively, indicate the ability of a nation to foster globally competitive firms. Porter developed his model through analysis of more than 100 industries, and these four factors characterized countries with globally competitive industries. For example:    

Countries with highly educated and skilled labor forces will tend to foster firms that are globally competitive in manufacturing. (ex. The Japanese automobile industry). Countries with sophisticated consumers will tend to foster globally competitive firms that cater to consumer sensitivities (ex. Danish firms in water pollution controls). Countries with clusters of advanced related and supporting industries will foster successful companies in products that involve integration of multiple inputs (ex. The Italian footwear industry). Countries with highly developed rivalries among domestic firms will foster globally competitive firms (ex. The U.S. information technology industry).

5. Explain the two opposing forces—cost reduction and adaptation to local markets—that firms must deal with when they go global. (In text, Achieving Competitive Advantage in Global Markets, LO 7-4) Response: As firms go global, they gain an ability to reduce costs by exploiting economies of scale, reducing costs of research and development, extending the product life cycle, and locating operations optimally. Especially for firms that follow a cost leadership strategy, going global may be necessary to compete. Achieving these cost advantages increases to the extent that firms can standardize products and services across countries and consolidate operations into large, global-scale facilities. On the other hand, as firms go global they face a number of country-specific risks. These risks include political risk, economic risk, currency risks, and management risks. These risks usually imply that it is necessary to adapt firm operations to each country. Therefore, international firms will be limited in the extent they can standardize operations across countries and achieve low costs. Therefore, what firms tend to do is to adopt some mix of operations. In some ways they are standardized and efficient. In other ways they are unique to each country. The result is often captured in the phrase ―Think global, act local.‖ We look at some of the relevant strategies below. 6. There are four basic strategies—international, global, multidomestic, and transnational. What are the advantages and disadvantages associated with each? (In text, Achieving Competitive Advantage in Global Markets, LO 7-4) Response: The four strategies are presented in Exhibit 7.4 on p. 230. Firms with international operations will be in industries that face two pressures, one for local adaptation and one for lower costs. An international strategy faces low pressures for local adaptation and low pressures for lower costs. A global strategy faces low pressures for local adaptation and high pressures for lower costs. A multidomestic strategy faces high pressures for local adaptation and low pressures for lower costs. And a transnational strategy faces high pressures for local adaptation and high pressures for lower costs. International strategies require minimal effort by firms to either adapt operations to national markets or to reduce costs. However, there is a tendency for firms in these industries to centralize operations in the home country. The advantages of this strategy are that firms incur few costs to expand internationally. The disadvantages are that firms may not locate operations optimally due to the home country preference, and that foreign customers may feel neglected.

Global strategies face high pressures for lower costs and low pressures for local adaptation. Usually, firms exploit scale economies, standardize products and processes, reduce costs throughout the value chain, locate activities in cost minimizing locations, and centralize decision-making. The advantages of a global strategy include barriers to entry in the form of large-volume plants and efficient distribution networks. Another advantage is that firms can set global quality standards that other firms must follow. The disadvantages include inflexibility to pursue revenue opportunities because of the focus on large volume markets. Having few large plants, often linked vertically with the output from one plant being the input of another plant in another country, makes the firm vulnerable to political risk, tariffs, and transportation costs. In addition, production may be isolated from markets by geographic distance, and the location decision, if suboptimal, can be very costly. Multidomestic strategies face high pressures for local adaptation and low pressures for lower costs. Operations tend to be decentralized and dispersed across national markets. The advantages are that firms can maximize revenue by adapting products and marketing to various national markets. The disadvantages of this strategy include the increased costs involved in adapting products to markets—economies of scale cannot be realized. Adapting products to national markets also is an imperfect art, and mistakes sometimes occur. In addition, it is difficult to determine the optimal level of adaptation. Transnational strategies face both high pressures for local adaptation and for lower costs. Operations tend to reflect a mix of centralization, for upstream activities, and decentralization, for downstream activities close to the customer. The organization is flexible in order to respond to various changes in the competitive and general environment. The advantages of this strategy are that the firm can respond to customer requirements and keep costs manageable. Operations can be located optimally, and knowledge and learning can be transferred throughout the organization. The disadvantages include the risks of choosing locations suboptimally. And knowledge transfer is difficult to manage given the dispersed decision-making and national cultural differences. 7. What is the basis of Alan Rugman’s argument that most multinationals are still more regional than global? What factors inhibit firms from becoming truly global? (In text, Achieving Competitive Advantage in Global Markets, LO 7-4) Response: Rugman and Verbeke found that very few firms were truly global. Rather, they tended to concentrate their sales in their home region—North America, Europe, or Asia. The reasons for this concentration probably are that distance matters. It is easier to do business and compete effectively in neighboring countries than far away ones. And distance is measured in miles but also in cultural distance. Another reason for firms to prefer doing business with neighbors is the rise of regional economic integration. Trading blocs such as the European Union and NAFTA make it easier to integrate operations within the bloc than between blocs.

8. Describe the basic entry strategies that firms have available when they enter international markets. What are the relative advantages and disadvantages of each? (In text, Entry Modes of International Expansion, LO 7-7)

Response: The basic entry modes are ways for firms to expand into international markets. They include exporting, licensing and franchising, strategic alliances and joint ventures, and wholly owned subsidiaries. Exporting is the least expensive method. The disadvantages of exporting are that the firm can‘t customize products to meet local needs, is dependent on a foreign distributor, and unless there are incentives for the distributor to effectively promote the exporter‘s product, the relationship is not likely to be adequate. Licensing and franchising are contractual arrangements where a foreign partner pays a royalty or fee in exchange for the right to use a firm‘s intellectual property (patent, copyright, trademark, or trade secret). The advantages are that the firm does not have a large investment and does not have to have operations in the foreign market. The disadvantages are that the partner can appropriate the intellectual property. The firm has to share a portion of revenues with the partner. And because the firm has limited exposure to the foreign market, opportunities for it to learn from its foreign customers and from the foreign market are limited. Strategic alliances and joint ventures are cooperative agreements where a firm would work with a partner, usually a firm from the foreign country, to market its products. The firm would offer the product and technical expertise, while the partner would offer marketing expertise. Usually, the goal of each partner is to learn from the other. The advantages are the effectiveness of enhancing learning and revenues, relative to licensing and franchising, as well as sharing of risks. As a result, firms can gain new core competencies and competitive advantages. The disadvantages are that the partners can work at cross-purposes, which would be the result of not agreeing to the goals of the collaboration. The partners must have a clear idea of what each contributes to the collaboration in order to allocate sufficient resources. The partners may not develop sufficient trust in each other, which can lead to various types of malfeasance. Lastly, international partnerships face the problem of dealing with cultural differences, which can lead to poor communication and misunderstanding. Wholly owned subsidiaries are foreign operations that are 100 percent owned by the expanding firm. The advantages are that the firm retains all revenue from operations and has full control over intellectual property and quality standards. The disadvantages are the expense and time involved in setting up operations. The firm has to make the necessary investments to learn how to deal with government, customers, and other players in the market. Experiential Exercises and Application Questions In this chapter, we discussed how several companies such as Ford (Learning from Mistakes opening incident) and Netflix (Strategy Spotlight 7.4) adopted a localized international 1-242 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

strategy. Interview a manager in an organization with foreign market exposure and ask the following questions: (1) what are the main benefits of localizing products or services in your industry?, (2) how do you manage the resulting complexity of localizing products or services?, and (3) do you find it necessary to localize other value chain activities (such as HR management)? Then ask yourself this question: Do the responses indicate that the organization is guided by established industry best practices or systematic strategic analysis of the internal and external environment? Response: Depending on the interview partner, answers to this question vary. Instructors can emphasize in the student responses that effective strategy should include many important stakeholders, not only the usual suspects such as customers and shareholders. For instance, sub-question (2) refers mainly to the product dimension while (3) refers to other value chain activities such as HR management. Many managers may take a too narrow view of strategy if they do not pay sufficient attention to the broader value chain. Of course, if the interviewed manager did take a broader value chain perspective, the instructor may use this as evidence of effective strategy. 9. The United States is considered a world leader in the motion picture industry. Using Porter’s diamond framework for national competitiveness, explain the success of this industry. Response: Answers for this question can be quite wide-ranging depending on the students‘ knowledge relating to this industry. One possible answer is given below: The position of the United States as the world‘s leader in the entertainment industry can be understood in terms of the following four broad attributes of the nation that, individually, and as a system, constitute ―the diamond of national advantage‖ for this industry. Factor conditions: The United States has one of the world‘s most highly skilled manpower and most developed infrastructure in this industry. There are several universities offering high-level programs in film production, music, and other forms of entertainment. Hollywood is the world‘s most regarded place for film production, and this has occurred as a result of decades of investments made toward that end. Access to capital for investment is another factor that contributes to competitive success in this industry. Perhaps the most critical is the stringent copyright law. Such copyright protection encourages investments in creating high-quality entertainment. A weak copyright protection regime would not leave much incentive for the artists or the producers to invest in creating ―masterpieces.‖ This is because they would not be able to appropriate the value created if the CDs or the movies created are copied and distributed freely, as it happens in some other countries.

Demand conditions: One of the key reasons for the sophistication in the entertainment industry is the existence of very sophisticated consumers who demand high-quality entertainment. By the very culture that encourages individualism, people do not hesitate having the best entertainment that they think they deserve. It would be surprising for many international students that there are courses offered in the U.S. universities on how to be sophisticated moviegoers. This is an example to show the kind of the customers in the United States as far as entertainment is concerned. Such demanding customers put pressure on the industry to deliver high-quality products, and thus it enhances the industry‘s world standing. Related and Supporting Industries are also very well developed. Suppliers are highly sophisticated and thus production costs can be kept low. Graphics computers, digital imaging equipment, and suppliers of talent are in abundance. Firm strategy, structure and rivalry: There is intense competition in this industry, and there is also a high potential for entry from related industries. Domestic rivalry thus promotes higher levels of innovation for gaining competitive advantages over one another. High domestic rivalry in this industry is certainly an indicator of global competitive success. Also, the creation, organization and management of companies are much easier in the United States, whose culture encourages entrepreneurial firms and has favorable bankruptcy laws. Therefore, any group of talented individuals can come together and form a company much more easily in this country than many other countries in the world. All of these attributes of the United States create its ―national competitive advantage‖ in the entertainment industry. 10. The Internet and digital technologies have lowered the entry barriers for smaller firms that wish to diversify into international markets. Why is this so? Provide an example. Response: The Internet enables firms to take orders from anywhere in the world. Also, customers can use the Internet to collect information on products made anywhere in the world, compare product features, and prices. So, firms are more able to export to foreign markets without first establishing large promotional campaigns. Even when firms have a sales office, warehouse, or production facility abroad, the Internet can help facilitate sales through providing information, taking orders, and payments. The Internet is also an advertising medium and method for providing product support and after sales service. So in a nutshell, the Internet greatly reduces the costs of expanding to international markets, making it more affordable. (Note to instructors) Students may offer a number of very good examples. For each, ask students to identify the entry barrier to small firms that is lowered. Also, ask students how effective the Internet is likely to be at reducing this barrier. Note the lesson we learned from the bursting of the dot.com bubble in 2000; a physical presence is still beneficial in many industries.

11. Many firms fail when they enter into strategic alliances with firms that link up with companies based in other countries. What are some reasons for this failure? Provide an example. Response: Most failures relate to lack of understanding and trust in the working relationships between the two organizations. Cultural differences are often at the heart of the problems, but contributory factors include lack of understanding between the partners as to the goals of the alliance and lack of investment of corporate resources into the alliance. Note to instructors: The examples are very useful for getting students to understand the process by which many international strategic alliances fail. Each failure is a unique story that often results from complex processes that most students do not have the life experience to understand. The press reports often lack sufficient detail for students to understand why the alliances fail. So, it is often useful to go into some depth in class discussions to understand why these alliances fail. We suggest that you use the analogy of a marriage or steady relationship that breaks up. Ask students why some relationships break up. Then apply the reason to an interfirm alliance. Usually, the reasons include misunderstanding, lack of trust, or unfaithfulness. Misunderstanding is analogous to failure of partners to agree on goals. Lack of trust is analogous to the alliance case. Low trust leads to less commitment to the alliance and less investment of necessary resources to make the alliance successful. And unfaithfulness is analogous to a strategic redeployment of assets to either compete with the alliance or to establish another partnership with a competitor. Similar to interpersonal relationships, perceptions of problems lead to real problems. 12. Many large U.S.-based management consulting companies such as McKinsey and Company and the BCG Group have been very successful in the international marketplace. How can Porter’s diamond explain their success? Response: Looking at management consulting as an industry, and applying Porter‘s diamond, is one way to respond to the question. The U.S. management consulting industry has many firms that compete vigorously. The competition hones their capabilities. So, firm strategy, structure and rivalry is strong. For factor conditions, the United States has an abundance of human capital, which is refreshed by a healthy education system and an influx of experienced executives from the fluid labor market. For demand conditions, the United States has a good supply of large corporations that use management consultants. For related and supporting industries, the United States has healthy industries in the service sector including accounting, economics research, occupational therapy, and management education. These observations suggest that the United States has a strong position in the diamond, which in turn suggests that the management-consulting industry will be strong in the United States. 1-245 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Ethics Questions Over the past few decades, many U.S. firms have relocated most or all of their operations from the United States to countries such as Mexico and Vietnam that pay lower wages. What are some of the ethical issues that such actions may raise? Response: Relocating operations to cost efficient locations is characteristic of the global strategy and, to a lesser extent, the transnational strategy. As with any such restructuring, relocations may be unfair to the individuals in the United States who lose their jobs, to the communities in the United States that are adversely affected, and to the corporation as a whole. For individuals, ethical concerns would be related to the suffering from loss of income. To limit this suffering, firms can give adequate severance pay, training, and opportunity for individuals to find other jobs. For the local community, the local economy is often hurt by the relocation. The livelihood of many can be affected. To limit this loss, the firm can take certain measures such as phasing out operations gradually so that the local economy can adjust, selling the operations to another firm, or government agency, which will bring replacement jobs to the local economy. The transition is likely to be fairer if the local community is a recognized stakeholder in the firm‘s board of directors. For the firm, the relocation can hurt the firm‘s reputation. As a result, sales could be affected, and unions or other groups could take legal and political actions against the firm. Firms should be aware of these costs and take measures to minimize the loss through negotiation and compensation of various types. The potential costs should be matched by potential gains from the relocation, or else firm value will be eroded. 13. Business practices and customs vary throughout the world. What are some of the ethical issues concerning payments that must be made in a foreign country to obtain business opportunities? Response: Payments to obtain business opportunities are not necessarily unethical. For example, in the United States, firms must be chartered and have a license to do business. These governmental approvals require payments. The problem is when such payments are not transparent, and where they are a means for government officials, or other powerful group, for self-enrichment. These payments tend to be of different amounts for different firms, so they are unfair. And the payments go to individuals and not the system, so the business infrastructure and government do not benefit from the payments. In addition, payments to individual officials are illegal under the U.S. Foreign Corrupt Practices Act (FCPA). Firms that make such payments are subject to legal action and fines under the Act.

Case Analysis Nollywood: Nigeria and the Diamond of National Competitive Advantage Hermès Pushes Deeper into Chinese Markets Terminus: Following Our Clients around the Globe

Chapter 8 Entrepreneurial Strategy and Competitive Dynamics 8-2 Recognizing Entrepreneurial Opportunities ........................... 8-5 Entrepreneurial Opportunities ................................................................ 8-5 Entrepreneurial Resources ....................................................................... 8-8 Entrepreneurial Leadership ..................................................................... 8-10

Entrepreneurial Strategy ........................................................... 8-11 Entry Strategies ......................................................................................... 8-12 Generic Strategies...................................................................................... 8-14 Combination Strategies............................................................................. 8-16

Competitive Dynamics ................................................................ 8-17 New Competitive Action ........................................................................... 8-17 Threat Analysis .......................................................................................... 8-18 Motivation and Capability to Respond ................................................... 8-19 Types of Competitive Actions................................................................... 8-20 Likelihood of Competitive Reaction ........................................................ 8-21 Choosing Not to React: Forbearance and Co-opetition ........................ 8-21

Issue for Debate ........................................................................... 8-22 1-247 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Reflecting on Career Implications ............................................ 8-23 Summary ...................................................................................... 8-25 End-of-Chapter Teaching Notes................................................ 8-26 Connect Resources ............................................................................... 8-32

Chapter 8

Entrepreneurial Strategy and Competitive Dynamics Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead New technologies, shifting social and demographic trends and changes in the business environment create opportunities for entrepreneurship. New ventures, which often emerge under such conditions, and small businesses, which are a major engine of growth in the U.S. economy, must rely on sound strategic principles to be successful. Effective strategies are needed to enter new markets and overcome intense competition from rivals who are threatened by new entrants. This chapter addresses how entrepreneurial firms create new value, achieve competitive advantages, and combat competitive rivalry. The chapter is divided into three major sections. 1.

The first section examines the role of opportunity recognition in the new value creation process. It describes characteristics of entrepreneurial opportunities and two phases of the opportunity recognition process—opportunity discovery and opportunity evaluation. It also addresses the role of entrepreneurial resources and the qualities of entrepreneurial leadership that are important to success.

The second section addresses entrepreneurial strategies. Three different types of new entry strategies are discussed—pioneering, imitative, and adaptive. The section also addresses the role of ―blue ocean‖ strategies in providing advantages to new entrants. Then, the generic strategies and combination strategies are addressed in terms of how they apply to new ventures and entrepreneurial firms.

The third section addresses competitive dynamics. The entry of competitors into a competitive arena often evokes a cycle of actions and responses. This section examines the factors that must be considered when considering a competitive response—the seriousness of the threat, the ability to mount a competitive response, the types of strategic actions needed, the likelihood of competitive reaction, and forbearance and co-opetition as options to a counterattack.

Lecture/Discussion Outline The case in LEARNING FROM MISTAKES is on WeWork, a coworking space company. While it had a meteoric rise in its early days, the company suffered from many problems, including a failed IPO and leadership challenges. Discussion Question 1. How should a large shareholder, such as Softbank in this example, monitor and control a founder CEO who wields substantial power within the firm? 1-249 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Response guidelines: Large shareholders—such as Softbank—typically enjoy behind-the-scenes access to the top management team of a company. WeWork at the time the case was written featured weak corporate governance mechanisms such as outsized voting control for Adam Neumann, WeWork‘s CEO. Softbank may be able to exert pressure on the firm and its leadership team to improve the weak governance arrangements at WeWork. Softbank may also use personal connections between its top executive (Masayoshi Son) and Adam Neumann to discuss control issues on a more informal basis. These soft forms of power may be effective when more formal sources of power (such as voting shares) are unavailable. Softbank‘s status as an early investor and reputation in the venture capital industry may also carry a lot of weight in these informal interactions. Discussion Question 2. Do you think Neumann’s controversial leadership style had any positive effects during his tenure at WeWork? Response guidelines: While Neumann‘s leadership style is seen in a negative light at the time of the failed IPO, there was a time when his leadership and charisma received a lot of praise from the business press (sometimes from the same people who now criticize him). For instance, Adam Neumann certainly is a very charismatic CEO, which helped WeWork to build up its resource base in the early days of the venture. In addition, Neumann has a history of taking risks, which is an important characteristic of entrepreneurs. The SUPPLEMENT below discusses the importance of four species of entrepreneurs identified by Linda Rottenberg.

Extra Example: The Four Species of Entrepreneurs Linda Rottenberg has worked with hundreds of entrepreneurs looking to get their businesses off the ground and ramped up. She argues that for entrepreneurs to succeed, they need to have self-knowledge regarding the type or species of entrepreneur they are and to tailor how they manage the entrepreneurial venture to their type. The four species of entrepreneur are diamonds, stars, transformers, and rocket ships. Each have their own strengths, as well as key issues they need to be sensitive to. Diamonds

These are charismatic evangelists with bold innovations that are aimed at transforming people‘s lives. When they succeed, they change the game. When they fail, it is often dramatic and tragic. The classic examples of this are Mark Zuckerberg, Ted Turner, and Steve Jobs. They all bent reality to fit their vision. Their Achilles heel is that they tend to tune others out, but successful diamonds are conscious of their need to listen and learn, willing to take criticism from others, and can build a strong team around themselves.

Stars

These are dynamic trendspotters and trendsetters who have big personalities and can see how society is changing and what the next hot trends will be. They tend to be lone wolves who project themselves boldly into their environments. Examples include Martha Stewart, Lance Armstrong, and Jay Z. To be successful, stars need to be sure to build a strong support team and organization that can help them deliver on the promise of their personality. Essentially, they need to make sure there is a strong organization to handle the boring details of operations and customer service.

Transformers

Some entrepreneurs see established industries as settings open for transformation. These transformers modernize systems, redefine operating rules, and change the way products are delivered. Examples include Howard Schultz of Starbucks, the man who transformed both how customers saw a cup of coffee and how it was delivered. To ensure success, transformers need to be both disciplined in working through the details and financial logic of their transformations and also mindful of continuously looking forward for additional opportunities to transform the market. Their innovations are often easily imitated, leading to the need to be diligent in implementation and working to stay one step ahead of the imitators.

Rocket Ships

These entrepreneurs are brilliant experimenters who aim to build businesses that are consistently cheaper, faster, and more efficient. They excel at using analytics to see opportunities for streamlining operations. However, they can struggle to see creative, industry changing innovations. Their narrow focus can limit the opportunities their firms see and pursue. Examples include Michael Dell, Bill Gates, and Jeff Bezos. Rocket Ships can benefit by surrounding themselves with individuals who are more creative and higher in emotional intelligence. Successful rocket ships are also sensitive to the need to consider qualitative data and others‘ emotional reactions even though it doesn‘t come naturally to them.

The key point is that there is no optimal species of entrepreneur. But success comes in two steps. First, an entrepreneur needs to know herself. Second, she needs to acknowledge the strengths she can leverage and be aware of her weaknesses. Third, she needs to surround herself with others who complement her strengths and weaknesses. Source: Rottenberg, L. 2014. The Four Species of Entrepreneurs. Wsj.com, October 4: np.

Discussion Question 4: What are some examples of entrepreneurs you are familiar with who are diamonds, stars, transformers, and rocket ships?

Recognizing Entrepreneurial Opportunities

PowerPoint Slide 4: Need for Entrepreneurial Strategy PowerPoint Slide 5: Recognizing Entrepreneurial Opportunities PowerPoint Slide 7: Entrepreneurial Opportunity Analysis PowerPoint Slide 8: Entrepreneurial Opportunity Recognition PowerPoint Slide 9: Entrepreneurial Opportunities: Discovery PowerPoint Slide 10: Entrepreneurial Opportunities: Evaluation PowerPoint Slide 11: Entrepreneurial Opportunities: Viability PowerPoint Slide 12: Entrepreneurial Resources PowerPoint Slide 13: Entrepreneurial Financial Resources PowerPoint Slide 14: Entrepreneurial Human, Social and Governmental Resources PowerPoint Slide 15: Entrepreneurial Leadership PowerPoint Slide 17: Entrepreneurial Leadership: Vision, Drive and Dedication PowerPoint Slide 18: Entrepreneurial Leadership: Commitment to Excellence New value can be created in many different contexts including start-up ventures, major corporations, family-owned businesses, non-profit organizations, and established institutions. For an entrepreneurial venture to create new value, three factors must be present—an entrepreneurial opportunity, the resources to undertake it, and an entrepreneur or entrepreneurial team willing to pursue it. EXHIBIT 8.1 identifies the three factors that are needed to successfully proceed: opportunity, resources, and entrepreneur(s). A.

Entrepreneurial Opportunities

Business opportunities come from many sources. For entrepreneurial start-ups, opportunities often come from past work experience, hobbies, or chance encounters. Established firms get ideas from customers, suppliers, or advances in technology. Most opportunities emerge due to some change in the business environment. The SUPPLEMENT below illustrates how an entrepreneur took his experience running a health spa in Mexico City and saw an opportunity in water-saving shower heads. Extra Example: Saving Water One Shower at a Time Carlos Gomez Andonaegui found it hard to plan for the costs of running his health spa in Mexico City. One of the most volatile costs he faced was the cost of water, which fluctuated widely as the antiquated water supply system in the city struggled to meet the needs of the city‘s population of 20 million. Looking around his spa, he realized that an area that used the majority of water was the shower room. Andonaegui with his partner, Philip Winter, took inspiration from this and aimed to design a better showerhead, one that overcame the limitations of current showers. As Winter stated, ―Showers have been the same for 100 years… 1-252 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

There‘s no meaningful innovation here.‖ With their design, the shower atomizes water to produce millions of tiny water droplets, creating a water mist in the shower. Borrowing the design from elements in an internal combustion engine, their showerhead, called the Nebia, uses an array of nozzles to direct water. As a result, the Nebia shower uses .75 gallons of water per minute, 70 percent less than competing showerheads. They tested their design with over 700 people, adjusting the design based on their feedback to ensure that the design worked well for a range of users. The potential for a breakthrough shower technology has attracted a large number of investors. The firm raised over $3 million from a Kickstarter funding campaign. The firm has also attracted prominent investors, including Tim Cook, CEO of Apple, and Eric Schmidt, a former executive chairman of Google. The product also won one of Fast Company‘s Innovation by Design Awards. The question is whether enough customers will be willing to shell out $500 for a water-saving showerhead. Source: Schwab, K. 2017. A water-saving shower. Fast Company, October: 92; Cutler, K. 2015. Y Combinator, Tim Cook back Nebia, A shower that uses 70% less water. techcrunch.com. August 11: np; Ugarte-Limer, A. 2016. Reinventing the shower experience: Interview with Nebia CEO Philip Winter. medium.com. November 22: np.

Discussion Question 5. What are other business opportunities that have come out of the drive to increase environmental sustainability? Not all good ideas are viable business opportunities. To identify, assess, and select opportunities, entrepreneurs engage in an opportunity recognition process. The process involves two phases—opportunity discovery and opportunity evaluation. Opportunity discovery may occur unintentionally because the discovery of opportunities is often spontaneous and unexpected. Alternatively, discovery may occur as the result of a deliberate search for new venture opportunities or creative solutions to business problems. STRATEGY SPOTLIGHT 8.1 illustrates how the social venture Goodr used a connected strategy to reduce food waste in the United States. The second phase is opportunity evaluation, which involves evaluating an opportunity to determine whether it is strong enough to be developed into a new venture. Business ideas are tested by various methods, including talking to customers about market potential and discussing operational requirements. Opportunity evaluation involves feasibility analysis to assess costs and benefits. Discussion Question 6: Which do you think is more important to launching a promising new venture and building a successful business—opportunity discovery or opportunity evaluation? The SUPPLEMENT below illustrates how a business incubator can provide support with the opportunity discovery and opportunity evaluation processes. Extra Example: Developing Business Ideas at the Foundry The Foundry, a business incubator affiliated with the University of Utah, aims to help young entrepreneurs get their business ideas moving forward. The university has rented space in downtown Salt Lake City. Over 60 aspiring 1-253 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

entrepreneurs have shared the space in the facility. They learn from each other as they develop their business ideas—including discussions about business ideas that foster opportunity discovery and discussions of their progress and challenges they face as they work through the opportunity evaluation process. They also get expert advice from business executives and professors from the Eccles School of Business, the University of Utah‘s Business School. The issues they deal with in evaluating and developing their business ideas include patent and intellectual property protection, organizational strategy, finance, public relations, marketing, and development of a web presence. In the first six months of operation, the Foundry triggered the creation of 18 registered businesses that generated over $220,000 in revenue. The benefits for the entrepreneurs have been clear. They get advice as they develop their business ideas, they build a social network to leverage as they launch their businesses, and they are encouraged by and driven to move forward by their peers. Source: Saadi, S. & Tozzi, J. 2010. An incubator hatches student startups in Utah. Bloomberg Businessweek. September 23: np.

Discussion Question 7. What are the potential benefits and risks of relying on peers as these entrepreneurs evaluate their entrepreneurial ideas? Discussion Question 8. How can entrepreneurs who don’t have access to a business incubator develop a set of advisors needed to develop and evaluate their business ideas? A critical element of opportunity recognition is assessing to what extent an opportunity is viable in the marketplace. For an opportunity to be viable it must have four qualities: 1. Attractive 2. Achievable 3. Durable

There must be market demand for the product or service. It must be practical and physically possible. It must be attractive long enough for the development and deployment to be successful. 4. Value-creating The benefits must surpass the cost of development by a profitable margin. Discussion Question 9: What are some examples of new venture start-ups that you are familiar with? Consider the opportunities that these new ventures are based on. Did they have the four features described above? What do you think will be the consequences if these ventures do not have these qualities? STRATEGY SPOTLIGHT 8.2 discusses how the California drought inspired an entrepreneur to develop a water-saving technology for farmers. The SUPPLEMENT below illustrates how articifial intelligence (AI) makes it easier for students to cheat, resulting in unique challenges and opportunities for entrepreneurs. Extra Example: AI helps students cheat Most educators have significant experience dealing with students who cheat on college writing assignments. The advance of AI, however, poses new challenges for college professors by making it increasingly difficult to identify who is cheating on writing assignments. The first attemp at AI-generated writing assignments debuted in 2005. Since then, AI has come a long was and is now able to create even sophisticated content, such as news articles.The principle is simple. Data scientists create computer algorithms that are trained (using large datasets and advanced 1-254 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

machine learning) to understand various topicla areas, such as climate change, politics, and literature. Users then simply ―feed‖ a few lines of text into an AI-supported text generator and the computer generates unique content that may even add context and detail. Students face little barriers using these AI-supported text generators for their papers. This brings up interesting questions and challenges for educators. For instance, using an AI-supported text generators is not technically ―plagiarism‖ since there was not previous text (written by a human) that students copied and pasted in their own papers. Hence, tradiational plagiarism detectors—such as Blackboard SafeAssign—will not help identify AIgenerated texts. Entrepreneurs may enter this emerging space to provide services for instructors and students. For instance, instructors may need help thinking about new ways to adapt their assignments to this new technology. Students may benefit from learning how to use AI ethically in college assignments. Similarly to how word processing software such as Microsoft Word made it easier to spot and correct spelling and grammar errors, AI-supported text generators may help students unlock new perspectives on the writing topics. Students may also need to learn to evaluate and check the text output from these programs. Overall, like with many new technologies, AI-supported text generators have many interesting applications and use cases. It is up to entrepreneurs to recognize and assess the opportunities in this emerging space. Source: Peritz, A. 2022. A.I. is making it easier than ever for students to cheat. www.slate.com. September 6: np.

Entrepreneurial Resources

Resources are an essential element of a successful entrepreneurial launch. For start-ups, the most important resource is usually money. However, human and social capital are also important during the early days of a new venture and throughout the life of a small business. In this section, we address some of the resource requirements of entrepreneurial firms. 1.

Financial Resources

Start-up firms need financing. The level of available financing is often a strong determinant of how the business is launched and its eventual success. The majority of new firms are low-budget start-ups launched with personal savings and the contributions of family and friends. Bank financing, public financing, and venture capital are often available only after a company has started to conduct business and generate sales. Crowdfunding, the funding of a venture by pooling small investments from a large number of investors, has emerged in recent years as a means to fund entrepreneurial firms. Funds are typically raised on websites that invite and list funding opportunities, such as Kickstarter. Discussion Question 10: When you think about start-up firms that you are familiar with, what kind of funding did they use to get their initial start? Personal savings? Family and friends? Credit cards? Selling shares of ownership in the business? Discussion Question 11. What are the advantages of using a crowdfunding approach for raising money for new businesses? Are there any downsides to raising funds this way?

If personal savings and bootstrapping efforts are insufficient to finance the business, entrepreneurs may turn to other sources of funds such as angel financing and venture capital. Both are forms of private equity financing. Venture capital may be an important source of funding as well as managerial advice for new ventures. To obtain it, however, entrepreneurs must sell shares of ownership in their firm. Discussion Question 12: What are the advantages and disadvantages of selling shares of ownership to venture capitalists? Discussion Question 13: What about selling shares to other investors such as family, friends, or strategic partners? What are the advantages and disadvantages of having these kinds of investors? Teaching Tip: There are wide differences in funding amounts between informal investments and venture capital investments as discussed in the text. Ask students what the strategic implications of these differences might be. For example, are firms that rely only on informal investments less important to the economy than firms that garner large venture investments? The obvious answer might seem to be “yes” but perhaps there are other issues to consider such as the importance of small businesses to the U.S. economy. In contrast, it could be argued that investments by families and friends reduce U.S. individual savings rates. Also, the high failure rate of firms that receive venture capital is potentially detrimental to the U.S. economy in terms of overall wealth creation. 2.

Human Capital

Bankers, venture capitalists, and angel investors that invest in start-up firms and small businesses agree that the most important asset an entrepreneurial firm can have is strong and skilled management. Ventures started by entrepreneurial teams are more likely to succeed in the long run than ventures founded by ―lone wolf‖ entrepreneurs. 3.

Social Capital

New ventures founded by entrepreneurs with extensive social contacts are more likely to succeed than ventures started without social networks. If the founders have contacts that will vouch for them, they gain exposure and build legitimacy faster. The social capital of entrepreneurs can be both built and leveraged through strategic alliances. Three types of strategic alliances and their intended goals are discussed. The SUPPLEMENT below describes how crowdsourcing is extending the social capital of entrepreneurs by enabling them to make new contacts in the graphic design business. Extra Example: Using Crowdsourcing to Tap into Social Capital Chicagoans Ross Kimbarovsky, 38, and Michael Sampson, 49, are using crowdsourcing to bring the spirit of friendly competition to the graphic design business—and help thousands of struggling entrepreneurs in the process. Their company, CrowdSpring.com, allows buyers to run competitions for company logos, websites, T-shirts and the 1-256 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

like. For buyers of designs, that means more choice at a fraction of the cost; for aspiring designers, it means a shot at stealing workers from entrenched design firms. ―The beauty of our site is that it doesn‘t matter if you have a degree from the Rhode Island School of Design or if you‘re a grandma in Tennessee with a bunch of free time and Adobe Illustrator,‖ says Samson. ―If the client likes the grandma‘s work better, then she‘s going to get the job.‖ In other words, through a form of social networking, CrowdSpring.com is vastly increasing the contacts that both designers and buyers of designs can draw from. An established design firm like Razorfish or Critical Mass might demand a $5,000 retainer to take on a project; CrowdSpring lets customers load rough specs into the site and pledge as little as $200 to the winner (higher purses, however, lure more artists). Designers compete by posting their work, gratis, for all to see, and buyers can offer instant feedback. CrowdSpring‘s cut is 15 percent of the pledged amount, meaning that on a $500 project, $500 goes to the winning designer and $75 to CrowdSpring. If at least 25 designs come in, buyers are obligated to buy one, even if they don‘t like any of them; if fewer than 25 come in, buyers can get their money back. On the supply side, freelance designers—some 80,000 in the U.S—need lots of help. Sarah Urbanek couldn‘t find a drop of work until she went on CrowdSpring, where the 28-year old Titusville Florida designer has since snared 37 projects. ―It‘s been a total savior to me,‖ she says. Despite competition from the established design community and sites such as Elance.com and Guru.com, CrowdSpring is thriving. Over 100,000 projects have been completed through crowdspring. ―We have clients chasing good designers rather than desperate designers chasing work,‖ says Kimbarovsky. They now bill themselves as ―the world‘s #1 marketplace for logos and graphic design.‖ Source: Steiner, C. 2009. The creativity of crowds. Forbes, February 16: 62–66, www.crowdspring.com.

Discussion Question 14: What other ways might social networking practices enhance the social capital of start-up entrepreneurs? 4.

Government Resources

The U.S. government is an important resource for many young and small businesses. It provides support for entrepreneurial firms in two key arenas—financing and government contracting. Teaching Tip: Examples of how young firm start-ups were aided and/or encouraged by mentors, experienced businesspeople, and local or federal government support programs are typically very interesting to students. Although we provide a few examples, it is always useful to ask students what examples they can come up with—both from their studies as well as from personal experience. It also provides an opportunity to get some of their perspectives on the role of public agency assistance versus private contacts and personal relationships as a way to foster entrepreneurial development. C.

Entrepreneurial Leadership

Launching a new venture requires a special kind of leadership. It involves courage, belief in one‘s convictions, and the energy to work hard under difficult circumstances. In this section, we address three entrepreneurial leadership characteristics—vision, dedication and drive, and commitment to excellence. 1-257 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Vision

The entrepreneur has to envision realities that do not yet exist. It may consist of a new product or a service, a competitive challenge such as beating a competitor, or a personal goal such as building something from scratch, being one‘s own boss, making a difference, or achieving financial security. In every case, entrepreneurs exercise a kind of transformational leadership that aims to create something new. Discussion Question 15: Can entrepreneurs learn to develop vision, or do they have to be “born with it”? 2.

Dedication and Drive

Dedication and drive are reflected in hard work. They require patience, stamina, and a willingness to work long hours. Drive involves internal motivation, and dedication calls for an intellectual commitment to the enterprise that keeps the entrepreneur going even in the face of bad news or poor luck. Entrepreneurs typically have a strong enthusiasm, not just for their venture but for life generally. Discussion Question 16: What are some examples of entrepreneurs who have strong dedication and drive? Discussion Question 17: Why do some people believe that drive and dedication are negative qualities? Under what circumstances are these qualities negative? What are the consequences? 3.

Commitment to Excellence

Entrepreneurs sometimes launch businesses without understanding what it will take to succeed. To achieve excellence, therefore, venture founders and small business owners must understand the customer, provide quality products and services, manage the business knowledgeably, and, expertly, pay attention to details, and continuously learn. Discussion Question 18: What are some examples of entrepreneurial firms that have

demonstrated a strong commitment to excellence? Discussion Question 19: What are the potential consequences for start-up firms that do not

strive for excellence? STRATEGY SPOTLIGHT 8.3 illustrates how entrepreneurs without technical expertise—such as coding skills—can start highly successful digital startups without hiring technical talent.

II.

Entrepreneurial Strategy

PowerPoint Slide 19: Entrepreneurial Strategy PowerPoint Slide 20: Entry Strategies PowerPoint Slide 21: Entry Strategies: Pioneering PowerPoint Slide 22: Entry Strategies: Imitative PowerPoint Slide 23: Entry Strategies: Adaptive PowerPoint Slide 24: Generic Strategies for New Ventures PowerPoint Slide 26: Combination Strategies for New Ventures To be successful, new ventures must evaluate industry conditions, the competitive environment, and market opportunities in order to position themselves strategically. In this section, we consider several different strategic factors that are unique to new ventures. Tools and techniques such as five forces and value chain analysis can also be used to guide decision making among new ventures and small businesses. In terms of five forces analysis, two factors are especially important—barriers to new entry and threat of retaliation by incumbent firms. A.

Entry Strategies

The idea of an entry strategy or ―entry wedge‖ describes several approaches that firms may take to get an initial foothold in an industry. 1.

Pioneering New Entry

A young firm with a radical new product or highly innovative service may engage in pioneering—creating new ways to solve old problems or meeting customers‘ needs in a unique new way. If the product or service is unique enough, a pioneering new entrant may actually have little direct competition. There are many potential pitfalls. Customers may not accept the new product or service; competitors may quickly imitate it; sustaining an advantage may require heavy expenses on advertising or protecting intellectual property. Discussion Question 20: What are some examples of companies you are familiar with that started with pioneering new venture concept? What made it pioneering? How radical was it? Did it change an existing industry or create a new one? 2.

Imitative New Entry

Imitators look for opportunities to capitalize on proven market successes. An imitation strategy is used when products or services that have been successful in one market niche or physical locale can be effectively introduced in another segment of the market. If a strategy is easy to imitate, then a major pitfall is that it may be difficult to ever build a sustainable competitive advantage. On the other hand, franchises are built on the concept of 1-259 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

imitation—and duplication. Franchising is a type of imitation strategy that often works very well because customers value reliable products that they can trust. Discussion Question 21: What are some examples of companies you are familiar with that use an imitation strategy? 3.

Adaptive New Entry

Most new entrants are somewhere between ―pure‖ imitation and ―pure‖ pioneering—they offer a product or service that is somewhat new and sufficiently different to create new value for customers and capture market share. Such firms are adaptive because they are aware of marketplace conditions and conceive entry strategies to capitalize on current trends. EXHIBIT 8.2 provides examples of several firms that pursued adaptive strategies. Pitfalls of an adaptive strategy include 1) the value proposition may not be perceived as unique; 2) close competitors could copy the new firm‘s adaptation as a way to hold onto its customers; and 3) once an adaptive entrant achieves initial success, the challenge is to keep the idea fresh. Discussion Question 22: What are some examples of new ventures that have been launched using a business concept that is an adaptation of an existing business? The SUPPLEMENT below describes how Slice Corporation took a single idea for a product and turned it into a catalog of improved cutting devices. Extra Example: Cutting a Path to Success TJ Scimone had an idea to develop better designed, and aesthetically pleasing cutting tools. He founded his firm, Slice, in 2008 to create and build ultramodern versions of staple kitchen tools, such as vegetable peelers and cheese graters, but he found real success in the market when he turned to building a better cutting device. He started with a pocket-sized ceramic blade for opening shrink-wrapped packages, such as DVDs. The firm now designs and sells a range of box cutters, scissors, and other cutting devices that are familiar but very distinct due to Slice‘s efforts to offer true innovation in established product categories. Scot Herbst, the firm‘s director of industrial design summarized the firm‘s adaptive strategy when he said, ―We look for simple, incremental twists to existing products. All it takes is a functional twist here and an ergonomic twist there to make it better than what the competition is offering.‖ Slice‘s ability to develop new interpretations of old implements is evident in its Auto-Retractable Box Cutter. As Simone stated, ―box cutters are scary and antiquated tools—most of them are dangerous and ugly.‖ In their design, Slice makes several changes to improve the utility and safety of the box cutter. First, Slice uses a ceramic blade that can last ten times longer than steel. To improve safety, it uses a rounded tip on the blade and a protective housing that reduces blade exposure. Slice also devised a wrap-around handle that is fits the contours of the user‘s hand, as well as a rubberized grip to enhance comfort and limit the possibility that the box cutter will slip in the user‘s hand. Finally, Slice built the cutter in a hook shape so users could easily hook it on their belts. This element was built in when Slice realized that most accidents with box cutters occurred when users were either putting the cutter in or taking it out of their pockets.

With their innovative designs on these basic products, Slice has received professional acclaim and market success. For example, one of its products received the Chicago Athenaeum Museum of Architecture and Design Good Design Award. On the market side, its products have seen solid demand and are now distributed through Home Depot, Crate & Barrel, Amazon.com, the Container Store, and major office-supply chains. Sources: Ankeny, J. 2013. Sharp-sighted: Slice‘s professional-grade tools don‘t cut corners on safety or style. Entrepreneur. June: 23.

Discussion Question 23: Can you think of other products that could use the mindset that Slice takes to cutting tools? Are their products where the basic design is well established but could also be greatly improved upon? Discussion Question 24: What are some examples of companies you are familiar with that use an adaptive entry strategy? Considering the strategic choices that a new entrant has, which new entry strategy is best? None of the strategies is inherently better than another. Nevertheless, some research suggests that entering new markets may provide greater opportunities than seeking growth in existing markets. B.

Generic Strategies

In general, new ventures are single-business firms using business-level strategies. This section addresses how overall low cost, differentiation, and focus strategies can be used by new ventures to achieve a competitive advantage. 1.

Overall Cost Leadership

Entrepreneurial firms achieve success by doing more with less. By holding down costs or making more efficient use of resources than larger competitors, new ventures can often offer lower prices and still be profitable. New ventures often have simple organizational structures that make decision making both easier and faster. The smaller size also helps young firms change more quickly when upgrades in technology or feedback from the marketplace indicate that improvements are needed. Discussion Question 25: What advantages do young firms have relative to larger firms in terms of keeping costs to a minimum? What are the disadvantages of trying to maintain overall lower costs? 2.

Differentiation

Both pioneering and adaptive entry strategies involve some degree of differentiation. In the case of pioneers, the new venture is attempting to do something strikingly different either by using a new technology or deploying resources in a way that changes the way business is conducted. Offering something that is different enough to be better is an aspect of an adaptive entry as well. 1-261 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

A differentiation strategy is generally thought to be expensive to enact. Yet those activities that tend to be expensive—innovation, technology, customer service, distinctive branding—are also areas where new ventures can make a name for themselves. Discussion Question 26: What are some examples of new ventures that have used a differentiation strategy in order to succeed? Discussion Question 27: In general, do you think it is easier or more likely that a differentiation strategy would work best for a new venture, or an overall cost leader strategy? Explain.

The SUPPLEMENT below describes how Allbirds has differentiated itself as an upstart in the athletic shoe market. Extra Example: Allbirds takes on Adidas and Nike It is a bold claim to call your shoes the ―world‘s most comfortable shoes,‖ but that is exactly what Tim Brown has done. Tim was a professional soccer player from New Zealand and wore the sneakers of the companies that sponsored the teams on which he played. He always felt the shoes were too flashy, too prominent in their corporate logos, and not comfortable enough. He set out to design a simpler, more comfortable, and more subtly stylish shoe. Allbirds shoes are built from environmentally friendly materials, including merino wool and eucalyptus tree fiber. They are also minimalist in design. The firm only produces about half a dozen varieties of its shoes and uses understated colors such as ―natural gray‖ and ―tuke honey.‖ Brown used Kickstarter to raise $120,000 to launch the brand. The firm differentiates itself in two simple ways: comfort and sustainability. In doing so, the firm contrasts itself with the big shoe companies. As Brown says, ―sometimes innovation can be about taking things away. It can be whispering when others are screaming.‖ The firm has found significant success since being launched in March 2016, selling its millionth pair of shoes in under two years. Customers appear to love their shoes, describing them in Google reviews as ―shockingly comfortable‖ and ―slippers made of clouds.‖ Other customers see value in their environmental consciousness, with one customer stating, ―I don‘t feel bad buying multiple pairs of them because they are eco-friendly and sustainable.‖ Investors have noticed as well. The privately held firm has been valued at nearly $1.5 billion. The message of Allbirds appears to be that entrepreneurs don‘t have to be flashy or extreme to build a differentiated position. They just have to identify an unmet customer need and address that need authentically. Sources: Huddleston, T. 2018. How Allbirds went from Silicon Valley fashion staple to a $1.4 billion sneaker startup. Cnbc.com. December 18: np; Gallagher, J. 2018. How the ‗World‘s most comfortable shoe‘ is changing Nike and Adidas. Wsj.com. May 21: np.

Focus

Focus or ―niche‖ strategies provide an effective entry strategy for many new firms. A niche represents a small segment within a market. A young or small firm can play an important role in such a market space if there is an opportunity to thrive in that environment. Typically, a focus strategy is used to pursue a niche. Here‘s why: If a start-up wants to enter a mature industry, it often has to take business away from an existing competitor. Thus, young firms can often succeed best by finding a market niche where they can get a foothold and make small advances that erode the position of existing competitors. By contrast, if a start-up enters a market with a broad or aggressive strategy, it is very likely to evoke retaliation from a more powerful competitor. Discussion Question 28: Could there be an industry condition or other business circumstance in which it would be good for a new start-up to enter with a broad or aggressive strategy rather than a niche strategy? What would it be? (In a growth industry, a more aggressive strategy is likely to be more effective.) 1-263 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The SUPPLEMENT below presents the example of Fridababy, an entrepreneurial firm that found success focusing on the unpleasant aspects of baby care. Extra Example: Fridababy Aims to Make Parenting Easier Fridababy offers a range of products that are designed to make awkward, difficult, and unpleasant childcare moments easier. The firm‘s founder, Chelsea Hirschhorn, found inspiration in difficult parenting moments. For example, the challenge of brushing a toddler‘s teeth led her to design a wraparound toothbrush that makes the task easier. The firm offers over a dozen products that aim to make it easier to handle unpleasant baby-care tasks. By focusing on this specific market, the firm believes it can produce products that meet parents‘ needs better than larger personal-care product manufacturers that serve a broad range of customers. Its products include:    

NoseFrida: a device to suck out mucous from baby‘s nostrils MediFrida: a combination syringe and pacifier that makes giving liquid medicines easier NailFrida: a nail clipper designed to make clipping a baby‘s nails easier DermaFrida: a bath brush to keep a baby‘s skin smooth and itch-free

The firm‘s products meet a focused market need and are now carried at over 18,000 Targets, and Fridababy is one of Amazon‘s top baby-care brands. Segran, E. 2017. A nose for business. Fast Company. September, 32–34.

Discussion Question 29: What are the advantages and disadvantages of a focus strategy? Discussion Question 30: Is Fridababy limiting it opportunities by focusing on one market segment? Should they look to expand to develop products for older children? Emphasize that many of the industries that small firms participate in have thousands of participants that aren‘t direct competitors. For example, they may be separated geographically. These industries are considered ―fragmented.‖ Therefore, small firms only need to focus on the market share in their trade area. This may be defined as geographical area or a small segment of a larger product group. Discussion Question 31: What are the advantages of competing in a fragmented industry? What are the disadvantages? C.

Combination Strategies

One of the best ways for new ventures and small businesses to achieve success is with combination strategies. By combining the best features of low cost, differentiation, and/or focus strategies, young and small firms can often achieve something that is truly distinctive. Entrepreneurial firms are often in a strong position to offer a combination strategy because they have the flexibility to approach situations uniquely. Discussion Question 32: What are the key ways in which a combination strategy differs from the generic strategies?

III.

Competitive Dynamics

PowerPoint Slide 27: Competitive Dynamics PowerPoint Slide 28: Competitive Dynamics Model PowerPoint Slide 29: Competitive Dynamics: Why Launch Actions? PowerPoint Slide 30: Competitive Dynamics: Incumbents PowerPoint Slide 31: Competitive Dynamics: Threat Analysis PowerPoint Slide 32: Competitive Dynamics: Actions PowerPoint Slide 33: Competitive Dynamics: Reaction PowerPoint Slide 35: Competitive Dynamics and Entrepreneurial Strategies New entry into markets nearly always threatens existing competitors. As a result, the competitive actions of a new entrant are very likely to provoke a competitive response from companies that feel threatened. This, in turn, is likely to evoke a reaction to the response. As a result, a competitive dynamic—action and response—begins among the firms competing for the same customers in a given marketplace. Thus, studying competitive dynamics helps explain why strategies evolve and reveals how, why, and when to respond to the actions of close competitors. Discussion Question 33: In general, do you believe competition is beneficial or damaging to incumbents in an industry? In what ways is competition beneficial or damaging? EXHIBIT 8.3 identifies the factors that that competitors need to consider when determining how to respond to a competitive act. In the sections below, we will review the elements that contribute to a competitor‘s decision to launch a competitive attack. A.

New Competitive Action

Why do companies launch new competitive actions? There are several reasons:     

Improve market position Capitalize on growing demand Expand production capacity Provide an innovative new solution Obtain first mover advantages

When a company enters into a market for the first time, it is like an attack on existing competitors. Attacks come from many sources besides new entrants. Some of the most intense competition is among incumbent rivals intent on gaining strategic advantages. Discussion Question 34: What are some examples of new entrant companies you are familiar with whose entry into a market evoked a competitive response? What was the response? What was the impact of the response on the new entrant? On the incumbent? 1-265 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The SUPPLEMENT below provides the example of Judicata to suggest that new entrants often introduce a new dynamic into a marketplace for which incumbents often have difficulty responding to immediately. Extra Example: Judicata aims to ―Map the Legal Genome‖ Attorneys and their staff who are researching prior court cases and related case law documents typically turn to Lexis-Nexis and Westlaw, the dominant legal research databases. These systems have been around to decades and require users to enter search terms and then painstakingly read through the volumes of references that the search spits out. This tends to be a very labor intensive and costly process. Judicata aims to move into this space by providing a more user friendly and less time intensive process. Judicata‘s system relies on natural language search technologies, text analytics, and advanced search tools to create systems that allow users to bore down quickly to the most relevant case law on a particular topic. Rather than providing the users with a list of possibly relevant cites, Judicata provides structured output with key findings from the legal literature. For example, Judicata quickly allows users to systematically differentiate the findings on cases for which the plaintiff was a male compared to when a plaintiff was a female. The entrenched incumbents are finding it difficult to respond to Judicata since their systems are based on decades of programming that they have developed. It is too costly to scrap that code and build up a more advanced system. Additionally, though their systems are not terribly user friendly, users have grown accustomed to the structure of the user interface and would resist any major changes to a new interface. Source: Primack, D. 2013. A startup tries to hack the law. CNNMoney.com. May 29: np; Halliburton, A. Judicata raises $5.8M second round to build out advanced legal research systems. Techcrunch.com. May 28: np.

Discussion Question 35: Do you think Judicata will be able to change the legal research business? How should Lexis-Nexis and Westlaw respond to this entry? EXHIBIT 8.4 outlines five strategies for improving competitive position and consolidating gains in preparation for another attack from Hardball: Are You Playing to Play or Playing to Win? by George Stalk, Jr. and Rob Lachenauer. B.

Threat Analysis

Prior to actually observing a competitive action, effort is needed to become aware of potential competitive threats. Awareness of the threats posed by industry rivals allows a firm to understand what type of competitive response, if any, may be necessary. Two factors are used to assess whether or not companies are close competitors: 1. 2.

Market Commonality—whether or not competitors are vying for the same customers and how many markets they share in common. Resource Similarity—the degree to which rivals draw on the same types of resources to compete.

On the one hand, a market rival may be hesitant to attack a company that it shares a high degree of market commonality with because it could lead to an intense battle. On the other hand, 1-266 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

once attacked, rivals with high market commonality will be much more motivated to launch a competitive response. In general, the same set of conditions holds true with regard to resource similarity. That is, companies that have highly similar resource bases will be hesitant to launch an initial attack but pose a serious threat if required to mount a competitive response. Discussion Question 36: Think of two close rivals among the companies you are familiar with—two clothing stores or two auto manufacturers. Do they have a high or low degree of market commonality? What are the implications of that? Discussion Question 37: What are the implications of two close rivals having very similar resources? C.

Motivation and Capability to Respond

Once attacked, competitors are faced with deciding how to respond. Before deciding, however, they need to evaluate not only the type of response, but also their reasons for responding and their capability to respond. There are several factors to consider. First, how serious is the impact of the competitive attack to which they are responding? Second, companies planning to respond to a competitive challenge must also understand their motivation for responding. What is the intent of the competitive response? Is it merely to blunt the attack of the competitor or is it an opportunity to enhance its competitive position? Another consideration when planning a competitive challenge involves assessing the capability to respond. What strategic resources can be deployed to fend off a competitive attack? Does the company have an array of internal strengths it can draw on or is it operating from a position of weakness? For example, young or small firms may be able to respond quickly because they are more nimble than large firms. However, they may not have the financial resources to follow through on an attack. Discussion Question 38: What are some of the reasons a company might be motivated to respond to a competitive attack? Discussion Question 39: What types of assets or resources that a company might possess gives them a strong capability to respond? What are the implications of that? The SUPPLEMENT below discusses how personal factors can affect the motivation to engage in competitive actions.

Much like the story line of a Shakespearian play or a plot in Game of Thrones, Cisco Systems finds itself fighting off an attack from a former member of its own inner circle. Jayshree Ullal used to be a senior executive at Oracle, but she became frustrated at Cisco as she saw the firm moving its focus away from network switches, its traditional core product, to higher margin video conferencing and consumer electronics products. After she left the firm in 2008, she took on the role of CEO at Arista Networks. Since then, this small startup has grown into a major player in the network switch market, challenging Cisco‘s dominance in this business. At first, Ms. Ullal directed the firm to avoid taking Cisco on directly, knowing Cisco could drive Arista out of business. The firm focused on narrow market segments in the switching market that were not critical to Cisco. The strategy worked, and Arista was able to build a foothold in the market. It worked to design a flexible switch that could be reprogrammed to serve a range of customers. Once the firm was established, it moved to take Cisco on directly. Because Cisco‘s focus was on other market segments, its technology development had lagged. Arista seized on the opportunity, selling switches that were cheaper, faster, and more flexible than Cisco‘s competing products. In the last few years, Arista has taken business from Cisco at a number of major customers, including Microsoft and Facebook. Its revenue grew nearly 1000 percent from 2012 to 2019. For Cisco, the fight has become personal. John Chambers, Cisco‘s chairman, reportedly saw Ms. Ullal‘s efforts to take Cisco on directly as a personal betrayal. In 2013, an internal Cisco management presentation included a picture of Ms. Ullal on a bullseye with arrows in it. The presentation included the phrase, ―Arm the field, stop the bleeding and fire back.‖ Cisco has since attacked Arista both in the market and in court. Cisco has developed an entirely new generation of automated and programmable switches to counter Arista‘s growth. Cisco has also filed a lawsuit claiming Arista uses Cisco‘s patented technology in its designs. Arista denied the allegations and responded that Cisco only sued because it couldn‘t respond with better ideas and better products. Source: King, R. 2017. Cisco‘s feud with former star executive turns personal—and costly. wsj.com. August 17: np; .

Types of Competitive Actions

Once an organization determines whether it is willing and able to launch a competitive action, it must determine what type of action is appropriate. 1.

Strategic actions represent major commitments of distinctive and specific resources.

Tactical actions include refinements or extensions of strategies.

Discussion Question 40: What are some examples of companies you are familiar with that responded to a competitive attack? What type of response was used? Was the action successful? Did the response evoke a counterattack? EXHIBIT 8.5 provides several examples of strategic and tactical competitive actions. Some competitive actions take the form of frontal assaults, that is, actions aimed directly at taking business from another company or capitalizing on industry weaknesses. Guerilla offensives and selective attack provide an alternative for firms with fewer resources. Some companies limit their competitive response to defensive actions. Discussion Question 41: Think of a young firm that you are familiar with that is trying to build up its business and grow. What kind of competitors is the company up against? 1-268 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Considering its rivals, what would be the best type of competitive actions the company could take? Frontal assault? Guerilla tactics? Offensive actions? Defensive actions? E.

Likelihood of Competitive Reaction

The final step before initiating a competitive response is to evaluate what a competitor‘s reaction is likely to be. Evaluating potential competitive reactions helps companies plan for future counterattacks. It may also lead to a decision to hold off, that is, not to take any competitive action at all because of the possibility that a misguided or poorly planned response will generate a devastating competitive reaction. How a competitor is likely to respond will depend on three factors: 1.

Market Dependence—If a company has a high concentration of its business in a particular industry, it has more at stake because it must depend on that industry‘s market for its sales.

Competitor’s resources—The types of internal resource endowments a competitor has must be evaluated when assessing its capability to respond.

Actor’s Reputation—Whether a company should respond to a competitive challenge depends on who launched the attack against it. Some competitive actors have the ability and motivation to mount overwhelming counterattacks.

Discussion Question 42: What are some examples of close competitors you are familiar with? Do they have a high or low degree of market dependence? How will that affect their likelihood of response? Discussion Question 43: What are some examples of companies you are familiar with that refrain from intense competition because of stronger rivals’ competitive resources and/or reputation? F.

Choosing Not to React: Forbearance and Co-opetition

There may be many circumstances in which the best reaction is no reaction at all. This is known as forbearance—refraining from reacting at all, as well as holding back from initiating an attack. Competition among the big automakers is provided as an example. Related to forbearance is the concept of ―co-opetition.‖ This is a term that was coined to suggest that companies often benefit most from a combination of competing and cooperating. For example, close competitors that differentiate themselves in the eyes of consumers may work together behind the scenes to achieve industrywide efficiencies. Discussion Question 44: Under what circumstances would a strategy of forbearance be the best course of action? What are some examples of companies you are familiar with that chose forbearance rather than a competitive response?

Discussion Question 45: What are some examples of companies you are familiar with that have been successful through collaboration and cooperation rather than competition? STRATEGY SPOTLIGHT 8.4 discusses how the action of collusion between rivals in the German automotive market allowed them to reduce costs but also led to higher auto pollution. Discussion Question 46: What are the advantages and disadvantages of co-opetition and forbearance? Can you think of examples of companies that have used these approaches?

IV.

Issue for Debate

Amazon is the dominant e-commerce platform in the U.S. and many other countries. This fact presents unique challenges for entrepreneurs and small businesses. Discussion Question 47: If you found a promising product idea, would you sell it on Amazon or develop your own e-commerce website? Students can go both ways on this question. What is important is to understand the unique challenges of each direction. Students who prefer to go through Amazon can get their products to market quickly since Amazon takes care of many business functions (e.g., logistics, and order processing). This may be a viable path for products that need to be brought to market quickly (perhaps to beat the competition in order to build a first mover advantage). On the other hand, an own e-commerce site may be better in the long run as it allows the seller to keep a larger portion of the profits as well as to build closer customer relationships. Finally, instructors may encourage students to combine the benefits and cons of these approaches. For instance, entrepreneurs may first sell on Amazon and, once the product proofs to be a hit, transition to building their own e-commerce website. Discussion Question 48: Given that Amazon increasingly becomes dependent on thirdparty sellers, is it time for Amazon to treat small and medium businesses more favorably by providing, for instance, lower selling fees and more support? Instructors can tie this question to earlier chapters (such as the role of suppliers in the five forces framework). It may be the case that Amazon continues to expand in this area. However, many small and medium sellers may still be at a disadvantage vis-à-vis Amazon. This may have important implications for these sellers. For instance, they may consider ways to organize or diversify their sales channels. In addition, they may utilize more visible strategies (such as PR campaigns) to pressure Amazon to improve its small and medium seller conditions. 1-270 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Reflecting on Career Implications

PowerPoint Slide 36: Reflecting on Career Implications Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 8. 

Opportunity Recognition: What ideas for new business activities are actively discussed in your work environment? Could you apply the four characteristics of an opportunity to determine whether they are viable opportunities? If no one in your organization is excited about or even considering new opportunities, you may want to ask yourself if you want to continue with your current firm.

Students should be aware that firms succeed by reinventing themselves. Consider Apple, which has transformed itself from a computer firm to a music and communications company. IBM used to specialize in mainframe computers, but now does very little in that business. Students may be able to come up with similar examples from their work or their experience. Therefore, firms should have a capability for generating and evaluating new opportunities. It would be useful to practice this process using an example from a student‘s employing organization. For this example, ask students to apply the four qualities for viability: attractive, achievable, durable, and value creating. In discussion, develop a balanced assessment for each quality. As for the prospects of a firm that does not look for new opportunities, opinions may vary. But it is worthwhile to at least have students vote or debate as to whether such a firm merits students‘ employment. The exercise will force students to consider the value of entrepreneurship to their firm‘s success, and whether such entrepreneurship is something they want to get involved with. 

Entrepreneurial New Entry: Are there opportunities to launch new products or services that might add value to the organization? What are the best ways for you to bring these opportunities to the attention of key managers? Or might this provide an opportunity for you to launch your own entrepreneurial venture?

The specifics of successfully bringing up new opportunities to key managers will vary for each student and each organization. There are no right answers. However, it is very important to have students consider the prospect. Ask students whom within the firm they should approach. Should they write a proposal first or discuss the issue informally? What factors, such as cannibalism of existing products, affect on current operations, or risk tolerance, may reduce the likely success of the opportunity? Role play would be appropriate if you have the time. Also, ask students to identify an entrepreneurial venture they would like to lead. Perhaps only a couple of students would be willing to admit to considering any venture, but it would be useful to name these and talk through the opportunity. Such thinking about pursuing ventures is an important first step to entrepreneurship. The value of this discussion is to expand students‘ thinking about such opportunities. 

Entrepreneurial Resources: Evaluate your resources in terms of financial resources, human capital, and social capital. Are these enough to launch your own venture? If you are deficient in one area, are there ways to compensate for it? Even if you are not interested in starting a new venture, can you use your entrepreneurial resources to advance your career within your firm?

The goal of this discussion is to pursue the details involved in entrepreneurship. Resources are an important consideration, but the amount and type needed will vary for each venture. So, it is important to anchor the discussion by first identifying a specific venture. Consider first the skills and capabilities of the team that make it unique and consider how the venture will lead to a durable competitive advantage. Will the venture need specific human capital, relationships with suppliers, attractive location (such as a restaurant), special equipment, or a trademark (to promote brand loyalty)? Make a list. Then match this list against the resources that the student(s) currently have access to. How will the needed assets be obtained? The goal here is to be creative. Can special equipment be borrowed, rented, shared, or bought at an estate sale? Let students come up with difficulties and objections, and if the discussion goes well, these objections can at least be addressed. There may be a seed of optimism planted in some students. And extension is to look at the entrepreneurial resource acquisition process within the context of a ―normal‖ job. Students may appreciate that in many situations, such as preparing a proposal for a deadline, it may be necessary to improvise. If the projector fails at a presentation, students may need to make paper copies of the slides. If the copier runs out of color ink, then you need a ―plan B.‖ Students should be able to identify such situations they have faced, and they may appreciate the value of entrepreneurial resource acquisition. 

Competitive Dynamics: There is always internal competition within organizations: among business units and sometimes even among individuals within the same unit. What types of strategic and tactical actions are employed in these internal rivalries? What steps have you taken to strengthen your own position given the ―competitive dynamics‖ within your organization?

Students should be asked to identify a rivalry they have at work (or in any aspect of life). Competitive dynamics can provide a useful framework for analyzing and winning these rivalries, 1-272 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

but the situation should be made concrete. It may be useful to ask a student about a specific action a rival took. Then go through the steps in Exhibit 8.3—threat analysis, motivation & capability to respond, and then consider a response. For the potential response, consider the likelihood of competitive reaction. Students may see that the framework applies to even these situations, and the exercise will help them to understand how competitive dynamics works.

VI.

Summary

New ventures and entrepreneurial firms that capitalize on marketplace opportunities make an important contribution to the U. S. economy. They are leaders in terms of implementing new technologies and introducing innovative products and services. Yet, entrepreneurial firms face unique challenges if they are going to survive and grow. To successfully launch new ventures or implement new technologies, three factors must be present—an entrepreneurial opportunity, the resources to pursue the opportunity, and an entrepreneur or entrepreneurial team willing and able to undertake the venture. Firms must develop a strong ability to recognize viable opportunities. Opportunity recognition is a process of determining which venture ideas are, in fact, promising business opportunities. In addition to strong opportunities, entrepreneurial firms need resources and entrepreneurial leadership to thrive. The resources that start-ups need include financial resources as well as human capital and social capital. Many firms also benefit from government programs that support new venture development and growth. New ventures thrive best when they are led by founders or owners who have vision, drive and dedication, and a commitment to excellence. Once the necessary opportunities, resources, and entrepreneur skills are in place, new ventures still face numerous strategic challenges. Decisions about the strategic positioning of new entrants can benefit from conducting strategic analyses and evaluating the requirements of niche markets. Entry strategies used by new ventures take several forms, including pioneering new entry, imitative new entry, and adaptive new entry. Entrepreneurial firms can benefit from using overall low cost, differentiation, and focus strategies, although each of these approaches has pitfalls that are unique to young and small firms. Entrepreneurial firms are also in a strong position to benefit from combination strategies. The entry of a new company into a competitive arena is like a competitive attack on incumbents in that arena. Such actions often provoke a competitive response that may, in turn, trigger a reaction to the response. As a result, a competitive dynamic—action and response— begins among close competitors. In deciding whether to attack or counterattack, companies must analyze the seriousness of the competitive threat, their ability to mount a competitive response, and the type of action—strategic or tactical—that the situation requires. At times, competitors find it is better not to respond at all or to find avenues to cooperate with, rather than challenge, close competitors.

End-of-Chapter Teaching Notes Chapter 8: Entrepreneurial Strategy and Competitive Dynamics 1-273 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Summary Review Questions 1. Explain how the combination of opportunities, resources, and entrepreneurs helps determine the character and strategic direction of an entrepreneurial firm. (In text, Recognizing Entrepreneurial Opportunities, LO 8-1) Response: The character and strategic direction of an entrepreneurial firm refers to the new products and markets it enters, as well as the type of alliances formed, types of financing pursued, and other aspects of strategy. Opportunities determine what types of new investments are likely to succeed. Resources determine the ability of the entrepreneur to pursue the opportunity. And entrepreneurs themselves determine the willingness (or risk tolerance) and ability to allocate the resources to pursue the opportunity. 2. What is the difference between discovery and evaluation in the process of opportunity recognition? Give an example of each. (In text, Recognizing Entrepreneurial Opportunities, LO 8-1) Response: Discovery is the process of becoming aware of a new business concept. For example, Howard Schultz of Starbucks discovered the coffee-and-conversation café concept while in Europe. Opportunity evaluation is the analysis of the opportunity to determine whether it is viable and strong enough to be developed into a full-fledged new venture. For an opportunity to be viable, it needs to be attractive, achievable, durable, and value creating. For example, evaluation of the Starbucks opportunity involved market testing, analysis of the investment needed to establish the stores, assessment of the entry barriers and first mover advantages to ward off the competition, and estimation of the difference relative to other establishments that offered similar value to customers, such as libraries and bookstores. (Note to instructors) We think there is great value to asking students to identify multiple examples and to identify not-yet-exploited opportunities. 3. Describe the three characteristics of entrepreneurial leadership: vision, dedication and drive, and commitment to excellence. (In text, Recognizing Entrepreneurial Opportunities, LO 8-1) Response: Entrepreneurial vision involves realities that do not yet exist and an ability to communicate that vision to others in a way that excites and motivates them. Entrepreneurial dedication refers to an ability to work hard and to keep going even in the face of bad news or poor luck. Entrepreneurial commitment to excellence refers to entrepreneurs‘ relentless desire to learn and improve the venture, as well as to surround themselves with high-quality talent. 1-274 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

4. Briefly describe the three types of entrepreneurial entry strategies: pioneering, imitative, and adaptive. (In text, Entrepreneurial Strategy, LO 8-2) Response: Pioneering new entry refers to creating new ways to solve old problems or meeting customers‘ needs in a unique new way. Pioneering new entry is often a radical new product or highly innovative new service that changes the way business is done in an industry. Imitative new entry improves on market success and looks for business concepts that have been successful in one market niche or physical locale and introduces the same basic product or service in another segment of the market. Adaptive new entry is between pure pioneering and pure imitation. It involves offering a product or service that is somewhat new and sufficiently different to create new value for customers and capture market share. 5. Explain why entrepreneurial firms are often in a strong position to use combination strategies. (In text, Entrepreneurial Strategy, LO 8-2) Response: Existing firms, especially large firms with established corporate cultures, policies and bureaucracies, have limited flexibility to serve all segments of a market or to use technology optimally. The competitive advantages of existing firms are established, which determines their strategies such as overall low cost, differentiation, and/or focus. Entrepreneur firms do not have any history and are therefore more flexible to exploit the opportunities neglected by existing firms. Once entrepreneur firms have demonstrated that they are successful, there is a strong threat of imitation from existing firms. In order to make it costlier to imitate their strategy, entrepreneurs can use their flexibility to employ combination strategies to make their advantage more durable. 6.

What does the term competitive dynamics mean? (In text, Competitive Dynamics, LO 8-4)

Response: Competitive dynamic refers to intense rivalry among competitors vying for the same customers in a marketplace. A model of competitive dynamics involves a series of actions and reactions, starting with a new competitive action, which is analyzed and then assessed as to how a competitor can respond. Then a competitive reaction is devised and assessed as to difficulty for a competitor to in turn respond effectively. If the reaction is carried out, then the cycle is repeated.

7. Explain the difference between strategic actions and tactical actions and provide examples of each. (In text, Competitive Dynamics, LO 8-4) Response: 1-275 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Strategic actions are major commitments of distinctive and specific resources to strategic initiatives. Tactical actions are refinements or extensions of strategies usually involving minor resource commitments. Examples of strategic actions include entering new markets, new product introductions, changing production capacity, and mergers/alliances. Examples of tactical actions include price-cutting, product/ service enhancements, increased marketing efforts, and new distribution channels. (Note to instructor) We think it is useful for students to come up with their own examples and their own reasoning for whether the examples are strategic or tactical actions. The list above just includes categories of actions and given the nearly limitless number of possible actions (in the past, present, and future), the need to classify them will be important to future managers. Experiential exercises and Application Questions 1. In Strategy Spotlight 8.1, we discussed how Jasmine Crowe transformed her passion for helping people in need to overcome food insecurity into a valuable business. Consider something that you feel passionate about and develop a business idea to address this passion. Discuss how this business creates value for customers and whether the idea is a pioneering, adaptive, or imitative entry into the market. Response: This can be a valuable exercise for students to see both the opportunity and challenge of generating business ideas. Everyone is passionate about something. Thus, students should be able to identify potential ideas. The challenge is to assess how it creates value for consumers and whether this value creation is sufficient to support a new business. In doing this exercise, students should discuss how they will position themselves as a cost leader, differentiator, or combination firm. They should also discuss what market segment(s) they will serve. Finally, strong answers will begin to address the resources the new business will need to thrive. 2. E-Loan and Lending Tree are two entrepreneurial firms that offer lending services over the Internet. Evaluate the features of these two companies and, for each company: a. Evaluate their characteristics and assess the extent to which they are comparable in terms of market commonality and resource similarity. Response:

These firms use an imitative entry strategy. Market commonality is the extent to which competitors are vying for the same customers in the same markets. They offer services similar to what banks normally offer. E-Loans offers savings accounts and consumer loans for vehicles, home equity, and mortgages. Lending Tree offers a similar array of services. Lending Tree is a market maker. It matches customers with banks and financial institutions that do provide services. Lending Tree provides consulting services for free to customers and takes no fees for its services. Its geographic range is limited to the United States. Through its Lendingtree.com family, it offers a growing array of other services. E-Loans is a subsidiary of Banco Popular, an international bank. It offers customers savings accounts and some other basic services. It does originate loans and does charge fees for some of its services. E-Loans also provides a great deal of its services, similar to Lending Tree, through partners. Its scope of operations is also the United States. In terms of resource similarity with other traditional banks, these new firms differ greatly from normal banks. Resource similarity is the extent to which rivals draw from the same types of strategic resources. E-Loan and Lending Tree have fewer costs in terms of offices and employees. The lower costs mean that these firms can pass on the savings in the form of lower fees and interest rates. However, the lack of loan officers and offices might mean that these firms are not as close to the customer as bricks-and-mortar banks. The distance might mean that E-Loan and Lending Tree have a deficit in customer information and are less able to accurately determine the risk profile of potential customers, so their loan portfolios may be relatively rich in underperforming loans. The table below describes how Lending Tree and E-Loans compare with respect to market commonality and resource similarity. Market Commonality

Resource Similarity

E-Loan

Company

High market commonality with Lending Tree

Lending Tree

High commonality with ELoans

Expertise in providing information to customers and in providing financial services. Charges fees for services. Expertise is in providing information to customers and referring them to partners. Paid by partner firms.

b. Based on your analysis, what strategic and/or tactical actions might these companies take to improve their competitive position? Could E-Loan and Lending Tree improve their performance more through co-opetition rather than competition? Explain your rationale.

Response: Based on the above description of their operations, some strategic and tactical actions that E-Loans and Lending Tree may take include the following: Strategic Actions

Tactical Actions

E-Loan

Company

Make investments in providing more services in-house rather than through partners. Expand operations internationally.

Lending Tree

Expand services to other marketmaking arenas for the public such as auctions, product evaluations, and services such as a stockbroker.

Advertise its awards and good performance. Improve response to customer inquiries. Recruit more partners. Advertise its good service and free advice. Work to reduce perceived bias in advice by restructuring relationships with partners.

E-Loans and Lending Tree currently follow low-cost focus strategies. It is likely that there are few barriers to entry for large banks for setting up their own Web sites that compete with them, so combination strategies might be a good way to go. Lending Tree has made some inroads by providing customers information such as blue book values for used cars, free credit reports, car insurance and the like. E-Loan advertises its awards and site security, an effort to develop brand equity. (Note to instructor) Students may come up with a variety of other suggestions for strategic and/or tactical actions. We think it is valuable to consider these. For each suggestion, ask the student if it is a strategic or tactical action. Then ask if the action leads the firm to a combination strategy. And lastly, rate the difficulty that an established bank would have imitating the action. The idea of an action-reaction cycle may lead to an illustration of the competitive dynamics model. Co-opetition is a combination of competition and cooperation. For example, close competitors that differentiate themselves on the consumer side may actually collaborate behind the scenes to achieve industrywide efficiencies. One example by which E-Loans and Lending Tree could do co-opetition is by sharing information on customers‘ risk profiles. Or the online banks could assist bricks-and-mortar banks in setting up their online operations in exchange for an equity stake in the business. In each case, the competing formats would be able to address their competitive weaknesses through cooperation. (Note to instructors) Students may come up with a variety of suggestions regarding coopetition. For each, ask the students if the action would be perceived as collusion. Is there any chance the actions could be interpreted as the firms setting price, output levels, or quality of product? 3. Research the Small Business Administration’s website (www.sba.gov). What different types of financing are available to small firms? Besides financing, what other programs are available to support the growth and development of small businesses? 1-278 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Response: The Small Business Administration offers a wide range of services, including market information, financial analysis, compliance with regulations, business plan development, referrals to others in the locality who can provide more textured advice, and advice for disposal of assets (should the business fail). In terms of financing, the SBA offers disaster assistance loans, grants, and information on contracting opportunities with the federal government. (Note to instructors) This list is only a start of what is available. One goal of this assignment is to increase students‘ awareness of this government resource. 4. Think of an entrepreneurial firm that has been successfully launched in the past 10 years. What kind of entry strategy did it use—pioneering, imitative, or adaptive? Since the firm’s initial entry, how has it used or combined overall low cost, differentiation and/or focus strategies? Response: (Note to instructor) For each example, have the student first describe the firm and what it does. Then ask about the firm‘s competitive advantages, and, once identified, how these advantages are not easily copied by other firms in the industry. After establishing these, a context is set for the discussion about entry strategy and combination strategy. 5. Select an entrepreneurial firm you are familiar with in your local community. Research the company and discuss how it has positioned itself relative to its close competitors. Does it have a unique strategic advantage? Disadvantage? Explain. Response: (Note to instructor) For each example, have the student first describe the firm and what it does. Then ask how the firm is able to limit imitation. Ethics Questions 1. Imitation strategies are based on the idea of copying another firm’s idea and using it for your own purposes. Is this unethical or simply a smart business practice? Discuss the ethical implications of this practice (if any). Response: There are at least two primary problems with imitation strategies. First, the firm that invented or developed the idea has intellectual property that is protected by law. Imitation risks violating the patent, copyright, trademark, or trade secrets of the competitor. Violation of intellectual property rights subjects the firm to legal action. Second, imitation may threaten the value of the firm, which harms shareholders and firm value. 1-279 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The first mover on an idea is likely to have first mover advantages and be able to keep one step ahead of the imitator. As a result, the imitation strategy may not succeed to the extent that costs are covered. 2. Intense competition, such as price wars, is an accepted practice in the United States, but cooperation between companies has legal ramifications because of antitrust laws. Should price wars that drive small businesses or new entrants out of business be illegal? What ethical considerations are raised (if any)? Response: We would answer the question with ―depends.‖ If a price war represents a large firm lowering prices below a small firm‘s cost, but still above the large firm‘s cost, then consumers are likely to get a sustainable benefit. The tactic seems ethical and a challenge to small firms to either focus operations on a market niche or offer customers some other value that justifies the higher price. Price wars are unethical if the large firm tactic is to lower prices below their costs. In this case, the large firms are trying to drive the small businesses out of the market only to raise prices later. Consumers only derive a temporary benefit in terms of price and lose the vigorous and legal competition that would result in product/service improvements as well as low price. Predatory pricing is also illegal under antitrust legislation, but the possibility of successful legal action by small firms is low in the current legal environment.

CONNECT RESOURCES Comprehension Case Metabolix Case Analysis Metabolix Pandora Rocked by the Music Business Gemini, Coinbase, and Crypto Competitive Dynamics

part 3

Strategic Implementation

Chapter 9 Strategic Control and Corporate Governance ........................ 9-2 Ensuring Informational Control: Responding Effectively to Environmental Change ....................................... 9-3 A Traditional Approach to Strategic Control ........................................ 9-4 A Contemporary Approach to Strategic Control .................................. 9-4 1-280 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Attaining Behavioral Control: Balancing Culture, Rewards, and Boundaries .......................................................... 9-5 Building a Strong and Effective Culture ................................................. 9-7 Motivating with Rewards and Incentives ............................................... 9-9 Setting Boundaries and Constraints ........................................................ 9-12 Behavioral Control in Organizations: Situational Factors ................... 9-14 Evolving from Boundaries to Rewards and Culture ............................. 9-14

The Role of Corporate Governance .......................................... 9-14 The Modern Corporation: The Separation of Owners (Shareholders) and Management............................................................................................... 9-15 Governance Mechanisms: Aligning the Interests of Owners and Managers ..................................................................................................................... 9-16 CEO Duality: Is it Good or Bad?............................................................. 9-20 External Governance Control Mechanisms............................................ 9-21 Corporate Governance: An International Perspective.......................... 9-25

Issue for Debate ........................................................................... 9-27 Reflecting on Career Implications ............................................ 9-28 Summary ............................................................................................... 9-30 End-of-Chapter Teaching Notes ......................................................... 9-33 Connect Resources ............................................................................... 9-40

Chapter 9

Strategic Control and Corporate Governance Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead The purpose of this chapter is to explain how strategic control systems may be used to effectively implement strategies. As the first of the four chapters in Part 3 of the text, it introduces students to the issues surrounding implementation and leadership. It includes both traditional and contemporary approaches to control, and outlines informational (e.g., monitoring, performance milestones) and behavioral (e.g., rewards, culture, boundaries) techniques for achieving control, as well as for corporate governance. The chapter is organized into three sections: 1.

Informational control: We describe contrasting approaches to information control. The first is termed ―traditional‖ and emphasizes setting objectives and standards and controlling by comparing performance to achievements. The second is ―contemporary,‖ in which conditions are continually monitored and strategy is modified in an interactive fashion to adapt to changing conditions.

Behavioral control: We introduce the role of cultures, rewards and incentives, boundaries, and how firms must achieve a proper balance between these forces in order to maintain strategic control.

We explain the role of corporate governance in ensuring that managerial and shareholder (owner) interests are aligned. Examples of effective and ineffective governance are given, and we address three mechanisms for effective governance: committed and involved board of directors; shareholder activism; and effective managerial rewards and incentives. We also propose several external control mechanisms: the market for corporate control, auditor, banks and analysts, the media, and public activists. We close this section with a discussion of corporate governance from an international perspective.

Lecture/Discussion Outline The introductory case in LEARNING FROM MISTAKES focuses on how McDonald‘s board of directors failed to intervene effectively in the handling of its CEO‘s consensual romantic relationships with at least three McDonald‘s employees. Discussion Question 1: McDonald’s board is composed of several very successful individuals (CEOs, COOs, etc.). Why would the board dismiss the CEO without cause for 1-282 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

a clear violation of company policy? How should the board handle future policy violations? Response guidelines: Individuals serving on the board may come from similar backgrounds— such as top business schools and similar ranks in the corporate elite. This shared background may signal close social relationships among board members, including the CEO. While formal listing requirements on U.S. stock exchanges emphasize formal independence of directors from the CEO, these social relationships may lead to the board treating the CEO more favorably, including dismissing him without cause in this example. An interesting question is how the board should deal with similar violations of company policy. It may be important for the board to impose clear guidelines on itself. This may have the advantage that directors can refer to these guidelines when they penalize undesirable CEO actions and behavior. This may help them to maintain good relationships with the CEO since directors can refer to formal policy in their governance decisions. Discussion Question 2: Given the #MeToo movement and increasing awareness for inclusive workplaces, how would you change McDonald’s company culture to prevent such problems in the future? Response guidelines: McDonald‘s should seriously consider creating a more inclusive culture in which all employees feel heard and important. This may be accomplished by appointing female leaders who are representing the interests and better understand the viewpoints of women in the McDonald‘s workforce. Yet, changing corporate culture—including turning an existing culture into a more inclusive culture—may result in resistance from top management and other employees. Here it may be important to clearly communicate the benefits of such a culture change. Some benefits may include reducing the instances of sexual harassment lawsuits and creating a more engaged (and productive) workforce. This chapter focuses on how management can develop and use effective strategic control. The first two sections address: 1. 2.

informational control (the ability to respond effectively to change) behavioral control (the appropriate balance and alignment among an organization‘s culture, reward, and boundaries.)

The third section focuses on strategic control from a broader perspective—corporate governance. Here we focus on a firm‘s need to assure that the elected representatives (board of directors) of the owners of the firm (shareholders) ensure that the firm‘s executives (the management team—headed by the chief executive officer) strive to fulfill their fiduciary duty of maximizing long-term shareholder value. I. Ensuring Informational Control: Responding Effectively to Environmental

Change PowerPoint Slide 4: Strategic Control PowerPoint Slide 5: Strategic Control Mechanisms 1-283 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

PowerPoint Slide 6: Strategic Control Mechanisms: Traditional Approach Model

PowerPoint Slide 7: Strategic Control: Traditional Approach PowerPoint Slide 8: Strategic Control: Contemporary Approach Model PowerPoint Slide 9: Strategic Control: Contemporary Approach PowerPoint Slide 10: Strategic Control: Contemporary Approach Effectiveness PowerPoint Slide 12: Informational Control: Issues PowerPoint Slide 13: Informational Control: Characteristics This section addresses ―traditional‖ and ―contemporary‖ approaches to informational control. Although both have the same purpose—using information to select, monitor, and implement effective strategies—they have a different impact on employees and organizational outcomes. Also, as environmental conditions become more complex or unpredictable, the need for contemporary approaches to informational control increases. A.

A Traditional Approach to Strategic Control

With a traditional approach to strategic control, goals and objectives are set, strategies are implemented, and performance is compared to the desired standards. Then there is a feedback loop in which information about how performance compares to goals is used to revise strategies. Thus, it is a highly sequential process. EXHIBIT 9.1 illustrates the traditional approach. Examples of control systems that rely on feedback controls include sales quotas, operating budgets, and production schedules. Discussion Question 4: What is the value of feedback systems that compare performance to objectives? Point out that the traditional process can often be time-consuming and that many firms update budgets or other control devices only once a year, during annual planning meetings. Thus, it may be best suited for environments that are relatively simple and stable. Discussion Question 5: Under what conditions might a traditional sequential control system be inadequate (in cases where factors in the internal and external environment change very slowly)? B.

A Contemporary Approach to Strategic Control

Because business conditions typically change rapidly, information controls are needed that can quickly adjust. With contemporary controls, an organization‘s assumptions, goals, and strategies are continuously monitored, tested, and reviewed. Thus, anticipating and adapting to change is built into the control process. EXHIBIT 9.2 illustrates the contemporary approach. Notice in EXHIBIT 9.2 that both informational and behavioral controls are needed for the contemporary approach. Informational controls ask whether the organization is ―doing the right things.‖ Behavioral controls, by contrast, ask whether the organization is ―doing things right.‖ With this framework, therefore, you can illustrate how the combination of effectiveness (―doing the right things‖) and efficiency (―doing things right‖) applies in the context of strategic controls. 1-285 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 6: What is the advantage of continuously monitoring and updating information controls? Emphasize that contemporary control systems—which require continually monitoring numerous information sources and result in rapid revisions to corporate strategies or direction— may be ―easier said than done.‖ Sometimes, the most important thing strategic managers can do is to continually question assumptions about the business and have frequent face-to-face meetings to discuss direction and outcomes. The SUPPLEMENT below emphasizes that old systems often have to be updated. It describes the methods that Praxair used to overhaul its budget process and make it timelier. Extra Example: Creating a Responsive Budget Process In many companies, budgeting involves a ten-week cycle. Besides being overly drawn-out, the process can often cause problems if lower level managers propose budgets that consider only their own priorities and not the company‘s overall situation. Then, in budget negotiations, top managers typically ask for more ambitious goals, while lower level managers shoot for targets they know they can hit. The result is silo thinking and compromise. Praxair implemented a speedier and more comprehensive system to address this issue. The process begins with the company‘s overall goal, articulated by top management and based on the big-picture environment. Managers from each unit then state, in a maximum of 50 budget lines, the most important things they believe the firms must accomplish to achieve that goal. Then, the critical 20 to 30 people get together and openly discuss key actions and assumptions for each unit. With information technology, managers can see the effects of changes to the budget instantly. The horse trading goes on for about three days and in the end, everyone understands the total picture and collaboration between units becomes easier. Source: Charan, R., & Colvin, G. 2001. Managing for the slowdown. Fortune, February 5: 79–88.

Discussion Question 7: What are some examples of other information control systems that could benefit from the type of processes used by Praxair? Discussion Question 8: What are some examples from other companies of interactive information control systems?

II.

Attaining Behavioral Control: Balancing Culture, Rewards, and Boundaries

PowerPoint Slide 15: Behavioral Control Model PowerPoint Slide 16: Behavioral Control: Culture PowerPoint Slide 17: Behavioral Control: Role of Culture PowerPoint Slide 18: Behavioral Control: Sustaining an Effective Culture PowerPoint Slide 19: Behavioral Control: Rewards PowerPoint Slide 20: Behavioral Control: Downside of Reward Systems PowerPoint Slide 21: Behavioral Control: Reward Systems Characteristics PowerPoint Slide 22 and 24: Behavioral Control: Boundaries 1-286 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

PowerPoint Slide 25: Behavioral Control Systems: Situational Factors Behavioral control is an approach to implementing strategy that relies on three behavioral forces or ―levers‖—culture; rewards and incentives; and boundaries. The aim is to use these levers to evoke appropriate actions in the workforce and also to maintain a proper balance between these three factors. Depending on the type of organization and the business environment, the way these forces are manipulated may vary in order to achieve goals with the greatest degree of efficiency. EXHIBIT 9.3 illustrates the three behavioral controls. Point out that there are two reasons why behavioral controls are important for strategic managers today. 1.

Increasingly complex and unpredictable environments make it important that all workers respond quickly. Reward systems and culture provide an implicit type of coordination mechanism. Today‘s work force includes younger managers who see themselves as free agents. Traditional controls such as rules and regulations typically will not motivate such employees. Effective behavioral controls are needed to build loyalty and commitment.

The SUPPLEMENT below illustrates how poor behavioral controls can lead to tragedy. It discusses the inadequate controls that played a key part in BP‘s 2005 refinery disaster that took place in Texas City, Texas that killed 15 people and injured 180. Of course, BP‘s disaster in the Gulf on April 10, 2010 was also partly attributed to poor behavioral controls. Extra Example: Poor Behavioral Controls at BP‘s Refinery in Texas The Chemical Safety Board, a U.S. government agency that investigates industrial disasters, had long believed that BP‘s executives did not spend enough time and money on the safety of their employees. Its latest report on the subject, released in March 2007, was no different: It claimed that such failings contributed to the explosion in 2005 at BP‘s refinery in Texas City, Texas. Consultants investigating frequent breakdowns at the refinery wrote in 2002: ―Budget cuts were imposed on the previous year‘s spending and did not take into account the specific needs of the refinery… The prevailing culture at the Texas City Refinery was to accept cost reductions without challenge and not to raise concerns when operational integrity was compromised.‖ In 2002, an employee noted in an internal email: Orders to slash costs by 25 percent seem ―to have been taken literally‖ by those in charge of Texas City, whereas managers elsewhere ―knew how to play the BP game‖ He refers to a colleague who thinks ―the top level in London need to understand the consequences of their orders.‖ An internal audit of Health, Safety and Environment (HSE) throughout BP, released in 2004, discovered ―widespread tolerance of non-compliance with basic HSE rules…poor implementation of HSE management systems…lack of leadership competence and understanding to effectively manage all aspects of HSE…(and) insufficient monitoring of key HSE processes.‖ Several employees at Texas City complained that ―managers were not nearly worried enough about the ‗real‘ dangers and ‗too worried about seat belts‘,‖ according to another set of consultants. Others griped that it was ―acceptable to avoid costs related to integrity management because the consequences might occur later, on someone else‘s watch.‖ Consultants also said they had ―never heard so many people say they were personally afraid of 1-287 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

injury.‖ Sadly, there was in an email written by an employee a few weeks after the disaster: ―It‘s a shame what had to happen to get us to where we recommended we go several years back.‖ Source: Anonymous. 2007. In their own words… The Economist. March 24: 74.

Discussion Question 9: How could such a tragedy have been prevented? (Address behavioral controls of culture, rewards, and boundaries. You might also raise broader leadership and ethical issues.) A.

Building a Strong and Effective Culture

Culture refers to the shared values, unspoken understandings, and sense of purpose within organizations. It provides unwritten standards of acceptable behavior. When a culture is strong and positive, it can be a powerful force for accomplishing company goals. Discussion Question 10: What makes an organizational culture strong? What are some examples of companies with a strong culture? Discussion Question 11: What would be the effect on an organization if its culture were “negative” rather than “positive?” What are some examples of companies that have a negative culture? 1.

The Role of Culture

Point out that a company‘s culture is often what makes it unique compared to other firms in an industry. This uniqueness gives workers a sense of ―specialness.‖ It may also influence other stakeholders. We provide examples of Zappos and Amazon (customer service), Lexus and Apple (product quality), Google and 3M (innovation), and Nucor and Walmart (efficiency). Discussion Question 12: What are some of the other examples of culture that give companies a sense of uniqueness or set them apart in the mind of employees or customers? The SUPPLEMENT below addresses the importance of culture at Nucor in maintaining focus and morale during the recent economic downturn. Extra Example: Culture Keeps Company Strong During an Economic Downturn U.S. Steelmaker Nucor is known for its unique culture. Former Chair Ken Iverson (1925–2002), who transformed a failing nuclear instruments company into a successful chain of steel minimills, established principles that are the key to Nucor‘s success: no executive parking spaces or dining rooms and everyone flies coach and gets the same health insurance and benefits package. In other words, Nucor is frugal, fraternal, and egalitarian. Keeping with the tradition of not laying off employees or cutting benefits, Chairman Daniel DiMicco faced the challenge of maintaining a strong culture in the face of a slumping economy in 2008. Some Nucor employees switched from their normal roles into roles where they cleaned bathrooms and mowed lawns. The firm‘s bonusdriven pay plan saw dramatic cuts in paychecks because of deep production losses—plants were running at 50 percent capacity and many of Nucor‘s employees were working half-time. 1-288 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Because of the strong emphasis on operational efficiency, paying for performance lies at the heart of Nucor‘s culture. Steel mill workers earn weekly bonuses based on how many steel sheets or beams their group turns out. The bonuses account for two-thirds of take-home pay. ―We pay weekly because spouses will perform a good kick in the butt if you have an off week,‖ says DiMicco. How did DiMicco sustain the fair and efficient culture that has made Nucor strong? Besides shunning layoffs, DiMicco became a vocal spokesman in support of buying U.S. steel and requiring China, which accounts for 30 percent of U.S steel purchases, to abide by the rules of the World Trade Organization. He also fought cap-and-trade legislation that could have added $50 to the cost of a ton of U.S. steel. Nucor worked its way through the economic challenges of the great recession and has fully rebounded financially. Importantly, the firm retained its culture through this period. They still haven‘t had a layoff since 1984, and 88 percent of employees responding to a survey support the job DiMicco is doing as CEO. Source: Helman, C. 2009. Test of mettle. Forbes, May 11: 81–82; www.nucor.com; www.glassdoor.com

Discussion Question 13: Given changing economic conditions, is there a potential downside to companies that rely on a strong culture to maintain behavioral control? STRATEGY SPOTLIGHT 9.1 discusses how GE‘s strong culture played a role in its downfall from its position as a leading industrial conglomerate. 2.

Sustaining an Effective Culture

Companies use many different techniques to foster a positive culture and create an environment that is fun and motivating. Another advantage of a strong culture is that it builds cohesion within the work force. This can become a critical management activity. We discuss actions of leaders at Warby Parker and adventur.es to sustain and reinforce firm culture. STRATEGY SPOTLIGHT 9.2 discusses how the CEOs of large American banks try to sustain a positive workplace culture by requiring employees to return to the office following the COVID-19 pandemic. Discussion Question 14: Many employees favor to work from home rather than in an office building? How would you react if your supervisor askes you to exclusively work in an office rather than your own home? How can your supervisor make a return to the office more enjoyable and productive for all employees? The SUPPLEMENT below describes how the leadership at VW is working to change the culture after a corporate scandal. Extra Example: Fixing the Culture at Volkswagen In 2015, Volkswagen was involved in a major scandal. It was revealed that VW had put in place software that would help the firm pass emission tests on their diesel vehicles even though the vehicles actually produced emissions over legal standards when they were driven normally. For engineers working on diesel car designs, it was simpler and cheaper to cheat on emission tests than it was to change the design of engines to meet the emission standards. In the United States alone, the scandal cost the firm over $25 billion in fines, payments to individuals who purchased these

cars, and in repairs to address the violations. Employees responsible for the deception have pleaded guilty to criminal offenses. It also hit the reputation of the firm hard and cost the CEO his job. The CEO who took over after the scandal, Matthias Muller, has been trying to shake up VW‘s culture to improve the firm‘s decision making and to get decision makers to think about the larger corporate purpose when making choices. As part of its efforts, VW has put in place a new oversight board charged with ensuring legal compliance and integrity in the firm‘s decisions. The firm also undertakes an extensive background investigation of all new candidates for the board of directors to ensure they have exhibited ethical behavior throughout their careers. Muller is also traveling to VW facilities to meet with employees in town hall meetings to answer their questions and implore them to ensure the firm is ethical in its decisions and actions. Even he admits it is a slow process. Muller states, ―I‘d like to see an acceleration of the pace of change because such a large organization is sluggish.‖ Source: Boston, W. 2017. VW chief contends with scandal. Wall Street Journal. September 13: B9.

Discussion Question 15: What kind of actions, substantive and symbolic, can Muller take to push the culture change forward? Emphasize that recreation and ―fun parties‖ are not the only way companies cultivate and maintain a strong culture. In fact, the company leadership is one of the most important sources of a strong and positive culture. Sam Walton was known for his pep talks. Ford CEO, Alan Mullaly, was known for the way he emphasized accountability and collaboration. Teaching Tip: Ask students how they define organizational culture and how it can be a source of competitive advantage that can be sustainable over time. Point out that it is particularly important in the knowledge economy for several reasons: it helps to combine/leverage resources, it enhances firm-specific ties (which is particularly important given that human capital is highly “mobile”), and it can help the firm convert tacit knowledge into codified knowledge, etc. You may wish to draw on some of the core concepts in Chapter 4 to reinforce your points. B.

Motivating with Rewards and Incentives

Reward systems specify who gets rewarded and why. They can have a powerful influence on individual performance and overall firm outcomes. Reward systems need to be closely linked to culture since they ―put the money where the mouth is‖ of the organization. If rewards don‘t match up to the espoused values and beliefs, reward systems can also be a powerful demotivator. We provide the example of how Not Your Average Joes, a Massachusetts restaurant chain, uses a sophisticated system to reward its best servers with more tables and a preferred schedule. Discussion Question 16: Are you familiar with other firms that have different incentives and rewards for individuals at different hierarchical levels? Is the reward system effective? Why? Why not? 1-290 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The Potential Downside

While rewards can be powerful tools to get employees to work for the benefit of the firm, they can also have some negative outcomes. First, if the incentive criteria seem out of the control of workers (e.g., stock incentives for lower level employees) or the goals unreachable, they can be demotivating. Second, incentive can sometimes lead to perverse outcomes. For example, if workers are incentivized to maximize the rate of production or the speed of a process, it can easily lead to quality problems. Rewards and incentive systems can trigger unexpected or unwanted behaviors if the incentives lead to subcultures within an organization or perceived competition between organizational units. These issues can lead to a deterioration in the cohesion of the workforce and damage the organization. Discussion Question 17: What is it about reward systems and incentives that make them an emotional flashpoint within organizational control systems? Discussion Question 18: What are some examples of companies that have effectively aligned their reward systems with their goals and culture? The SUPPLEMENT below discusses how organizational control and incentive systems can undercut the desired culture a firm espouses that it pursues. Extra Example: Desired vs. Enacted Cultures A few years ago, when a bank experienced a scandal, the bank‘s CEO lamented that employees failed to honor the bank‘s culture of putting the customer first. What he failed to acknowledge was that it was really the firm‘s fault that employees did not live out the firm‘s espoused culture. Most firms have formal value statements that assert the firm ―works for our customers,‖ ―respects diversity,‖ ―is dedicated to our employee‘s success,‖ and ―is dedicated to supporting the communities in which we operate.‖ Still, firms differ greatly in how their actions either work to achieve or contradict these values. Why is this? In short, employees do not do what you expect but rather what you inspect. The review and incentive systems firms put in place have a much stronger effect on the actual culture of firms than the firm‘s lofty value statements. Formal and informal incentive systems play a key role in determining what the true culture is. If compensation of executives and employees is primarily short-term oriented and financial performance-focused, that is a clear signal to organizational members what is really valued. If a firm wants to build a culture that is customer-centric, then customer satisfaction and retention data needs to be as prominently considered in evaluation and compensation systems as financial performance. Informal signals also play an important role. Employees notice who gets an accolade in meetings with executives. Do top executives laud managers who made their financial targets, or do they give credit to individuals who raise concerns that a corporate policy appears to value financial concerns over meeting customer needs? Further, which of these individuals advances in the organization? Budgeting policies also set the tone for the organization‘s culture. If the CEO asserts that the firm is building a culture of innovation, pushing the frontiers of technology, that will have little effect on organization culture if a memo comes down from the firm‘s CFO a few weeks later that the firm is running over budget in the current quarter and all discretionary spending, including R&D, is being frozen. Similarly, if a firm doesn‘t back up statements highlighting the value of customers with budgeting that includes sufficient emphasis on marketing and customer service, those statements will simply be seen by employees as cheap talk. 1-291 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

So, if a leader wants to understand what a firm‘s culture really is going to be, don‘t look to the firm‘s lofty value statements. Instead, look to the firm‘s budgeting, review, and incentive practices. Again, employees will do what you inspect, not what you expect. Source: Gerstner, L. 2016. The culture ate our corporate reputation. Wall Street Journal. October 3: A17.

Discussion Question 19: What are some examples of firms that appear to reward their employees for the wrong things? 2. Creating Effective Reward and Incentive Programs Another challenge for strategic managers is to create reward and incentive programs that are effective across all parts of the organization. EXHIBIT 9.4 presents the qualities and characteristics of a good reward system: 1. 2. 3. 4. 5. 6.

Objectives are clear, well understood, and broadly accepted. Rewards are clearly linked to performance and desired behaviors. Performance measures are clear and highly visible. Feedback is prompt, clear, and unambiguous. The compensation ―system‖ is perceived as fair and equitable. The structure is flexible—it can adapt to changing circumstances.

The SUPPLEMENT below addresses how Home Depot is building a reward system that support its desire to be an omnichannel retailer. Extra Example: Giving Credit to the Store Along with most other retailers, Home Depot is experiencing a major shift in its business with many of its customers increasingly shopping online. To respond to this, HD is moving to an omnichannel system, running their business in a way that customers can interact with the firm online or in the store in a seamless way. Prices and product availability need to span across the two channels. The firm also works to integrate its service offerings. Customers can order online and pick up in the store, or shop in the store and order it for home delivery. For this to work well, the firm aims to be agnostic about whether customers shop online or in the store. A key part of this is to make sure that managers and employees in the physical stores don‘t see the online business as a rival, stealing the store‘s business. To limit this, as part of its performance evaluation system, HD credits physical stores for online sales that take place in their region. This way, store employees are likely to look at HD‘s online presence as a tool to better serve the store‘s customers and not as a threat to them. Source: Wallace, T. 2016. Home Depot‘s innovative, successful multichannel strategy your brand should copy–– now. bigcommerce.com. np; Lindner, M. 2017. Home Depot and Lowe‘s reap the benefits of their omnichannel strategies. digitalcommerce360.com. May 24: np; Giannopoulos, N. 2014. Home Depot builds omnichannel foundation. risnews.com. March 18: np.

Discussion Question 20: What kind rewards can HD use to incentivize store employees to build online business or for online platform developers to build store business? Emphasize that there needs to be a close link between reward systems and an organization‘s culture. A culture of risk taking may be present in firms that are entrepreneurial, 1-292 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

but then a reward system is needed that encourages risk taking. Similarly, if technological superiority is an organization‘s key distinctive competence, then reward systems must be created that highlight technical skills development and performance. We discuss the concept of agile compensation, setting up reward systems that compensate employees when managers see exemplary behavior or realize they have ramped up the job demands on workers. We also note that incentive and reward systems don‘t have to just be about money. The INSIGHTS FROM RESEARCH for this chapter provides further evidence that employees are more motivated when they find a sense of purpose in their work and feel valued by their employers than when they are only monetarily rewarded for their work. C.

Setting Boundaries and Constraints

This section discusses how rules and regulations, as well as aspiration levels and goals, can provide effective forms of organizational control. Point out that culture and reward systems often need to be supplemented or reinforced by boundaries and constraints. Used properly they can: 1. 2. 3. 4.

Focus individual efforts on organizational priorities. Provide short-term objectives and action plans that channel efforts. Improve efficiency and effectiveness. Minimize improper and unethical conduct.

Emphasize that boundaries and constraints must be used sparingly in order to be effective. Excessive regulations or rules that are enforced with poor judgment can be counterproductive. Discussion Question 21: Have you ever been asked to observe a rule that was excessive? What is an example from your own experience? Discussion Question 22: What effect does an excessive rule, or an overly strict regulation have on your behavior? How do you think such rules and regulations affect organizational performance? 1. Focusing Efforts on Strategic Priorities It is important that firms focus their attention on a limited number of shared priorities. Vision, mission, and strategic objectives are a type of boundary that was introduced in Chapter 1. Focusing sometimes involve the need to change the boundaries of the firm by selling or spinning off business that don‘t fit the firm‘s current priorities. We present GM and Pfizer as examples of firms that sold off businesses to focus on core strategic priorities. Management can also take a role in clarifying the boundaries of the firm‘s priorities. As an example, we discuss how Steve Jobs would have his executive team work to identify the 10 most pressing initiatives in the firm. He would then cross off the bottom seven and say, ―we can only do three.‖ 1-293 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 23: Can you think of firms that have significantly changed their strategic priorities in the last several years? Why did they make this change? Discussion Question 24: What kind of actions can managers take to highlight the priorities and boundaries for the firm? 2. Providing Short-Term Objectives and Action Plans Strategic objectives and actions plans may have a more direct impact on the behavior of an organization‘s employees. Discuss the attributes of short-term objectives that need to be present for them to be effective. They must: 1. 2. 3.

Be specific and measurable. Include a specific time horizon for their attainment. Be achievable yet challenging enough to motivate managers who must strive to accomplish them.

Short-term objectives must provide proper direction but also be flexible enough to keep pace with changing conditions and unexpected circumstances. Discussion Question 25: What are some examples of short-term goals that you have been faced with as a student? In your place of work? Did you find that those goals had a positive influence on your behavior? Action plans are another type of boundary or constraint because they provide specific, measurable frameworks for how a strategy is to be implemented. Once managers understand the outcome that is to be achieved, developing an action plan gives them a sense of ownership of the company‘s goals. They also feel a degree of autonomy since they can often select (or modify) the specific means for accomplishing the implementation. 3.

Improving Operational Efficiency and Effectiveness

Discuss why rules-based controls are most appropriate in organizations where: 1. 2. 3. 4.

Environments are stable and predictable. Employees are largely unskilled and interchangeable. Consistency in product and service is critical. The risk of malfeasance is extremely high (as in banking or casino operations), and controls must be implemented to guard against improper conduct.

McDonald‘s and the Ritz Carlton are used as examples.

Minimizing Improper and Unethical Conduct

Rules and guidelines are often used to control commercial practices such as bribes, kickbacks, and other forms of payment that may be illegal. These guidelines are used in many arenas, including maintaining customer confidentiality and developing sourcing strategies for dealing with suppliers. D.

Behavioral Control in Organizations: Situational Factors

In this section, we take a contingency approach to behavioral control. That is, the effective use of rewards/incentives, culture, and boundaries are dependent on a variety of internal and external factors. To summarize, we suggest that culture is most associated with professional organizations, where high autonomy and norms are the basis for behavior; rules/boundaries are best where there are standardized output, repetitive tasks, and a minimal need for creativity; and rewards are most appropriate when performance evaluation is quite straightforward. STRATEGY SPOTLIGHT 9.3 highlights how an upstart firm is using data analytics to strengthen control in major financial firms. EXHIBIT 9.5 provides a summary of alternative approaches to behavioral control. Ask: Discussion Question 26: Are you familiar with organizations that effectively (or ineffectively) matched their elements of behavioral control with their particular situation (internal and external factors)? E.

Evolving from Boundaries to Rewards and Culture

In general, the use of culture and reward systems provides a more favorable ―internalized‖ control system than a set of rules and regulations. Often, however, companies have to develop in this direction. We provide four guidelines: 1. 2. 3. 4.

Hire the right people, those who identify with the company‘s dominant values. Use training and indoctrination to build a strong identity and sense of the company culture. Encourage managers to set examples for the whole company with their behaviors. Align company reward systems with organizational goals and objectives.

III.

The Role of Corporate Governance

PowerPoint Slide 27: Control Systems: Agency Theory PowerPoint Slide 28: Control Systems: Mechanisms PowerPoint Slide 29: Corporate Governance Mechanisms: Board of Directors Effectiveness PowerPoint Slide 30: Corporate Governance Mechanisms: Shareholder Activism PowerPoint Slide 31: Corporate Governance Mechanisms: Managerial Rewards & Incentives PowerPoint Slide 32: Corporate Governance Mechanisms: CEO Duality? PowerPoint Slide 33: External Corporate Governance Mechanisms PowerPoint Slide 34: International Corporate Governance In this section, we focus on the need for both shareholders (the owners of the corporation) and their elected representatives—the board of directors—to actively ensure that management fulfills its overriding purpose: increasing long-term shareholder value. As noted by Robert Monks and Nell Minow, two of the leading scholars in corporate governance, the primary participants in corporate governance are: (1) the shareholders, (2) the management (led by the Chief Executive Officer), and (3) the board of directors. In recent years, there have been many instances of poor corporate governance; we provide brief, bulleted examples of Wells Fargo, Walmart, and Olympus Corporation. This is certainly a topic that should create a lot of student interest. You may want to pose some ―lead-off questions‖ such as: Discussion Question 27: What are some of the most notable examples of flawed corporate governance? What do you feel were the causes? How could they have been avoided? A. The Modern Corporation: The Separation of Owners (Shareholders) and Management Here, we address some of the implications for the separation of ownership and management in the modern corporation. We begin with some definitions of the corporation, including a humorous one from The Devil’s Dictionary: ―An ingenious device for obtaining individual profit without individual responsibility.‖ In a nutshell, we mention that a corporation is a mechanism created to allow different parties to contribute capital, expertise, and labor for the maximum benefit of each party. We briefly draw on the classic work of Adolf Berle and Gardiner C. Means who over eighty years ago advanced the idea of the divergence of the interests of the owners of the firm (shareholders) and its managers. Such separation is central to agency theory, which addresses the relationship between two primary players—the principals, who are the owners of the firm (stockholders), and agents, who are the people paid by the board of directors to perform a job on their behalf (management). Agency theory is concerned with resolving two problems that can occur in agency relationships: 

when the goals of the principals conflict.



when it is difficult or expensive for the principal to verify what the agent is actually doing. Discussion Question 28: In general, do you believe there are fewer or minimal governance problems in organizations where there is no separation of ownership and management, such as small businesses or family firms? Why or Why not?

We also address two instances of conflicts of interests (Mylan Pharmaceuticals and McKesson Corporation) by corporate leaders in the United States. Such actions reflect the individual‘s self-interest rather than the interests of shareholders. B.

Governance Mechanisms: Aligning the Interests of Owners and Managers

Three key governance mechanisms are addressed in this section. The first two address the primary means by which the behavior of managers can be monitored: (1) a committed and involved board of directors that acts in the best interests of shareholders, and (2) shareholder activism, wherein the owners of the corporation become actively involved in the governance of the corporation. In addition, a third mechanism of governance is the effective use of managerial incentives, which are intended to align the interests of management with those of the stockholders. 1.

A Committed and Involved Board of Directors

In effect, the board of directors is the ―middlemen‖ or ―middlewomen‖ who provide a balance between a small group of key managers in the firm and a vast group of shareholders. In the United States, the law requires that the board have a strict and fiduciary duty to ensure that the company is run consistent with the long term-interests of the owners (shareholders). We provide three duties of the board of directors, according to the Business Roundtable. These include such issues as the selecting, evaluation, and replacement (if necessary) of the CEO; review of strategies; financial objectives; providing advice and counsel to top management; etc. Discussion Question 29: At what point should firms prepare for CEO succession? As the CEOs get older, or as soon as they are instated? Discussion Question 30: Why do companies need to prepare for a CEO transition? Given that most VPs are familiar with the company’s operations, and could quickly take over, is extra preparation necessary? STRATEGY SPOTLIGHT 9.4 discusses the pressures organizations face to build younger and more diverse boards. The SUPPLEMENT discusses the challenge of getting board members from underrepresented groups, specifically female directors, into positions of authority on the board. 1-297 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Extra Example: The Lagging Influence of Female Board Members From 2006 to 2016, the percentage of females on the Boards of Directors at Fortune 500 firms almost doubled to nearly 25%. While this represents progress in increasing the voice of women in corporate governance, the progress has been limited in one key way. The power of women on boards remain limited. While all board members have influence on the strategy of corporations, board members have greater voice if they are in key roles on the board. The most obvious position of power is to serve as the Chair of the Board. Additionally, a great deal of important board processes occur on board committees, with the audit, compensation, nominating, and governance committees being the key committees. Thus, chairs of these committees also wield substantial power since they set the agendas and guide the discussion on issues such as executive compensation, CEO succession, and the nomination of new board members. However, the increased involvement of female board members in these powerful roles lags. Only 6 percent of Board Chairs are female. As to the committees, a small percentage of key committees are chaired by women, with only 18 percent of audit chairs, 13 percent of compensation chairs, and 21 percent of nominating and governance chairs being female. Thus, in order for corporate governance to fully benefit from female board membership, efforts are needed to more fully advance female board members into these key roles. How to accomplish this? Researchers suggest the following steps. 1. Directly measure female board members’ influence: Collecting and publicizing the proportion of females in key board leadership roles will increase both internal drive and external social pressure on increasing the voice of females on boards. 2. Recruit women with the right backgrounds to serve on these powerful committees: Certain key roles, such as chair of the audit committee, require a strong financial background. When selecting external female board members, firms should look for women with experience that will allow them to serve major roles on these key committees. 3. Coach women into these roles: Females appointed to their first boards may not be fully aware of the structure of boards and key power roles. Coaching from existing board members could aid novice female board members in seeing the importance of these roles and how to position to take on key roles. 4. Emphasize the nominating and governance committees first: These committees identify new board members and select membership for key board roles. Having female directors on these boards committees increases the likelihood that females will be considered for new board positions and key roles since the social networks of female board members are likely to include a higher percentage of female managers than for male board members. Source: Whitler, K., & Henretta, D. 2018. Why the influence of women on boards still lags. MIT Sloan Management Review. SpringL 79–81.

A key element of effective boards is director influence, i.e., that board members are free of all ties to the CEO or the company. The majority of large firms now have only one or two managers on the board (typically either just the CEO or the CEO and the CFO), but firms need to ensure that the outsider members are not just the friends of the CEO or closely aligned outsiders, such as the CEO of a supplier to the firm. We also discuss some downsides of having outsider dominated boards. For truly effective governance, firms need to move beyond just setting up an independent board. They need to build an engaged and committed board. We discuss several prescriptions to build an engaged, knowledgeable, and committed board: 1-298 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Building the right expertise on the board to meet the strategic challenges of the firm Keeping the board to a manageable size Choosing directors who can participate fully and aren‘t overly burdened by other commitments Balancing the board‘s focus on the past, present, and the future Considering management talent development below the CEO level Getting a broad view of the firm‘s operations by meeting in different locations Maintaining norms of transparency and trust within the board The SUPPLEMENT below cautions that having outside directors in not a panacea for improving the objectivity of directors. The quality of the outside directors is critical as well, but the same people seem to pop up on boards, even if they have a checkered past. Extra Example: Recycled Board Members One reason that outside board members may not lead to effective governance is that firms fail to attract strong outside board members. Boards primarily provide value by giving advice and counsel to the firm‘s top managers and by monitoring the strategic direction of the firm and the actions of top managers. However, individuals in the ―corporate elite‖ appear to get invited to serve on boards even if their own track record as a corporate manager or board member is spotty or downright unsuccessful. For example, Ellen Futter headed the audit committee for the board of for Bristol-Meyers when the firm had an accounting scandal in 1999 and served as a board member for AIG Corporation when it failed in 2008 and required a nearly $200 billion bailout from the U.S. government. Still, she has plum seats on the boards of JPMorgan Chase and Consolidated Edison. Similarly, Frederic Salerno, who served on Bear Stearns‘ board when the firm collapsed, serves on five boards including CBS and Viacom. The recycling of these tainted directors can create two problems. First, these directors are likely appointed to new boards because they are part of the ―club‖ and not necessarily the best candidates who can provide the optimal advice and counsel to the managers of the firm. As Sydney Finkelstein, a professor at Dartmouth‘s Tuck School of Business states, ―There is a comfort level issue here.‖ These ―tainted‖ board members are appointed to new boards because CEOs are comfortable with them, not because they are the best candidates. Second, they may not be the best monitors because they feel a strong loyalty to CEOs who nominate them to the board even though they are tainted. Professor Finkelstein puts it this way. ―Directors may be more concerned about friendships and connections‖ than about diligent oversight of the firm. Source: Olson, E. 2011. CEO careers: A case of rinse and repeat? cnnmoney.com. September 16: np.

Discussion Question 31: When should the directors of failed firms get another chance on a new board? Discussion Question 32: How can firms broaden the pool of potential directors to make sure they end up with the best board? 2.

Shareholder Activism

Although, as a practical matter, individual shareholders hold relatively little influence, they do—acting collectively—have power to bring about shareholder action suits and demand that key issues be brought up for proxy votes at annual board meetings. In addition, shareholder influence has intensified in recent years because of the growing influence of large institutional 1-299 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

holders such as retirement (e.g., TIAA-CREF, CalPERS) and mutual funds (e.g., Fidelity, Vanguard). In fact, institutional investors hold about 50 percent of all listed corporate stock in the United States. Some institutional shareholders are being very proactive in demanding changes. We discuss how CalPERS (the California Public Employees Retirement System) reviews firms‘ performance patters and market conditions and works firms they are concerned about to improve their governance practices and to protect shareholders‘ rights. CalPERS also holds out the threat of undertaking proxy fights at the firm‘s annual meetings or even file a court case if the firm‘s board and CEO are unresponsive to its concerns. CalPERS has seen significant success with its investments and has found that its investments have outperformed the overall stock market by nearly 12 percent over a recent three-year period. We also discuss the process activist investors undertake to influence corporations, the types of actions they push for and the level of success they have with their initiatives. Discussion Question 33. Why should firms care about CalPERS’ or other activist investors’ concerns and complaints? Discussion Question 34. What other organizations might have a similar effect as external control governance mechanisms? Would their role in influencing the companies they oversee be proportional to the size of their investments? What might change this influence? The SUPPLEMENT below discusses the value activist investors can bring to other shareholders. Extra Example: The Value of Activist Shareholders Some commentators have worried that activist shareholders are only out to enrich themselves, but evidence from a study undertaken by Bloomberg indicates that the involvement of activist investors benefits other investors. Stocks of companies that were targeted by activist investors between 2009 and 2013 rose in value by an average of 48 percent, beating the average rise of S&P 500 firms by 17 percent. Looking at longer-term trends, research by professors from Harvard Law School and Duke Fuqua School of Business found that firms targeted by activist investors showed improved market and accounting performance in the five years following activist investors‘ interventions. The conclusion is that other stockholders should not fear the activists. Instead, they should appreciate the potential for value gains. Activist investors generate gains by taking stakes in firms they see as undervalued and pushing for changes, including reorganizing and replacing management, restructuring the firm, selling units of the corporation, pushing for stock buybacks, and increasing dividend payouts. Source: Lachapelle, T & Jenks, G. 2014. Predators Are Good for Stocks. bloomberg.com. April 3: np.

Managerial Rewards and Incentives

From a corporate governance perspective, one of the most critical roles of the board of directors is to create incentives that align the interests of the CEO and top executives with the interests of the owners of the corporations. After all, shareholders rely on CEOs to adopt policies and strategies that maximize the value of their shares. We note research that shows that CEO pay is related to the performance of the firm‘s stock. However, CEO pay appears to be somewhat out of control, with CEO pay escalating over time and with the average CEO pay in S&P 500 firms being many times the pay of an average employee. Discussion Question 35: It could be argued that since top corporations have to compete for top talent, it is okay to, in essence, “out-bid” the competition by offering larger compensation packages to attract the best talent. Do you agree? Why or why not? There must be an effective combination of three basic policies to create the right financial incentives for CEOs to maximize the value of their companies: 1. 2. 3.

Boards can require that the CEOs become substantial owners of company stock. Salaries, bonuses, and stock options can be structured so as to provide rewards for superior performance and penalties for poor performance. Threat of dismissal for poor performance can be a realistic outcome.

STRATEGY SPOTLIGHT 9.5 describes why Nike ties CEO pay to social objectives. The SUPPLEMENT below points out that executive compensation, which is supposed to align the interests of stockholders and managers, can lead to managers to pay too much attention to short-term performance. Extra Example: Bonuses and Stock Grants Can Lead to a Short-Term Focus Commentators regularly lament the short-term focus of managers of corporations. This problem is often attributed to activist investors pushing for quick performance improvements and day traders punishing firms for momentary missteps, but the empirical evidence indicates that activist investors have a longer-term focus and that day traders have little influence on the strategic actions of firms. So, what leads managers to take such a short-term focus? It may be the structure of top managers‘ compensation. Firms often grant top executives‘ bonuses based on a single years‘ performance. With this timeframe, it is not surprising that top executives manage the firm to perform well in the short term. Options they grant typically vest in three years and are instantly exercisable by managers. Thus, managers have an incentive to goose up the firm‘s stock price as much as possible right around the options‘ vesting date, at which point they quickly cash out. What are possible solutions? It may be as simple as using three- to five-year windows of performance for bonuses. Additionally, rather than allowing managers to immediately cash out their options, firms could require managers to hold a proportion of their vested stock options for an additional three to five years before selling them to generate a longer-term perspective. Source: Pozen, R. 2014. The Misdirected War on Corporate Short-Termism. wsj.com. May 19: np.

Duality, where one person is both CEO and chairman of the board of directors, is one of the most controversial issues in corporate governance. We present ―both positions‖—Unity of Command and Agency Theory, which favors and opposes duality, respectively. There has been a great deal of pressure to separate these roles, and a number of firms did so in response to pressure they received in recent years. We discuss research suggesting that the pressure to separate the chair and CEO positions may not always generate benefits to shareholders. When firms had been performing poorly, separating the roles resulted in positive performance changes. But when a firm has been performing well, separating the roles was associated with worse performance. Discussion Question 36: Under what conditions is duality advisable? Why? D.

External Governance Control Mechanisms

Thus far, our discussion has been on internal governance mechanisms. However, internal controls do not always ensure good governance. The separation of ownership and control that is central to the concept of the corporation requires multiple control mechanisms. In this section, we address several external control mechanisms that have been developed in most modern economies. These include the market for corporate control; governmental regulatory bodies; auditors; analysts; and the business press and public activists. The SUPPLEMENT below discusses how external governance mechanisms uncovered one of the largest governance scandals in Germany. Extra Example: Fraud at Wirecard Wirecard was a payment processor and financial services provider with headquarters in Munch, Germany. The company experienced a meteoric rise since it was founded in 1999. First listed on the German stock exchange in 2005, Wirecard was included in the TecDAX stock index (an index of the 30 largest German technology companies) in 2006 and moved up into the DAX stock index (an index of 40 major German blue chip companies) in 2018. Wirecard‘s peak stock valuation was around 24 billion Euros at its peak. Management attributed the fast growth and success to rapid international expansion, often through acquiring smaller local businesses around the world. Yet, Wirecard filed for insolvency in 2020 after revealing that 1.9 billion Euros were missing from its financial statements. Following these revelations, CEO Markus Braun was arrested and COO Jan Marsalek disappeared. What happened? Wirecard used accounting irregularities to inflate the company‘s profits. Internal governance mechanisms such as the board of directors were largely ineffective. External governance mechanisms were more critical of Wirecard‘s business strategy and financial success. For instance, the Financial Times—a prominent British newspaper that focuses on business topics—reported in 2019 on alleged accounting mispractices. In addition, short sellers— investors betting on declining stock prices of overvalued companies—similarly reported financial and managerial misconduct. Yet, German regulators were slow in taking the allegations seriously. It was only after a special audit by KPMG—one of the Big Four accounting firms—that Wirecard‘s governance and financial scandal came to light. Specifically, KPMG revealed that the majority of Wirecard profits from 2016 to 2018 could not be verified. This 1-302 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

example highlights the importance of external governance mechanisms in uncovering fraud when management and internal governance mechanisms fail to work in the interests of shareholders. Source: McCrum, D. 2022. Money men: A hot startup, a billion dollar fraud, a fight for the truth. London: Bantam Press.

The Market for Corporate Control

If a company‘s internal control mechanisms are failing—that is, the board is not effectively monitoring managers and shareholders are largely indifferent, there is a strong likelihood that managers will behave opportunistically. Such behavior can take many forms, including shirking (failure to exert maximum effort), on the job consumption (perks such as private jets, luxurious club memberships, expensive artwork for their offices), or excessive product-market diversification (which serves to reduce employment risk but often results in lower shareholder value). The market for corporate control is one external mechanism that provides a potential solution to the problems above. Rather than ―fight,‖ shareholders will eventually sell their shares, which will depress the value of the stock. At some point, the low stock price will make the firm an inviting target for a corporate raider—because the market value of the firm may be less than the book value. The first thing a ―successful‖ corporate raider may do upon gaining control of the corporation is to fire the management and replace it with its own appointed leaders. The risk of being taken over is often referred to as the takeover constraint, which deters management from engaging in opportunistic behavior. In recent years, the threat of the takeover constraint has become less effective as the result of a number of defense tactics that have been employed by management. These include poison pills, greenmail, and golden parachutes. 2.

Auditors

Despite stringent disclosure requirements, there is no guarantee that the information disclosed by a firm will be accurate. Managers may purposely disclose false information or withhold negative financial information. Thus, accounting statements are required to be audited by external auditors. However, these audits often fail to catch accounting problems. A study found that big accounting firms were deficient in their audits of 20 to 45 percent of audits they conducted. We note that accounting firms often have a conflict of interest in raising all concerns since they rely on ongoing accounting business from the firms they audit, as well as on lucrative consulting arrangements with these client firms. 3.

Banks and Analysts

Financial institutions and stock analysts are two external groups that monitor publiclyheld firms. Commercial and investment banks have a vested interest because they lend money to corporations and must ensure that the borrowing firm‘s finances are in order and that the loan covenants are being followed. Also, stock analysts conduct studies of the firms that they follow and make recommendations to their clients to buy, hold, or sell. In practice, analyst recommendations have been more optimistic than warranted by the facts. ―Sell‖ recommendations are very infrequent, in part, because most analysts work for firms that also have investment banking relationships with the companies that they follow. And, negative recommendations can displease a firm‘s management who may decide to take their investment banking business elsewhere. This conflict of interest has led to substantial litigation. 4.

Regulatory Bodies

All corporations are subject to some regulation by the government and the extent of regulation is largely a function of the industry within which they compete. Industries such as banks, utilities, and pharmaceuticals are subject to more regulatory oversight because of their importance to society. Public corporations are subject to more regulatory requirements than privately held corporations. Public corporations are required to disclose a substantial amount of financial information by bodies such as the Securities and Exchange Commission. Although the financial regulation of corporations by the Securities and Exchange Commission and the Internal Revenue Service are often the most visible government regulators, firms can find themselves facing stringent, and possibly biased, oversight by other, less prominent, regulatory authorities. The SUPPLEMENT below discusses how Boeing faced strong regulatory pressure that altered its strategic plans and its contracts with its unions. Extra Example: The NLRB Takes on Boeing‘s Expansion For years, Boeing has had a contentious relationship with unions at its main production facilities in the state of Washington. When Boeing faced growing demand for its planes and it needed to expand its operations, it decided to open a new plant in South Carolina. Boeing hoped it would have better relationships with workers in North Carolina, which tends to have weaker unions and more favorable labor rates than Washington. Even though Boeing did not plan to cut any jobs to its unionized workforce in Washington, the National Labor Relations Board (NLRB), the federal agency that regulates labor and union rules, charged Boeing with retaliating against its unionized workers in Washington by opening the new plant in South Carolina. The NLRB threatened to block the opening of the South Carolina plant. The NLRB pressed its case for months, but it dropped the case after the International Association of Machinists (IAM), the main union in its Washington plants, asked the NLRB to drop the case. Why did the union ask the NLRB to drop the case? It only did so after Boeing guaranteed that a new plane, the 737 Max, would be manufactured in Washington and offered the unionized workers raises and bonuses. Critics have looked at this deal and concluded that the NLRB acted not as an independent, neutral regulator but, instead, as an agent for the IAM, insuring that the union was able to squeeze Boeing to offer it a sweetened union contract. Others have argued that the NLRB was only acting to ensure that Boeing didn‘t harm its unionized workers in Washington by moving production to South Carolina. 1-304 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Source: Anonymous. 2011. Boeing bullied. The Economist. December 17: 115.

Such a highly partisan perspective should generate some spirited discussion. Ask: Discussion Question 37: Do you think the NLRB acted fairly in this case? Discussion Question 38: How should Boeing have handled this situation? 5.

Media and Public Activists

Although the press is not typically recognized as an external control mechanism in the corporate governance literature, it would be hard not to argue that the financial press and media play an important role in monitoring the management of public corporations. In the United States, business magazines such as BusinessWeek and Fortune, financial newspapers such as the Wall Street Journal and Investors Business Daily, and television networks such as CNBC and Fox Business Network are constantly reporting on companies. We note how unethical business practices at Turing Pharmaceuticals first came to light on a healthcare news website and then in major media outlets. Consumer groups and activists can also play a very visible role by crusading against what they perceive as corporate malfeasance. We briefly describe how pressures from social activists led to changes in actions by and regulation of diamond, gold, and other precious mineral firms. Discussion Question 39: Do you feel that social activist groups constitute an effective external governance mechanism for corporations? Why? Why not? The SUPPLEMENT below points out how a CEO can be viewed by outsiders, depending on one‘s perspective, as both a role model and as an example of what not to do. Extra Example: CEO Friend or Foe to the Environment? Cypress Semiconductor CEO T.J. Rodgers certainly would qualify as a black hat to many. No friend of environmentalists and others who disagree with his libertarian reflexes, Rodgers is as outspoken as he is blunt. For example, Rodgers was seated between representatives from Environmental Defense and the Competitive Enterprise Institute at a 2008 panel discussion on climate change. Likening their remarks to ―two loudspeakers screaming political slogans,‖ he said, in his typical manner, that he ―almost would rather have been waterboarded.‖ In 1996, Rodgers first gained a degree of notoriety with the socially and environmentally oriented community when he replied to a letter from Sister Doris Gormley, a Philadelphia nun. Sister Doris expressed disappointment in the makeup of Cypress‘s board of directors, which included no women or minority members. ―Get down from your high horse,‖ Rodgers urged in his blistering 2,800-word letter of refutation, labeling Sister Doris‘s requirements ―immoral.‖ He argued that he would be happy to add a woman or minority to his board—so long as they brought the requisite talent for the job. Lost in the biting tone of the letter were the great many positives at Cypress identified by Rodgers, from premium salaries to excellent benefits to an award-winning charity program. The letter was quickly publicized, leading to charges that Rodgers had stooped to ―nun-bashing.‖ Given the ill will that this episode left behind, it is ironic that Rodgers‘s SunPower is now busy manufacturing solar cells that reduce carbon emissions and support energy independence. In the days of cheap oil, SunPower was down to its last watt when Rodgers joined and invested in the company. His investment was part of the solution that kept the operations going trough the thin years, until demand picked up for the company‘s improving solar cells. 1-306 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Source: Russo, M.V. 2010. Companies on a mission. Entrepreneurial strategies for growing sustainably, responsibly, and profitably. Stanford, California: Stanford University Press.

Discussion Question 40: Should we celebrate T.J. Rodgers’s solar energy success story or second guess his business methods? Should the focus be on the CEOs’ results or on the way they achieve them? E.

Corporate Governance: An International Perspective

In this section, we recognize that corporate governance differs among countries and regions of the world. In the United States and the United Kingdom, corporate governance has been traditionally dominated by agency theory and based on the explicit assumption of the separation of ownership and management. Here, the central conflicts are principal-agent conflicts between shareholders and management. Such a perspective, however, seldom applies outside of the United States and United Kingdom. This is particularly true in emerging economies and continental Europe where there is often:    

concentrated ownership extensive family ownership and control business group structures weak legal protection for minority shareholders

Thus, serious conflicts often exist between two classes of shareholders: controlling shareholders and minority shareholders. These are called principal-principal (PP) conflicts—as opposed to principal-agent conflicts. EXHIBITS 9.6 and 9.7 address how principal-principal conflicts differ. There must be three conditions for PP conflicts to occur. These are:   

a dominant owner or group of owners who have interests that are distinct from the minority shareholders a motivation for the controlling shareholders to exercise their dominant positions to their advantage few formal (i.e., legislation or regulatory bodies) or informal constraints that discourage or prevent the controlling shareholders from exploiting their advantageous positions

The result is that family managers, who represent (or actually are) the controlling shareholders, engage in expropriation of minority shareholders. Expropriation is defined as activities that enrich the controlling shareholders at the expense of minority shareholders. Another ubiquitous feature of corporate life outside the United States and Great Britain are business groups such as the keiretsus of Japan and the chaebols of South Korea. These are 1-307 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

particularly dominant in emerging economies. A business group is ―a set of firms which, though legally independent, are bound together by a constellation of formal and informal ties and are accustomed to taking coordinated action.‖ We address how business groups can both benefit (e.g., facilitate transfer of technology or capital) as well as harm (e.g., engage in related transactions—controlling members sell firm assets to another firm they own at below market prices or spin off the most profitable part of a public firm and merge it with another of their private firms) minority shareholders. The SUPPLEMENT below addresses an interesting issue: Is there a global standard for governance? Extra Example: Is There a Global Standard for Governance? Various ownership structures, financial market infrastructures, cultural influences, and legal systems create alternative approaches to corporate governance structures and philosophies in countries around the world. For example, the governance systems that exist in such markets as the United States, Germany, Japan, China and Russia are all distinctive and reflect their own political and market economies. The United States is characterized by dispersed ownership structures, a strong shareholder orientation, and a tradition of ―outsider‖ governance through independent non-executive directors. Japan and Germany are more stakeholder oriented, have a higher concentration of ownership and corporate control, and a tradition of ―insider‖ governance involving controlling shareholders as well as banks or related industrial groups. Russia and China, on the other hand, are undergoing a transition to more market-oriented economies and have an insider/outsider mix. Will such distinctions prevail, or will a global governance standard emerge? There is no one country model that has proven to be ideal; all systems are vulnerable to problems. These include conflicts of interest with controlling shareholders, ownership rights, stakeholder relations, problems of control and risk management, effectiveness and independence of board oversight and excessive executive compensation. In particular, ownership structure can be a key differentiator. The governance concerns of a widely-held firm can be quite different compared to those with concentrated ownership. Thus, many of the governance practices advocated in American might fit poorly for closely-held firms in Europe or Asia. However, this does not mean that European or Asian companies should be passive or complacent. After all, family-owned firms around the world generally benefit from protecting minority shareholder rights, disclosing relevant financial and non-financial information, and having a meaningful level of independent board oversight. What should companies do?   

Consider governance to be both a source of competitive advantage and a key aspect of enterprise risk management. Regularly review governance structures and practices—particularly for publicly-traded companies wanting to maintain access to public capital markets. Strive to improve transparency and disclosure standards—especially with regard to non-financial risks and how these are communicated to various stakeholder group. Source: Dallas, G. 2005. Ensuring companies walk the talk. www.euromoneyplc.com, np.

Discussion Question 41: What are the pros and cons of establishing global standards of governance? Is it a goal worth striving for?

IV.

Issue for Debate

This case sets up a discussion of whether CEOs should share the pain with employees during an economic downturn, such as the COVID-19 pandemic. Discussion Question 42: What economic and social criteria should corporate boards use when determining CEO pay cuts during an economic crisis? Response guidelines: Boards may consider a range of economic and social criteria when setting CEO pay. On the economic side, boards should closely track financial success metrics, such as relative share price or shareholder returns. Next, companies in industries that benefit from a downturn (such as exercise equipment and online shopping companies during the COVID-19 pandemic) may decide to give their employees a bonus since the CEO likely benefitted from raising stock prices. An employee bonus may be perceived as fair (or even justified) if CEO pay raises due to industrywide stock price increases. On the social side, boards should consider how ESG investors react if CEOs do not share the pain with employees when the company or the whole industry faces difficulties. This may be particularly important when underrepresented employee groups are hit the hardest during a crisis. The optics of laying off front-line workers (who often include underrepresented employee groups) without taking corresponding steps involving reducing CEO pay may lead to shareholder activism and stock price declines. Strategy Spotlight 9.5 provides an excellent example of Nike incorporating social criteria when setting CEO pay. Discussion Question 43: Would these criteria change when the crisis is firm-specific (such as an accounting violation) or person-specific (such as personal indiscretions)? Response guidelines: A crisis that was triggered by an individual or person-specific indiscretion (such as an undisclosed intimate relationship with an employee—as happened with exMcDonald‘s CEO Steve Easterbrook) may warrant more attention on social criteria. The reason is that personal indiscretions may be symptomatic of a larger problem in the organization. Stakeholders inside (such as employees) and outside (such as suppliers) of the organization may engage in similar actions and behaviors if the CEO is cutting corners or does not adhere to company policy. Once the personal scandal breaks, external governance mechanisms such as the media or hedge funds may look closer at widespread misconduct in the organization. Hence, companies may find it useful to include social criteria in CEO pay packages under these circumstances to provide leadership with the proper incentives to address more systematic issues in the company or to show external governance players such as the media that the company takes personal misconduct seriously.

When the crisis is caused by firm-specific factors (such as accounting issues or manufacturing defects), more economic or financially driven criteria may be more appropriate. A crisis caused by failures in functional areas of the corporation—such as accounting or manufacturing—may often be tied to mismanagement or suboptimal operational processes. These issues may be addressed by a focus on economic or financial metrics (such as benchmarking against industry best practices).

Reflecting on Career Implications

PowerPoint Slide 35: Reflecting on Career Implications Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 9. 

Behavioral Control: What types of behavioral control does your organization employ? Do you find that these behavioral controls help you to do a good job or hinder you from doing a good job? Some individuals are comfortable with and even desire rules and procedures for everything. Others find that they inhibit creativity and stifle initiative. Evaluate your own level of comfort with the level of behavioral control and then assess the match between your own optimum level of control and the level and type of control used by your organization. If the gap is significant, you might want to consider other career opportunities.

Students should understand that at work there is a culture. It determines acceptable dress and behavior. Ask students for examples of behaviors that are not acceptable at their work, but which may be acceptable in other places. Now, ask how the organization enforces these norms. Usually students will appreciate the subtle and nuanced way that organizational norms are enforced through culture, such as offhand comments, role models, explicit conversations, and the like. At this point, it may be useful to examine these norms. Are the norms helpful to the organization‘s productivity? Students should understand the tradeoffs involved. There are benefits to following established controls, as they ensure stability, predictability, motivation, and commitment. However, if the controls become onerous to some individuals, then they may reconsider their positions. It is probably useful to ask students if there were some organizational norm that would be unacceptable to them. The point would be to get students to consider the conditions under which they would not tolerate their employment. 

Setting Boundaries and Constraints: Your career success depends to a great extent on you monitoring and regulating your own behavior. Setting boundaries and constraints on yourself can help you focus on strategic priorities, generate short-term objectives and action plans, improve efficiency and effectiveness, and minimize improper conduct. Identify the boundaries and constraints you have placed on yourself and evaluate how each of those contributes to your personal growth and career development. If you do not have boundaries and constraints, consider developing them.

Personal boundaries are important for students to consider, especially when it comes to ethical behavior. Ethical behavior directly applies to the business environment, too. Ask students what ethical behavior they could not ever consider, regardless of the financial reward, such as plagiarism, lying, and spreading untrue rumors about a friend. Now ask why students have these internal behavioral boundaries. This question should start an interesting discussion, as students will likely have different levels of tolerance. The next step is to ask how these internal boundaries affect students‘ long-term career prospects. Consider these prospects in terms of promotions and status as well as in terms of satisfaction, happiness, and contentment. A lively discussion will likely encourage students to think about their long-term career goals in a new light. 

Rewards and Incentives: Is your organization‘s reward structure fair and equitable? On what criteria do you base your conclusions? How does the firm define outstanding performance and reward it? Are these financial or nonfinancial rewards? The absence of rewards that are seen as fair and equitable can result in the long-term erosion of morale, which may have long-term adverse career implications for you.

Students can benefit from examination of their organization‘s reward structure. One way to look at rewards is as a form of positive feedback that encourages a firm‘s desired behavior. Feedback can be pecuniary, such as salary, raises, and other compensation, or non-pecuniary, such as ―employee of the month‖ awards or other recognition. Ask students to list the types of rewards they can earn at work. Then ask which types of rewards are more important. A key follow-up question is to ask students how the important rewards are allocated. Is the allocation fair? Is the allocation system transparent? For students who are working, instructors could ask if the reward system is fair to them personally. Does the system limit their potential within the organization because others will be favored? If so, then the organization may not be an appropriate place for career development. The next topic should be to ask students how the reward system could be improved. This topic is important because it puts students in the position of a senior manager, and hopefully allows them to think of how the reward structure can support overall organizational performance. 

Culture: Given your career goals, what type of organizational culture would provide the best work environment? How does your organization‘s culture deviate from this concept? Does your organization have a strong and effective culture? In the long run, how likely are you to internalize the culture of your organization? If you believe that there is a strong misfit between your values and the organization‘s culture, you may want to reconsider your relationship with the organization.

This topic is a continuation of the first one. It personalizes students‘ responses to organizational culture in the long term. In reality, many students will not know the extent to which they can adapt to an organizational culture, so the goal is not to have them assess whether or not they can survive in a specific organizational culture. A possible fruitful approach is to have students list the types of organizational culture they would like. Do they like stability? Or do they thrive in a creative and fluid organization? Can they tolerate an organizational culture with a strict dress code? Or do they strongly prefer an informal environment? Do they like to work independently or in close collaboration with a mentor? The point is to get students to think about the 1-311 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

characteristics of organizational cultures that they like. These positive aspects may make it worthwhile for them to adapt to the other aspects of the organizational culture that they may not find ideal.

VI.

Summary

For firms to be successful, they must implement their strategies by means of effective strategic controls. Without such controls, the firm will not be able to achieve competitive advantages and outperform rivals in the marketplace. We began the chapter with the key role of informational control. We contrasted two types of control systems: what we termed ―traditional‖ and ―contemporary‖ information control systems. Whereas traditional control systems may have their place in placid, simple competitive environments, there are fewer of those in today‘s economy. Instead, we advocated the contemporary approach wherein the internal and external environment is constantly monitored and, when surprises emerge, the firm must modify its strategies, goals, and objectives. Behavioral controls are also a vital part of effective control systems. We argued that firms must develop the proper balance between culture, rewards and incentives, and boundaries and constraints. Additionally, where there are strong and positive cultures and rewards, employees tend to internalize the organization‘s strategies and objectives. This permits a firm to spend fewer resources on monitoring behavior, and the firm is assured that the efforts and initiatives of employees are more consistent with the overall objectives of the organization. With regard to corporate-level strategies, we discussed the need for firms following related diversification strategies to develop cultures and incentives that reward information and resource sharing as well as overall goals of the corporation. However, in the case of unrelated strategies wherein there is limited need or opportunity for resource sharing and collaboration, cultures and incentives that are highly based on a manager‘s individual business-unit performance will suffice. In the final section of this chapter, we addressed corporate governance, which can be defined as the relationship between the various participants in determining the direction and performance of the corporation. The primary participants include shareholders, management (led by the chief executive officer), and the boards of directors. We reviewed studies that indicated a consistent relationship between effective corporate governance and financial performance. There are also several internal and external mechanisms that can serve to align managerial interests and shareholder interests. The internal mechanisms include a committed and involved board of directors, shareholder activism, and effective managerial incentives and rewards. The external mechanisms include the market for corporate control, banks and analysts, regulators, the media, and public activists. We also address corporate governance from an international perspective.

Chapter 9: Strategic Control and Corporate Governance Select an organization with which you are familiar. How effective are its behavioral controls—rewards, culture, and boundaries? How could these controls be improved? What trade-offs may be involved? Teaching suggestions: You can organize the discussion around the following: 

What is ―behavioral control‖ and how is it different from ―informational control?‖ Informational control:   

Concerned with whether or not the organization is ―doing the right things‖ Deals with both internal and external environments of the firm Addresses how well the organization‘s goals and strategies still ―fit‖ within the context of the current strategic environment.

Behavioral control:  

Is focused on implementation i.e., ―doing things right‖ Deals with culture, rewards and boundaries within the organization that help in ―doing things right‖

You might want to discuss each of these terms: ―culture,‖ ―rewards,‖ and ―boundaries.‖ A quick recap of these is given below: Organizational culture is a system of shared values (what is important) and beliefs (how things work) that shape a company‘s people, organizational structure, and control systems to produce behavioral norms (the way we do things around here.) Rewards and incentive systems are important means of influencing an organization‘s culture, focusing efforts on high-priority tasks, and motivating individual and collective task performance. Boundaries and constraints are the rules laid down for appropriate conduct of business. They are important to focus individual efforts on strategic priorities, providing short-term objectives and action plans to channel efforts, improving efficiency and effectiveness and minimizing improper and unethical conduct.

You can ask the students to describe the organizational culture, rewards and boundaries in organizations they have chosen to the answer the question. 

Will a strong organizational culture substitute for rewards and boundaries? The key point to be emphasized here is that none of these aspects of behavioral control can be totally substituted by any other one. A strong culture would certainly help in improving the motivation and morale of employees and can help in reducing the need for monetary incentives. Culture can also reduce the need for external rules and regulations and thus lower the monitoring costs. However, it does not mean that culture can substitute for rewards or boundaries completely. For behavioral control to be effective, all three of these aspects of behavioral control must be in a healthy balance.

You might want to ask if the students would be willing to work for a very reputed organization known for its culture, offering very low pay, or for an organization with no emphasis on culture, but with very high pay. You can expect to see a split in the students‘ responses; some of them will favor working for the first organization and some for the second. You can also expect questions such as: ―How high is the high pay?‖ or ―How low is the low pay?‖ This would help in emphasizing the need for balance between all the three levers rather than substitution of one with the other for behavioral control to be effective.  Can all organizations place equal emphasis on all three aspects of behavioral control in all kinds of environments? Here you must emphasize the role of situational factors, both external and internal, in determining which types of behavioral controls would work better for an organization. As explained in the text, in organizations where individual performance is difficult to measure accurately (for example, high-technology firms operating in highly uncertain environments), internalized norms and values become very important, whereas in more stable and predictable environments such as an assembly line, strict adherence to rules and procedures would work better. A key point to be made is that while it is easy to suggest improvements to organizational culture and incentives and reward systems, which of the improvements are really necessary given the environment in which the firm is operating? Also, each such improvement would have cost implications that need to be justified.

End-of-Chapter Teaching Notes Chapter 9: Strategic Control and Corporate Governance Summary Review Questions 1. Why are effective strategic control systems so important in today’s economy? (In text, Ensuring Informational Control: Responding Effectively to Environmental Change, LO 91) Response: In today‘s economy, there have been a number of problems related to unchecked behavior by executives. The recession, starting in 2008, was due in part to banks, mortgage brokers, and bond rating agencies not exercising appropriate controls on unethical behavior. A recent flurry of U.S. government investigations into backdating options has affected the fortunes of many large firms. The bursting of the dot.com bubble in 2000 was due, in part, to firms overestimating the value of their future sales, which later did not materialize. Good strategic control systems and corporate governance would have prevented many of these abuses. 2. What are the main advantages of contemporary control systems over traditional control systems? What are the main differences between these two systems? (In text, Ensuring Informational Control: Responding Effectively to Environmental Change, LO 9-2) Response: Traditional control systems are a sequential method of organizational control in which (1) strategies are formulated and top management sets goals, (2) strategies are implemented, and (3) performance is measured against the predetermined goal set. Strategic control is done after performance is found to be lacking, usually on a quarterly or annual basis. There have been a number of problems with this system. First, the volatility of the business environment makes it difficult for top managers to accurately set effective strategies that will be useful for a period of a quarter or a year. Second, as strategies should respond to a volatile environment, so should implementation. An incremental approach is most effective. Third, performance measurement should be more continuous, as a strategy is implemented incrementally, performance should also be measured to determine how the implementation is doing. Contemporary control systems emphasize continuous monitoring of the internal and external environment for trends and events that signal the need to make modifications to a firm‘s strategies, goals and objectives. Contemporary control systems use both informational control to formulate strategies and behavioral control to implement strategies. Informational control involves the gathering of information from the internal and external environment in order to obtain the best fit between the organization‘s goals and strategies and the strategic environment. Behavioral control seeks to influence employees through culture, rewards, and boundaries. 1-315 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

3. Why is it important to have a balance between the three elements of behavioral control—culture; rewards and incentives; and, boundaries? (In text, Attaining Behavioral Control: Balancing Culture, Rewards, and Boundaries, LO 9-4) Response: Organizational culture is a system of shared values and beliefs that shape a company‘s people, organizational structures, and control systems to produce behavioral norms. The organizational reward system specifies who gets rewarded and why. Boundaries are a clear statement of behavior that is and is not appropriate, such as which product markets a firm will compete in, short-term objectives and action plans, rule-based controls, and guidelines for proper relationships with customers and suppliers. A balance between these three elements is needed. Organizational culture is essential for motivating employees and their identification with the organization and its goals. Culture establishes behavioral norms and therefore implicitly sets boundaries and reduces monitoring costs. Culture influences beliefs, behaviors and attitudes, but it is not sufficient for control. Behaviors and attitudes must be kept focused on organizational goals, and that is where rewards come in. Rewards are both a motivator and a control system. Ideally, rewards reinforce behavior that is consistent with organizational culture. Rewards help to ensure that employees work to achieve organizational goals. Boundaries are necessary because, even with a strong organizational culture and an effective rewards system, there might be individuals and groups (1) motivated by self-interest, (2) without a clear understanding of goals and objectives, or (3) are subject to malfeasance. Boundaries are a tool for clearly specifying, even quantifying, the limits of acceptable behavior. 4. Discuss the relationship between types of organizations and their primary means of behavioral control. (In text, Attaining Behavioral Control: Balancing Culture, Rewards, and Boundaries, LO 9-4) Response: Culture is an effective form of behavioral control in situations where individuals‘ contribution to organizational performance is difficult to measure. For example, professional organizations, high-tech organizations, organizations engaged in creative endeavors, and organizations where individuals have high autonomy lend themselves to culture control. In organizations where individuals‘ output or performance is quantifiable and straightforward, rewards may be an effective method of control. Sales managers are often motivated by commissions, and the monetary rewards may be more important to them than organizational norms and values. Rewards are also effective in organizations using an unrelated diversification strategy. In any type of organization, rewards should reinforce other types of control.

For organizations in stable industries with stable output, and organizations with routine and repetitive tasks, boundaries can be an effective control measure. Written and explicit guidelines provide effective constraints on behavior. 5. Boundaries become less important as a firm develops a strong culture and reward system. Explain. (In text, Attaining Behavioral Control: Balancing Culture, Rewards, and Boundaries, LO 9-4) Response: Strong culture and effective rewards systems establish norms that constrain undesirable behavior. Individuals in the organization internalize and accept the norms. Organizations can facilitate such internalization by hiring people with values similar to what the organization requires, training them well, and keeping top managers who are role models. In addition, reward systems should be clearly aligned with organizational goals and objectives. 6. Why is it important to avoid a “one best way” mentality concerning control systems? What are the consequences of applying the same type of control system to all types of environments? (In text, Attaining Behavioral Control: Balancing Culture, Rewards, and Boundaries, LO 9-4) Response: Control systems that are not aligned with the organizational environment will not be effective. For example, if individuals in an organization have a lot of autonomy, such as a research lab, and a firm installs a rewards control system, then it would have to install a system of performance milestones on which the rewards system would be based. However, the system of performance milestones risks diverting efforts from organizational goals. For example, in a lab, the rewards system might offer bonuses based on the number of experiments conducted. That system might skew the research towards doing numerous, quick experiments, but the experiments that would best serve the firm‘s objectives might be more complex and take longer. In general, control systems that do not fit the firm‘s environment will tend to either be costly or divert effort from what the firm needs to do to achieve its goals and objectives. (Note to instructor) Students will come up with examples of consequences, which is very useful for learning purposes. For each example of consequences, ask the student to identify the cost or other negative consequence of the inappropriate control system.

7. What is the role of effective corporate governance in improving a firm’s performance? What are some of the key governance mechanisms that are used to ensure that managerial and shareholder interests are aligned? (In text, The Role of Corporate Governance, LO 9-5) Response: Corporate governance is the relationship among shareholders, management, and the board of directors that determines the corporation‘s performance. Corporate governance is, in a way, a control system for top management. Corporate governance refers to a system for measuring top managers‘ performance and motivating them to work to maximize shareholder value. It aligns incentives between principals (owners) and agents (managers) such that the agents have objectives and risk propensities similar to the those of the principals. Governance mechanisms include an active board of directors who regularly evaluate the CEO, replacing him/her if necessary, review the vision, mission, and strategic objectives of the corporation, provide advice to top management, manage the board judiciously, and review various systems that ensure that the corporate office complies with laws and regulations. Shareholder activism, or actions by shareholders to protect their interests when they feel that managerial actions diverge from shareholder value maximization, can embarrass top managers who are not performing well. Managerial rewards and incentives can be used to align incentives by (1) ensuring that managers own substantial shares of company stock, (2) structuring rewards such that good corporate performance is rewarding, and poor corporate performance is not, and (3) make the possibility of dismissal for poor performance a realistic one. In addition to these internal methods, there are external corporate governance methods, or methods used by groups outside the corporate governance system. These include the market for corporate control, where shareholders can sell their shares if not satisfied with management, auditors, banks and analysts, regulatory bodies, and media & public activists. 8. Define principal-principal (PP) conflicts. What are the implications for corporate governance? (In text, The Role of Corporate Governance, LO 9-5) Response: Principal-principal conflicts are between two classes of principals—controlling shareholders and minority shareholders—within the context of a corporate governance system. Often, the controlling shareholders belong to families or other business groups and prefer to have the firm do business with other firms in family or business group control. These related transactions may be on unfavorable terms for the firm and will therefore hurt firm value. The implications for corporate control are that the system will not work to maximize shareholder value, but rather to maximize controlling shareholder interest at the expense of minority shareholders.

Experiential Exercises and Application Questions 1. In the Learning from Mistakes, we discussed how the decisions of directors at McDonald's negatively affected the firm. Research the board of directors of another major restaurant chain and evaluate the degree to which the firm's corporate governance is likely to support the firm's success. There is a great opportunity here for students to use this exercise to examine the structure of and experience on the board of directors and external governance mechanisms. Major competitors in the restaurant industry have received significant scrutiny as the competitive landscape of the market has changed. This has included significant discussion of the governance structures of the firms in the industry. Thus, students can research business analyst reports and news articles of the firm the student chooses. Students can also use annual reports and proxy statements to assess and analyze the board. 2. McDonald’s Corporation is the world’s largest fast-food restaurant chain. Using the Internet, evaluate the quality of the corporation in terms of management, the board of directors, and shareholder activism. Are the issues you list favorable or unfavorable for sound corporate governance? Response: The corporate website contains ample information on corporate governance. It highlights some governance strengths but also some weaknesses. Some highlights are below: Management Positives 1. The CEO, Chris Kempczinski, has a diverse background in food-related industries, including time at PepsiCo and Kraft, before joining McDonald‘s 2. Diversity on the top management team Potential issues 13. Kempczinski has only worked at McDonald‘s since 2015, raising some potential concerns about his knowledge of the firm and its industry. Board of directors Positives: 14. High caliber of executives as members 15. Written corporate governance policies including code of conduct, ethics, compensation, and director independence 16. Staggered board 17. CEO is the only member of the board 18. None of the board members have a clear tie to the CEO 19. Board members are required to own significant stock in the firm 1-319 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Possible issues: 1. At 13 members, the board is fairly large 2. Board tenure is fairly high, with 7 of the 13 members being on the board for over eight years 3. Little experience on the board from the restaurant or hospitality industry Shareholder activism Possible issue: 20. No large ownership stakes by activist shareholders—largest owners are indexed mutual funds Some discussion questions may include:   

The Chair is an outsider. Does this leave him at a position of information deficiency compared to the CEO? The written policies seem very ethical and appropriate, but how would a shareholder know if they are being followed? If the top management were to choose between a profitably opportunity and social responsibility, which would it choose? Can you identify a choice that McDonald‘s has made in the past of social responsibility over profits?

3. The problems of many firms may be attributed to a traditional control system that failed to continuously monitor the environment and make necessary changes in their strategy and objectives. What companies are you familiar with that responded appropriately (or inappropriately) to environmental change? Response: Note to instructors: For each company the students provide, ask the following:    

What environmental change did the company not respond to? How did the company respond? How should the company have responded? Why did the company not respond appropriately?

The answer to the last question may highlight the deficiencies of the traditional control system and the need to continuously monitor the environment.

4. How can a strong, positive culture enhance a firm’s competitive advantage? How can a weak, negative culture erode competitive advantages? Explain and provide examples. Response: A strong, positive culture will provide a supportive work environment, motivate employees to work together to achieve organizational goals, and set norms for positive behavior. Firms with strong, positive cultures will therefore tend to have a sustainable competitive advantage in human and social capital. Firms with weak, negative cultures will not motivate employees, not set behavioral norms, and possibly lead to managers behaving out of self-interest. The weak, negative culture will thereby tend to erode human and social capital. Note to instructor: It is an important lesson for students to understand the kind of organizational culture that they want to have in their organizations. In discussion, ask students to identify the effects on them personally of working in an organization with a weak, negative culture. Then ask students to identify the characteristics of a strong, positive culture. How could they recognize an organization with a good culture? What questions could they ask on a job interview that would describe the corporate culture? 5. Use the Internet to research a firm that has an excellent culture and/or reward and incentive system. What are this firm’s main financial and nonfinancial benefits? Response: Note to instructor: The purpose of the assignment is to increase student awareness of effective rewards systems. Ask students to identify what the firm‘s financial and nonfinancial benefits are. Then ask which is more important, the financial or nonfinancial components and why. What does the provision of nonfinancial benefits tell about the firm‘s values and about its work environment? What questions should you ask in a job interview to ensure that you will join an appropriate firm? 6. Using the Internet, go to the website of a large, publicly held corporation in which you are interested. What evidence do you see of effective (or ineffective) corporate governance? Response: One approach is to examine the corporate governance policies, procedures, ethical codes, independence of the Board, management representation on the board, and other observable characteristics. A second approach is to look at top management behavior and compensation. Look to see if the bonus makes sense given the corporation‘s performance. Look to see if the explanation of the bonus is logical. Your investigation might also go beyond examination of the corporation‘s website and go to that of independent auditors, news reports, or other information that indicates effective corporate governance. Note to instructor: Corporate websites are probably full of mostly good news about the corporation, and the evidence from there is likely to be one-sided. Some evidence that might raise questions is whether or not the CEO is also chair of the board, the number of CEOs on the 1-321 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

compensation committee, the independence of board members, and the history of the board at aligning top management compensation with corporate performance. Ethics Questions 1. Strong cultures can have powerful effects on employee behavior. How does this create inadvertent control mechanisms? That is, are strong cultures an ethical way to control behavior? Response: Culture can control behavior through social censure. Individuals who have internalized an organizational culture will behave appropriately in order to preserve their status in the organization. Possible problems with strong cultures are that they stifle creativity or reinforce unethical behavior. The problem with stifling creativity is groupthink. Individuals will tend to go along with the group consensus rather than raise objections or concerns with particular decisions. Ethically, the problems with groupthink are on the individual level, as it may tend to stifle expression and limit personal development. Organizationally, groupthink can lead to bad decisions that erode shareholder value. Reinforcing unethical behavior is a more apparent problem. If a corporate culture, say, allows individuals to leave at 4:00 pm yet be paid as if they were at work until 5:00 pm, then the corporation is being shortchanged out of an hour. Such culturally reinforced unethical behavior erodes personal integrity and, especially in the extreme, harms shareholder value. 2. Rules and regulations can help reduce unethical behavior in organizations. To be effective, however, what other systems, mechanisms, and processes are necessary? Response: Rules and regulations must be enforced. Someone in the organization has to both monitor behavior and sanction unethical behavior. This implies a need for an independent internal affairs ombudsman, or other corporate department. At the least, there should be some verification system to check that reported and self-reported information is accurate.

CONNECT RESOURCES Case Analysis Toronto-Dominion Bank and Strategic Control Wells Fargo Corporate Governance and Firm Performance Zappos

Chapter 10 Creating Effective Organizational Designs .............................. 10-2 1-322 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Traditional Forms of Organizational Structure ...................... 10-4 Patterns of Growth of Large Corporations: Strategy-Structure Relationships ...................................................................................................................... 10-5 Simple Structure ........................................................................................ 10-6 Functional Structure .................................................................................. 10-6 Divisional Structure ................................................................................... 10-7 Matrix Structure ........................................................................................ 10-9 International Operations: Implications for Organizational Structure 10-11 Global Start-Ups: A Recent Phenomenon ............................................... 10-12 How an Organization’s Structure Can Influence Strategy Formulation 10-13

Boundaryless Organizational Designs ...................................... 10-13 The Barrier-Free Organization ................................................................ 10-15 The Modular Organization ....................................................................... 10-18 The Virtual Organization ........................................................................................................ 10-21

Boundaryless Organizations: Making Them Work ............................... 10-23

Creating Ambidextrous Organizational Designs .................... 10-24 Ambidextrous Organizations: Key Design Attributes ........................... 10-25 Why Was the Ambidextrous Organization the Most Effective Structure? ...................................................................................................................... 10-25

Issue for Debate ........................................................................... 10-26 Reflecting on Career Implications ............................................ 10-27 1-323 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Summary ...................................................................................... 10-29 End-of-Chapter Teaching Notes................................................ 10-32 Connect Resources ...................................................................... 10-42

Chapter 10 Creating Effective Organizational Designs Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead Organizational structures and integrating systems are necessary to manage the relationships between internal processes and external parties such as suppliers, customers, and alliance partners. The challenge to managers is to create systems that both maintain order and provide flexibility and permeability. The purpose of this chapter is to describe the different types of organizational structures and how they contribute to organizational performance. The chapter is divided into four sections. 7.

The first section uses a “patterns of organizational growth” framework to describe how structure relates to strategy. Then, four different types of organizational structure—simple, functional, divisional, and matrix—are discussed in terms of important contingencies and relative advantages and disadvantages. The implications of international operations on organizational structure are also discussed.

We address the role of contingencies in determining which reward and evaluation system is appropriate. Emphasize that there is no “one best way” and that various approaches (financial or behavioral) are likely to be more effective depending on conditions. Different business-level and corporatelevel strategies may require alternate approaches to designing reward and evaluation systems.

The second section addresses the “boundaryless” approach to organizing. This discussion emphasizes the importance of flexibility and permeability in environments of unpredictability and rapid change. Three different types of boundaryless approaches are described—barrier-free, modular, and virtual.

10.

The fourth section suggests the need for ambidextrous organizations. Here, managers must address two opposing challenges: (1) being proactive in taking advantage of new opportunities; and (2) ensuring the effective coordination and integration of existing operations.

Lecture/Discussion Outline The opening case in LEARNING FROM MISTAKES illustrates the challenges of managing a boundaryless organization. When it launched the development of the 787 Dreamliner aircraft, Boeing decided to outsource the bulk of both the design and manufacturing of the plane. However, they found that many of the suppliers were unable to complete their tasks or completed them after deadlines. Boeing also had difficulty coordinating and integrating the work of suppliers. In the end, Boeing saw their delivery schedule slip by three years, and the process was much more expensive than anticipated. Discussion Question 1: A number of firms benefit from outsourcing design and manufacturing. What is different with Boeing that makes it so much harder to be successful? Response: The purpose of this question is to allow students to understand the complexity of Boeing‘s operations. Fifty suppliers on multiple continents are difficult to coordinate. While the suppliers have technological expertise and could collectively build some components better than what Boeing could do in-house, they do not have experience working together. The suppliers may also have issues putting their work for Boeing as the highest priority. Jet plane components are all interdependent, and it may be very difficult to anticipate how the technologically advanced components would function together. To sum up, Boeing‘s outsourced design may have been harder because of the following reasons:     

There were many suppliers. The suppliers were geographically dispersed. The suppliers may not be putting their work for Boeing at the highest priority. The suppliers were using new technologies that had not been used together in the same plane. The components had to be assembled in a very complex, interdependent plane. Discussion Question 2: What lessons does their experience with the 787 offer Boeing for its next plane development effort?

Response guidelines: Students can approach this question as a typical case analysis. First, students could advise Boeing regarding different options it could use—such as in-house manufacture, outsourced manufacture, or mixed. The trade-offs may include: Benefits of in-house manufacture:     

Control over operations All technologies developed in-house, so better expertise as to how they interact with each other Better appreciation of the final customers‘ expectations Less cost of monitoring and controlling suppliers‘ operations Less cost of transporting components and working to solve problems with suppliers

Benefits of outsourcing:   

Access to better technologies Cost savings Political benefits from using suppliers in client countries

Students may opt for a mixed approach, where Boeing outsources the production of ―lowtech‖ components. For ―high-tech‖ components, Boeing may want to partner with firms in order to design the new components but manufacture in-house. The goal of the discussion is to get students to appreciate the essential trade-offs with the make or buy decision, and that Boeing can choose from a bewildering number of options.

Traditional Forms of Organizational Structure

PowerPoint Slide 4: Organizational Designs PowerPoint Slide 5: Organizational Structure PowerPoint Slide 7: Organizational Structures: Growth Patterns PowerPoint Slide 8: Organizational Structures: Simple Structure PowerPoint Slide 9: Simple Structure Advantages and Disadvantages PowerPoint Slide 10: Organizational Structures: Functional Structure PowerPoint Slide 11: Functional Structure Example PowerPoint Slide 12 Functional Structure Advantages and Disadvantages PowerPoint Slide 13: Organizational Structures: Divisional Structure PowerPoint Slide 14: Divisional Structure Example PowerPoint Slide 15: Divisional Structure Advantages and Disadvantages PowerPoint Slide 16: Organizational Structures: SBU Structure PowerPoint Slide 17: SBU Structure Advantages and Disadvantages PowerPoint Slide 18: Organizational Structures: Holding Company Structure PowerPoint Slide 19: Holding Company Structure Advantages and Disadvantages PowerPoint Slide 20: Organizational Structures: Matrix Structure PowerPoint Slide 21: Matrix Structure Example PowerPoint Slide 22: Matrix Structure Advantages and Disadvantages PowerPoint Slide 23: Organizational Structures: International Operations PowerPoint Slide 24: International Operations Multidomestic vs. Global PowerPoint Slide 25: International Operations Global Startup This section emphasizes the relationship between strategy and structure and addresses the importance of flexibility and permeability in the context of four traditional forms of organizational structure—simple, functional, divisional, and matrix—as well as structures for firms with international operation. The SUPPLEMENT below illustrates the importance of organizational design and structure. Globalization and the recent economic crisis have forced organizations to rethink their 1-327 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

strategies and change they way they operate. When organizational strategy changes, its structures, roles, and functions should be realigned with the new objectives.

Extra Example: Importance of Organizational Design and Structure Poor organizational design and structure can result in a bewildering mess of contradictions: confusion about roles, a lack of coordination among functions, failure to share ideas, and slow decision making. This can lead to unnecessary complexity, stress, and conflict. Often those at the top of an organization are oblivious to these problems or, worse, pass them off as challenges to overcome or opportunities to develop. Structure dictates the relationship of roles in an organization, and therefore, how people function. An outdated structure can result in unnecessary ambiguity, confusion, and a lack of accountability. Gill Corkindale, an executive coach, shared some business and leadership challenges of executives to illustrate the importance of updated and appropriate organizational design. 1. The “unworkable” job: A Swiss engineer‘s boss had modified so many parts of his original role that it was becoming impossible to do his work since one part of his role contradicted the other. Moreover, he was stretched beyond his limits by the scope of the role and the fact that he had to operate across several time zones. 2. Politics: A Hong Kong retail executive said his role was ―schizophrenic‖ because he was required to influence a group of internal stakeholders who had been instructed by their boss not to cooperate with him. The anomaly was the result of historical turf wars between his boss and his boss‘s peer: the latter had used his influence to restructure the department and bring it under his control. 3. Over-regulation: A British banker explained how he was required to get approval from so many people for a major project that he wasted six months trying to get it off the ground. This severely limited his ability to compete effectively in the market. Source: Corkindale, G. 2011. The importance of organizational design and structure. blogs.hbr.org February 11: np.

Discussion Question 3: What are some lessons learned from the examples Corkindale suggested?

Discussion Question 4: At what level should organizational roles be designed to ensure that all the relevant details are accounted for? Should individuals who actually perform the job be consulted? Why/why not? Patterns of Growth of Large Corporations: Strategy-Structure Relationships

In this section, we discuss how a firm‘s strategy and structure change as it increases in size, diversifies into new product-markets, and expands its geographic scope. EXHIBIT 10.1 depicts Galbraith and Kazanjian‘s model of dominant growth patterns of large corporations. The dominant pattern of growth is first from a simple structure to a functional structure as sales and volume increase. A functional structure enhances efficiency and effectiveness by structuring according to specialized functions. When firms grow beyond existing markets or regions, the decision-making burden is too great, and a divisional structure is needed to organize around products, projects, or markets. As firms grow into international markets and/or enjoy expanding sales revenues, international structures are needed. There are several types of international structures, which will be discussed below.

Simple Structure

Because most organizations are very small, they need only a simple structure. Simple structures are usually highly centralized because the founder or a top executive makes nearly all of the decisions. Emphasize that the simple structure is the oldest and most common. It also tends to be the most informal, with little specialization. This may enhance creativity since employees are often not bound by many rules but may lead to management problems if employees do not understand their responsibilities. Simple organizations often offer few chances for career advancement. Discussion Question 5: Have you ever worked for an organization with a simple structure? How were decisions made? Discussion Question 6: What are some examples of companies that operate with a simple structure?

Functional Structure

As firms grow, excessive demands may be placed on the owner-manager in order to process all the information necessary to run the business. Specialists are needed in various functional areas (such as accounting, marketing, and engineering). Thus, a functional structure often develops in which functions are managed by specialists. Then, the chief executive‘s job shifts to coordinating and managing the departments. EXHIBIT 10.2 depicts a diagram of a typical functional organizational structure. Functional structures are generally found in organizations in which there are single or closely related products or services, high production volume, and some vertical integration. In these areas, which correspond to the dominant pattern of growth (i.e., into new markets, new product lines, or via vertical integration), centralized decision making is still needed to coordinate activities. Functional organizations have advantages and disadvantages. One advantage is enhanced coordination and control. Also, managerial and technical talent is used more efficiently. In a functional structure, there are more opportunities for professional development and career advancement. A disadvantage of functional organizations is that the beliefs, assumptions, and goals associated with different functional activities may vary across functions. MIT Professor Edgar Schein suggests that such different orientations may even cause certain words to hold different meanings in different groups. This, in turn, leads to functional biases or ―silo‖ thinking that may impede communication and coordination. The SUPPLEMENT below addresses another kind of problem that Professor Schein has identified with organizational structures that emphasize differences in function. It is related to the culture that emerges around different levels of hierarchy. 1-330 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Extra Example: Professor Schein Comments on Hierarchical Subcultures Several management authors, including Edgar Schein of MIT, have warned about the potential problems that can occur because of the shared assumptions that form around the functional units of an organization. These beliefs form a type of culture that can inhibit cross-functional activities such as communication and consensus building. Schein is also concerned about another cultural bias: ―Another kind of subculture, less often acknowledged, reflects the common experience of given levels within a hierarchy. Culture arises through shared experiences of success. If first-line supervisors discover ways of managing their subordinates that are consistently successful, they gradually build up shared assumptions about how to do their job that can be thought of as the ‗culture of first-line supervision.‘ In the same way, middle management and higher levels will develop their own shared assumptions and, at each level, will teach those assumptions to newcomers as they get promoted. These hierarchically-based cultures create the communication problems associated with ‗selling senior management on a new way of doing things,‘ or ‗getting budget approval for a new piece of equipment,‘ or ‗getting a personnel requisition through.‘ As each cultural boundary is crossed, the proposal has to be put into the appropriate language for the next higher level and has to reflect the values and assumptions of that level. Or, from the viewpoint of the higher levels, decisions have to be put into a form that lower levels can understand, often resulting in ‗translations‘ that actually distort and sometimes even subvert what the higher levels wanted.‖ Source: Schein, E. H. 1996. Three cultures of management: The key to organizational learning. Sloan Management Review, Fall: 12.

Discussion Question 7: Have you ever experienced the type of hierarchical “bias” described by Professor Schein? Teaching Tip: Ask students how hierarchical subcultures can differ in the various parts of an organization. This is, production and operations may be very formalized and “bureaucratic,” whereas research and development (especially primary R&D) may be rather loosely structured. Ask how such “cultural differences” may create challenges in bringing about major change in an organization (i.e., require the use of different incentives, different procedures, etc.). Other disadvantages of a functional structure include short-term thinking due to excessive concern for the function rather than the whole organization, a heavier burden for top management who must resolve conflicts between functions, and difficulty establishing policies that apply uniformly to all functional areas. Discussion Question 8: Have you ever worked for an organization with a functional structure? How were decisions made? Discussion Question 9: What are some examples of companies that operate with a functional structure?

Divisional Structure

The divisional structure is organized around products, projects, or markets. Each division has its own functional specialists organized into departments. Divisions are independent units 1-331 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

managed by a central corporate office. Divisional executives manage divisional performance to achieve corporate financial objectives. EXHIBIT 10.3 presents a diagram of a typical divisional organizational structure. General Motors is presented as an example of a divisional structure. Emphasize that a divisional structure is needed as organizations become large and more complex. Advantages of a divisional structure include separation of strategic and operational control. That is, the divisions focus on managing operations and the corporate office addresses strategic issues. Also, a divisional structure makes it easier to respond quickly to changes in the business environment. Multiple management levels mean that rewards and career paths are linked to the development of general management talent. Disadvantages include a tendency to duplicate activities such as personnel management, which makes overall costs higher, dysfunctional competition between divisions, conflicting goals, and uneven performance comparisons that inhibit resource sharing. Another potential disadvantage is that with many divisions providing different products and services, there is the chance that differences in image and quality may occur across divisions. Finally, since financial success is valued so highly, there may be too much focus on short-term performance. Discussion Question 10: Have you ever worked for an organization with a divisional structure? How were decisions made? Discussion Question 11: What are some examples of companies that operate with a divisional structure? The SUPPLEMENT below addresses how 3M took steps to coordinate the various activities among its divisions in order to present a unified and positive corporate image. Extra Example: Communicating a Uniform Corporate Image at 3M The 3M Corporation once had over 1,200 distinct brands but its market research indicated that most consumers did not really understand what 3M did or what it stood for. Although divisional autonomy and an entrepreneurial spirit had contributed to 3M‘s success, it had also created a diffuse corporate image. The process of developing a uniform and positive worldwide image began by defining 3M as a corporation. Ultimately, research in this area led to the development of a list of descriptors of 3M that was pared from 13 adjectives to a critical two: innovative and reliable. With these in hand, three communication objectives were established: 1.

Use the 3M corporate personality as the foundation for an effective, active identity strategy.

Make 3M the master brand, link it to all the company‘s values and products, and leverage it in all markets.

Establish worldwide communication standards.

The result of this campaign was the emergence of a single, unified 3M image. The number of 3M brand names shrank from 1,200 to fewer than 600. Advertising in more than 40 countries now focuses on reinforcing the innovation theme. And most important, awareness of 3M has jumped by 10 percent or more in Japan, Australia, Europe, and even the United States.

Source: Olson, E. M., Cooper, R. & Slater, S. F. 1998. Design strategy and competitive advantage. Business Horizons, March–April: 57.

Discussion Question 12: What are some examples of other companies that use brand image and corporate messages to coordinate the activities of its various divisions? 1.

Strategic Business Unit Structure

Highly diversified corporations often combine similar divisions into strategic business units (SBUs). This helps coordinate activities and attain synergies. ConAgra is presented as an example of a company with dozens of divisions grouped into three SBUs—food service, retail, and agricultural products. SBUs are typically run as profit centers. The primary advantage of the SBU structure is that it makes planning and control more manageable. The disadvantages include it may be difficult to realize synergies even among similar divisions and the additional hierarchical level of an SBU adds personnel and overhead expenses. Discussion Question 13: What are some examples of companies that operate with an SBU structure? Discussion Question 14: What factors might prevent companies from attaining synergies among divisions within an SBU? 2.

Holding Company Structure

The holding company structure (also referred to as a conglomerate) is another type of divisional structure. Whereas SBUs are used to group similar divisions, the holding company structure is used to manage a portfolio of unrelated businesses. Since the businesses are unrelated, most management decisions, controls, and incentives are left to the operating divisions. As a result, corporate staffs are small. An advantage of the holding company structure is the cost savings from having a small corporate office. Additionally, autonomy at the division level enhances motivation. The disadvantage relates to the dependence that corporate executives have on divisional executives to achieve financial goals. Discussion Question 15: What are some examples of companies that operate with a holding company structure? 1-333 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 16: What factors might contribute to poor performance by the divisions of a holding company?

Matrix Structure

A matrix structure is, in essence, a combination of a divisional and functional structure. Most commonly, functional departments are combined with product groups on a project basis. As a result, personnel from functional departments work under a product group manager for the duration of a project. Multinational corporations combine product groups and geographical units—an alternative to the product/function matrix. In both cases, personnel become responsible to two managers. EXHIBIT 10.4 portrays a diagram of a typical matrix organizational structure. An advantage of the matrix structure is that it facilitates the use of specialized personnel, equipment, and facilities. This reduces duplication and allows individuals with a high level of expertise to divide their efforts among multiple projects at one time. Such sharing and collaboration leads to more efficient use of resources. It also provides professionals with greater responsibilities and enhances the use of their skills. Disadvantages of a matrix structure are related to dual reporting requirements. This can lead to power struggles and conflict. Further, matrix structures are often used in situations that are complex, which may lead to excessive reliance on group processes and teamwork, and erode timely decision making. Teaching Tip: When discussing the concept of the matrix organization with the class, you have the opportunity to address, in effect, the difference between “theory” and “practice.” That is, the matrix organization has many potential benefits (e.g., flexibility, quick adaptation to change) that may be very difficult to realize in practice (e.g., the structure can become very cumbersome, lead to turf wars, etc.). Ask students if any of them have had experience with a matrix structure and see if any of these problems were experienced. Also, ask what managers should do to effectively implement matrix structures. Discussion Question 17: What are some examples of companies that operate with a matrix structure? EXHIBIT 10.5 outlines the advantages and disadvantages of the three different organizational structures discussed above—functional, divisional, and matrix. The SUPPLEMENT below issues managers should consider as they consider changing the firm‘s organizational structure.

Extra Example: Steps for Getting Organizational Redesign to Work McKinsey consulting has worked with a wide range of firms undertaking actions to change their structure. From this experience and a survey they conducted, they have developed a set of steps they recommend for firms undertaking restructuring efforts. 1. Focus first on long-term goals. Leaders often obsess over the limitations of the current structure. They should work with key employees to develop a set of clear goals for the redesign effort and communicate those goals clearly throughout the organization. 2. Take time to assess the situation. A McKinsey survey found that 60% of managers admit they didn‘t take enough time to fully assess the strengths and weaknesses of the current structure. Leaders must carefully consider how people work together and fully understand the talent pools within the firm. 3. Be careful in developing the new organizational blueprint. Knowing the goals for the redesign and the key processes and talent pools, top management should work with leaders throughout the firm to identify both the most appropriate basic structure (functional, divisional, etc.) and the other structural elements, such as cross-unit teams that the firm will use to overcome the barriers created by the chosen structure. 4. Thinking beyond lines and boxes. Managers need to consider issues beyond the structure of the firm to get the right people talking and coordinating. This includes a range of organizational attributes, including incentives, the design of physical space (to get people interacting), and who is involved in HR evaluations and promotion decisions. McKinsey found firms that focus on a larger set of levers, both structural lines and boxes as well as softer personnel factors, experienced more successful redesigns. 5. Communicate and reinforce the need for change. To successfully change organizations, the firm needs to change the mindset of employees. To do this, to managers needs to communicate a compelling story for the change effort, role model the new mindset and desired actions, put in place systems (reporting and evaluation systems, incentives, etc.) that reinforce the change, and highlight early successes. 6. Establish metrics to measure short- and long-term success. Developing measures to assess the performance of the firm in working toward its long-term goals is a critical issue. Old metrics may not allow the firm to see whether the change is succeeding. If the desire of the change is to speed up processes, assess that directly. If it is to better retain talent and move people into more fulfilling roles, measure that. Doing so allows top managers to assess how well the change is working and also gives information that can be communicated to reinforce the change efforts. 7. Manage the transitional risks. Change efforts have the potential to disrupt normal operations; create coordination challenges with supplier, customers, and alliance partners; and lead to higher employee turnover. Firms should strive to identify key risks, develop metrics to identify problems early, and have crisis teams ready to attack critical problems that arise due to the change. Source: Aronowitz, A, DeSmet, A, and McGinty, D. 2015. Getting organizational redesign right. mckinsey.com. June: np.

International Operations: Implications for Organizational Structure

Consistency between strategy and structure is required to be successful in global markets. As firms expand into foreign markets, changes in structure follow changes in strategy.

Firms that pursue multidomestic strategies (as discussed in Chapter 7) would most likely use international division or geographic-area division structures. With these, local managers have high autonomy to manage within the demands and constraints of the local market. If product diversity becomes large, firms may benefit from a worldwide matrix structure. Global strategies, by contrast, typically have more centralized operations in order to manage for overall efficiency. Here, worldwide functional and worldwide product division structures are more likely because the market is more homogeneous and requires less local attention. Once firms with global strategies become highly diversified, they are likely to shift to a worldwide holding company structure. Discussion Question 18: What are some examples of international companies that use worldwide, international, and geographic-area structures?

Global Start-Ups: A Recent Phenomenon

Up to this point in this section, we have suggested that international expansion occurs primarily after the potential of domestic growth is exhausted. However, there are two interrelated trends that have given rise to ―global start-ups.‖  

Many firms now decide to expand internationally relatively early in their history. Some firms are ―born global‖—that is from the very beginning many start-ups are global in their activities.

There is no reason for all start-ups to be global; global start-ups require a higher level of communication, coordination, and transportation costs. Some of the circumstances under which going global from the beginning is advantageous are:     

The required human resources are globally dispersed, and going global may be the best way to access those resources. Foreign financing may be easier to obtain and more suitable for the project. The target customers in many specialized industries are located in other parts of the world. There is a gradual move from domestic markets to foreign markets, and if a product (or service) is successful, it may be immediately imitated by firms in other countries. With high up-front development costs, a global market is necessary to recover the costs.

STRATEGY SPOTLIGHT 10.1 discusses BRCK, a Kenyan technology start-up with a global vision and scope of operations.

How an Organization’s Structure Can Influence Strategy Formulation

Typically, in discussing the relationship between strategy and structure, we strongly imply that structure follows strategy. However, in this section we stress the caveat that structure can influence a firm‘s strategy. Given that a firm‘s structure can be rather difficult to change, strategy cannot realistically be formulated without taking structure into account. The SUPPLEMENT below discusses how the chief diversity officer (CDO) can promote diversity and spur innovation. Extra Example: A Key Position in the Corporate Organizational Chart: Chief Diversity Officer In the corporate world, the position of the Chief Diversity Officer (CDO) has emerged in recent years. The more progressive companies are releasing CDO‘s from the confines of human resources departments and positioning them to work closely with the heads of product development, business development, marketing, and sales. This change in reporting relationships (a key component of organization structure) allows the CDO to more easily detect innovation opportunities throughout the organization. ―Increasingly, CDOs report to the CEO, outside of HR,‖ asserts Edie Fraser, founder and president of Diversity Best Practices, an organization that tracks diversity initiatives by corporations. One company that has taken this approach is the Russell Corporation, with $1.5 billion in revenues. The company (founded in 1902 and recently acquired by Berkshire Hathaway) now has three business segments: apparel, sports equipment, and athletic shoes. At Russell, the human resources function handles the traditional diversity matters such as affirmative action, recruiting, and legal issues. However, CDO Kevin Clayton is busy turning a separate diversity department into a profit center. For example, Clayton‘s group discovered that a large number of Russell‘s employees had graduated from historically black colleges and universities. The group then used those graduates‘ ideas to create products for the black university market, resulting in an $8 million-to-$10 million contract. Since then, Clayton has created several additional development groups that combine employees of different ethnicities and religions. Clayton is expecting to significantly increase revenues in the future. Sources: Johansson, F. 2006. Masters of the multicultural. Harvard Business Review, 83(10): 18–19; Young, N. 2006. Berkshire Hathaway to acquire Russell Corporation. Russell Corporation press release, April 17: np; and https://www.russellcorp.com/.

Discussion Question 19: In organizations that are too small to have a separate Chief Diversity Officer, what would be the best ways to achieve the objectives described in the above supplement; that is, spurring innovation and promoting diversity? STRATEGY SPOTLIGHT 10.2 discusses how elements of Pfizer‘s organizational structure enabled the pharma giant to develop its COVID-19 vaccine in record time.

II.

Boundaryless Organizational Designs

PowerPoint Slide 26: Organizational Structure: Boundaryless Designs PowerPoint Slide 27: Organizational Structure: Barrier-Free Organizations PowerPoint Slide 28: Barrier-Free Structures Pros and Cons 1-337 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

PowerPoint Slide 30: Boundaryless Designs: Modular Organizations PowerPoint Slide 31: Modular Structures Pros and Cons PowerPoint Slide 32: Boundaryless Designs: Virtual Organizations PowerPoint Slide 33: Virtual Structures Pros and Cons PowerPoint Slide 34: Boundaryless Designs: Making Them Work PowerPoint Slide 35: Boundaryless Designs: Benefits and Costs Organizations that become boundaryless become more open and permeable, not ―chaotic.‖ Boundaryless approaches should be considered a complement to, not a replacement for, traditional forms of organizing. Several types of structures can be used to make organizations more boundaryless. Barrier-free approaches involve removing internal boundaries to encourage teamwork and widespread sharing of information. Virtual and modular organizational forms are used to make external relations more permeable and create seamless knowledge systems across organizations. The SUPPLEMENT below highlights some of the big challenges faced by firms in today‘s global economy associated with coordinating activities among diverse professionals spread across the world. It states that, among other initiatives, many multinationals are hiring sociologists to help unlock the secrets of teamwork among colleagues who have never met. Extra Example: Coordinating a Firm‘s Activities in a Global Economy—A Perspective For global companies, success once meant having bodies and factories on the ground from Sao Paulo to Silicon Valley to Shanghai. Coordinating their activities was a deliberately planned effort handled by headquarters. Now, the challenge is to weld these vast, globally dispersed workforces into superfast, efficient organizations. Given the conflicting needs of multinational staff and the swiftly shifting nature of competition brought about by the Internet, that‘s an almost impossible task. And getting professionals to collaborate instantly—not tomorrow or next week, but now—requires nothing less than a management revolution. Complicating matters is the fact that the many business activities are no longer accomplished by a single, integrated entity with full-time employees and a recognizable hierarchy. Business activities are now being accomplished by a fluid constellation of firms, with a classic corporation at the center of an ever-shifting network of suppliers and outsourcers, some of whom only join the team for the duration of a single project. To adapt, multinationals are hiring sociologists to unlock the secrets of teamwork among colleagues who have never met. They are arming staff with an arsenal of new technology tools to keep them perpetually connected. They include software that helps engineers to co-develop 3D prototypes in virtual worlds and services that promote social networking and that track employees and outsiders who have the skills needed to nail a job. Corporations are investing lavishly in posh campuses, crafting leadership training enters, and offering thousands of online courses to develop pipelines of talent. Source: Engardio, P. 2007. Managing the new workforce. BusinessWeek, August 20–27: 48–51.

Discussion Question 20: Have you coordinated project work with professionals in other parts of the organization? Other countries? What were the challenges? How were they overcome? Discussion Question 21: What are some examples of other companies that have implemented more flexible and permeable organizational structures? Have they been successful? Why? Why not?

The Barrier-Free Organization

Traditional organizations had boundaries intended to maintain order by making the role of managers and employees clearly defined. But these boundaries also stifled communication and created a ―not my job‖ mindset. A barrier free organization enables a firm to bridge differences in culture, function, and goals to find common ground that facilitates information sharing and cooperation. STRATEGY SPOTLIGHT 10.3 discusses how GM is working to build a boundaryless organization to enhance its ability to innovate. 1.

Creating Permeable Internal Boundaries

Teams are an important part of barrier-free structures because they 1) substitute peerbased for hierarchical control; 2) often develop more creative solutions via brainstorming and other group problem solving techniques; and 3) absorb administrative tasks previously handled by specialists. The SUPPLEMENT below provides examples of how GE is working to create permeable boundaries to boost collaboration within its global network of businesses. Extra Example: GE Takes Steps to Break Down Silos GE traditionally relied on formal organizational structures and clear business boundaries. Today, as it strives to increase its innovative potential, GE is taking steps to more effectively integrate people and knowledge across business unit boundaries. The firm has invested in training and digital platforms to create an internal marketplace to share ideas, innovations, and business practices. The firm has taken five steps to enhance its abilities to allow employees to work across traditional organizational boundaries: 1.

Create a network effect: GE has taken informal and formal actions to get employees to look to other units for knowledge and ideas. Management encourages employees to look outside their units. To reinforce this, the firm has set up virtual forums where employees can share insights, facilitating faster and bolder actions. One such forum included 30,000 employees from 10 businesses in 91 countries. Get to “why” early and establish an underlying “yes” philosophy: Cross-unit teams are tasked to quickly identify a shared mission and decide on shared metrics that allow the team to agree on solutions and make decisions to keep projects moving forward. Hunt in packs: All substantial business actions at GE happen in teams. Management councils, training activities, and leadership meetings are all cross-business activities. This builds a collaborative mind-set for all decision actions. 1-339 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Move at market speed: As global business units strive to build business in diverse markets, GE emphasizes the need of business unit managers to engage individuals with relevant geographic market knowledge and experience, regardless of the business unit in which they are based. Also, the firm has built infrastructure to support multiple businesses in these markets. For example, GE built a flexible manufacturing facility in India that can serve the manufacturing needs of multiple divisions so the firm can exploit new opportunities in the dynamic Indian market. Be the dog with the bone: At times, leadership still needs to step in to counsel and enforce cross-unit action. This can include the development of new metrics and evaluation systems to increase the degree of cross-unit cooperation.

Together, the development of platforms, new evaluation systems, emphasis on meeting market needs, and leadership initiatives are helping GE create permeable boundaries. Source: Rice, J. 2017. How GE is becoming a truly global network. mckinsey.com. April: np.

Discussion Question 22: What are some other means of ensuring coordination across geographically dispersed team members? (e.g., leadership, culture, trust, reward systems, rules/regulations) The SUPPLEMENT below discusses the role of cultural brokers in bringing together employees from different parts of the organization. Extra Example: The Role of Cultural Brokers Employees who have experiences that span multiple sectors, functions, or business units often serve to formally or informally overcome organizational boundaries. These cultural brokers play a key role in firms looking to create permeable boundaries that facilitate the work of diverse teams. Cultural brokers promote cross-boundary work either by acting as a bridge or as an adhesive. A bridge serves as a go-between, allowing workers in different units collaborate with minimal disruption to their normal work. Bridges are most effective when they have knowledge about both sides and can figure out and communicate what each needs. For example, Moet Hennessey Espana hired two enologists, or wine experts, to bridge the firm‘s sales and marketing groups, two units that had historically clashed. The enologists understood the emotional element of wine, a key concern for marketers to use, as well as the distinctive properties of each wine the firm produced, a key issue for the salesforce. Understanding both sides, the enologists could communicate the needs of the marketers to the salespeople and vice versa. Adhesives work by bringing people together and building connections and lasting relationships. Adhesive identify who the right people are to collaborate with, vouch for each of them with the other party, and facilitate a connection. For example, a manager at National Instruments connects people from different units. His process works in four steps. First, an employee reaches out to him to help solve a problem by identifying where the right knowledge or ability resides in the firm. He identifies who the right person is to solve the problem. Second, he meets with the person who contacted him and lets this person know how the other unit operates and even the particular interpersonal behaviors of the specific connection partner he has in mind. Third, he reaches out to the target person and communicates the need and verifies the validity of the request. Fourth, the two parties connect and work together to solve the issue the firm faces. Companies can build bridging and adhesive capabilities by hiring people with multifunctional or multicultural boundaries who also have strong interpersonal skills. They can also build in systems to allow employees to move

into roles that expose them to different units and regions. Finally, the firm can build formal roles for boundary spanning cultural brokers. Source: Casciaro, A.; Jang, S. 2019. Cross-Silo Leadership. Harvard Business Review. 97(3); 130–139.

STRATEGY SPOTLIGHT 10.4 provides advice for managers to make agile transformations in their organizations and help teams to implement agile principles.

Developing Effective Relationships with External Constituencies

Emphasize that barrier-free relationships must also extend to other divisions of a corporation and to external stakeholders. To promote interdivisional coordination and resource sharing, firms often use interdivisional task forces and common training programs and create reward and incentive systems that foster cooperation. Boundaries between organizations and external constituencies, such as customers, also need to be more flexible and porous. IBM‘s relationship with the Mayo Clinic is provided as an example. Discussion Question 23: Have you ever worked for a barrier-free organization? How were relationships among participants in barrier-free transactions and/or projects managed? The SUPPLEMENT below addresses the example of the Irvine Medical Center, a hospital that developed more efficient processes by fostering barrier-free relationships inside the hospital and with employee unions. Extra Example: Breaking Barriers at the Irvine Medical Center In 2008, the Irvine Medical Center, a unit of Kaiser Permanente, wanted to streamline its costliest, most timeintensive surgeries: total hip and knee replacements. The task was daunting, because the solution required collaboration among specialists who normally fight for resources. Neither a top-down administrative mandate nor a surgeon-driven approach would work to improve the processes. A top-down approach wouldn‘t have worked because surgeons in different groups each had their own way of doing things and would be resistant to an administrative mandate, and each surgery group had little influence on the practices in other surgery units. Also, the hospital had to get other employees on board, and most of them are covered by unionized contracts that limit changes in workload and flow. Kaiser created a collaborative community, the Labor Management Partnership (LMP), that included Kaiser managers, surgeons, and most of the hospital‘s employee unions. The LMP worked cooperatively to find efficiency gain opportunities. The benefit was that all members felt engaged. As one nurse stated about operating room procedures, ―Usually when we are in the room, we wish it would be done differently, but this time we actually got a voice in how it‘s done differently.‖ They identified ways to streamline sequential operations, such as by bringing housekeeping in to begin clean-up as soon as a surgeon begins suturing the patient closed. They also set up an alert system to ensure that staff knew when they were needed. For example, they trigger the post-op and transportation staff to prepare fifteen minutes before the end of a surgery. Finally, they found ways in which the hospital could be more efficient by adding staff. For example, they added a ―floater‖ nurse who could move between operating rooms to provide extra help or relieve staff on breaks. These steps all reduced surgery cycle-times and also improved employee morale. They increased the number of total joint replacement surgeries from two to four per day and freed up 188 hours of operating time room per year. A survey of the operating room staff showed an 85 percent increase in job satisfaction. Seeing the benefits, Kaiser implemented similar LMP teams in general surgery, head and neck surgery, urology, heart, and other surgery specialties in Irvine as well as in other Kaiser hospitals. Source: Adler, P., Heckscher, C., & Prusak, L. 2011. Building a collaborative enterprise. Harvard Business Review. 89(7/8); 94–101. 1-342 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 24: How might approaches such as the Irvine Medical Center’s LMP be used in other organizations? Some organizations have even benefited from breaking down barriers with competitors by creating cooperative relationships that benefit groups of competitors in an industry. Discussion Question 25: In what ways might competitors work together cooperatively to mutually benefit all participants? Point out that barrier-free approaches can be difficult to implement and maintain. The type of democratic processes that emerge in a boundaryless approach often need to be carefully managed. The entire organization—goals and strategies—must support the effort. One way to enhance a barrier-free approach is to utilize well-designed and effectively implemented information technology systems that support knowledge gathering and sharing. Discussion Question 26: What other types of organizational systems might be utilized to ensure the success of a barrier-free approach? STRATEGY SPOTLIGHT 10.5 discusses how large corporations benefit by participating in the Business Roundtable. We highlight how it has aided Walmart‘s sustainability initiatives. The INSIGHTS FROM RESEARCH for this chapter offers evidence on how breaking down internal and external boundaries influences organizational learning. 3.

Risks, Challenges, and Potential Downsides

Not all efforts to create barrier-free structures have been successful. We briefly discuss Puritan-Bennett Corporation who found process times increased rather than decreased because a lack of top management, team member turnover, and ineffective coordination. Teaching Tip: Virtually all students have worked in teams—either in “real world organizations” or on projects for their college courses. Ask them what they felt the characteristics were of both effective and ineffective teams that they worked on. And, ask them how the teams that they worked on could have been made more effective. EXHIBIT 10.6 outlines the pros and cons of the barrier-free type of organization.

The Modular Organization

The modular organization type is actually a central hub surrounded by networks of outside suppliers and specialists that perform non-vital functions. Such outsourcing allows the firm to tap into the knowledge and expertise of ―best in class‖ suppliers but retain full strategic control. For modular companies, outsourcing the non-core functions offers three advantages: 1-343 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

It can decrease overall costs, quicken new product development by hiring suppliers whose talent may be superior to that of in-house personnel, avoid idle capacity, realize inventory savings, and avoid becoming locked into a particular technology.

It enables a company to focus scarce resources on the areas where they hold a competitive advantage. These benefits can translate into more funding for research and development, hiring the best engineers, and providing continuous training for sales and service staff.

By enabling an organization to tap into the knowledge and expertise of its specialized supply chain partners, it adds critical skills and accelerates organization learning.

The modular type of organization allows a company to leverage relatively small amounts of capital and a small management team. By minimizing the need to make big investments, it can promote rapid growth. Firms taking this approach, however, must 1) identify the best suppliers and establish mutually beneficial working relationships; and 2) avoid outsourcing critical components of its business in ways that compromise it long-term competitive advantage. The SUPPLEMENT below discusses how Porsche relies on outsourced engineering to remain innovative. Extra Example: Porsche Outsources Research Porsche makes some of the most technologically advanced cars in the world, but the company does not have a large in-house R&D staff. It has to find another way of sourcing innovative ideas and expertise. One highly successful method is to outsource the work to universities and doctoral students doing basic R&D. Another method is to bring students into the company with internships. Every year, Porsche welcomes some 600 Masters students to work with its engineers for four to six months. Porsche budgets for both outsourced research and internships and has found that it has resulted in cheaper and faster results than most equivalent in-house research efforts. A critical factor in making this work is that the engineers at Porsche must respect their colleagues; whether they are full time colleagues, university researchers or graduate students doing internships; and value what comes out of their research efforts. This allows Porsche to draw on much of this research and rapidly integrate it into their product line. Source: Lorange, P. 2010. Leading in turbulent times. Lessons learnt and implications for the future. Bingley, UK: Emerald Group.

Discussion Question 27: Do you believe the average corporation is capable of integrating such R&D efforts into its operations? Why? Why not? Discussion Question 28: Are you familiar with any other organizations that have similar programs? 1.

Strategic Risks of Outsourcing

Potential disadvantages of the modular form include 1) loss of critical skills or developing the wrong skills; 2) loss of cross-functional skills; and 3) loss of control over a supplier. EXHIBIT 10.7 addresses the pros and cons of the modular form of organizational structure. It is not only what a firm chooses to outsource but also how they manage relationships with the firms they use as suppliers that will determine their long-term prospects. The SUPPLEMENT discusses how firms need to be very conscious of how they control and manage relationships with suppliers of key components Extra Example: The Need to Manage the Supply Chain Thomas Choi and Tom Linton argue that manufacturers have delegated too much power to their top-tier suppliers. By pushing the design of key components and the management of lower-tier suppliers onto top-tier suppliers, manufacturers are undermining their ability to control key technologies, innovate, cut costs, and manage risk. Their prescription is for firms to retain or reassert control for items that have the most significant impact on the cost of goods sold. They use the old 80/20 rule and note that typically 20 percent of the components of a product account for 80 percent of the product‘s total component cost. For example, in a typical smartphone, two or three semiconductors and the LCD screen account for over 50 percent of the total component cost of the phone. Rather than delegate the design, manufacturing, and sourcing of these components to top-tier suppliers, manufacturers should be more involved in managing the design process and maintain direct contact with lower-tier suppliers of key components. If they don‘t, they delegate key decisions to firms that may not always be working in the firm‘s best interests. For example, one risk that arises if a phone manufacturer outsources the purchasing of the semiconductors to a top-tier supplier is that the supplier may choose to use a chip that benefits the supplier firm at the expense of the phone manufacturer. If the supplier works with several phone manufacturers, it may choose to use a supplier and a specific semiconductor that it is also using in a competing company‘s phone rather than the optimal chip for this phone design. If the phone firm, instead, works directly with the chip supplier, they are more likely to get the best chip for their phone. Manufacturers who retain control over their key components develop deep knowledge of the technical aspects of the parts, have stronger knowledge of the critical costs in their supply chains, and can react more quickly to market dynamics since they have direct ties with the suppliers of these key components. The experience of LG Electronics bears this out. In 2009, when recession hit the electronics industry, LG worked directly with about 300 top- and lower-tier suppliers to reduce components costs and found savings of more than $6 billion. It would have been unlikely to find similar savings potential if it delegated the cost savings efforts to top-tier suppliers. Having direct ties with lower-tier suppliers also gives the manufacturers direct insight on new technology development and new product introductions in these supplier industries, enhancing their ability to design and launch innovative products using these leading technologies. Sources: Choi, T. & Linton, T. 2011. Don‘t let your supply chain control your business. Harvard Business Review. 89(11); 112–116.

Discussion Question 29: Why do firms often choose to delegate responsibilities to top tier suppliers even though it leaves them less responsive and less able to manage costs in their supply chain?

The SUPPLEMENT below illustrates how Boeing continues to struggle with outsourcing key parts of its 787 Dreamliner production. Extra Example: Boeing finds more faulty parts in Dreamliner 787 Boeing‘s 787 Dreamliner dealt with a range of production issues before the aircraft entered commercial service in 2011. Since entering service, Boeing continues to face production issues, which at least partially were a result of Boeing‘s sprawling supplier network and outsourcing strategy. In 2021, Boeing discovered that Italy‘s Leonardo SpA, one of the largest 787 Dreamliner suppliers, did not meet the specifications of some titanium components. As a result, these parts needed to be replaced on some aircraft, which is costly for airlines since they need to ground the affected airplanes. The supplier suggested that the weak titanium parts were provided by a subcontractor. While the weak parts did not pose a direct safety risk to passengers, it shows how extensive aircraft supply chains can be. A major concern for Boeing is that repeated media coverage of safety issues and suboptimal production processes will harm its reputation for quality aircraft in the long term. This is especially true after the media uncovered that junk is frequently left over in aircraft and production facilities. Source: Johnsson, J. & Brambilla, A. 2021. Boeing finds faulty titanium parts in latest setback for 787. www.seattletimes.com. October 14: np; Tangel, A. 2021. Boeing Deals With New Dreamliner Defect Amid Production Problems. www.wsj.com. October 14: np.

The Virtual Organization

The virtual type of organization is an evolving network of independent companies— suppliers, customers, even competitors—linked together to share skills, costs, and access to one another‘s markets. By pooling and sharing resources and working together in a cooperative effort, each gains in the long run. Virtual organizations are a type of strategic alliance in which complementary skills are used to pursue common objectives. Virtual organizations also may not be permanent. And, participating firms may be involved in multiple alliances at once. Unlike the modular type, virtual organization firms give up part of their control and participate in a collective strategy that enhances their own capacity, makes them better able to cope with uncertainty, and enhances their competitive advantages. The SUPPLEMENT below discusses some key statistics regarding virtual teams. Extra Example: The Challenge of Virtual Teams As companies expand geographically and as telecommuting becomes more common, work groups often span farflung offices, shared workspaces, private homes, and hotel rooms. It is no surprise, then, that the use of virtual teams is on the rise. A survey by Ferrazzi Greenlight, a consulting firm, found that 79 percent of knowledge workers always or frequently worked in dispersed teams. The appeal of virtual teams is clear. Employees can manage their work and personal lives more flexibly, and they have the opportunity to work with colleagues around the world. Companies can use the best and lowest-cost talent from around the world and lower their real estate costs. 1-346 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

While the promise with virtual teams is great, they are a challenge to manage well. In a study of virtual teams conducted by management scholars Vijay Govindarajan and Anil Gupta, it was found that 82 percent of the teams fell short of their goals and 33 percent rated the teams as largely unsuccessful. In a study of virtual teams undertaking IT projects conducted by Deloitte, a management consulting firm, 66 percent of the teams failed to satisfy client‘s requirements. However, other studies show that well managed virtual teams can offer great value for corporations. In a study of global software teams, researchers from the Boston Consulting Group and WHU School of Management found that well-managed dispersed teams can outperform those in shared office space. Similarly, an Aon Consulting report found that using virtual teams can lead to improved employee productivity, in some cases by up to 40 percent. These results reinforce the idea that virtual teams have great potential, but they need to be consciously and effectively managed by organizations. Source: Ferrazzi, K. 2014. Managing Yourself: Getting Virtual Teams Right. Harvard Business Review, December: 120–123.

Discussion Question 30: What are some other ways that virtual organizing—either with the help of technology or not—might contribute to costs savings and service improvements? The SUPPLEMENT below points out that effective leadership is the number one factor that influences success in a virtual organization. Moreover, it discusses the importance of collaboration tools, goal definition, and coaching where HR can help a manager enable a virtual team. Extra Example: Transitioning to a Virtual Organization The virtual workspace can be defined as an environment where employees work away from company locations and communicate with their respective workplaces via telephone or digital devices. The virtual organization has different and/or greater challenges than the traditional face-to-face workplace environment, with lines of work crossing over geographies, markets, cultures, alliances, partnerships, and supplier networks. The very nature of virtual work requires planning and thoughtful design. The development and evaluation of virtual teams present a unique opportunity for HR to partner with many different elements of the business. Further, with increasing dependence on technology for communication in the workplace, the role of leadership is changing. Leaders of virtual workplaces require certain essential skills including a strong focus on relationships, emotional intelligence, a track record of results and innovation, a focus on process and outcome, and the ability to give positive and constructive feedback. HR should be part of any pilot program to help leaders understand, anticipate and mitigate management problems. Elain Orler, president of talent Function Group LLC, summarizes, ―Leaders need to be more flexible in how and when they communicate. Some people connect on instant messenger while others prefer text messages…the more flexibility I have, the more I can connect with my diverse team.‖ Flexibility of leadership seems to be the paramount to ensure success in virtual workplace. Source: Anonymous. 2010. Successfully transitioning to a virtual organization: Challenges, impact and technology. HR Magazine. April. Vol. 55 Issue 4: 1–9.

Discussion Question 31: The supplement above discusses the role of leadership in a virtual workplace. Can you think of an example of how a leader bridges and understands cultural differences in a virtual workplace? Discussion Question 32: Can such virtual organizations be successful in the long run? How can leaders motivate employees they rarely see in person? Can relationships develop in such an environment? Are they relevant for productivity? 1.

Challenges and Risks

Despite their many advantages, alliances often fail to meet expectations. One reason is that unique managerial skills are required—managers who can find good partners, build win-win relationships, and achieve the right balance of freedom and control. Point out that some alliances are short-term only and may be dissolved once the objective is fulfilled. Others may have longterm objectives. The key to managing both is to be clear about the overall strategic objectives at the time the alliance is being formed. The virtual organization is the culmination of joint venture strategies of the past. To form effective virtual organizations, strategic planning is needed to determine what synergies exist and how to capitalize on them by combining core competencies. As such, the virtual form may work better for some types of organizations than others. Discussion Question 33: What types of contingencies are likely to influence whether a virtual organizational type will be a successful form for pursuing a venture or strategic goal? EXHIBIT 10.8 summarizes the pros and cons of the virtual form of organizational structure.

Boundaryless Organizations: Making Them Work

Often, the most effective way to design an organization is by using a combination of organizational types. Often, when firms face external pressures, resource scarcity, and declining performance, they tend to become more internally focused. Point out that this may actually be the best time to reexamine value-chain activities and determine how to better manage relationships both internally and externally. By so doing, organizations may find that they can solve some of their problems by turning to boundaryless forms of organizing. In making the transition to more democratic, participative styles of management and greater reliance on teamwork, managers must select a balance of tools and techniques to facilitate the effective coordination and integration of key activities. The next four subsections 1-348 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

address factors that must be considered in any transition from traditional to boundaryless organization forms. 1. Common Culture and Shared Values 2. Horizontal Organization Structures 3. Communications and Information Technologies

4. Human Resources Practices The SUPPLEMENT below discusses how Novartis has created horizontal organizational structures to break down silos that inhibited learning across organizational units and with outside groups. Extra Example: Breaking Down Silos at Novartis Novartis, the Swiss pharmaceutical giant, sees the need to be more effective at developing new drugs. Joerg Reinhardt, the firm‘s CEO, has committed to invest more in R&D, but he is also making changes in the organization‘s structure to enhance its effectiveness in drug development. Novartis is consolidating its R&D staff and housing them in four geographic locations: Shanghai, Basel (Switzerland), Boston, and San Diego. In combining researchers from different scientific disciplines and product areas in these locations, the firm is trying to create an environment where researchers can bounce questions and ideas off of each other. They have also based these operations in cities with major research universities so the firm can better tap the knowledge emerging from academic communities in each of these cities. In the words of Mr. Reinhardt, ―A larger group of people benefiting from the infrastructure that been created at a research place is a better approach than having small groups with limited infrastructure spread around the world.‖ Source: Falconi, M. 2014. Novartis Chairman Stresses Need for R&D Investment. wsj.com. March 22: np.

Managers need to also be aware of the benefits and costs of developing strong and longterm relationships with both internal and external stakeholders. We discuss three primary benefits that organizations accrue when building and relying on long-term relationships. 

Reduced agency costs within the firm



Reduced transaction costs with suppliers and customers



Greater commitment to shared goals and finding win-win solutions

We also identify three potential costs of relying on long-term relationships. 

Firms get locked-in with employees, suppliers, and customers



Conflicts are resolved through ad hoc negotiations and processes



The social capital of individuals and firms drives their opportunities rather than their competencies

III.

Creating Ambidextrous Organizational Designs

PowerPoint Slide 36: Organizational Structures: Ambidextrous Designs PowerPoint Slide 38: Ambidextrous Designs: Effectiveness 1-350 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

In this section, we address the challenge that organizations face in rapidly changing and complex competitive environments: exploring for new opportunities (adaptability) and effectively exploiting the value of their existing assets and competencies (alignment). Firms that achieve both adaptability and alignment are considered ambidextrous organizations—aligned and efficient in how they manage today‘s business but flexible enough to changes in the environment so that they will prosper tomorrow.

Ambidextrous Organizations: Key Design Attributes

Here, we focus on a study by O‘Reilly and Tushman that investigated 35 efforts to launch breakthrough innovations undertaken by 15 business units in nine different industries. They studied the organizational designs, as well as the processes, systems, and cultures associated with the innovative projects and their impact on the operations and performance of the traditional businesses. The firms organized their breakthrough projects into one of four primary ways: 1. 2. 3. 4.

functional organizational structures cross-functional teams unsupported teams ambidextrous organizations (structurally independent units integrated into the existing senior management structure)

STRATEGY SPOTLIGHT 10.5 discusses innovative firms use of teams that draw on the involvement of all team members. B. Why Was the Ambidextrous Organization the Most Effective Structure? The ambidextrous organizational form was most effective on both dimensions: success in creating desired innovations and the performance of the existing business. The study found that there were many factors that explained the superior performance. Among these were:     

a clear and compelling vision cross-fertilization among business units tight coordination and integration at the managerial levels sharing was encouraged and facilitated by effective reward systems established units were shielded from the distractions of launching new businesses

Discussion Question 34: Do organizations that you are familiar with share the structural attributes of ambidextrous organizations? Why? Why not?

The SUPPLEMENT below provides some of the attributes of ambidextrous behaviors of individuals. It was based on research that involved interviews with a wide variety of people from front-line workers to senior executives. Extra Example: The Behaviors of ―Ambidextrous Individuals‖ Based on a study by Julian Birkinshaw and Cristina Gibson, ambidextrous individuals: 

take the initiative and are alert to opportunities beyond the confines of their own jobs



are cooperative and seek out opportunities to combine their efforts with others



are brokers, always looking to build internal linkages



are multitaskers who are comfortable wearing more than one hat Source: Birkinshaw, J. & Gibson, C. 2004. Building ambidexterity into an organization. MIT Sloan Management Review, 45 (4): 47–55.

Discussion Question 35: Think about times in your own life when you were expected to both cooperate and take initiative. How easy or difficult is it to be an ambidextrous individual? Teaching Tip: The above behaviors would appear to have important career implications. You might consider asking students questions such as the following: First of all, you might ask them what behaviors would be conducive to ambidexterity—prior to discussing the four bulleted items. Then, consider asking them how important they feel these behaviors are for career success, as well as how to develop such behaviors (e.g., taking the initiative to develop social networks, being open to new opportunities, being comfortable taking on multiple projects, and improving one’s ability to be a valuable “team player,” and so on).

IV.

Issue for Debate

A number of high profile firms, including Tata Motors and Tesla, have taken steps to flatten their organizational structures. In removing layers of management, these firms are trying to improve the flexibility and responsiveness of the firm. But critics of these actions argue that managers are left with a wider scope of authority and too taxed with their communication responsibilities to be effectively engaged in organizational initiatives. Also, some argue that long-serving middle managers are highly knowledgeable and serve as a steadying influence in the firm. This issue for debate looks at the opportunities and challenges of flattening organizations. Discussion Question 36: What are the benefits and costs of flattening the organization? In your view, do the benefits outweigh the costs? The benefits include:  Less bureaucratic decision processes, allowing the firm to be more responsive and flexible 1-352 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

   

More efficient operationally with fewer managers Greater autonomy and authority to work teams, an attractive attribute for younger employees Feedback processes are quicker since responsible individuals are closer to the customer Top managers receive more timely information from front line employees

The costs include:  Loss of knowledge as experienced middle level managers are cut  Remaining managers are responsible for a larger number of employees, leaving them less time to coach and train employees  Remaining managers get over-taxed undertaking communication and administrative tasks, leaving less time to be actively involved in the firm‘s initiatives  Loss of middle manager who often serve as a buffer between the top managers and employees and as a check-point that dampens the firm‘s likelihood of acting on the impulses of either top managers or lower level employees  Reduced advancement opportunities for front line employees, leading to higher turnover rates. Discussion Question 37: What industries or firms are most likely to benefit from flattening? In what situations does it not make sense? Flattening is likely to have the greatest benefit in industries that are fast moving and require an enhanced speed of responsiveness, while it is likely to be the most challenging in industries that require consistency and a high degree of safety. Also, in industries that are highly regulated, the reduction of middle managers increases the likelihood that the firm will not meet all regulatory requirements. At the firm level, firms that suffer from bureaucratic inertia due to having too many layers or find themselves being slower in responsiveness to market changes than their rivals could benefit from de-layering. In contrast, firms that find they have difficulty moving projects forward due a lack of management attention or are too inconsistent in their actions may benefit from increasing the number of layers of management in the firm.

Reflecting on Career Implications

PowerPoint Slide 39: Reflecting on Career Implications Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 10. 

Boundaryless Organizational Designs: Does your firm have structural mechanisms (e.g., culture, human resources practices) that facilitate sharing information across

boundaries? Regardless of the level of boundarylessness of your organization, a key issue for your career is the extent to which you are able to cut across boundaries within your organization. Such boundaryless behavior on your part will enable you to enhance and leverage your human capital. Evaluate how boundaryless you are within your organizational context. What actions can you take to become even more boundaryless? Students may benefit from their abilities to interact with others in their local business environment, be they others in different divisions of the organization, different geographic regions, different companies, or different levels of the hierarchy. It‘s most effective to work with students who are able to interact with those outside their office, and most probably can. Even in the smallest organizations, student employees will probably be able to interact with suppliers and customers. To increase students‘ awareness of their boundary-spanning activities, ask students to list ways that they interact with others outside their office. Then ask students to assess the value of these boundary-spanning interactions. At the least, students should appreciate the information that these interactions give. The interactions are also likely to be enjoyable. The information can be very useful, as it may help students do their jobs and be more aware of career opportunities. Next, ask students what they can do to increase their interactions with others outside their office. Some possibilities are to get more involved with selling to customers, or supply chain management. For those working in multidivisional firms, there may be opportunities to volunteer or otherwise participate in cross-functional task forces or new venture initiatives. The point of the discussion is to increase students‘ appreciation of these outside interactions and relationships. 

Culture and Shared Values: Does your firm or department have a strong or weak culture? Consider how your actions can help reinforce or build a strong culture. Also, think of the types of actions leaders in your group can take to strengthen the group‘s culture. Consider sharing these ideas with your leaders. Do you think they will be receptive to your suggestions? Their response likely gives you further insight into the group‘s culture.

This discussion can help students consider whether they are a positive force in the culture of their workplace. While participating in gossip and backbiting between workers and management can help someone feel connected with coworkers, it also creates or perpetuates negative cultures at work. As they work to build careers, students should look to take actions to improve the cultural environment of work. Also, students should be aware of the larger cultural environment and consider whether their current work organization is one where they can buy into the shared values and feel comfortable in the organizational culture. To present their thinking to immediate superiors, there is no correct method because it all depends on factors such as students‘ position, experience, relationships with superiors, and organizational culture. However, students could discuss the prospect of approaching their superiors and assessing what would happen. Class discussion of the possibility will likely bring out some of the factors that could determine the success of the proposal. The point is to get students to visualize the possibility. They may act on it someday, and that would probably help their careers. 1-354 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.



Ambidextrous Organizations: Firms that achieve adaptability and alignment are considered ambidextrous. As an individual, you can also strive to be ambidextrous. Evaluate your own ambidexterity by assessing your adaptability (your ability to change in response to changes around you) and alignment (how good you are at exploiting your existing competencies). What steps can you take to improve your ambidexterity?

There are three steps to this discussion. First, ask students to assess their adaptability. Students who rate themselves high on this characteristic may have the potential to be entrepreneurs. Second, ask students to assess their alignment. Alignment is very important, as it should be maximized if the organization were to get the most value out of the students, and students were to maximize their potential. The problem with achieving ambidexterity is that responding to changes around you, such as dealing with crises and ―putting out fires,‖ draws employees away from their areas of expertise. Third, ask students how they can improve adaptability and alignment. One possibility is to develop expertise in a specific type of recurring problem and then handle that type of challenge when it comes up. Let others handle the other types of challenges. Most possible solutions may involve some sort of teamwork, and that point should emerge from the discussion. Let students wrestle with the issue. It‘s complex and nuanced, so use their contributions to assess how well they understand the situation. The point is to appreciate the nature of much managerial work, and to think about working with others to maximize team effectiveness.

VI.

Summary

Successful organizations must ensure that they have the proper type of organizational structure. Furthermore, they must ensure that their firms incorporate the necessary integrating and processes so that the internal and external boundaries of the firm are flexible and permeable. Such a need is increasingly important, as the environments of firms become more complex, rapidly changing, and unpredictable. In the first section of the chapter, we discussed the growth patterns of large corporations. Although most organizations remain small or die, some firms continue to grow in terms of revenues, vertical integration, and diversity of products and services. In addition, their geographical scope may increase to include international operations. We traced the dominant pattern of growth, which evolves from a simple structure to a functional structure as a firm grows in terms of size and increases its level of vertical integration. After a firm expands into related products and services its structure changes from a functional to a divisional form of organization. Finally, when the firm enters international markets its structure again changes to accommodate the change in strategy. We also addressed the different types of organization structure—simple, functional, divisional (including two variations: strategic business unit and holding company), and matrix, as well as their relative advantages and disadvantages. We closed the section with a discussion of the implications for structure when a firm enters international markets. The three primary factors 1-355 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

to take into account when determining the appropriate structure are type of international strategy, product diversity, and the extent to which a firm is dependent on foreign sales. The second section of the chapter introduced the concept of the boundaryless organization. We did not suggest that the concept of the boundaryless organization replace the traditional forms of organization structure. Rather, it should complement them. This is necessary to cope with the increasing complexity and change in the competitive environment. We addressed three types of boundaryless organizations. The barrier-free type focuses on the need for the internal and external boundaries of a firm to be more flexible and permeable. The modular type emphasizes the strategic outsourcing of noncore activities. The virtual type centers on the strategic benefits of alliances and the forming of network organizations. We discussed both the advantages and disadvantages of each type of boundaryless organization, as well as suggested some techniques and processes that are necessary to successfully implement them. These are common culture and values, horizontal organization structures, horizontal systems and processes, communications and information technologies, and human resource practices. The final section addresses the need for managers to recognize two opposing challenges. These include (1) being proactive in taking advantage of new opportunities, and (2) ensuring the effective coordination and integration of existing operations. Such challenges suggest the need for ambidextrous organizations. Such organizations are both efficient in how they manage existing assets and competencies, as well as take advantage of opportunities in rapidly changing and unpredictable environments. We discussed several attributes of effective ambidextrous organizations. Chapter 10: Creating Effective Organizational Designs Select an organization with which you are familiar—preferably one that you have worked in. To what extent is this organization “boundaryless,” that is, are the boundaries across departments and hierarchical levels rather permeable or are they fixed and rigid? How is this aspect of organizational design affecting its performance? How could it be improved? Teaching suggestions: 

When and under what kind of industry environments is boundarylessness more important, and when would it not work? Clearly, organizations operating in dynamic environments would need greater permeability across boundaries than those that operate in stable and predictable environments. Boundarylessness is a higher concept than mere communication and coordination across departments. Not all organizations can afford to be boundaryless. Consider a bank. Tight controls and rigidity are very critical for maintaining the integrity and efficiency in a banking system. Also, the strategy a firm pursues will have a determining impact on its structure. A tight cost control strategy would require a rigid organization structure with strict controls than

a more flexible system as envisaged by a boundaryless organization. The importance of keeping the structure aligned with the strategy needs to be driven home strongly.

You can then raise discussion on the various forms of boundarylessness. Barrier-free type involves making both internal and external organizational boundaries (with outside organizations such as supplier organizations, buyer organizations etc.,) permeable. Modular organizations and virtual types of organizations focus on the need to create seamless relationships with external organizations. Outsourcing non-core activities is at the core of a modular organization. Forging alliances among independent entities to exploit specific market opportunities is the essence of a virtual organization. (Strategy Spotlight 10.6 provides the example of collaborative relationships among firms from different industries.) Organizations such as Dell can be used as examples of organizations that balance between the need for tight control and creating boundarylessness. Dell has extremely tight controls on its assembling operations and supply chain management. On the other hand, it made its boundaries extremely permeable with its suppliers. Suppliers own the inventory facility on the Dell campus in Austin, Texas. Creating effective partnerships with various stakeholder groups reflects itself in the structure and control at Dell. You can draw attention to the kind of culture, communication, investment in information technologies and human resource practices that are necessary to support a boundaryless organization.

End-of-Chapter Teaching Notes Chapter 10: Creating Effective Organizational Designs Summary Review Questions 1. Why is it important for managers to carefully consider the type of organizational structure that they use to implement their strategies? (In text, Traditional Forms of Organizational Structure, LO 10-1) Response: Organizational structure is the formalized patterns of interactions that link a firm‘s tasks, technologies, and people. Structures ensure that firms use resources effectively to accomplish the organizational mission. Firms also need structure to balance the need to divide tasks into meaningful groups and integrate between them to ensure efficiency and effectiveness. 2. Briefly trace the dominant growth pattern of major corporations from simple structure to functional structure to divisional structure. Discuss the relationship between a firm’s strategy and its structure. (In text, Traditional Forms of Organizational Structure, LO 102) Response: A simple structure is an organizational form in which the owner-manager makes most of the decisions and controls activities, and the staff serves as an extension of the top executive. The entire management is one team. As the corporation becomes more complex, simple structures tend not to be capable of dealing with all the complexity, so the corporation divides problems into manageable chunks by function. Teams form to handle marketing, accounting, operations, and other functional tasks. This new organizational structure with groups reporting to the CEO is called a functional structure. As corporations become more complex, they add on multiple related divisions, each with a functional structure, also called a divisional structure. So the firm could have functional structure divisions for a number of (a) geographical markets, (b) products, and/or (c) projects. For the divisional structure, the divisions are interdependent, and the corporation follows a single, coherent mission. Firms follow a growth strategy as they evolve from a simple structure to a functional structure. From functional structures, they can follow a related diversification strategy to evolve into a divisional structure. Corporations with functional structures that follow a vertical integration strategy maintain their functional structures but with more integration. As these vertically integrated corporations pursue related diversification, they tend to adopt division structures. Corporations with functional structures that follow unrelated diversification strategies tend to develop holding company structures, which have business units that do not follow related 1-359 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

business strategies. As these holding companies develop relatedness in their products and markets, their business unit strategies converge, and the corporations tend to evolve into division structures. 3. What are the relative advantages and disadvantages of the types of organizational structure—simple, functional, divisional, matrix—discussed in the chapter? (In text, Traditional Forms of Organizational Structure, LO 10-2) Response: The simple structure has advantages of:  Being very effective and efficient in the coordination of activities  Having control systems and performance evaluation that are efficient and informal  Implementing decision making that is centralized and clear The disadvantages of the simple structure include:  Possible misunderstandings of tasks and responsibilities, because they are frequently not written, which may lead to conflict and confusion  Employees who may act out of self-interest due to the lack of clarity in boundaries and sanctions. Such actions may erode other employees‘ motivation and waste resources  The small size and flat structure that may limit potential upward mobility of employees, which makes recruitment and retention of managers a possible problem The functional structure has the advantages of:  Centralizing and coordinating activities within each functional area  Decision making that is centralized and clear  A more efficient and effective use of managerial talent  Facilitated career paths within each functional area The disadvantages of the functional structure include:  Difficult coordination due to the functional-specific perspectives in each department that leads to stovepipes or silos within the organization  Short-term thinking based on what is best for the functional area and not the organization as a whole  Top executives distracted by the need to settle conflicts between departments  Difficulties with establishing performance evaluation standards that are consistent across departments The division structure has the advantages of:  Enabling division managers to set strategies that are effective within the division‘s business environment  Less conflict between functional departments  Greater coordination and integration between all divisions and functional areas due to multiple levels of general managers in the organization 1-360 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The disadvantages of the division structure include:  The expense of maintaining large numbers of general managers  Dysfunctional competition between divisions  Consistent manager evaluation that promotes distributive bargaining between divisions and inhibits sharing of resources  Inconsistent corporate image across various products and markets  A tendency to focus on short-term performance. The matrix structure has multiple lines of authority and some individuals report to at least two managers. The advantages of the matrix structure include:  Better use of specialized personnel, equipment, and facilities  Less duplication of functions  Resource sharing enabling collaboration and more effective response to changes in the business environment  Organizational flexibility that gives managers greater range of responsibility, which may help to develop their skills and competencies. The disadvantages of the matrix structure include:  Uncertainty of priorities due to dual-reporting structure  Possible power struggles and conflict over performance evaluations, resources, and personnel  Complicated working relationships, with a possible over reliance on group processes  Diffusion of responsibility and accountability 4. When a firm expands its operations into foreign markets, what are the three most important factors to take into account in deciding what type of structure is most appropriate? What are the types of international structures discussed in the text and what are the relationships between strategy and structure? (In text, Traditional Forms of Organizational Structure, LO 10-3) Response: The three factors to take into account are (1) the type of strategy that is driving the firm‘s foreign operations, (2) product diversity, and (3) the firm‘s dependence on foreign sales. The text discusses the following structures:  International division  Geographic-area division  Worldwide functional  Worldwide product division  Worldwide matrix Multidomestic strategies require firms to respond to unique conditions in each country and are consistent with the international division and geographic area division structures. These structures allow autonomy of local mangers to respond to conditions in the local business 1-361 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

environment. As the firm‘s dependence on foreign sales increases, the preferred structure would likely change from international division to geographic area division. As product diversity increases, along with dependence on foreign sales, the firm will likely benefit from a worldwide matrix structure. Global strategies require firms to coordinate operations across countries and are consistent with the worldwide functional and the worldwide product division structures. Firms with low levels of product diversity tend to benefit from worldwide functional structures, and firms with high product diversity tend to benefit from worldwide matrix structures. 5. Briefly describe the three different types of boundaryless organizations: barrier-free, modular, and virtual. (In text, Boundaryless Organizational Designs, LO 10-4) Response: Boundaryless organizational designs have permeable boundaries, be they vertical, horizontal, external, or geographic. Barrier-free organizations bridge real differences in culture, function, and goals to find common ground that facilitates information sharing and other forms of cooperative behavior. Removing barriers enables firms to share information and engage in other types of cooperative behaviors, thus improving innovation, productivity and enhanced organizational capability. Modular organizations outsource non-vital functions, which benefits from the knowledge and expertise of outside suppliers while retaining strategic control. Virtual organizations are continually evolving networks of independent companies that are linked together to share skills, costs, and access to one another‘s markets. The companies may be suppliers, buyers, or even competitors that mutually benefit from the closeness. 6. What are some of the key attributes of effective groups? Ineffective groups? (In text, Boundaryless Organizational Designs, LO 10-4) Response: Effective groups, or teams, are able to maximize the potential of organizational human capital. Research indicates that effective teams have:    

Common culture and shared values Horizontal organizational structures, which group similar and related business units under common management control Horizontal systems and processes, which break through barriers that often exist between divisions Communications and information technologies, which play an important role in bridging gaps between isolated units



Human resource practices, which upgrade human capital by providing training and skills to handle new information technologies, build effective teams, and interact with individuals with different perspectives.

Ineffective groups may respond to external pressures, resource scarcity, or declining performance by becoming more internally focused. But this response does not take advantage of innovative opportunities for radically improving the organization. 7. What are the advantages and disadvantages of the three types of boundaryless organizations: barrier-free, modular, and virtual? (In text, Boundaryless Organizational Designs, LO 10-4) Response: The advantages of barrier-free organizations include:  Leverages talents of all employees  Bridging differences in culture, function, and goals to find common ground  Facilitates information sharing and other types of cooperative behavior  Enables quicker response to market changes through a single-goal focus  Greater innovation and productivity  Can lead to coordinated win-win initiatives with key suppliers, customers, and alliance partners. The disadvantages of barrier-free organizations include:  Difficult to overcome political and authority boundaries inside and outside the organization  Lack of strong leadership and common vision, leading to coordination problems  Longer time to sort out responsibilities on projects  Lacks high levels of trust, which can impede performance  Frustration of managers trained in traditional hierarchical organizations  Possible lack of top management commitment  Possible high turnover of team members  Insufficiently frequent meetings The advantages of modular organizations include:  Decrease in overall costs (stimulate new product development by incorporating talented personnel from suppliers, avoid idle capacity, reduce inventories, and avoid being locked into a particular technology)  Focus scarce resources on the areas where firms hold competitive advantages (maintains control over most critical activities, more funding for research and development, hiring the best talent, and providing training for sales and service staff)  Tapping into the knowledge and expertise of specialized supply chain partners, which adds critical skills and accelerates organizational learning. Firms benefit from best practice throughout the industry supply chain. 1-363 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The disadvantages of modular organizations include:  Loss of common vision through reliance on outsiders  Loss of critical skills and possible competitive advantage  Developing the wrong skills  Loss of flexibility to respond to market shifts by bringing back into the firm specific activities  Loss of cross-functional skills  Loss of control over suppliers The advantages of virtual organizations include:  Sharing of costs and skills  Access to global markets  Increased market responsiveness  Allows access to best practices and core competences of all members in the organization  Encourages knowledge sharing and accelerates organizational learning The disadvantages of virtual organizations include:  Lack of boundaries between constituent firms, thus making it difficult to determine the terms of exchanges  Potential loss of operations control among partners  Loss of strategic control over emerging technologies  Need to acquire new and difficult-to-acquire management skills. 8. When are ambidextrous organizational designs necessary? What are some of their key attributes? Response: Ambidextrous organizations achieve both alignment, involving short-term coordination of activities and modest incremental innovations, and adaptability, involving long-term proactive actions characterized by dramatic, breakthrough innovations that enable a firm to better exploit opportunities. Most business environments indicate a need for some degree of ambidextrous organization. Too much reliance on adaptability will result in low short-term profitability. Too much reliance on alignment will result in loss of business opportunities. Ambidextrous organizations have established traditional structures that maintain alignment, and breakthrough efforts organized within structurally independent units that were integrated into the existing senior management structure. Effective ambidextrous structures are related to:  A clear and compelling vision that is consistently communicated by senior management  Cross-fertilization among business units without cross-contamination  Tight coordination and integration of management that enabled sharing of resources such as cash, people, and expertise  Reward systems that pertain to overall company goals  Autonomy of the breakthrough effort 1-364 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Experiential Exercises and Application Questions: 1.

Boeing has experienced another product crisis with its 737 Max aircraft. Investigate how Boeing designed this plane, including the internal structure of the firm, the use of external partners, and the degree to which the firm employed a boundaryless design. In what ways might the structure used have played a part in the crisis with the 737 Max?

Response: A number of factors appear to have played into the failure of the 737 Max. The initial decision to develop the 737 Max was a competitive response to Boeing‘s primary rival, Airbus. Airbus had announced a new, fuel efficient airplane the 320neo. Boeing felt the need to respond quickly with a new design that had similar fuel efficiency and set out to develop the plane in record time. There were fairly clear signs of organizational dysfunction in the development and design process for the aircraft:  Disempowered mid-level experts (engineers, designers, software experts) o Top management pushed hard for the plane to go through the development process and gain quick approval from regulators. Concerns raised by middle-level staff were ignored.  Inadequate organizational embodiment of safety oversight o The criteria used to assess the progress of the aircraft through the design process did not place a premium on safety.  Business priorities placing cost savings, timeliness, profits over safety o Market pressures led Boeing to focus on the degree to which the new plane would (a) meet fuel efficiency goals, (b) be quickly approved by the FAA, and (c) not require extensive pilot training, allowing airlines to use the aircraft with existing pilot certifications.  Breakdown of internal management controls leading to faulty manufacturing processes o There was limited communication and coordination between different units in the firm. Faulty design schematics were sent to the shop floor. Incomplete software that had not been fully tested was implemented into flight control systems. In short, the firm seemed to employ an autocratic structure with teams of engineers working in silos on components of the plane. As a result, the firm didn‘t benefit from the communication and ability to raise questions that truly boundaryless organizations are able to benefit from. Students going through the attributes that allow boundaryless organizations to work will find that Boeing failed to employ any of these effectively. 2.

Many firms have recently moved toward a modular structure. For example, they have increasingly outsourced many of their information technology (IT) activities. Identify three such organizations. Using secondary sources, evaluate (1) the firm’s 1-365 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

rationale for IT outsourcing and (2) the implications for performance. Response: You may get students responding with the following pattern. Note that these are just hypothetical cases not similar to any real firm. These examples are merely illustrative. Firm Firm A: outsourced statistical process controls for its manufacturing operations Firm B: outsourced e-marketing

Rationale Reduce costs

Firm C: outsourced its IT operations

Focus on marketing, and outsource other activities

Get better IT quality

Implication(s) for Performance Cost savings, but lower quality, and some problems dealing with international partners Got better IT, but had difficulties managing relationship with partner Improvement in marketing, but loss of IT expertise that had contributed to firm success

Note to instructor: For each example, ask students to identify the activity(ies) that have been outsourced, the firm‘s rationale, and the implications for performance. It is interesting to also challenge the students to identify potential costs of the outsourcing (assuming that the student responded that the implications for performance were positive). How might the outsourcing hurt the firm in the short or medium-term? The purpose of the exercise is to get students to recognize and examine the modular organization strategy. 3.

Select an organization that competes in an industry in which you are particularly interested. Go on the Internet and determine what type of organizational structure this organization has. In your view, is it consistent with the strategy that it has chosen to implement? Why? Why not?

Response: There are two challenges. First, firms do not advertise their strategies. Students will have to look at the evidence and argue for one strategy or another. Use one of the three generic strategies or, for international firms, one of the four international strategies. Second, firms often do not advertise their organizational structure. Finding it may be a challenge. One method is to look at the top management of the firm and examine their titles. If they are, say, VP Marketing, VP operations, and VP Finance, then we have some evidence for a functional structure. Also, not many firms are easy to classify, so this exercise requires a bit of judgment. After determining the strategy and structure, assess the fit. Is there another structure that should go with this strategy? What if the firm adopted another structure? Would performance worsen? Why? Note to instructors: Understanding the need to fit strategy and structure is a central concept that is very important for the students to understand. We suggest that you first ask students to describe the corporate strategy that the organization follows. Then ask students about the organization‘s core competence and how it competes. Does the organization need divisions with autonomy or more centralized decision making? Is the organization small enough for a simple 1-366 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

strategy? Ask about relatedness of divisions, vertical integration, product diversity, and other characteristics that determine organizational structure. The end result is to help students to understand that organizational structure determines what type of competitive advantage the firm can develop. This understanding is often a challenge for inexperienced students. 4.

Choose an article from BusinessWeek, Fortune, Forbes, Fast Company, or any other well-known publication that deals with a corporation that has undergone a significant change in its strategic direction. What are the implications for the structure of this organization?

Response: Note to instructor: To guide classroom discussion, first ask students to identify the original strategic direction and the reason for the change. Then ask students to identify the original organizational structure and the degree of fit with the original strategy. Then ask students how the structure should change, if at all, given the new strategic direction. For each proposed change in structure, ask students to justify the change. Ask students to identify what boundaries, internal or external, need to be made more permeable. A possible extension of this exercise is to have students research firms that have strategies similar to the corporation‘s new strategic direction. Ask them what type of organizational structures these firms have and whether or not the corporation-of-interest should imitate those structures. 5.

Use the Internet to look up some of the public statements or speeches of an executive in a major corporation about a significant initiative such as entering into a joint venture or launching a new product line. What do you feel are the implications for making the internal and external barriers of the firm more flexible and permeable? Does the executive discuss processes, procedures, integrating mechanisms, or cultural issues that should serve this purpose? Or are other issues discussed that enable a firm to become more boundaryless?

Response: Note to instructors: The purpose of this exercise is to get students to identify the trend toward boundaryless organizations. If students do not identify any tendency or methods for boundarylessness, ask the students to identify some boundaries that the corporation should consider making more permeable. It might be useful to review the benefits of boundaryless organizations such as the ability to reduce costs, share resources or more fully exploit managerial talent, and ask students how the corporation might achieve these benefits. 6.

Look up a recent article in the publications listed in question 2 above that addresses 1-367 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

a firm’s involvement in outsourcing (modular organization) or in strategic alliance or network organizations (virtual organization). Was the firm successful or unsuccessful in this endeavor? Why? Why not? Response: Note to instructor: The exercise enables students to analyze a move toward boundaryless organization. All such moves are characterized by potential costs and benefits. The first step is to identify the move, including its form, who the partners are (if any), and what internal and external barriers were bridged. Then ask if the move was a success and why. For discussion, ask students what concerns the CEO should address in order to improve performance in the next five years. Ethics Questions 1. If a firm has a divisional structure and places extreme pressures on its divisional executives to meet short-term profitability goals (e.g., quarterly income), could this raise some ethical considerations? Why? Why not? Response: Any time there are such extreme pressures to meet profitability goals, there is a potential for unethical behavior. In the divisional structure, the divisions are interdependent, which means that the performance of each division depends in part on cooperating with other divisions. Selfinterested managers might try to be unethical by  Bargaining with other divisions for access to his or her division‘s resources  Cutting costs by reducing headcount  Taking credit for the results of another division  Disagreeing with other divisions regarding allocation of resources or executive performance evaluations. These actions are unethical to the extent they are done in the self-interest of managers at the expense of the firm‘s performance. The actions are a violation of the manager‘s obligation to the firm‘s owners of maximizing firm value. 2. If a firm enters into a strategic alliance but does not exercise appropriate behavioral control of its employees (in terms of culture, rewards and incentives, and boundaries—as discussed in Chapter 9) that are involved in the alliance, what ethical issues could arise? What could be the potential long-term and short-term downside for the firm? Response: Without effective behavioral control, employees will tend not to have (a) shared values, (b) a commitment to organizational success, (c) a clear understanding of the organizational mission, and (d) an understanding of investments and activities that the organization will avoid. For the alliance, employees will therefore tend to work at cross purposes. They will not be consistent in 1-368 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

their understanding of the purpose of the alliance, which could lead to destructive conflicts over responsibilities, resources, and alliance strategy. The problem is compounded by the presence of the alliance partner. There is a possibility of inappropriate sharing of information and resources with the partner, which could erode the firm‘s competitive advantage. Without effective behavior control, employee self-interest is a common problem. In addition to the direct costs of employee misbehavior, additional problems occur because the alliance partner will observe the behavior. The firm‘s reputation in the industry could be affected, and the alliance partner could surreptitiously get access to the firm‘s intellectual property. Therefore, the downsides include costs to the firm from internal conflict and wasted effort, the loss of reputation, and the loss of trade secrets and know-how to the partner.

CONNECT RESOURCES Comprehension Case ArcelorMittal Case Analysis ArcelorMittal Aarong Dairy Organizational Design at Accenture

Chapter 11 Strategic Leadership: Creating a Learning Organization and an Ethical Organization 11-2 Leadership: Three Interdependent Activities .......................... 11-4 Setting a Direction ..................................................................................... 11-5 Designing the Organization ...................................................................... 11-6 Nurturing a Culture Committed to Excellence and Ethical Behavior . 11-7

Getting Things Done: Overcoming Barriers and Using Power 11-8 Overcoming Barriers to Change .............................................................. 11-8 Using Power Effectively ............................................................................ 11-9

Emotional Intelligence: A Key Leadership Trait .................... 11-10 Emotional Intelligence: Some Potential Drawbacks and Cautionary Notes ..................................................................................................................... 11-12 1-369 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Creating a Learning Organization ............................................ 11-12 Inspiring and Motivating People with a Mission or Purpose ............... 11-13 Empowering Employees at All Levels ..................................................... 11-13 Accumulating and Sharing Internal Knowledge.................................... 11-14 Gathering and Integrating External Information.................................. 11-15 Challenging the Status Quo and Enabling Creativity ........................... 11-16

Creating an Ethical Organization ............................................. 11-17 Individual Ethics versus Organizational Ethics ..................................... 11-18 Integrity-Based versus Compliance-Based Approaches to Organizational Ethics .......................................................................................................... 11-19 Role Models ................................................................................................ 11-20 Corporate Credos and Codes of Conduct ............................................... 11-20 Reward and Evaluation Systems ............................................................. 11-20 Policies and Procedures ............................................................................ 11-21

Issue for Debate ........................................................................... 11-21 Reflecting on Career Implications ............................................ 11-22 Summary ...................................................................................... 11-24 End-of-Chapter Teaching Notes................................................ 11-26 Connect Resources ...................................................................... 11-33 1-370 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Chapter 11

Strategic Leadership: Creating a Learning Organization and an Ethical Organization Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead Strong and effective leadership is a key organizational success factor. Strategic leadership is needed to successfully formulate and implement strategies. In today‘s economy, leaders have two additional roles as well—to create learning organizations and to create an ethical climate. This chapter is organized into four sections. 1.

The first section describes three key leadership activities—setting a direction, designing the organization, and nurturing a culture of excellence and ethical practices.

The second section addresses two practices and capabilities that enable executives to be more effective leaders—overcoming barriers to change, and the effective use of power.

The third section addresses the critical role of emotional intelligence (EI) in effective strategic leadership. EI refers to an individual‘s capacity for recognizing one‘s emotions and those of others. We also address some potential drawbacks of EI.

The fourth section addresses the importance of leader‘s developing competency companions and their role in creating a learning organization. Emphasize the importance of motivating and harnessing individual and collective talents by accumulating and sharing information and empowering and motivating employees at all levels to use new knowledge.

The final section discusses the challenge to leaders to inspire and maintain an ethical organization. Point out the positive benefits of good ethical leadership and the disadvantages for companies that face ethical crises. Four topics are addressed—role models; corporate credos and codes of conduct; rewards and evaluation systems; and, policies and procedures.

Lecture/Discussion Outline In LEARNING FROM MISTAKES, we open the chapter with the example of Carlos Ghosn, the former CEO of Renault, Nissan, and Mitsubishi, who was toppled from his leadership position after being accused of personal financial misconduct. Discussion Question 1: What lessons can members of a board of directors take away from the Carlos Ghosn saga? What actions can boards take to limit the chance they will face a similar scandal? The allegations in this case point to weak oversight by the board, evidenced by actions the board took as a whole and the actions of a single board member. The board approved the use of company funds to pay for personal home expenses. Thus, the board, as a whole, appeared to be willing to benefit Mr. Ghosn at the expense of other stakeholders of the firm. Additionally, the whistleblower alleged that Mr. Ghosn conspired with one board member, Greg Kelly, to personally enrich himself. This suggests that the board had lax controls and gave an individual board member significant autonomy with limited oversight. As discussed in Chapter 9, a board of directors is tasked with monitoring management and representing the interests of shareholders. As part of this, they should ensure that the CEO and the larger management team are leading morally and working to create an ethical organization. In this case, they clearly failed to do so. While Nissan was successful in improving its financial performance and market position, it appears to have come at the expense of appropriate moral and ethical behavior. Students can discuss where Nissan missed the mark and how the board can act to ensure that the firm moves appropriately in this direction. To do so, the board can institute committees that review key principles here, such as an auditing committee that reviews the financial actions of the firm, a strategy committee that reviews the firm‘s mission and strategy to ensure it includes both financial and ethical components, and a compensation committee that ensures that the CEO‘s compensation supports the attainment of the organization‘s goals. Students can also look to the discussion of integrity-based and compliance-based approaches to ethics and discuss how the board should use each of these approaches. Discussion Question 2: What sort of punishment does Carlos Ghosn deserve for his actions? This could trigger a range of reactions from students. As noted in the write-up, the strong reaction to Mr. Ghosn‘s actions is partly cultural. His business actions were seen as being too aggressive and a violation of the cultural norms of Japan, and his pay level was significantly higher than CEOs of other Japanese corporations. This appears to have made him more vulnerable to criticism than other CEOs may have been. As a follow up, some students may know that Mr. Ghosn escaped house arrest and flew out of Japan to Lebanon, a country that does not have an extradition treaty with Lebanon. As of 1-373 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

early 2020, it did not appear that he would face any legal penalties. This could lead to a discussion of whether it was appropriate for him to leave Japan. This chapter provides insights into how organizations can more effectively manage change and cope with increased environmental complexity and uncertainty. First, it defines leadership and introduces three important leadership activities. Second, it discusses three elements of effective leadership—integrative thinking, overcoming barriers to change, and the effective use of power. Third, it discusses the important role of emotional intelligence (EI) in effective strategic leadership. Fourth, it emphasizes the leader‘s role in learning and adapting in the face of accelerating change. Fifth, it addresses the leader‘s role in building an ethical organization.

Leadership: Three Interdependent Activities

PowerPoint Slide 4: Strategic Leadership PowerPoint Slide 5: Strategic Leadership Definition PowerPoint Slide 6: Strategic Leadership Model PowerPoint Slide 8: Strategic Leadership: Setting a Direction PowerPoint Slide 9: Strategic Leadership: Designing the Organization PowerPoint Slide 10: Nurturing a Culture In this section, a definition of leadership is presented. Leadership is not custodial management. Rather, it is proactive, goal-oriented, and focused on the creation and implementation of a creative vision. Defined succinctly: Leadership is the process of transforming organizations from what they are to what the leader would have them become. Point out that this definition implies a dissatisfaction with the status quo, a vision of what should be, and a process for bringing about change. Leaders must be concerned with both ―doing the right thing‖ and ―doing things right.‖ Discussion Question 3: What are some examples of leaders who have had a transformative effect on their company? What made their activities transformative? Discussion Question 4: What challenges do leaders face when trying to balance the task of simultaneously doing the right things and doing things right? Leaders recognize three interdependent activities that must be continually reassessed for organizations to succeed: 1. 2. 3.

Determining a direction Designing the organization Nurturing a culture dedicated to excellence and ethical behavior

The SUPPLEMENT below offers discusses how Ed Catmull, cofounder of Pixar, effectively led the Pixar-Disney animation studios. Extra Example: Keeping the Magic Alive at Pixar-Disney

Ed Catmull helped start Pixar and led the combined Pixar and Disney Animation Studios for 12 years. He has clear thoughts on how to provide strong leadership. First, leadership requires listening and learning before taking action. When Disney purchased Pixar, he was put in charge of the combined studios. Rather than quickly realigning the two studios or taking bold action to fix the struggling Disney Studio, he listened. He and John Lassiter, the chief creative officer of Pixar and Disney, started by ―talking with people, doing some coaching, and so forth. But we drew no conclusions for two months, about people or anything else. We just watched.‖ The key for him was to truly understand Disney and the strengths of the combined studios. Then, he could set directions and redesign the combined businesses. Second, remember that employees and stakeholders are always trying to understand and assess the firm leaders. As Catmull stated, ―When you come in and you‘re the new boss, everybody‘s rather nervous. They‘re trying to figure you out, too.‖ As a result, he tried to reassure everyone at Disney that he trusted that they were trying their best, and his goal was to help them be better. It was then important for him to work with them and help them improve. Only after repeated failures would he decide a change was needed. Third, working in a dynamic market, he sees the need to set some direction but also allow for uncertainty. This involves understanding the limitations of how far he can see ahead. ―Change is coming, and the impact isn‘t clear,‖ Catmull asserts. ―If you pay attention, you can get it right about two to four years out. After that, we are doing a lot of guessing.‖ It also suggests the need for direction and order is not absolute. He states, ―you are always in this balance between clear leadership and chaos… Rather than thinking, ‗OK, my job is to prevent or avoid all the messes.‘ I just try to say, ‗well, let‘s make sure it doesn‘t get too messy.‘‖ Finally, leading a firm in a dynamic market means setting a direction that allows for creativity and failures. One of the reasons Pixar creates short films that it shows before its main feature movie is to allow for experimentation and creativity. The firm also regularly works on experimental films that aren‘t aimed for theatrical release to allow the creative staff to try riskier ideas. In short, Catmull believes that being a good leader doesn‘t mean exercising great authority. Instead, it involves a degree of visioning the future, setting direction as far as what the firm‘s identity and values are, figuring out what the firm‘s strengths are, coaching up people to perform, and creating conditions for experimentation. Source: Webb, A. & Hao, H. 2016. Staying one step ahead at Pixar: An Interview with Ed Catmull. mckinsey.com. March: np.

Setting a Direction

The leader is closely involved with the vision, mission, and goals of the organization. To establish a direction, the leader must have a holistic perspective that takes into account all of the organizational stakeholders, as well as the salient environmental conditions and trends. A vision is important because it provides a framework for problem solving and developing strategic options. A vision is also important in communicating a clear future direction and enhancing employee participation and commitment.

Discussion Question 5: How have leaders you have worked for helped set the direction of the organization? Discussion Question 6: What are some examples of leaders who have used direction setting to lead and/or transform their organizations? The SUPPLEMENT below points out that leaders can signal the purpose of the firm through their own actions. Extra Example: Broad Air‘s CEO Signals the Firm‘s Purpose with a Warm Office Broad Air, a Chinese manufacturer of central air conditioning systems, has a broader purpose than simply generating economic value. Broad Air‘s CEO, Zhang Yue, talks boldly of the firm‘s concern for larger environmental issues. Mr. Yue stated, ―I have completely shifted the focus of this business towards the direction of reducing emissions. I‘ve taken on the challenge of climate change.‖ These values are evident in the firm‘s product line, which centers on absorption chillers, a more efficient technology for air conditioning than conventional air conditioners. The firm has also developed systems that use natural gas and waste heat for power, avoiding electric systems that might rely on coal-fired electric plants for power. Broad‘s air conditioners cost more up front but are cheaper to run over the long run because they are use half the energy of a conventional air conditioner. The firm is active in developing energy efficient building designs even though their implementation reduces the demand for Broad‘s air conditioners. With the firm‘s commitment to sustainability and energy efficiency, it was one of ten companies awarded a BusinessWeek Greener China Business Award in 2009. But Mr. Yue also walks the talk. For example, he doesn‘t find it at all ironic that the CEO of an air conditioning firm keeps his office thermostat set to a balmy 81 degrees in the summer. Doing so signals to the rest of the firm that everyone has a part in saving energy and green initiatives. Sources: Winston, A. 2014. The Big Pivot. Harvard Business Review Press. Boston, MA: 201; theclimategroup.com.

Discussion Question 7: Do Mr. Yue’s values help or hinder the strategic success of Broad Air? STRATEGY SPOTLIGHT 11.1 discusses how CEOs and other top leaders in organizations can create an inclusive culture to build truly great work environments in which all employees can thrive. Discussion Question 8: What are some additional steps you think company leadership should take to create an inclusive workplace culture? B.

Designing the Organization

Leaders must be actively involved in shaping the organization by building structures, teams, systems, and organizational processes that facilitate implementation of their strategic vision. Failure to provide leadership in shaping and maintaining organizational design can result in numerous problems, including:

1. 2. 3. 4.

Inadequate understanding of responsibility and accountability among managers and employees Reward systems that fail to motivate individuals toward common objectives Poor or inappropriate budgeting and control systems Inappropriate or insufficient mechanisms to integrate and coordinate activities across the firm

Discussion Question 9: Have you ever worked for an organization with accountability and control problems such as these? What was the leader’s role in causing the problems? What could the leader have done to prevent the problems? The SUPPLEMENT below discusses Lou Gestner‘s insights on the importance of rewards and incentives in designing an effective organization. Extra Example: Lou Gerstner on the Mismatch between Values and Incentives Lou Gerstner, former CEO of IBM, thinks values are an important element of designing an effective organization, but he argues that firms need to build incentives to support those values. Gerstner‘s view: ―I think values are really, really important, but I also think too many values are just words… When you go inside those companies, you often see the words don‘t translate into practices. When I first arrived at IBM, one of my first questions was ‗Do we have teamwork?,‘ because the new strategy crucially depended on our ability to provide an integrated approach to our customers. ‗Oh yes, Lou, we have teamwork,‘ I was told… I responded. ‗How do we pay people?‘ ‗Oh, we pay on individual performance.‘ The rewards system is a powerful driver of behavior and therefore culture. Teamwork is hard to cultivate in a world where employees are paid solely on their individual performance.‖ ―If the practices and processes inside a company don‘t drive the execution of values, the people don‘t get it.‖ Sources: Davis, I. 2014. Lou Gerstner on Corporate Reinvention and Values. mckinsey.com. September: np.

Nurturing a Culture Committed to Excellence and Ethical Behavior

Leaders play a key role in developing and sustaining—as well as changing, when necessary—an organization‘s culture. We discuss how the cofounder of Airbnb worked to reinforce the culture of the firm as it grew. The SUPPLEMENT below discusses the danger of not building an ethical culture. Extra Example: SoFi Stumbles Due to a Poor Culture For a while, SoFi, a financial services company focusing on student loans and other personal finance products, seemed to be flying high. Founded in 2011, the firm had grown to over 12 billion dollars in funded loans by the end of 2016 and had also attracted over $2 billion in investors‘ money. But while it was still growing, the firm faced challenges internally. Its hard-driving, competitive culture appears to have driven the firm to quick success, but it also led to the skirting of risk and compliance controls, the emergence of harsh work conditions, and biased treatment toward female employees. As it grew rapidly, the firm gave customer service employees the authority to approve loans even though they had no training in loan evaluation. As for work 1-377 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

conditions, the firm‘s CEO, Michael Cagney, reportedly told employees that if they ―weren‘t waking up twice a week in a cold sweat, they weren‘t working hard enough.‖ Employees felt if they didn‘t work late night hours and on holidays, they would be fired. There were also complaints of mistreatment of female employees. The company‘s finance chief resigned from the firm in the wake of claims of improper treatment of women. A former employee in a wrongful termination lawsuit, claimed that Mr. Cagney built a ―male bravado‖ culture in the firm that facilitated sexual harassment. As the pressure built, Mr. Cagney announced that he would step down as CEO. SoFi saw great success growing its business, but their culture was not functional or ethical and needs to change if the firm is going to mature into a successful market leader. Source: Rudegeair, P. 2017. SoFi staff criticize startup‘s culture. Wall Street Journal, September 11: B1, B2.

Discussion Question 10: A number of technology companies, including SoFi, have been criticized for having a “bro culture.” Why is this a problem? What is the solution? At times, executives must make difficult decisions in order to strengthen the culture of the organization. The example below shows a courageous action taken by a leader—firing a large client of the firm. Extra Example: The Founder Takes a Strong Action: Firing a Huge Client! Fearful that his creative talent would bolt because the main contact for a huge client was abusive, Kim McConnell, founder of agricultural marketing communications firm AdFarm made a courageous decision—he fired the client! Morale improved immediately. ―Very quickly the revenue from this very sizable account was made up,‖ he says. ―I guess it put pressure on our people to go and find the revenue we lost from this client.‖ Source: Harnish, V. 2010. Stop doing these five business killers now. Fortune. December 6: 71.

Discussion Question 11: Do you know of any other courageous decisions that a leader has taken to strengthen (or maintain) his/her firm’s culture? Managers and top executives are responsible for strengthening and modeling ethical behavior throughout an organization as well. To do so, they must consistently demonstrate that ethical values are central to the organizational vision and mission. STRATEGY SPOTLIGHT 11.2 discusses how Fisk Johnson sustains the culture at his family‘s firm, SC Johnson.

II.

Getting Things Done: Overcoming Barriers and Using Power

PowerPoint Slide 11: Strategic Leadership: Overcoming Barriers to Change PowerPoint Slide 12: Strategic Leadership: Effective Use of Power PowerPoint Slide 13: Strategic Leadership: A Leader’s Bases of Power Leaders must perform a variety of tasks, and the success of their organizations often depends on how well they meet challenges and deliver on promises. In this section, we focus on two capabilities that are marks of successful leadership—overcoming barriers to change and the effective use of power. 1-378 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Overcoming Barriers to Change

Effective leaders must recognize that to bring about meaningful change in their organizations, they must overcome barriers (or resistance) to change. There are several types of resistance to change. Among these are:      B.

Many people having ―vested interests in the status quo‖ ―Systemic‖ barriers (such as a bureaucratic structure involving many rules and regulations) ―Behavioral‖ barriers (which is the tendency of managers to look at issues strictly from their biased perspective—based on education, work background, etc.) ―Political‖ barriers (which refer to conflicts arising from power relationships and selfinterest) ―Personal time constraints‖ (which simply means that managers may be so absorbed with operating details and responsibilities that they have little time to see ―the big picture‖) Using Power Effectively

Leaders derive their power from many bases. There are two primary types of power: organizational (which includes legitimate, reward, coercive, and information power) and personal (which includes referent and expert power). These sources of power are illustrated in EXHIBIT 11.2. Effective leaders use the different bases of power as the need arises. They often use a combination of them, depending on such factors as the nature of the task, the personality characteristics of the subordinates, the urgency of the issue, and other factors. STRATEGY SPOTLIGHT 11.3 addresses how humble leaders may be able to overcome resistance to change in organizations. The following SUPPLEMENT is part of an HBR interview given by Sheryl Sandberg, COO of Facebook, who wrote Lean In, a book for women aspiring to leadership positions. It should spur some spirited discussion. Extra Example: Sandberg‘s View on Women and the Use of Power Question: Some have criticized you for essentially blaming women for not being “better,” even though many of the challenges they confront are institutional. How do you respond? Sandberg’s Response: Women face huge institutional barriers. But we also face barriers that exist within ourselves, sometimes as the result of our socialization. For most of my professional life, no one ever talked to me about the ways I held myself back. I‘m trying to add to that side of the debate. There‘s a great quote from Alice Walker; ―the most common way people give up their power is by thinking they don‘t have any.‖ I am not blaming women: I‘m helping them see the power they‘ve got and encouraging them to use it. One important way, as I write in the book is that they ―leave before they leave.‖ That is, they take themselves out of the running for career advancement because they want to have a family. But in some cases, they‘re making these decisions years in advance—before they even have a partner. That should be a time when they lean in, not pull back. 1-379 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Source: Ignatius, A. 2013. Now is our time. Harvard Business Review. 91(4): 84–88.

Discussion Question 12: Do you agree? What other strategies and tactics should women use to have more successful careers? Teaching Tip: The issue of power is very interesting to students. It would be interesting to ask them to think of leaders that they have known (or read about) and what type of power they exercised. Then ask if they were effective or ineffective—and what explained their success (or lack thereof). You could also integrate this with the previous topic and ask whether or not these leaders were able to bring about significant change and if their success (or failure) could be attributed to the application of power (or if there were other factors). The following SUPPLEMENT describes a large experiment conducted by LinkedIn, which provides strong causal evidence that ―weak ties‖ provide better and more valuable information to working professionals (which is an important source of power in organizations). Extra Example: The Power of Weak Ties LinkedIn, the prominent professional network, is well known for allowing its members to stay in touch with professional contacts. What is less known is that LinkedIn also runs massive experiments on its user base that offer interesting insights into effective professional networking. As a case in point, LinkedIn ran an experiment on more than 20 million users from 2015 to 2019. In this experiment, the connections shown by LinkedIn‘s ―People You May Know‖ algorithm (the company‘s recommendation system for new connections) were randomly changed. Sometimes users saw people to which they have many ties through current connections (called strong ties) while other times users saw people to which they have few connections (called weak ties). Researchers have now analyzed this experimental dataset and published an academic article in the prestigious journal Science. What they found was interesting indeed. The researchers set out to test a social science theory according to which people are more likely to gain employment and other opportunities through more distant acquaintances (―weak ties‖) than through close friends (―strong ties‖). The experiment revealed that relatively weak ties on LinkedIn proved twice as effective in securing new employment as stronger ties. These results show that weak ties are incredibly advantageous for people‘s career success. Weak ties provide more new information and contacts than strong ties and therefore offer better opportunities. The fact that weak ties are so useful suggests that working professionals should spend more time building relationships with people to which they currently have few ties. In practice, professionals may network with individuals from other industries, geographies, associations, and companies, rather than with people they already know or who have a lot in common with them. Source: Singer, N. 2022. LinkedIn ran social experiments on 20 million users over five years. New York Times. September 24: np; Rajkumar, K., Saint-Jacques, G., Bojinov, I., Brynjolfsson, E., & Aral, S. 2022. A causal test of the strength of weak ties. Science, 377(6612): 1304–1310.

III.

Emotional Intelligence: A Key Leadership Trait

PowerPoint Slide 14: Strategic Leadership: Emotional Intelligence PowerPoint Slide 15: Strategic Leadership: Emotional Intelligence at Work PowerPoint Slide 16: Strategic Leadership: Emotional Intelligence, Pros and Cons 1-380 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

In the previous section, we focused on ―what leaders do and how they do it.‖ In this section, we address ―who leaders are.‖ That is, we focus on individual attributes instead of leader behavior. It is important to point out that these two issues are highly related because successful leaders possess valuable traits that enable them to engage effectively in activities to create value for their organization. Although there have been countless studies of leader traits (e.g., integrity, maturity, energy, intelligence), we address one that has really garnered a lot of attention in both the academic and business presses: Emotional Intelligence (EI). This concept has been popularized by Daniel Goleman, who has published best-selling books. Goleman defines EI as the capacity for recognizing one‘s own emotions and those of others. Recent studies have found that effective leaders have a high level of EI and that EI is a better predictor of life and career success than IQ (intelligence quotient). The five components of EI are: A. B. C. D. E.

Self-Awareness Self-Regulation Motivation Empathy Social Skill

These five components are briefly summarized in EXHIBIT 11.3. Teaching Tip: To drive home the importance of EI, it is useful to write on the board three types of “traits” or “resources” that all managers have to varying degrees. These could be called “human capital” (i.e., skills, technical competencies, etc.), “social capital” (i.e., positive relationships with others), and “political capital” (i.e., an awareness of where power, influence, or resources are located in an organization and rather highlevel access to such resources). Then ask students if successful managers need an equal amount of these three types of resources. Many students may contend (correctly) that the “balance” may depend on the type of position in an organization (e.g., people higher in the organization need more social and political capital than human capital). It may be interesting to point out that most of their coursework focuses on developing human capital, but the other two types of capital are also very important for career success. And, you may ask them how social and political capital can be enhanced and developed. The SUPPLEMENT below discusses five common empathy mistakes leaders should avoid. Extra Example: Avoiding Empathy Mistakes Responding empathetically to subordinates and peers can help you connect with others and become an effective leader. However, in an effort to be empathetic, we often quickly ―put ourselves in other‘s shoes‖, and this can cause problems. Being eager to help, we can misunderstand what a colleague is going through and offer solutions or an outlook that doesn‘t resonate with the colleague. 1-381 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Here are five mistakes to avoid when trying to be empathetic: 1. Telling others how they feel. The situation someone is in may be similar to experiences we‘ve had, but each experience is unique. Thus, saying ―I know how you feel‖ can come across as presumptuous and condescending. Instead, reflect back the feelings of the colleague with phrases such as ―I can see this has made you really upset‖ or ―Wow, that must be incredibly hard for you.‖ 2. Hijacking the story. While you may see sharing similar experiences as connecting you with the colleague, don‘t take over your colleague‘s narrative with your own. Rather than going over similar experiences at length, mention a similar experience in passing and turn it back to what your colleague needs. For example, if a colleague raises concerns about a challenging colleague they have had on their team, say something like ―I can see how that would be stressful. I‘ve had challenging team members before. How can I help you in this situation?‖ 3. Suggesting a positive spin. If a colleague shares disappointment at not getting a promotion, don‘t try to prop the colleague up by saying, ―Well, at least you have a job you like.‖ This invalidates your colleague‘s feelings. Simply acknowledge your colleague‘s disappointment and watch for cues about where to take the conversation. 4. Overdoing it. Avoid overwhelming your colleague with words or actions. Allow your colleague to set the pace of the conversation and what outcomes would be helpful. Sometimes, people just want your presence and feel heard. They aren‘t necessarily looking for a solution. When offering advice, keep it simple and limited but offer to talk more if the colleague desires. 5. Taking on others’ experiences as your own. Being with someone who is struggling with something similar to our experiences can trigger strong emotions and lead us into a dark mood. Be aware if you are feeling this way and take a break from the conversation and get yourself rebalanced before returning and supporting your colleague. Source: Nawaz, S. 2017. 5 common empathy mistakes CEOs make, and how to avoid them. forbes.com, October 23: np.

Discussion Question 13: Think of experiences you’ve had where you’ve tried to show empathy. What actions worked well, and what actions seemed to make it worse? A.

Emotional Intelligence: Some Potential Drawbacks and Cautionary Notes

This section serves to provide some balance to our discussion of emotional intelligence. We suggest that too much EI can lead to inappropriate behaviors that erode a leader‘s ability to excel. We first suggest that a leader could be ineffective if he/she focuses too much on one aspect of EI. For example, too much self-awareness and a lack of empathy may make a person come across as self-obsessed, and too much empathy may cause a leader to become too ―hard to read.‖ We also suggest some potential drawbacks of EI by discussing the ―flipside‖ of the benefits of its essential components: 1. 2. 3.

Effective Leaders Have Empathy for Others (Leaders may confuse empathy with sympathy and fail to make ―hard decisions.‖) Effective Leaders Are Astute Judges of People (Leaders may rely too much on their judgment and dismiss others‘ insights.) Effective Leaders Are Passionate about What They Do, and They Show It

(Passion may prevent leaders from other possibilities and ignore realities that others see.) Effective Leaders Create Personal Connections with Their People (If there are too many unannounced visits, it may lead to fear and micromanagement.)

IV.

Creating a Learning Organization

PowerPoint Slide 18: Strategic Leadership: A Learning Organization PowerPoint Slide 19: Key Elements of a Learning Organization PowerPoint Slide 20: Successful Learning Organizations Motivate People PowerPoint Slide 21: Successful Learning Organizations Empower Employees PowerPoint Slide 22: Successful Learning Organizations Share Internal Knowledge PowerPoint Slide 23: Successful Learning Organizations Gather External Knowledge PowerPoint Slide 24: Successful Learning Organizations Challenge the Status Quo Leading-edge organizations recognize the importance of having everyone in the company involved in the process of learning and adapting. The days when company leaders learned for the organization are gone. Today, leaders must stimulate and harness the collective genius of all organization members. Learning and change typically involve an ongoing questioning of an organization‘s status quo. Point out that this is simple, but easy to ignore. Most companies get caught up in carrying out day-to-day activities and rarely stop to think about themselves and their business. To enhance learning, leaders must ask probing questions that question basic assumptions, strategies, and processes. Successful learning organizations create a proactive, creative approach to the unknown, actively solicit the involvement of employees at all levels, and enable everyone to use their intelligence and apply their imagination. A learning organization also requires an organizationwide commitment to change, an action orientation, and the tools and methods needed to create change. Another key role for leaders is to link learning to the organizational vision, mission, and goals. Emphasize that inspiring and motivating people with a mission or purpose is a necessary but not a sufficient condition for developing a learning organization. Four other critical learning processes are discussed next. EXHIBIT 11.4 lists all five elements of a learning organization.

Inspiring and Motivating People with a Mission or Purpose

A critical requirement of all learning organizations is that everyone feels and supports a compelling purpose. We mention that a major finding of a study was that most leaders‘ greatest challenge was to effectively communicate an image of the future that draws others in and speaks to what others see and feel. (We provide the example of Medtronic, a medical products company.) B.

Empowering Employees at All Levels

Empowerment involves creating an environment where employees can achieve their own potential as they help move the organization toward its goals. To achieve this balance, leaders must be flexible resources within the organization who are willing to assume numerous support roles. The SUPPLEMENT below addresses the promise and limitations of empowerment from the perspective of learning scholar Chris Argyris. Argyris argues that empowerment requires a delicate balance that is often hard to achieve. Extra Example: Guidelines for Effectively Empowering Organizations and Employees Chris Argyris, who has been writing about learning and leadership for over 30 years, has some sobering thoughts and useful advice about how to make empowerment programs work. He suggests that effective empowerment is difficult to achieve because it‘s complex. ―The change programs and practice we employ are full of inner contradictions that cripple innovation, motivation, and drive. At the same time, CEOs subtly undermine empowerment. Managers love empowerment in theory, but the command-and-control model is what they trust and know best. For their part, employees are often ambivalent about empowerment—it is great as long as they are not held personally accountable. Even the change professionals often stifle empowerment. Thus, despite all the best efforts that have gone into fostering empowerment, it remains very much like the emperor‘s new clothes: we praise it loudly in public and ask ourselves privately why we can‘t see it.‖ To create empowerment programs that work, Argyris suggest a few guidelines: 1.

Understand that empowerment has its limits. Know how much can be created and what can be accomplished. Once it has been created, do not misuse it. Be clear about who has the right to change things.

When implementing empowerment initiatives, calculate factors such as morale, satisfaction, and even commitment into your human relations policies, but do not make them the ultimate criteria. The ultimate goal is performance. Individuals can be excellent performers and report low morale, yet it is performance and not morale that is paramount.

Help employees understand the choices they make about their own level of commitment. One of the most helpful things we can do in organizations—indeed, in life—is to require that human beings not knowingly kid themselves about their effectiveness. Source: Argyris, C. 1998. Empowerment: The emperor‘s new clothes. Harvard Business Review, 76(3): 98–105.

Discussion Question 14: What are some examples of companies that have implemented empowerment programs? Have these programs been effective? Discussion Question 15: What do you think of empowering lower level employees? Is it likely to benefit the company? Why or why not? Are there potential dangers to the company? What are they? Explain. C.

Accumulating and Sharing Internal Knowledge

Employees need to understand the overall business in order to make a strong contribution. Emphasize that effective organizations share information and give workers the skills to act on that information. Along with redistributing information and giving employees the knowledge to use it, the reward systems must also encourage this behavior.

The SUPPLEMENT below provides two other examples of a firm‘s effective use of sharing internal information—Alaska Airlines and Zingerman‘s. Extra Example: The Benefits of Sharing Internal Information People can contribute more effectively when they understand how their efforts fit with the organization‘s mission and strategy. Consider two examples: 

Alaska Airlines has invested management time in helping employees gain a broad view of the firm‘s strategy. The 2010 Plan was launched with traditional communications but also with a months-long road show and training classes designed to help employees share ideas. The CEO, the president, and the COO still go on the road quarterly to gather information about the idiosyncrasies of various markets. Then they disseminate what they‘ve learned. The benefits show up in annual measures of employee pride in the company—now at an exceptional 90 percent.



At Zingerman‘s, a community of food-related businesses, information is as transparent as possible. The firm has never consciously withheld its numbers—financial information was tacked up for employees to see. However, when cofounders Ari Weinzweig and Paul Saginaw studied open book management in the mid-1990s, they came to believe that employees would show greater interest if they got involved in the ―game.‖

Source: Spreitzer, G. & Porath, C. 2012. Creating sustainable performance. Harvard Business Review, 91 (1/2): 92– 99.

We also point out the importance of listening skills (which involves more than not talking until the other person stops!). Discussion Question 16: What do you see as some of the benefits of practicing effective listening skills? (e.g., obtaining valuable information, developing rapport and respect, enhancing your “personal” bases of power) Informal information also needs to be shared for effective management. Point out that executives who are regarded as good listeners are more likely to make good decisions and get promoted. D.

Gathering and Integrating External Information

Recognizing opportunities and threats is vital to a firm‘s success. We present three methods that companies are using to do so in today‘s economy: 1.

Employees at all levels can use a variety of sources of information on competitors and the firm‘s market. Firms can learn by tapping into knowledge from alliance partners, suppliers, competitors, and the scientific community. Membership in trade and professional organizations provides important information via networking. Social network sites, such as LinkedIn, can also provide information on new employees at competitors and access to contacts to learn about changes in the external environment. Firms can also monitor the communications of competitors, such as in press releases, executive press conferences and earnings‘ calls, to learn about competitors‘ actions.

Benchmarking is a technique for using external information to make comparisons to best practices in an industry. Two types are highlighted: competitive benchmarking is limited to the best practices of competitors; functional benchmarking is used to assess similar functions regardless of industry.

Obtain information directly from customers.

Discussion Question 17: What are some other methods companies might use to gather and integrate useful information? Discussion Question 18: What are some examples of companies that are using information gathering to improve their performance? E.

Challenging the Status Quo and Enabling Creativity

Leaders can use several means to overcome the inertia of the status quo. In general, efforts to create a learning organization help establish an environment that is receptive to change. Another solution is to encourage and enable creativity to keep organization members open to new ideas. Generating a sense of urgency by painting a picture of what will happen if the company does not change is another way to make employees receptive to change and motivate them to practice information sharing and trust. Fostering a ―culture of dissent‖ is another way to challenge the status quo. Norms are established whereby dissenters can openly question authority without fear of retaliation. Companies such as Microsoft and Motorola are presented as examples of companies that encourage dissent. Related to a culture of dissent is a culture of risk taking in which failure is not punished. Point out that companies that don‘t make mistakes aren‘t taking risks and risk taking is needed to push ahead. Companies that cultivate cultures of experimentation and curiosity make sure that failure is not ―a four-letter word.‖ People who push the envelope and stretch their creative wings are protected. Discussion Question 19: Are there potential disadvantages to fostering a climate of change and experimentation? What are they? What makes them problematic? Discussion Question 20: What are some examples of companies that encourage risk taking and “dissent” in order to stimulate creativity, productivity, and growth? We also provide examples of how several firms encourage risk taking and celebrate failures.

Discussion Question 21: Do organizations you are familiar with effectively encourage risk taking and tolerate failure? If so, how? In the following SUPPLEMENT, we discuss the potential perils of hiring people who ―fit‖ your firm. Extra Example: The Perils of Hiring Employees Based on Fit? Corporations often work to hire people they think will be a good ―cultural fit‖ for the firm. The desire is to build an employee base that will work more effectively and efficiently and also increase the firm‘s ability to retain employees. But this drive can come with some significant costs—demographic similarity and reduced creativity. Patty McCord, former Chief Talent Officer at Netflix framed it this way, ―What most people mean by cultural fit is hiring people they‘d like to have a beer with. You end up with this big homogeneous culture where everybody looks alike, everybody thinks alike, and everybody likes drinking beer at 3 o‘clock in the afternoon with the bros.‖ Firms need to think deeper about what they desire when they think of cultural fit. It has to be more than enjoying cultural frills like ping pong and craft beer. Firms need to think about the purpose of the organization and how it can provide meaning for employees. They want to end up with employees who are committed to their work, see value in what they do, and, as a result, will keep working hard when no one is watching. Thus, hiring managers need to look for cues about whether prospective employees are excited about how the company innovates, serves customers, or makes a social impact. They also need to consider whether applicants will mesh with how individuals and teams in the company interact and whether they are likely to make decisions that will support the organization‘s mission. Assessing these traits requires creativity. One hiring manager whose firm has no formal titles and requires people to work on collaborative teams, asks the drivers of the cars who transport people between the airport and the interview their impressions of the candidates. His logic is that if ―they‘re a jerk to the car service guy, that‘s a warning sign.‖ Another manager asks candidates about their experience in their first jobs since it offers insight into how people see work and deal with jobs with little glamour. The key is to try to figure out what applicants really value and what they‘ll be like on a day to day basis. Those are the more important elements of fit. Source: Shellenbarger, S. 2019. The Perils of Cultural Fit. Wall Street Journal. September 24: A12.

Discussion Question 22: Does McCord’s reasoning apply only to knowledge intensive firms such as Netflix? Can you think of other examples? Discussion Question 23: Are there still industries where hiring for culture fit might be OK? What are some examples?

Creating an Ethical Organization

PowerPoint Slide 25: Strategic Leadership: Creating an Ethical Organization PowerPoint Slide 26: Strategic Leadership Ethical Orientation PowerPoint Slide 27: Strategic Leadership: Ethical Frameworks PowerPoint Slide 28: Strategic Leadership: Approaches to Ethics Management PowerPoint Slide 30: Strategic Leadership: Elements of an Ethical Organization PowerPoint Slide 31: Strategic Leadership: Ethical Organization Role Models 1-388 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

PowerPoint Slide 32: Strategic Leadership: Ethical Organization Corporate Credos PowerPoint Slide 33: Strategic Leadership: Ethical Organization Reward Systems PowerPoint Slide 34: Strategic Leadership: Ethical Organization Policies Ethics can be defined as a system of right and wrong. Ethics assist individuals in deciding when an act is moral or immoral, socially desirable or not. There are many sources of ethics: religious beliefs, national and ethnic beliefs, community standards, family practices, educational experiences, and friends. Business ethics is the application of ethical standards to commercial enterprise. The SUPPLEMENT below provides an excerpt from a speech by Richard F. Syron, former Chairman and CEO of the American Stock Exchange, regarding the sources and importance of ethical beliefs. Extra Example: What Ethics Really Means ―Most of us think we learn about ethics in the normal course of our lives. We learn about it from our parents, hopefully, at an early age. We learn about it from our teachers. We learn about it from religious leaders, and we see ethics in action in the workplace. But I think it‘s very important that we consider what ethics really means in a broader sense.‖ ―Ethics doesn‘t mean just not doing what is wrong. It doesn‘t mean just avoiding fraud or lying. Ethics means— more and more—doing the right thing because the right thing works in the long run. Ethics also means doing the right thing even if it‘s unpopular and difficult in the short run.‖ Source: Syron, R. F. 1999. Ethical imperatives for stock markets in the new millennium. Speech made at Bentley College Center for Business Ethics, February 8.

Discussion Question 24: What other sources of ethical beliefs influence actions in the workplace? Discussion Question 25: Is there a conflict when business leaders apply ethical beliefs from outside the workplace to business decisions? Why or why not? A

Individual Ethics versus Organizational Ethics

Many leaders think of ethics as a question of personal scruples, a confidential matter between employees and their consciences. Such leaders are quick to describe any wrongdoing as an isolated incident. In fact, however, ethics is strongly influenced by leadership. Seldom does the character flaw of a lone actor completely explain corporate misconduct. Instead, unethical business practices usually reflect the values, attitudes, and sometimes even the cooperation, of other organizational members. Businesses face many types of ethical issues. In addition to lying and fraud, for example, concerns about protecting the environment, fair employment practices, distributing unsafe products, fetal tissue research, disproportionate executive pay, and discrimination have all raised 1-389 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

questions about corporate ethical performance. Without a strong ethical culture, the chance that one of these issues might lead to an organization crisis is enhanced. The potential benefits of an ethical organization are many but may be indirect. Research has shown positive relationships between ethical performance and strong organizational culture, increased efforts by employees, lower turnover, higher organizational commitment, and enhanced social responsibility. An ethically sound organization can also strengthen its bonds with external stakeholders. Discussion Question 26: Why do you think employees would prefer to work at a company with ethical leaders? Discussion Question 27: What are some examples of companies that build loyal ties with their employees because of the ethical values and behaviors of its leaders? STRATEGY SPOTLIGHT 11.4 highlights potential ethical problems at utility companies that are trying to capitalize on consumers‘ desire to participate in efforts to curb global warming. We address what actually happened to customer payments that ―green‖ utility companies said would be used for renewable energy development. B.

Integrity-Based versus Compliance-Based Organizational Ethics

There is an important link between organizational integrity and the personal integrity of an organization‘s members. While there can‘t be high-integrity organizations without highintegrity individuals, individual integrity is seldom self-sustaining. Even good people can lose their bearings when faced with pressures, temptations, and heightened performance expectations. Organizational integrity goes beyond personal integrity. It is based on the concept of purpose, responsibility, and ideals for the entire organization. A key responsibility or leadership in building organizational integrity is to create this ethical framework and develop organizational capabilities to make it operational. Lynn Paine, a scholar at Harvard, has identified two approaches that organizations typically take when dealing with ethics: compliance-based and integrity-based approaches. EXHIBIT 11.5 provides a distinction between these two approaches. Compliance-based programs are generally designed by corporate counsel with the goal of preventing, detecting, or punishing legal violations. On the other hand, an integrity-based approach to ethics combines a concern for the law with an emphasis on managerial responsibility for ethical behavior. Such an approach is broader, deeper, and more demanding than a legal compliance initiative. We provide the example of Texas Instruments, an organization that goes beyond the mere compliance with laws to building an ethical organization.

To sum up, compliance-based approaches are externally motivated, that is, based on fear for doing something unlawful. In contrast, integrity-based approaches are driven by a personal and organizational commitment to ethical behavior.

Four key elements—role models; corporate credos and codes of conduct; reward and evaluation systems; and, policies and procedures—contribute to an ethical organization. Teaching Tip: Ask students which of these four elements—role models, corporate credos/codes of conduct, reward and evaluation systems, policies and procedures—are the most important to ensure an ethical organization. Then ask why it is important to have consistency among these elements (e.g., if the last three are present but top executives aren’t good role models, i.e., “walk the talk,” the other elements will not be as effective in shaping behavior). C.

Role Models

Leaders are role models in their organizations. (The example of General Dynamics‘ CEO dramatically illustrates how her behavior was mimicked!) Leaders must be consistent in their words and deeds because their values and beliefs become transparent to organizational members through their behaviors. We present the corporate leaders of energy company AES as an example. When lower-level employees lied to the EPA, senior managers took pay cuts even though they weren‘t directly responsible. D.

Corporate Credos and Codes of Conduct

Corporate credos and codes of conduct are statements that describe a firm‘s commitment to certain standards or values. They provide guidelines for norms, beliefs, and decision making. They also provide a basis for employees to refuse to commit unethical acts. E.

Reward and Evaluation Systems

Inappropriate reward systems may cause individuals at all levels of an organization to commit unethical acts that they might not otherwise do. The penalties for such acts in terms of damage to reputations, human capital erosion, and financial loss are usually much higher than any gains that could be obtained through such behavior. The SUPPLEMENT below provides some insights on unethical behavior and some of the possible underlying causes. Extra Example: Unethical Behavior and Some of the Underlying Causes Ernst & Young conducted its 12th annual Global Fraud Survey of more than 1,700 senior executives in 43 countries, including chief financial officers and heads of legal and compliance audits. It found that 15 percent were willing to make cash payments to win or retain business. The corruption perception index of Transparency International, a multinational organization dedicated to curbing corruption in business, ranked countries according to its level of corruption. The United States ranked 24. New Zealand was first and Canada was tenth, in terms of the absence of corruption. Malcolm Slater, in a Harvard Business Review article, argues that the short-term focus of businesses invites corruption. He cites examples such as Wall Street‘s mortgage banking fiasco, defining it as ―institutionally supported behavior that while not necessarily unlawful, undermines a company‘s legitimate processes and core 1-392 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

values. In the private sector, institutional corruption typically entails gaming society‘s laws and regulations, tolerating conflicts of interest, persistently violating accepted norms of fairness and pursuing various forms of cronyism.‖ Salter contends that the excessive focus of executive on short-term results discourage long-term investments and weakens the economy. Source: Williams, R. 2012. How competition can encourage unethical business practices. business.financial.post. July 31: np.

Discussion Question 28: What can be done to promote ethical behavior in organizations/reduce unethical behavior? (Address some of the issues in this section of the chapter and others, of course—such as reduced focus on short-term results and a broader stakeholder, long-term perspective.) F.

Policies and Procedures

Policies and procedures are used to guide employees in handling routine occurrences or events in a uniform manner. It is important to develop policies and procedures carefully so that all employees will be encouraged to behave in an ethical manner. Policies and procedures must also be reinforced with effective communication, enforcement, and monitoring.

VI.

Issue for Debate

Here, we consider whether companies should hire for culture fit. QUESTIONS: 1.

Do you see any situations where hiring for culture fit based on personal traits is a viable hiring strategy?

Some situations may warrant culture-fit hiring on personal characteristics. For instance, teams that need to make quick decisions may benefit from this approach. However, instructors may also want to push back a bit when students prefer hiring for culture fit based on personal traits in some situations. Specifically, individuals may share may values and ideals with the culture in an existing team or organization. Hiring for ―fit‖ on these more deep-seated attributes may help teams to make rapid decisions that may arise in time-sensitive environments. In fact, hiring in this manner may result in better culture fits than hiring on rather coarse-grained surface-level characteristics. 2.

How would you overcome the resistance from a hiring manager who refuses to hire a job candidate that differs from existing team members in personal traits, but who clearly would benefit the company with needed skills and experiences?

Instructors may want to use some insights from LO 11-2 (overcoming barriers to change and using power effectively). It may be a good idea to start understanding the resistance of the hiring manager. Perhaps the hiring manager simply views hiring based on personal attributes as ―best practice‖ or simply ―the way things are done around here‖. Providing new evidence-based findings and research that hiring according to newer approaches (such as ―culture add‖) can 1-393 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

improve unit performance may be effective. In addition, hiring a consulting firm with deep HR and diversity expertise may overcome resistance due to using the ―expert power‖ of the consultant (see Exhibit 11.2).

VII. Reflecting on Career Implications PowerPoint Slide 35: Reflecting on Career Implications Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 11.  Strategic Leadership: The chapter identifies three interdependent activities that are central to strategic leadership: namely, setting direction, designing the organization, and nurturing a culture dedicated to excellence and ethical behavior. Both during your life as a student and in organizations you work, you have often assumed leadership positions. To what extent have you consciously and successfully engaged in each of these activities? Observe the leaders in your organizations and assess to what extent you can learn from them the qualities of strategic leadership that you can use to advance your own career. This discussion is largely visionary. One approach is to ask students to think about a leader in their lives. Then ask students how this leader effectively does each of the three leadership activities. It may be useful to have a dialogue about how each of these three activities is important to the success of the organization. Have students share their observed activities to bring out the breadth of possible responses. To extend the discussion, ask students to identify one way that each of them could more effectively engage in each of the three activities. At the conclusion of the discussion, ask students to focus on the leadership activities of their supervisor over the next week and see if they can add to their personal list of desired leadership traits.  Power: Identify the sources of power used by your superior at work. How do his or her primary source of power and the way he/she uses it affect your own creativity, morale, and willingness to stay with the organization? In addition, identify approaches you will use to enhance your power as you move up your career ladder. Explain why you chose these approaches. This discussion is mostly about students‘ relationships with their supervisors. Ask students about their perceived quality of this relationship, and there are likely to be a range of responses. Ask students about the importance of a good relationship with their supervisors. Is there an effect on creativity, morale, and willingness to stay with the organization? Are there other consequences? It is relevant to establish the importance of good supervisor-employee relationships. Now ask students about the type of power the supervisor uses. You might find that the worst relationships are with supervisors who use coercive power. Other patterns may be that worse managers rely on reward power and better ones rely on referent power. In any case, ask students to identify the power base of their supervisor. Ask how the supervisor enhances and maintains his or her power. As this topic evolves, shift the issue to whether or not the students could or should use similar approaches. The point of the discussion is that power can be established and maintained in 1-394 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

various ways, but students may not want to use all the ways. They may feel more comfortable using their own approach. There may be more to being a manager than maximizing power.  Emotional Intelligence: The chapter identifies the five components of emotional intelligence: self-awareness, self-regulation, motivation, empathy, and social skills. How do you rate yourself on each of these components? What steps can you take to improve your Emotional Intelligence and achieve greater career success? Emotional Intelligence (EI) is an effective topic to complement that of power (above). Students can rate themselves on EI, and they may also rate their superiors. There may be a very close association between students‘ ratings of their relationships with superiors and the students‘ perceived level of their superiors‘ EI. The gist of this discussion is to emphasize the importance of EI. It is also useful to have students rate themselves on each of the dimensions. It may be that some students rate themselves high on some components and low on others. Ratings on the five components do not correlate very strongly. As a result, note that EI can be of different types. There can be managers with high ―empathy‖ EI but low ―motivation‖ EI, and vice versa. There may be as many different types of EI as there are students. However, most students will understand that all components of EI are useful, and it would be nice to improve on them. Studies show that EI can be changed, but it is not easy. It takes time and effort, but students should understand that it is possible. Changing your EI score may be as difficult as turning an introvert into an extrovert. Introverts may never feel comfortable in social situations, but they can learn to function. Similarly, managers with low empathy can learn how to pay attention to others‘ emotional cues. They may never find it ―natural‖, but they can develop a reasonable level of empathy with practice. It would be valuable if students agreed that the effort was worth it.  Creating an Ethical Organization: Identify an ethical dilemma that you personally faced in the course of your work. How did you respond to it? Was your response compliance-based, integrity-based, or even unethical? If your behavior was compliancebased, speculate on how it would have been different if it were integrity-based. What have you learned from your experience that would make you a more ethical leader in the future? With all the unethical behavior reported in the business press, casual readers may assume that business executives are ethically challenged. That perception may not be true, but it certainly appears to be true that unethical behavior has caused many firms and the economy great harm (the Bernie Madoff scandal, and the possible scandals associated with the 2008 recession— possible fraudulent mortgages, possible conflict of interest in selling mortgage-backed securities, and possible deception in rating mortgage-backed securities as AAA). So, ethics is a critical issue that students should discuss and consider throughout their careers. Ask students to identify an ethical dilemma such as conflict of interest, misrepresenting facts to a potential customer, and the like. Regardless of how students claim they responded to the dilemma, they should be able to articulate an unethical response, a compliance-based response, 1-395 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

and an integrity-based response. A discussion of the different implications of each response should bring out the short-term and long-term implications of each to the firm. It is also worth discussing the consequences to individuals of each response. What effects on managers result from frequent unethical behavior? Ask students if they want to be a manager who frequently engages in unethical behaviors. Would they want to work for an organization that has a culture of tolerating unethical behavior among top managers? Also, ask if students would prefer an organization with compliance-based or integrity-based ethics. For those students who prefer the integrity-based approach, ask how they personally can help the organization develop and ensure its high ethical standards. As students progress in their careers, challenge them to maintain their commitment to high standards. They can help to improve the business community‘s reputation.

VIII. Summary Strategic leadership is vital in ensuring that strategies are formulated and implemented in an effective manner. Leaders must play a central role in performing three critical and interdependent activities: setting the direction, designing the organization, and nurturing a culture committed to excellence and ethical behavior. In the chapter, we provided the imagery of these three activities as a ―three-legged stool.‖ If leaders ignore or are ineffective in performing any one of the three, the organization will not be very successful. The success of today‘s organizations depends on how well their leaders meet challenges and deliver on promises. The demands of the business environment require leaders to learn to effectively overcome barriers to change and be aware of how they use their organizational and personal bases of power. For leaders to effectively fulfill their activities, emotional intelligence (EI) is very important. Five elements that contribute to EI are self-awareness, self-regulation, motivation, empathy, and social skills. The first three elements pertain to self-management skills, whereas the last two are associated with a person‘s ability to manage relationships with others. We also address some of the potential drawbacks of EI. Leaders must also play a central role in creating a learning organization. Gone are the days when the top-level managers can ―think‖ and everyone else in the organization ―does.‖ With the rapidly changing, unpredictable, and complex competitive environments that characterize most industries, leaders must engage everyone in the ideas and energies of people throughout the organization. Great ideas can come from anywhere in the organization, from the executive suite to the factory floor. The elements that we discussed as central to a learning organization are inspiring and motivating people with a mission or purpose, empowering people at all levels throughout the organization, accumulating and sharing both internal and external sources of information, and challenging the status quo to stimulate creativity. In the final section of the chapter, we addressed a leader‘s central role in instilling ethical behavior in the organization. We discussed the enormous costs that firms face when faced with 1-396 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

ethical crises in terms of financial and reputation loss, as well as the erosion of human capital and relationships with suppliers, customers, society at large, and governmental agencies. And, as one would expect, the benefits of having a strong ethical organization are also numerous. We contrasted compliance-based and integrity-based approaches to organizational ethics. Compliance-based approaches are largely externally motivated, that is, motivated by fear of punishment for doing something that is unlawful. Integrity-based approaches, on the other hand, are driven by a personal and organizational commitment to ethical behavior. We addressed the four key elements of an ethical organization: role models, corporate credos and codes of conduct, reward and evaluation systems, and policies and procedures.

End-of-Chapter Teaching Notes Chapter 11: Strategic Leadership: Creating a Learning Organization and an Ethical Organization Summary Review Questions 1. Three key activities—setting a direction, designing the organization, and nurturing a culture and ethics—are all part of what effective leaders do on a regular basis. Explain how these three activities are interrelated. (In the text, Leadership: Three Interdependent Activities, LO 11-1) Response: Leadership is the process of transforming organizations from what they are to what the leader would have them become. Effective leaders are able to transform their organizations by implementing visions and missions. Setting a direction refers to a clear organizational mission that a leader communicates with passion and that followers believe. Designing the organization refers to the leader‘s ability to implement the organizational mission using an appropriate organizational structure and design. Nurturing a culture and ethics refers to an effective set of behavioral controls. The interrelation of these three key activities is apparent when considering an organization without any one of them. First, consider an organization without clear direction but with an effective design and a nurturing culture. This organization would be disciplined and efficient but aimless. Its activities would not be adjusted to the business environment. Second, consider an organization without an effective organizational design but with a clear direction and strong culture. There would be a well-conceived strategy, but the organizational design would not effectively implement it. Executives would be motivated and work hard, but lack of accountability, inappropriate reward structures, and inadequate budgeting systems would send misleading signals about how work should be done. Third, consider an organization without a nurturing culture and ethics but with a clear direction and effective organizational design. This organization might look good on paper, but the lack of commitment by employees and lack of effort will render the rewards system impotent and the achievement of organizational mission difficult. 2. Define emotional intelligence (EI). What are the key elements of EI? Why is EI so important to successful strategic leadership? Address potential “downsides.” (In the text, Emotional Intelligence: A Key Leadership Trait, LO 11-3) Response: EI is an individual‘s capacity for recognizing his or her own emotions and those of others, including the five components of self-awareness, self-regulation, motivation, empathy, and social 1-398 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

skills. Self-awareness refers to a person having a deep understanding of his or her emotions, strengths, weaknesses, and drives. Self-regulation refers to a person being in control of his or her feelings and impulses. Motivation refers to a person‘s deeply embedded desire to achieve for the sake of achievement, not by external factors such as money or status. Empathy refers to a manager thoughtfully considering an employee‘s feelings, along with other factors, in the process of making intelligent decisions. Social skill is friendliness with a purpose, or the ability to move people in a desired direction. Research has shown that effective leaders have three sets of capabilities: (1) technical skills, (2) cognitive capabilities, and (3) EI. EI is important because it pertains to leaders‘ ability to persuade and motivate others, and manage relationships, which are critical to nurturing a culture and ethics. The downside of EI is that it should be used in moderation. For example, leaders need to be empathetic, but not too empathetic. To maintain efficiency, leaders need to make tough decisions about people. And leaders need to be motivated and have a passion for their organization, but they have to be constrained in expecting others to have the same passion, or in being too critical of their employees. 3. The knowledge a firm possesses can be a source of competitive advantage. Describe ways that a firm can continuously learn to maintain its competitive position. (In the text, Creating a Learning Organization, LO 11-4) Response: Generally, individuals in different parts of an organization are learning, but that learning may not be contributing to the organization‘s competitive advantage. To continuously learn as an organization, it needs to collect information from all levels of employees, from top down and bottom up. It needs to process this information into organizational actions that will help achieve the organization‘s mission, which will involve contributions from employees at all levels. And the organization needs to be able to challenge past practices, and change them, when the organization learns how to do better. To facilitate these processes, even lower-level employees and managers have to feel empowered, that their insights and understandings will be respected and, if appropriate, incorporated into strategy. 4. How can the five central elements of “learning organizations” be incorporated into global companies? (In the text, Creating a Learning Organization, LO 11-4) Response: Learning organizations create a proactive, creative approach to the unknown, characterized by (1) inspiring and motivating people with a mission and purpose, (2) empowering employees at all levels, (3) accumulating and sharing internal knowledge, (4) gathering and integrating external information, and (5) challenging the status quo and enabling creativity. Global companies have closely integrated operations in multiple countries. 1-399 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Incorporating the five elements into global companies is more complicated than for domestic companies because of the internal barriers between operations in different countries. For each of the five central elements, some implementing issues are:  



Mission has to apply to operations in multiple countries, so involvement of individuals from all countries in creating and communicating the mission will make the message more consistent across parts of the organization and promote commitment. Empowering employees at all levels will require trusting people at all levels and in all countries. People from all national cultures will have to overcome nationalistic biases and develop trust throughout the organization. Also, as lower-level employees make significant contributions, they need to be recognized and rewarded for their insights. Accumulating and sharing internal knowledge should include sharing across national boundaries. Communication barriers will have to be bridged to include operations from all countries. Internal databases of best practices will have to be adapted to each national business environment and made available to select individuals globally. Gathering and integrating external information will involve training employees throughout the organization on methods for gathering external information, which should be similarly intensive in all countries. Integrating the information globally will present challenges because interpreting information is somewhat dependent on the business context. So the organization will have to develop capabilities for interpreting external information from around the world and integrating it. Challenging the status quo involves developing a culture of dissent. This culture will have to be instilled in each nation and tailored to various national norms. In addition, there is a problem integrating the various national cultures of dissent into a global organizational culture that will involve challenging the organization-wide mission. And the dissent has to be focused on organizational improvement, not a reflection of national differences.

Applying the learning organization elements to global companies will present various challenges associated with international differences. 5. What are the benefits to firms and their shareholders of conducting business in an ethical manner? (In the text, Creating an Ethical Organization, LO 11-5) Response: The benefits of an ethical organization are often indirect and not reflected in financial performance. However, ethical performance has been associated with strong organizational culture, increased employee efforts, lower turnover, higher organizational commitment, and enhanced social responsibility.

6. Firms that fail to behave in an ethical manner can incur high costs. What are these costs and what is their source? (In the text, Creating an Ethical Organization, LO 11-5) Response: Lawsuits based on unethical behavior, such as discrimination, options backdating, tax evasion, or fraud can be costly to settle, but the larger lack of confidence can threaten the organization‘s existence. But a greater cost is the loss of confidence by investors, suppliers, customers, and regulators. This paragraph from the text describes the costs in more detail: The past several years have been characterized by numerous examples of unethical and illegal behavior by many top-level corporate executives. These include executives of firms such as Enron, Tyco, WorldCom, Inc., Adelphia, and Healthsouth Corp., who were all forced to resign and are facing (or have been convicted of) criminal charges. Perhaps the most glaring example is Bernie Madoff, whose Ponzi scheme, which unraveled in 2008, defrauded investors of $50 billion in assets they had set aside for retirement and charitable donations. 7. What are the most important differences between an “integrity organization” and a “compliance organization” in a firm’s approach to organizational ethics? (In the text, Creating an Ethical Organization, LO 11-6) Response: An integrity organization (IO) combines a concern for law with an emphasis on managerial responsibility. A compliance organization (CO) prevents, detects, and punishes legal violations. Some of the differences are as follows. A CO seeks conformity with externally imposed standards (i.e. laws), while an IO pursues self-governance according to chosen standards. A CO seeks to prevent criminal misconduct, while an IO seeks to enable responsible conduct. A CO has lawyers in charge of ethics programs, while an IO has managers in charge with the assistance of lawyers, HR staff and others. A CO uses methods such as education, reduced discretion (boundaries), auditing and controls, and penalties, while an IO uses education leadership, accountability, organizational systems and decision processes, auditing and controls, and penalties. A CO assumes that individuals are autonomous beings subject to self-interest, while an IO assumes that individuals are social beings guided by material self-interest, values, ideals, and peers. Exhibit 11.5 illustrates these. 8. What are some of the important mechanisms for promoting ethics in a firm? (In the text, Creating an Ethical Organization, LO 11-5) Response: Four important mechanisms are role models, corporate credos and codes of conduct, reward and evaluation systems, and policies and procedures. Role models means that leaders must be consistent in their words and deeds. Leaders sometimes need to take responsibility for ethical lapses within their organizations even if they were not directly involved. 1-401 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Corporate credos and codes of conduct provide a clear, transparent statement of norms and beliefs as well as guidelines for decision making. These codes also provide a justification for employees to refuse to do certain things, which will reinforce ethical behavior and reputation. Corporate credos and codes of conduct, and associated guides for behavior, should be promoted within the organization and reinforced with corporate communications from top managers. Reward and evaluation systems can discourage ethical conduct by rewarding outcomes without regard to the behaviors that led to the outcomes. An inappropriate rewards system can lead to unethical behavior that causes much higher damage than whatever gain would be possible. Policies and procedures refer to written, transparent guidelines for conduct in certain routine activities. Examples include relationships with suppliers, setting up alliances, or developing budgets. Experiential Exercises and Application Questions 1. Select two well-known leaders—one you admire and one you do not. Evaluate each of them on the five characteristics of emotional intelligence. Response: There are, of course, a nearly unlimited set of possibilities. This exhibit is illustrative and debatable! Assessing leaders from afar is a matter of conjecture, and perhaps, debate. Emotional Intelligence Characteristics Self-awareness

Self-regulation

Motivation Empathy

Social skills

Admired Leader Martin Luther King High—speaks from his heart. Devotes his life to a heartfelt and unpopular cause. High—able to focus energy on the goal of racial equality. Able to adapt to situations as needed, such as the management of the Selma to Montgomery march. High—worked tirelessly on his cause Moderate—very focused on his cause and only limited ability, perhaps, to understand others‘ views, especially hostile, perspectives. High—was able to organize many different types of people to his cause. Was able to operate in a variety of social settings.

Leader Not Admired Adolph Hitler High—Had a fanatical devotion to German nationalism and was able to tap into others‘ patriotic emotions. Moderate—Able to focus emotions on cause of German nationalism, but not able to adapt to situations without thinking. Questionable judgment in invading Russia and the battle of Stalingrad. High—worked tirelessly on his cause Low—Was not very understanding of others‘ perspectives.

Low or unknown—Was able to build a network, but only under conditions of extreme duress as existed in Germany after World War I. Also, network of trusted associates included sociopaths.

(Note to instructor) The goal of this exercise is to increase students‘ awareness of emotional intelligence and its role in leadership. Ask students to separate the traits of the business leaders into technical knowledge, cognitive abilities, and emotional intelligence. What is the relative 1-402 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

contribution of each type of trait? Then, for each of the five characteristics of emotional intelligence, ask students for their evaluations and to provide justification for each, including examples. It is also interesting to isolate the key characteristics that separate admired from notadmired leaders. They may not be as different as commonly thought. 2. Identify two CEOs whose leadership you admire. What is it about their skills, attributes, and effective use of power that causes you to admire them? Response: (Note to instructor) Ask students to evaluate their CEO on technical skills, cognitive ability, emotional intelligence, and ethical role model. Ask which of these categories they most admire. Or is the CEO admired for some other reason? An interesting extension might be to ask how difficult it was for the CEO to achieve their skills, attributes, and effective use of power. And evaluate how the student needs to train in order to be as admirable. 3. Founders have an important role in developing their organization’s culture and values. At times, their influence persists for many years. Identify and describe two organizations in which the cultures and values established by the founder(s) continue to flourish. You may find research on the Internet helpful in answering these questions. Response: Some corporations such as Apple, HP, GE, and Wal-Mart still have Web pages devoted to the corporate founders. These pages usually contain short bios on the founder(s) with some vignettes that demonstrate corporate values. (Interestingly, we did not find much on Henry Ford on the Ford Motor Company website, which indicates that corporations sometimes and eventually evolve away from close identification with their founders) (Note to instructor) The purpose of this exercise is to show the enduring power of a founder/leader in shaping organizational culture, design, ethical standards, and mission. It may be useful to ask students to show how the founder (a) determined the organization‘s mission, (b) designed the organization, and (c) nurtured a culture dedicated to excellence and ethical behavior. To which of these activities is the founder‘s influence strongest? Are there other activities besides these where the founder made an impact? 4. Some leaders place a great emphasis on developing superior human capital. In what ways does this help a firm to develop and sustain competitive advantages? Response: Sustainable competitive advantages are by definition rare, valuable, costly to imitate, and costly to substitute. Human capital developed within the firm will likely contribute to a sustainable competitive advantage. So effective leaders appropriately focus on developing human capital in order to transform their organizations and improve organizational performance. Knowledgedriven organizations especially benefit from human capital. 1-403 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Leaders can develop human capital through all leadership activities, but at the individual level, the activity of nurturing a culture dedicated to excellence and ethical behavior has arguably the greatest impact on developing human capital. Through interpersonal relationships, leaders can use their emotional intelligence to motivate colleagues to work hard toward achieving organizational goals. And as an ethical role model, leaders can help their organizations‘ ethical performance, which is associated with strong culture, employee efforts, lower turnover, higher commitment, and greater social responsibility. These results should have the effect of increasing human capital and improving sustainable competitive advantage. 5. In this chapter we discussed the five elements of a “learning organization.” Select a firm with which you are familiar and discuss whether or not it epitomizes some (or all) of these elements. Response: (Note to instructor) We recommend that you start with the student justifying why he or she thinks the organization is a learning organization that has a proactive approach to the unknown (or not, but it is better to discuss an organization that is purported to be a learning organization). Then ask students to show how the organization performs on all five elements. Which elements most contribute to the organization‘s status as a learning organization? Ethics Questions 1. Sometimes organizations must go outside the firm to hire talent, thus bypassing employees already working for the firm. Are there conditions under which this might raise ethical considerations? Response: The primary ethical considerations pertain to fair treatment of the employees bypassed. If they are not treated with dignity and respect, or not perceived to be treated so, then their perception of the organization and its work environment could become less positive. As a result, motivation and organizational culture, including ethical values, can become less strong. Employees would be more likely to pursue self-interest such as outside employment opportunities. The conditions under which the ethical considerations are most likely are where the bypassed employees perceive unfair treatment. This treatment might be that (a) they were not informed or consulted regarding the new hire, (b) their concerns were not addressed by top management, (c) those bypassed report directly to the new hire, and (d) the new hire means that the bypassed employees have fewer opportunities for job enrichment or resources under their control. These conditions can be reduced by effective leadership that makes (a) appropriate organizational design changes that reduce potential conflicts between the new hire and those bypassed, and (b) appropriate use of emotional intelligence at the interpersonal level in dealing with the bypassed employees. 1-404 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

2. Ethical crises can occur in virtually any organization. Describe some of the systems, procedures, and processes that can help to prevent such crises. Response: Ethical crises can occur at even low levels of the organization, such as VW‘s emission scandal. An effective way to reduce such ethical crises is to elevate ethics programs to be integrity-based, rather than compliance-based, and have management directing ethics compliance rather than lawyers. Some systems, procedures, and programs that help to prevent such crises include:          

Implementing education programs that clearly delineate acceptable and unacceptable behavior: acceptable behavior focuses on achieving organization-wide performance, not personal or division performance Having leaders be role models of ethical behavior, including clearly articulating and emphasizing the importance of ethical conduct Having leaders share accountability for ethical lapses, even if they were not directly involved in the misconduct Having reward systems that include an evaluation of whether managers are acting in an ethical manner Formulating explicit policies for how to deal with certain routine activities such as managing relationships with suppliers and customers Publishing a comprehensive corporate credo and code of conduct Incorporating ethical guidelines for making decisions, such as hiring decisions Establishing a system of regular auditing of the entire organization, from top to bottom, for ethical performance Consistently and severely penalizing unethical behavior whenever it is discovered Changing organizational design after unethical behavior is discovered such that the behavior will not be repeated

CONNECT RESOURCES Case Analysis Environmental Sustainability at 3M Leadership of Jamie Dimon, Chairman and CEO of JP Morgan Chase Celebrating Ethics at the Cleveland Clinic Comprehension Case Leadership Training

Chapter 12 Managing Innovation and Fostering Corporate Entrepreneurship 12-2 Managing Innovation ................................................................. 12-3 Types of Innovation ................................................................................... 12-4 1-405 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Challenges of Innovation .......................................................................... 12-5 Cultivating Innovation Skills.................................................................... 12-7 Defining the Scope of Innovation ............................................................. 12-9 Managing the Pace of Innovation ............................................................ 12-10 Staffing to Capture Value from Innovation............................................ 12-10 Collaborating with Innovation Partners ................................................. 12-11 The Value of Unsuccessful Innovation .................................................... 12-12

Corporate Entrepreneurship ..................................................... 12-13 Focused Approaches to Corporate Entrepreneurship .......................... 12-14 Dispersed Approaches to Corporate Entrepreneurship........................ 12-16 Measuring the Success of Corporate Entrepreneurship Activities ...... 12-17

Real Options Analysis: A Useful Tool ...................................... 12-18 Applications of Real Options Analysis to Strategic Decisions .............. 12-18 Potential Pitfalls of Real Options Analysis ............................................. 12-19

Entrepreneurial Orientation ..................................................... 12-20 Autonomy ................................................................................................... 12-21 Innovativeness ............................................................................................ 12-22 Proactiveness .............................................................................................. 12-23 Competitive Aggressiveness ..................................................................... 12-24 1-406 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Risk Taking ................................................................................................ 12-25

Issue for Debate ........................................................................... 12-27 Reflecting on Career Implications ............................................ 12-28 Summary ...................................................................................... 12-30 End-of-Chapter Teaching Notes................................................ 12-32 Connect ........................................................................................ 12-40

Chapter 12

Managing Innovation and Fostering Corporate Entrepreneurship Summary/Objectives PowerPoint Slide 2: Learning Objectives PowerPoint Slide 3: Looking Ahead Strategic management and leadership are essential for entrepreneurial success. To remain competitive, established firms must seek out opportunities for growth and avenues for strategic renewal. Changes in customer needs, new technologies, and shifts in the competitive landscape require that companies continually innovate and initiate corporate ventures. This chapter addresses how innovation and corporate entrepreneurship help firms create competitive advantages. The chapter is divided into three major sections: 1. The first section addresses the role of innovation in the venture creation and strategic renewal process. We also discuss how firms can effectively manage the innovation process and overcome impediments and challenges to successful innovation. 2. The second section addresses corporate entrepreneurship. It describes techniques used by established firms to instill a spirit of entrepreneurship into corporate strategic thinking. It also discusses the role of focused and dispersed approaches to the venture development process. 3. The third section addresses the practical implications of real options theory (ROA) in the context of corporate venturing. ROA has been found to be a useful tool to help managers with resource allocation decisions. We also address some potential drawbacks of ROA. 4. The third section describes the influence of an entrepreneurial orientation on the venture creation processes. It outlines several practical applications of entrepreneurial thinking to strategic decision making and cautions about some of the pitfalls associated with an entrepreneurial frame of mind.

Lecture/Discussion Outline The opening incident, in LEARNING FROM MISTAKES, describes how Uber exited its quick delivery business once known as UberRUSH. This demonstrates the challenges even successful firms can have when innovating. Discussion Question 1: What role do you think the Uber IPO played in the decision to discontinue the UberRUSH business? 1-408 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Response guidelines: An IPO is a crucial step in the life cycle of any company. This is because companies need to increase their transparency and improve their reporting on profitability and other business metrics. As a result, shareholders and other market participants will be closely examining the promises and issues of Uber‘s various business units. It seems clear that UberRUSH did not find acceptance among larger companies but instead was used primarily by smaller companies with niche businesses. This of course presents a challenge for a company such as Uber with global ambitions. An interesting question may be how Uber could protect nascent businesses such as UberRUSH from the discipline of capital markets. One could imaging that early-stage businesses, such as UberRUSH, may be transferred into a holding company that gives ambitious projects the resources and flexibility to develop their business models. Discussion Question 2: Do you agree that the Application Programming Interface (API) business model is a promising venue for Uber and other companies to pursue? Response guidelines: API business models may be an interesting option for Uber but effective execution is important. Many business models depend on an interface and third parties to develop successful products or services: just think of game consoles such as the Sony Playstation system and third-party game developers. It seems that UberRUSH was only able to attract smaller partners. It may be a good idea to analyze the root cause. Is the API difficult to integrate or are important functions missing? Are business issues such as insuring goods for transit in Uber cars a major concern? These and similar questions may be important to answer to develop effective API-based businesses.

Managing Innovation

PowerPoint Slide 4: Managing Innovation PowerPoint Slide 5: Managing Innovation: Definition PowerPoint Slide 7, 8, 9, and 10: Managing Innovation: Types PowerPoint Slide 11, 12, and 13: Managing Innovation: Challenges PowerPoint Slide 14, 15, 16, 17, and 18: Managing Innovation: Improving the Process Innovation involves using new knowledge to transform organizational processes or create commercially viable products and services. The sources of new knowledge may include the latest technology, the results of experiments, creative insights, or competitive information. The innovation process needs to be managed. STRATEGY SPOTLIGHT 12.1 shows how technology in the form of wearable sensors allows companies to create products and services that vastly improve user experiences and makes employees more productive A. Types of Innovation There are several ways to characterize innovations. One distinction that is often used is between product and process innovation. Product innovation refers to efforts to create product 1-409 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

designs and applications of technology to develop new products for end users. Product innovations are commonly associated with a differentiation strategy. Process innovation, by contrast, is typically associated with improving the efficiency of organizational processes, especially manufacturing systems and operations. Process innovations are often associated with overall low-cost leader strategies. Discussion Question 3: What are some examples of product and process innovations? What types of firms are most likely to favor product innovations? Process innovations? Innovations can also be viewed in terms of their degree of innovativeness on a continuum from radical to incremental. 1.

Radical innovations. Produce fundamental changes by evoking major departures from existing practices. These are breakthrough innovations that can transform a company or even revolutionize an industry.

Incremental Innovations. Enhance existing practices or make small improvements in products and processes. They represent evolutionary rather than revolutionary applications within existing paradigms.

EXHIBIT 12.1 depicts an incremental-radical continuum and shows examples of several innovations. Another distinction (introduced by Harvard Professor Clayton Christensen) is between sustaining and disruptive innovations. Sustaining innovations are those that extend sales in an existing market and may be either radical or incremental. Disruptive innovations are those that overturn markets by providing an alternative approach to meeting customer needs. Disruptive innovations tend to:   

Be technologically simpler Appeal to less demanding customers Become disruptive only after they have taken root in a new part of the market

Streaming and sharing services are provided as examples of disruptive innovation. Discussion Question 4: What can be learned from characterizing innovations in different ways? How does this help to better understand the strategic implications of innovation? The SUPPLEMENT below provides an interesting perspective on how industry incumbents can survive and even thrive in the face of digital disruptions. Extra Example: Can Incumbent Firms Survive and Even Thrive in the Face of Digital Disruptions Digital technologies are often considered a threat to established firms. The story generally goes like this: Incumbent firms are taken over by digital competitors that serve customers more efficiently and cheaply than incumbents do. However, research by Julian Birkinshaw, a Professor at London Business School, shows that this story is often oversold. The reality is that incumbent firms can successfully respond to disruptive challenges posed by tech firms. 1-410 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Indeed, there has been less creative destruction than most people believe. For instance, only 17 of the companies in the 2020 Fortune 500 list did not exist in 1995, showing that industry transformation happens very slowly and incumbents can fight back effectively. Prof Birkinshaw advises that companies respond to digital disruption in four basic ways: 1. Fight back. Many companies react to disruption by trying to beat a tech disrupter at its own game. This may take the form of creating separate business units that can incubate new digital concepts and business models. This is often a reasonable response if the new technology presents an existential threat to the incumbent. However, large companies have a poor track record of fending off digital disruptors so incumbents should carefully examine this option. 2. Double down. Incumbents may also play to their existing strengths. For instance, when Disney was confronted with digital disruptors such as Netflix, it doubled down on its proven strength in moviemaking, resulting in the purchase of Pixar, Marvel, and Lucasfilm. This upgrade to the Disney content library gave the firm a distinct bargaining advantage over streaming services and eventually made its streaming service (Disney+) successful. 3. Retrench. Some firms may act defensively and yield ground to new digital competition. The incumbent would then use a variety of tactics to ensure their own continued survival, such as consolidation through mergers and acquisitions. 4. Move away. Incumbent firms may also enter new businesses and migrate to new opportunities. For instance, Thomson Corporation sold its newspaper business in the 1990s and invested in information services by merging with Reuters. Companies should choose an appropriate response based on a detailed analysis of their industry and competitive position. For instance, a company that has strong assets that market participants still value may consider doubling down on its strengths, rather than only fighting back against the digital disrupter and trying to beat it at its own game. Source: Birkinshaw, J. 2022. How incumbents survive and thrive. Harvard Business Review, 100(1): 36–42.

Challenges of Innovation

Innovation is essential to sustaining competitive advantages, but firms are often resistant to innovation. Only those companies that actively pursue innovation, even though it is often difficult and uncertain, will get a pay-off from their innovation efforts. The SUPPLEMENT below discusses evidence on how much effective innovating firms reallocate their innovation resources on an annual basis. Extra Example: Is there a Sweet Spot for Reallocating R&D Resources? When allocating investment resources to units in the corporations, many companies simply allocate the same level of innovation resources to each unit year in and year out. On average, companies only alter about 13 percent of their R&D allocations on a year-to-year basis. Thus, firms don‘t allocate R&D resources actively based on the performance or innovation prospects in different units. Instead, nearly 90 percent of the R&D resources a unit receives is based on last year‘s allocation. However, research by McKinsey & Company suggests there may be a sweet spot for changes in R&D adjustments. In a study of large corporations (over $1 billion in sales), this research found that successful innovators typically reallocated between 6 percent and 30 percent of the corporate R&D budget from one division to another each year. In contrast, unsuccessful innovators most commonly reallocated less than 5 percent of their R&D budgets year-toyear. 1-411 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

This research suggests that corporate managers who want to maximize the firm‘s innovation potential should not see the annual R&D budgeting cycle as a simple continuation of prior allocations. They should actively assess the potential in corporate units and be willing to alter allocations to each unit to match that unit‘s opportunities. Source: Chan, V., de Jong, M., & Ranade, V. 2014. Finding the Sweet Spot for Allocating Innovation Resources. McKinsey Quarterly. May.

Discussion Question 5: Why is it important for firms to consider reallocating R&D resources on a regular basis? What makes innovation so difficult? Five dilemmas that companies must wrestle with when pursuing innovation include 1. Seeds versus weeds—Companies must decide which of many ideas is most likely to bear fruit—the ―Seeds‖—and which should be cast aside—the ―Weeds.‖ 2. Experience versus initiative—Senior managers have experience and credibility but tend to be risk averse; mid-level employees may be overly enthusiastic but see the value of the innovation first-hand. 3. Internal versus external staffing—Insiders may have social capital but fail to think outside the box; outsiders need time to train and build relationships. 4. Building capabilities versus collaborating—Internal development is costly and timeconsuming but helps firms maintain control; partnering brings resources and experience but may result in conflict. 5. Incremental versus pre-emptive launch—Incremental launches are less risky but may not pay off; large-scale launches are riskier but may pre-empt competitive responses. STRATEGY SPOTLIGHT 12.2 discusses how Clorox learned from seemingly unsuccessful innovation efforts and applied these learning outcomes to other products in their vast portfolio of cleaning products Discussion Question 6: What are some examples of other major innovations that firms have pursued? What were the challenges of bringing them to market? The SUPPLEMENT below identifies a key idea for effectively managing innovation: embracing the tension between creativity and efficiency rather than struggling with it. Extra Example: Key to Managing Innovation? Make the Novel Routine Former Apple Computer product designer Andrew Hargadon believes the key challenge in managing innovation is being simultaneously innovative and efficient. Hargadon, who holds a PhD from Stanford‘s School of Engineering, makes a case that the best way to manage both creativity and efficiency is to build a bridge between them: ―Our obsession with the tension between the wild and crazy side of innovation and the button-downed nature of ongoing operations is distracting us from one of the more real problems in managing innovation.‖ ―The big challenge in managing innovation lies, I would suggest, not in building up two very strong skills in innovation and in operations, but rather in building the bridge between them–of developing the people and processes that facilitate the routinization of novelty. Of turning good ideas into practical processes that the larger organization can value, adopt, implement, and manage.‖ 1-412 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

―Forget 3M–think about Toyota. They are leaders in manufacturing efficiencies and also at exploring the new frontiers of innovation automobiles. How have they managed the tension? Read any number of books on them (but the original The Machine that Changed the World remains the best read) and you find that they are extremely effective at recognizing those ideas that can be routinized and doing so before their competition. Sometimes decades before. Consider the Prius. Ford and GM had many of the same technologies lying around R&D, but having the ideas is not the same as converting them into manufacturing routines, processes, supply chains, and ultimately customers. That‘s execution.‖ Sources: Deschene, L. 2007. Avoid complacency: How to manage innovation. BNET Intercom, www.bnet.com, August 27; and Hargadon, A. 2007. Creative efficiency or efficient creativity?

Discussion Question 7: Recall from Chapter 8 that one of the keys to entrepreneurial success is to “do more with less.” In your opinion, is it possible to be both highly innovative and highly efficient? Why or why not? Discussion Question 8: What are some examples of companies that you are familiar with that have highly innovative products (or services) but relatively low costs. What accounts for their ability to do that? Successful firms often struggle to maintain creativeness and a drive to improve its innovation. The SUPPLEMENT below discusses how Pixar Studios acts to limit complacency. Extra Example: Pixar‘s Steps to Push for Creativity and Improvement Pixar has had a remarkable run of over a dozen hit animated films. Such a pattern of success could easily lead to complacency and risk aversion in Pixar. To limit this tendency, Pixar undertakes a rigorous review of every film to assess the process used to make the film—even though each of its films have been box office successes. Top managers change the review process each time to limit the degree to which employees can game the system and to keep them engaged in the process. One question they have asked participants is to identify the top five things they would do again in a future movie project and the top five things they would not do again. Pixar also diligently collects data on all aspects of the film production process and uses this data ―to stimulate discussion and challenge assumptions arising from personal impressions‖ during the postmortems. They also occasionally do a multi-project review where they compare experiences across several productions to develop. Compare and contrast assessments and more general insights on what works and what doesn‘t work. Sometimes, they use an outsider or a newly hired manager to conduct these broad reviews to maintain an objective evaluation and to get a fresh perspective. Sources: Gino, F. & Pisano, G. 2011. Why leaders don‘t learn from success. Harvard Business Review. 89(4): 68–75.

The next four sections include steps that firms can take to address the dilemmas and challenges of innovation. C. Cultivating Innovation Skills The ability to think innovatively can be developed in managers. Jeff Dyer and his colleagues discuss the need to cultivate the Innovative DNA of managers. They identify five traits that managers should build on to be more innovative.

   



Associating: The ability to integrate questions and ideas that, to others, appear random and unrelated Questioning: The practice of questioning the status quo and taken-for-granted assumptions that exist within firm and industries Observing: The behavior of regularly observing customers and potential customers to identify their unmet needs and desires Experimenting: The willingness to try and fail regularly with new innovations-seeing experimentation, failure, and learning as the foundation for successful innovations Networking: Building diverse networks of friends and colleagues to get a range of insights and observations that serve to identify innovative opportunities and solutions

EXHIBIT 12.2 discusses the Innovator‘s DNA and provides examples of each of the underlying traits. Discussion Question 9: Is it more important for entrepreneurs or managers of large, established firms to develop these skills? Insights from Research 11.1 discusses the benefits of leveraging dormant ties to spur innovative thinking. The SUPPLEMENT below discusses eight attributes of innovative firms. Extra Example: Eight Attributes of Innovative Firms Innovation is difficult to sustain in large organizations. Interviews and surveys with over 2,500 executives from 300 firms identified eight core essentials of innovation. Four focus on strategic vision and creativity. Four are about organizing for innovation. 1. Aspire. Offering clear, aggressive goals for innovation is critical to aligning employees to strive for greater innovativeness. This involves setting overarching innovation goals but also breaking the overall goal into tangible innovation goals for units and assigning these goals to unit leaders. These leaders, in turn, push innovation targets across their unit to enhance the ownership of innovation throughout the firm. 2. Evaluate. Successful firms evaluate business opportunities to ensure they meet three conditions: a valuable problem to solve, a technology that enables a solution, and a business model that generates money from it. 3. Choose. Innovative firms generate a large number of ideas, but the firm must choose a set to pursue. This involves providing seed money to a larger number of projects the firm can ultimately finance, then having a transparent decision process that apportions the necessary funding to the most promising options, and finally having a rigorous ongoing evaluation process that informs decisions on continuing funding. 4. Evolve. As the market and technologies change, established firms need to reinvent their businesses before upstarts do. Successful innovators undertake rigorous market intelligence to understand the moves of competitors. They also fund new ventures that don‘t fit their dominant model and sponsor projects outside of their core business to avoid skepticism by core business managers. Finally, they fully examine new ideas and are willing to restructure the firm 1-414 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

to pursue highly promising ideas. 5. Accelerate. Cautious governance and decision making processes foster the ability of bureaucratic elements to slow or halt innovative businesses. Successful companies assign an idea manager who is well-connected in the organization, build a cross-functional team, and test promising ideas with customers to get clear feedback that will either kill or accelerate momentum for the new business. 6. Scale. Successful innovators evaluate the potential market for their new idea and quickly identify the scope of resources needed to build the necessary scale to exploit the opportunity. This involves building scalable financial controls, adequate hard assets, and a sufficient supply chain network. 7. Extend. High-performing innovators develop a strong network of collaborative partners who work with the firm to develop innovations, supply cutting-edge components, and provide excellent support and responsiveness. They also share economic success with their partners. The goal is to be the partner of choice in their market segment. 8. Mobilize. Successful innovators get employees and outside partners motivated to support innovative efforts. This begins with clear aspirations that are driven down the organization. It also includes efforts to reinforce the mission of building an innovative culture. It also includes employing incentives and rewards that are innovation focused. Thus, overcoming the inertial tendencies of organizations takes ongoing efforts that impact all parts of the organization. Sources: de Jong, M; Marston, N., & Roth, E. 2015. The eight essentials of innovation. mckinsey,.com. April: np.

STRATEGY SPOTLIGHT 12.3 discusses the insights of Waguith Ishak, an experienced innovation manager, on how firms can build an innovative culture. D. Defining the Scope of Innovation Firms must have a means to focus their innovation efforts. By defining the ―strategic envelope,‖ that is, the scope of a firm‘s innovation efforts, firms ensure that their innovation efforts are not wasted on projects that are uncertain or outside the firm‘s domain of interest. To maintain focus, a company needs to develop innovation questions to ask itself:  How much will the innovation initiative cost?  How likely is it to actually become commercially viable?  How much value will it add; that is, what will it be worth if it works?  What will be learned if it does not pan out? Discussion Question 10: If a company were to invest a large amount of time and money on a potential innovation that did not work out, would you consider it a failure? Why or why not? What factors would you consider in order to assess whether it was a failure? The following SUPPLEMENT describes a five-stage process that Corning, Inc., a leading innovator for over 150 years, uses to achieve superior innovation results. Extra Example: Corning‘s Five Stage Innovation Process 1-415 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Corning, Inc. has been a leading innovator since it was founded in the 1850s. It has made some risky moves and some of its decisions have not paid off. But in periods of both success and failure, Corning has survived by using a systematic management innovation process that has been effective for Corning and proven useful to many other companies. The process consists of five steps that a firm can use to advance through the stages of innovation: 1.

4. 5.

Build Knowledge. This involves establishing a shared view of trends, discontinuities and related events that could shape the future. It often includes developing a road map of industry conditions and events that is useful in formulating a portfolio of innovation projects. Determine Feasibility. This includes experimenting with new ideas both in laboratory settings and with potential customers and often involves developing a small working prototype. If proof of concept can be achieved and the technology can accomplish the intended objectives, the prototype can be developed into a product with significant market potential. Test Practicality. This includes developing a larger prototype that reflects the initial product or process concept and testing the prototype with customers and in the lab. At this stage, manufacturing costs and overall capital requirements are estimated, potential competitive responses are assessed, and funds may be appropriated. Prove Profitability. This involves determining if the product will satisfy a large market need, can be manufactured reliably, and produced at a cost that generates a profit. Manage Life Cycle. This involves building sales volume, gaining market share, and satisfying customer needs. In order to keep the product from maturing too rapidly, it also includes efforts to continuously improve the product and seek new growth markets. Sources: Graham, M. B. W., & Shuldiner, A. T. 2001. Corning and the Craft of Innovation. New York: Oxford University Press; www.1000ventures.com.

Discussion Question 11: How can the five stages of innovation used by Corning be used to help address the first dilemma—defining the scope of innovation? Managing the Pace of Innovation

Firms need to regulate the pace of innovation. Radical and incremental innovations need different amounts of time to realistically come to fruition. The project timeline of an incremental innovation may be six months to two years, whereas a more radical innovation may take ten years or more. Thus, radical innovations often involve more exploration in which experimentation makes strict timelines unrealistic. In contrast, firms that are innovating incrementally may use a milestone approach that is more stringently driven by goals and deadlines. The concept of time pacing is introduced and defined. We provide the examples of Intel and Apple as firms that effectively managed their product development using time pacing. F. Staffing to Capture Value from Innovation People are central to the process of identifying, developing, and commercializing innovations. Human resource practices that support innovation help companies effectively capture value from innovation activities. Discussion Question 12: What are examples that you are familiar with of other HR practices that companies have used to enhance their innovation activities?

The SUPPLEMENT below highlights the importance of managing the human resources that contribute to a company‘s innovation efforts. Extra Example: It Takes Time to Build Effective R&D Teams According to Harvard Professor Rosabeth Moss Kanter, the human side of innovation is often overlooked. Teams that are headed by technical experts rather than leaders often fail to emphasize external communications, because they believe the strongest innovative ideas will ―speak for themselves‖ and don‘t need to be championed. Technical types also falter because they emphasize tasks rather than build the kind of internal relationships and chemistry that teams need to turn underdeveloped ideas into successful innovations. Another problem relates to the length of time organization members typically spend on innovation teams. Researchers at the Massachusetts Institute of Technology found that it takes at least two years for an R&D team member to be truly productive. Food manufacturing giant Pillsbury made a similar discovery about the time required to take a new product from the idea stage to commercialization—it takes 24 to 26 months. However, the average R&D team membership at Pillsbury was just 18 months. ―No wonder the company was falling behind in innovation,‖ says Kanter. Source: Kanter, R. M. 2006. Innovation: The classic traps. Harvard Business Review, November: 72–83.

Discussion Question 13: What other factors determine how effectively an innovation team performs? Collaborating with Innovation Partners

Innovation partners can provide skills and insights that are often needed to make innovation projects succeed. Strategic partnering has other benefits as well. It requires firms to identify their strengths and weaknesses and make choices about which capabilities to leverage, which need further development, and which are outside the firm‘s current or projected scope of operations. Firms need a mechanism to help decide whom to partner with. Firms need to ask what competencies they are looking for and what the innovation partner will contribute. Innovation partnerships also need to specify how the rewards of the innovation will be shared and who will own the intellectual property that is developed. Discussion Question 14: What are some examples that you are familiar with of companies that have joined forces in order to collaborate on an innovation? What was the outcome of the collaboration? Discussion Question 15: What are some of the reasons a company would chose to partner on an innovation project? Discussion Question 16: What is the downside of partnering for the purpose of product or process innovation?

In the SUPPLEMENT below, we discuss how pharmaceutical firms scour the globe for new innovative compounds to cure diseases. Extra Example: The Role of Pharmaceutical Scouts in Keeping Big Drug Firms Innovative Sports teams have long used scouts to travel around the world looking for up-and-coming talent that will serve as the future lifeblood of major league teams. Pharmaceutical firms are now following the same path, employing scouts who travel around assessing the potential of new drugs being developed around the world and signing them to the pharma firm‘s ―team‖ before competitors can. In the past, large pharma firms preferred to develop drugs in-house. But these firms have found limited success in developing blockbuster new treatments to treat challenging diseases, such as diabetes, cancer, and Alzheimer‘s. This has led firms to increasingly look to outside partners with early stage development drugs as partners. As a result, over 1/3 of the drugs being developed in large pharma firms were initially discovered outside the firms. To accomplish the task, the major pharma firms have developed staffs of scientists and researchers who are experts in different diseases and technologies. They then send out these scouts to attend conferences, listen to talks, develop relationships with researchers in small firms and university labs so that the firm can develop knowledge about drugs in the early stage of development. If a drug looks promising, the pharma firm tries to strengthen the relationship with the small firm or university lab and begin the process of making a deal to acquire or co-develop the drug with the smaller firm. In one example of this, Johnson & Johnson (J&J) had its eyes on a small California firm, Pharmacyclics, that was developing a new drug to treat blood cancers. The drug was so early in development that it didn‘t even have a name yet. J&J initiated a conversation with the firm about making a deal in 2010, but J&J lacked expertise in blood cancers, and Pharmacyclics was initially skeptical of working with J&J. J&J set out to strengthen its scout team and recruited a new researcher from a competing pharma firm, Merck. J&J sent its new scout, Peter Lebowitz, to check out Pharmacyclics and its experimental cancer drug in early 2011. After spending three days checking out the drug and the firm, Lebowitz emailed his boss and said, ―We have to get this one.‖ He and other J&J executives made several trips to court the California firm and signed a deal to co-develop the drug with Pharmacyclics in December of that year. This development deal along with others J&J has made have rejuvenated J&J‘s drug portfolio. The drug developed by the firm, now branded as Imbruvica, is now coming on the market and has shown great potential in treating a rare lymphoma and a type of leukemia. One investment bank estimates Imbruvica will generate $1.3 billion in revenue for J&J in 2017. Source: Rockoff, J. 2014. Pharmaceutical Scouts Seek New Star Drugs for Cancer, Diabetes. wsj.com. March 9: np.

Discussion Question 17: What other industries could use a scout team approach to identify innovation partners? The Value of Unsuccessful Innovation

This section draws on research by NYU Professor JP Eggers that challenges conventional wisdom that there is a great deal of risk with innovations and, if firms pick the wrong technology, they are doomed. His research suggests that firms that initially choose the wrong technology often end up dominating the market in the long run. The key is to be open to change and to learn from early mistakes. He offers the following insights for firms pursuing innovation:    

Avoid overcommitting Don‘t let shame or despair knock you out of the game Pivot quickly once you realize you‘ve made a mistake Transfer knowledge from the failure to other market opportunities



Be aware that it is dangerous to be right at the outset since it often leads to complacency

We also discuss insights from Julian Birkinshaw‘s research on how firms can benefit from innovation failures. These include:    

Actively studying the firm‘s failures Crystalize insights from failures and share them throughout the organization Leaders need to occasionally undertake an overall assessment of the firm‘s innovation efforts to look for patterns in successes and failures Consider if the firm is becoming too conservative in order to avoid failure

II.

Corporate Entrepreneurship

PowerPoint Slide 19: Corporate Entrepreneurship PowerPoint Slide 20: Corporate Entrepreneurship: Focused Approach PowerPoint Slide 21: Corporate Entrepreneurship: New Venture Groups PowerPoint Slide 22: Corporate Entrepreneurship: Dispersed Approaches PowerPoint Slide 23: Corporate Entrepreneurship: Entrepreneurial Culture PowerPoint Slide 24: Corporate Entrepreneurship: Resource Allotments PowerPoint Slide 25: Corporate Entrepreneurship: Product Champions PowerPoint Slide 26: Corporate Entrepreneurship: Measuring Success PowerPoint Slide 27: Corporate Entrepreneurship: Exit Champions Corporate entrepreneurship (CE) refers to building entrepreneurial businesses within existing corporations. It has two primary aims: the creation of new venture opportunities and strategic renewal. In this section, we address corporate growth and renewal via internal venture development. All the factors that influence the strategy implementation process—corporate culture, leadership, features of organizational structure, and rewards and learning systems—will affect how corporations engage in internal corporate venturing. In some large corporations, the spirit of entrepreneurship permeates every part of the organization. It is found in companies where the strategic leaders and the culture together generate a strong impetus to innovate, take risks, and seek out new venture opportunities. Two distinct approaches to corporate entrepreneurship—focused corporate venturing and dispersed CE activities—are discussed in the next two sections. Discussion Question 18: What are some examples of major corporations that have a strong entrepreneurial spirit? A.

Discussion Question 19: What actions have they taken that make them entrepreneurial? Focused Approaches to Corporate Entrepreneurship

Firms using a focused approach typically separate the corporate venturing activity from the other ongoing operations of the firm. That is, CE is usually the domain of autonomous work groups that pursue entrepreneurial aims independent of the rest of the firm. Two forms—new venture groups (NVGs) and business incubators—are among the most common types of focused approaches. The SUPPLEMENT below describes one type of highly focused entrepreneurial environment—Samsung‘s ―VIP Center‖ where innovative ideas and engineering problems are addressed with great intensity and speed. Extra Example: Samsung‘s Intensely Focused VIP Center In order to build the capability to innovate, Darrell K. Rigby, Jeff Sutherland, and Hirotaka Takeuchi argue that firms need to embrace agility. To be agile, firms need to focus on four values and principles as the basis of strategy and innovation: •

People over processes and tools: Build projects around motivated team members. Management‘s role is to give the team the support they need, to get out of the way, and to trust the team to get the job done.

•

Working prototypes over excessive documentation: Rather than designing entire projects or products, teams should prototype small parts or modules of the product and test them with a few customers. If the modules are valued, keep them and move onto the next module. If not, work to fix or rework the module. Disagreements within the team should be solve through experimentation.

•

Respond to change rather than follow a plan: Teams should create a general vision but not a detailed plan, and instead, work out a plan as the project progresses. Changes that occur as the process unfolds should be accepted and even celebrated because they keep the team connected to what will be valued by the customer.

•

Customer collaboration over rigid contracts: The customer is key to product development. Use rapid prototyping, frequent market tests, and regular collaboration to keep the focus on customer engagement and value. Source: Rigby, D., Sutherland, J., & Takeuchi, H. 2016. Embracing agile. hbr.org. May: np.

Discussion Question 20: What are the advantages and disadvantages of an agile organization? 1.

New Venture Groups

Corporations often form new venture groups whose goal is to identify, evaluate, and cultivate venture opportunities. These groups typically function as semi-autonomous units with little formal structure. A NVG‘s mandate often extends beyond innovation and experimentation to coordinating with other corporate divisions, identifying potential venture partners, gathering resources, and, in some case, actually launching the venture. Discussion Question 21: What are the advantages and disadvantages of separating New Venture Group activities from other ongoing operations of the corporation? Explain. Discussion Question 22: What are the advantages and disadvantages of acquiring existing companies as a way to expand corporate innovation activities? 1-420 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Teaching Tip: Even organizations that have New Venture Groups often fail to convert their efforts into profit-making successes. Ask students what is it about large corporations that makes it difficult for smart, new ideas to find a home? Why is it that corporations frequently have to go outside the organization to find fresh ideas? This line of questioning can provide a means to address other implementation issues such as structure, control, and reward systems and how they contribute to or distract from successful corporate innovation and venturing. 2.

Business Incubators

Business incubators are designed to ―hatch‖ new businesses. They are a type of corporate new venture group with a more specialized purpose—to support and nurture fledgling entrepreneurial ventures until they can thrive on their own as stand-alone businesses. Company-sponsored incubators provide experience and resources. The following five functions are typically provided by corporate parents: 1. 2. 3. 4. 5.

Funding Physical Space Business Services Mentoring Networking

The SUPPLEMENT below describes Chipotle‘s efforts to spur food innovation by launching a business incubator. Extra Example: Chipotle‘s Business Incubator In 2018, Chipotle launched a business incubator to help food entrepreneurs to build their business ideas. The incubator brings food entrepreneurs in for a seven-month program that includes mentoring from industry leaders, such as urban farming entrepreneur, Kimbal Musk, and Richard Blais, the winner of Bravo‘s ―Top Chef All-Stars.‖ The program is designed for businesses operating in the areas of alternative farming, agricultural technology, food waste and recovery, and plant and alternative products. ―Chipotle has been committed to the future of food with integrity since opening our first restaurant 25 years ago,‖ CEO Brian Niccol said in a statement. ―Since then, we‘ve changed how customers and the industry think about food, and as part of our mission to cultivate a better world, we‘re looking for the next generation of entrepreneurs who are disrupting the food landscape.‖ Source: Meyer, Z. 2018. Chipotle joins growth field of food-startup incubators. USA Today, August 24: 3B.

Discussion Question 23: What are the advantages and disadvantages of company sponsored incubators as a way to support corporate entrepreneurial ventures? Dispersed Approaches to Corporate Entrepreneurship

Corporate entrepreneurship that is dispersed occurs when a dedication to the principles and practices of entrepreneurship is spread throughout the organization. Organizational members don‘t have to be reminded to think entrepreneurially or be willing to change. That ability is 1-421 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

considered to be a core capability. Such corporations often have a reputation for being entrepreneurial. Three related aspects of dispersed entrepreneurship include entrepreneurial cultures, resource allotments to support entrepreneurial actions, and the use of product champions in promoting entrepreneurial behaviors. 1.

Entrepreneurial Culture

A culture of entrepreneurship is one in which the search for venture opportunities permeates every part of the organization. Everyone is attuned to opportunities to leverage the assets and capabilities of the corporation to create new businesses. Discussion Question 24: What are some examples of firms that you are familiar with that have an entrepreneurial culture? Discussion Question 25: What are the elements of an entrepreneurial culture? That is, what does it take in terms of beliefs, values, incentives, rewards, and so forth for an organization to be continually thinking about entrepreneurial opportunities? 2.

Resource Allotments

Corporate entrepreneurship will only be successful if firms are willing to commit the resources necessary to both generate and implement innovative ideas. Some firms, such as 3M and Intuit, provide employees with time to generate and develop innovative ideas. Firms can also provide capital to internal entrepreneurs to develop new businesses. Johnson & Johnson, Nike, and Google are provided as examples of firms that provide financial support for corporate entrepreneurs. Discussion Question 26: What are some other examples of firms that provide resources to entrepreneurs within the firm? What are some innovative products that have come out of these programs? Discussion Question 27: Does providing time for entrepreneurial idea development work for all firms or for certain types of firms? For what types of firms does it offer the most potential?

Product Champions

In some organizations, even the best ideas have difficulty getting accepted. Therefore, many corporations rely on product champions to develop and build support for an entrepreneurial venture. A new venture idea must pass through two critical stages or it may never get off the ground—project definition and project impetus: 1. Project Definition

A promising opportunity has to be justified in terms of whether it will be attractive in the marketplace and how well it fits with the corporation‘s other strategic objectives.

2. Project Impetus

The strategic and economic impact of a project must be supported by senior managers who have experience with similar projects. Then it becomes an embryonic business with its own organization and budget.

The role of product champions is to generate support, especially during the time after a new project has been defined but before it gains momentum. They form a link between the definition and impetus stages of development. They do this by procuring resources and stimulating interest in the project.

Discussion Question 28: What are some examples of companies that have a favorable policy toward product champions? Measuring the Success of Corporate Entrepreneurship Activities

This section asks, ―Is corporate entrepreneurship successful?‖ What factors do corporations consider when evaluating the success of CE programs? 1.

Comparing Strategic and Financial CE Goals

Just over 50 percent of corporate venturing efforts reach profitability (measured by ROI) within six years of their launch. In addition to financial goals, however, most CE programs also have strategic goals. Three questions should be used to assess the effectiveness of a corporation‘s venturing initiatives: 1. Are the products or services offered by the venture accepted in the marketplace? 2. Are the contributions of the venture to the corporation‘s internal competencies and experience valuable? 3. Is the venture able to sustain its basis of competitive advantage? Another way to evaluate a corporate venture is in terms of the four criteria from the 1-423 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Balanced Scorecard. Discussion Question 29: Should the same criteria that are used to evaluate corporate performance in general also apply to corporate entrepreneurship? Why or why not? 2.

Exit Champions

Many entrepreneurial initiatives never work out or turn into profitable ventures. However, companies often wait too long to terminate a new venture and do so only after large sums of resources are used up, or worse, result in a marketplace failure. Corporations can avoid these costly defeats by supporting a key role in the CE process— ―exit champions.‖ Exit champions question the viability of venture projects and hold the line on ventures that appear shaky. Exit champions reduce ambiguity by gathering hard data and developing a case for why a project should be killed.

III.

REAL OPTIONS ANALYSIS: A USEFUL TOOL

PowerPoint Slide 29: Corporate Entrepreneurship: Real Options Analysis PowerPoint Slide 30: Corporate Entrepreneurship: Real Options Limitations This section discusses the practical implications of real options analysis (ROA) as a tool that has been adopted by executives and consultants to support the strategic decision-making in firms. The term ―real options‖ applies to situations where option theory and valuation techniques are applied to real assets or physical things, in contrast to financial assets. The two sections below address the potential applications of ROA as well as some possible drawbacks. A. Applications of Real Options Analysis to Strategic Decisions The concepts of options can be applied to strategic decisions to give management flexibility. That is, it enables management to decide whether or not to invest additional funds to grow or accelerate an activity, delay perhaps to learn more, shrink the scale of the activity, or abandon it altogether. This aspect makes ROA attractive in a corporate venturing context because firms can have the prospect of high gains with relatively little upfront investments that represent limited losses. The real options logic used by auto parts maker Johnson Controls provides an illustration. STRATEGY SPOTLIGHT 12.4 illustrates how corporate venture capital investments can be used in non-technology firms such as the insurance company Aflac or the auto giant Toyota. Teaching Tip: To illustrate the rather abstract concept of Real Options, you may ask students why companies provide business students with internships. You may probably give many answers that include reasons such as improved public relations, meet shortterm staffing needs, or trying out the candidate to see whether full-time employment will be later offered. The latter option is, of course, an application of real options theory. 1-424 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

That is, the firm is writing an option on the individual and can later either kill the option (i.e., terminate the employment relationship) or exercise the option by hiring the individual on a full-time basis. In this manner, the firm may benefit from a long-term benefit while risking only a short-term investment. Potential Pitfalls of Real Options Analysis We address some of the potential downsides of using ROA. These include: Agency Theory and the Back-Solver Dilemma—wherein managers may have an incentive and the know-how to ―game the system.‖ Managerial Conceit: Overconfidence and the Illusion of Control—in which managers may shift away from careful analysis and rely on their ―superior judgment;‖ they believe they have the ability to reduce risks inherent in decision making. Managerial Conceit: Irrational Escalation of Commitment—because the ―option to exit‖ requires reversing a decision often made by incumbent managers who are still employed by the firm, there may be a tendency to further invest in less promising opportunities—to save one‘s reputation. Discussion Question 30: What are the advantages and disadvantages of using a real options approach to evaluating entrepreneurial opportunities?

In the SUPPLEMENT below we link real options analysis to the task of evaluating promising innovations in an entrepreneurial context. Extra Example: Using Real Options to Manage Innovation Strategies A real options approach provides an ideal way for entrepreneurial firms to experiment by making incremental investments. Staging investments is a useful technique for companies seeking to explore opportunities and also avoid costly mistakes. Investments should be aimed at testing assumptions and resolving critical unknowns. Once a company has invested in the appropriate experiments, it is usually faced with one of four options:    

Double down—when winning strategies are identified, its time to move forward rapidly including making additional investments if necessary. Continue exploring—experiments may require further investments to reduce uncertainty and fully test assumptions Adjust the game plan—experiments sometimes reveal that when one way is blocked another is open; if so, change the approach and keep experimenting Shelve—when no clear path forward exists, it is best to cease investing until something changes

Another issue that companies must manage is the number of projects it attempts to handle at once. It‘s important to experiment with a lot of ideas at first but once the unpromising ones have been identified, companies need to focus and avoid trying to move dozens of ideas forward simultaneously. It‘s also important to make decisions rapidly and move forward quickly on the projects with the fewest uncertainties and highest potential. Thus, a real options approach provides a useful way to manage innovation. Source: Anthony, S. D., Eyring, M., & Gibson, L. 2006. Mapping your innovation strategy. Harvard Business Review, 84(5): 13–23. 1-425 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 31: Can you think of situations where a real options strategy might not be the best approach to managing innovation? Hint: 1) when a decision to acquire a young firm requires a rapid response; 2) when a new technology requires a large initial investment.

IV.

Entrepreneurial Orientation

PowerPoint Slide 31: Entrepreneurial Orientation PowerPoint Slide 32: Entrepreneurial Orientation: Dimensions PowerPoint Slide 33: Entrepreneurial Orientation: Autonomy PowerPoint Slide 34: Entrepreneurial Orientation: Innovativeness PowerPoint Slide 35: Entrepreneurial Orientation: Proactiveness PowerPoint Slide 36: Entrepreneurial Orientation: Competitive Aggressiveness PowerPoint Slide 37: Entrepreneurial Orientation: Risk Taking Entrepreneurial orientation (EO) refers to the strategy-making practices and decision-making styles that businesses use in identifying and launching corporate ventures. It consists of five dimensions which work together to enhance a firm‘s entrepreneurial performance—autonomy, innovativeness, proactiveness, competitive aggressiveness, and risk taking. EXHIBIT 12.3 summarizes the dimensions of an entrepreneurial orientation. The SUPPLEMENT below illustrates how Coca-Cola is trying to enhance its entrepreneurial orientation by pushing entrepreneurs outside the formal boundaries of the firm. Extra Example: Coca-Cola Becomes More Entrepreneurial by Kicking Entrepreneurs Out of the Firm If you ask 100 people to name the most entrepreneurial large firms, few people, if any, would name Coca-Cola. But Coke is trying to increase its entrepreneurial orientation in an interesting way. They tell entrepreneurs to leave the firm. What is the logic behind Coke‘s actions? Coke found that trying to foster entrepreneurial ventures inside the firm was largely unsuccessful. Initially, it tried to offer incentives for current Coke employees to develop innovative ideas, but that didn‘t work. Employees were simply too focused on and too busy with their day jobs, and the culture inside Coke didn‘t wholeheartedly support entrepreneurial thinking. Then the firm tried bringing in ―entrepreneurs in residence‖ but found that these entrepreneurs seemed to be enculturated into the ―corporate lifestyle‖ in Coke. Now, Coke has decided to tap outside innovation by providing seed capital to technology and business models that have the potential to offer entrepreneurial solutions that can enhance Coke‘s bottom line. For example, Coke helped fund an Australian start-up, Vending Analytics, that helps Coke make better sense of the usage patterns of its 10 million vending machines. Ironically, some of the start-ups Coke is working with are headed up by former Coke employees. For example, Wonolo is a business that is developing a sharing platform for workers. Think of it as aiming to be Uber for labor. It has the potential to add value to Coke by allowing Coke to flexibly hire workers to stock shelves or hand out Cokes or other beverages at promotional events. Wonolo is the brainchild of AJ Brustein and Yong Kim, two former Coca-Cola employees. Though Coke saw potential with Wonolo‘s concept, it told Brustein and Kim to leave the firm to develop their business. Brustein saw clear advantages in breaking away. ―Things got in the way of us operating like a true start-up, things like offering employees equity, which is key if you‘re going after the best engineering talent…,‖ Brustein said, ―Now we‘re far more agile.‖ 1-426 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

How does Coke benefit? Coke invests in these start-ups, typically $250,000 to $500,000 which converts to up to 20 percent ownership if the firm goes public. More importantly, Coke gets to implement the emerging ideas before others. As David Butler, Coke‘s VP of innovation and entrepreneurship, commented, ―This is the next wave of innovation for non-tech companies like us. It‘s now about co-creation, about providing seed funding and being their first customer. We know about soft drinks, but others can help us with tech-based solutions to problems in our business that we couldn‘t tackle.‖ Source: della Cava, M. 2015. Coke taps into start-up mojo. usatoday.com. May 26: np.

Discussion Question 32: What are the challenges Coke is likely to face as the firm relies on outside entrepreneurs to help the firm become more entrepreneurial? In this section, we will describe the five EO dimensions and how they contribute to internal venture development. A.

Autonomy

Autonomy refers to a willingness to act independently in order to carry forward an entrepreneurial vision or opportunity. It applies to both individuals and teams. In the context of CE, autonomy may apply to either dispersed or focused efforts. Corporate entrepreneurship requires that organizational members have time to investigate opportunities, act freely without fear of condemnation, and be allowed the independent thinking that goes into championing a corporate venture idea. We discuss two techniques often used to promote autonomy: 1. 2.

Using skunkworks to foster entrepreneurial thinking Designing organization structures that support independent action

Creating autonomous work units and encouraging independent action may have pitfalls that can jeopardize their effectiveness. Autonomous teams often lack coordination and excessive decentralization can create inefficiencies, such as duplication of effort and wasting of resources. Thus, for autonomous work units and independent projects to be effective, such efforts have to be measured and monitored. Discussion Question 33: How does autonomy help organizational members identify and develop entrepreneurial opportunities? The SUPPLEMENT below notes that one of the techniques corporations often use to achieve autonomy is physical separation. Extra Example: Corporations Use Physical Separation to Encourage Autonomy One of the key techniques that organizations use to create autonomy is physically separating venture development work teams from the rest of the organization. This is based on the belief, as some consultants put it, that companies seeking to develop innovations must ―plant seeds in walled gardens so that established business can‘t trample them.‖ 1-427 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

As a result, several major corporations have attempted physical separation as a way to create autonomous environments. Here are some examples: 

Procter & Gamble‘s ―Corporate New Ventures‖ division occupied a separate floor with a distinctly different appearance and a layout that encouraged informal meetings and easy exchange of information.



Raytheon initially housed its ―New Product Center‖ in run-down facilities that were physically separated from the company‘s headquarters.



Food processing company Barilla located its ―Divisione Prodotti Freschi‖ in an old building located several miles away from the firm‘s main office.



Spanish shoemaker Camper shields its 35 shoe designers from the influences of the fashion world by placing its design teams in remote locations such as a 17th-century estate and removed villages surrounded by mountains.

Sources: Hamner, S. 2005. Thinking outside the shoe box. Business 2.0, September: 68. Chesbrough, H. 2003. Open innovation: The new imperative for creating and profiting from technology. Cambridge, MA: Harvard Business School Press. Day, J.D., Mang, P. Y., Richter, A. & Roberts, J. 2001. The innovative organization: Why new ventures need more than a room of their own. The McKinsey Quarterly, 2: 21–31.

Discussion Question 34: Why do you think it is often necessary for corporations to use skunkworks and physical separation in order to stimulate entrepreneurial thinking in its corporate venture teams? Innovativeness

Innovativeness refers to a firm‘s efforts to find new opportunities and novel solutions. It involves creativity and experimentation and requires that firms depart from existing technologies and practices and venture beyond the current state of the art. Innovativeness is one of the major components of an EO. We discuss two methods companies can use to be innovative: 1. 2.

Fostering creativity and experimentation Investing in new technology, R&D, and continuous improvement

Pitfalls associated with innovativeness include potentially wasting resources, failure to innovate ahead of competitors, and limited funds for innovation during an economic downturn. In the SUPPLEMENT below, innovative practices from the domain of social entrepreneurship are highlighted. Extra Example: Four Practices of Innovative Social Organizations Daniel Bornstein writes about the role of innovativeness in the domain of social entrepreneurship. One of his key points is that to identify viable solutions, problems have to be conceptualized differently. This stems, in part, from the fact that social entrepreneurs often work in environments with highly constrained resources.

In his book How to Change the World, Bornstein describes four characteristics of innovative organizations that are valuable in any context, whether ―social‖ or not: 1. Institutionalize learning. Innovative organizations institute systems and guidelines for listening to their clients. Once you start listening to people, there is no limit to the ideas and opportunities that emerge. Childline, a 24-hour helpline and emergency response system for children in distress, provides explicit instructions to partner agencies about how to listen to children. 2. Pay attention to the exceptional. From the standpoint of innovation, the most important insights gained from listening or observing seem to come from exceptional or unexpected information, particularly unexpected successes. Muhammad Ynus, founder of the Grameen Bank, found this when the 42 poor villagers he loaned money to— people who were considered ―unbankable‖—promptly repaid the loans. 3. Real solutions for real people. One of the hallmarks of social entrepreneurs is that they are realistic about human behavior. They spend a great deal of time thinking about how to get their clients actually to sue their products. A key factor is communicating clearly and sensitively to the selected audience. 4. Focus on the human qualities. Organizations whose success hinges on high-quality human interaction generally pay close attention to soft qualities when recruiting, hiring, and managing staff. Ashoka, an organization that provides funding and support to social entrepreneurs, looks to hire people who are intrapreneurial, have strong ethical fiber, and consider themselves ―innovators for the public.‖ Source: Bornstein, D. 2004. How to change the world. New Delhi, India: Penguin.

Discussion Question 35: How might the innovative practices discussed above be used in for-profit settings? Are there major differences in how firms act innovatively depending on whether they are socially-oriented or not? Proactiveness

Proactiveness refers to a firm‘s efforts to find and seize new opportunities. Proactive organizations monitor trends, identify future needs, and anticipate changes in demand that can lead to new opportunities. Proactiveness involves not only recognizing changes but also being willing to act ahead of the competition. The benefit gained by firms that are the first to enter new markets, establish brand identity, implement administrative techniques, or adopt new operating technologies in an industry is called first mover advantage. First movers usually have several advantages. First, industry pioneers often capture unusually high profits because there are no competitors to drive prices down. Second, first movers are usually able to retain their image and hold on to the market share gains they earned by being first. First movers are not always successful. For one thing, the customers of companies that introduce novel products or embrace breakthrough technologies may be reluctant to commit to a new way of doing things. Second, some companies try to be a first mover before they are ready. We discuss two methods companies can use to be proactive: 1.

Introducing new products or technological capabilities ahead of the competition

Continuously seeking out new product or service offerings

Pitfalls associated with proactiveness include launching pioneering products that don‘t pay off and introducing brands that don‘t catch on.

Teaching Tip: Although many companies recognize the value of having an entrepreneurial orientation, not all seem to be able to develop one. Ask students to speculate on why so many firms have difficulty innovating, acting proactively, and taking risks. Possible reasons may include failure to recognize why an entrepreneurial orientation may be needed to effectively pursue opportunities, how to develop the competencies that support corporate venturing, or problems with culture, structure, and reward systems within the organization. This serves to reinforce the point made earlier in the chapter about how the innovation process has to be managed. It can also be used to emphasize the importance of having a vision and sense of direction in order to make the difficult choices that are often associated with entrepreneurial venturing as well as the challenge of coordinating entrepreneurial efforts across all aspects of the organization. Competitive Aggressiveness

Competitive aggressiveness refers to a firm‘s efforts to outperform its industry rivals. Companies with an aggressive orientation are willing to ―do battle‖ with competitors by slashing prices, sacrificing profitability to gain market share, or spending aggressively to obtain new capacity. However, unlike innovativeness and proactiveness, which tend to focus on market opportunities, competitive aggressiveness is directed toward competitors. In terms of SWOT analysis (Chapters 2 and 3) proactiveness, as we saw in the last section, is a response to opportunities—the O in SWOT. Competitive aggressiveness, by contrast, is a response to threats —the T in SWOT. A competitively aggressive posture is important for firms that seek to enter new markets in the face of intense rivalry. Strategic managers use competitive aggressiveness to combat industry trends that threaten their survival or market position. Sometimes firms need to be forceful in defending their competitive position or aggressive to ensure their advantages from capitalizing on new technologies or serving new market needs. We discuss two methods companies use to strengthen their position by being competitively aggressive: 1. 2.

Entering markets with drastically lower prices Copying the business practices or techniques of successful competitors

One practice companies use to overcome the competition involves making preannouncements of new products or technologies. These announcements signal both customers and competitors. 1-430 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

The SUPPLEMENT below discusses how Facebook competitively responds to new products. Extra Example: Facebook Relentlessly Mimics New Apps The founders at Houseparty lose sleep from the threat of Facebook overwhelming their app. Houseparty is a videochat app being used by over one million users monthly and has received over $50 million in investment. While it has generated good buzz, the founders know that the more success it has, the more aggressively Facebook will act to squeeze Houseparty. This is simply part of Facebook‘s business model. Facebook uses its own systems to monitor the behavior of its users. Facebook uses technology from an Israeli-based tech startup, Onavo, that Facebook acquired in 2013 to gauge what apps the firm should imitate. Using Onavo‘s technology, Facebook has developed a monitoring system that keeps track of what users do on their phones. This allows the firm to track which rival apps are being used by Facebook subscribers. When a rival app generates a lot of traffic, Facebook jumps into action and develops a competing app. In response to Houseparty‘s success, Facebook developed a competing app, Bonfire. While it‘s developed the app, it launched it as a standalone app. Houseparty believes it can defend its position and grow even with Bonfire out there. But if Facebook decides it‘s worth the effort to integrate video chat into the main Facebook app, all bets are off on Houseparty‘s ability to survive. Source: Morris, B. & Seetharaman, D. 2017. The new copycats: How Facebook squashes competition from startups. wsj.com. August 9: np.

A pitfall associated with competitive aggressiveness is damaged reputation due to excessive aggressiveness. E. Risk Taking Risk taking refers to a firm‘s willingness to seize a venture opportunity even though it does not know whether the venture will be successful. To obtain high returns, firms often assume high levels of debt, commit large amounts of firm resources, introduce new products or invest in unexplored technologies. Organizations and their executives face three types of risk: 1. Business risk taking

Venturing into the unknown without knowing the probability of success. This is the risk associated with entering untested markets or committing to unproven technologies.

2. Financial risk taking

Borrowing heavily or committing a large portion of resources in order to grow. Risk is used in this context to refer to the risk/return tradeoff that is familiar in financial analysis.

3. Personal risk taking

Risks that an executive assumes in taking a stand in favor of a strategic course of action. Executives who take such risks influence the course of their company and impact their careers.

Even though risk taking involves taking chances, it is not gambling. The best run companies investigate the consequences of various actions and create scenarios of possible outcomes in order to reduce the riskiness of business decisions. We discuss two methods companies can use to gain competitive advantages via risk taking: 1. 2.

Researching and assessing risk factors to minimize uncertainty Using techniques that have worked in other domains

A pitfall associated with risk taking is acting before the risks of a project are clearly understood. The SUPPLEMENT below identifies steps companies can take to reduce risk when the economy is weak. Extra Example: Confronting Risks in a Risky Economy Business is riskier when the economy is stormy. In such times, technology firms often have a particularly difficult time. But there have been bright stars among tech companies. Many of them were identified in the Business 2.0 list of the 100 fastest-growing tech companies. Based on an analysis of what these companies had in common, here is a summary of the actions they have taken to stay afloat during the downturn in the tech business cycle: 1. 2. 3. 4. 5. 6. 7.

Do one thing well. If you do one thing better than anyone else, in a downturn your customers will dump everyone else first. Watch your wallet. In a rough market, protecting cash flow is everyone‘s responsibility. Keep innovating. While others protect gains in a slow economy, top performers continue to spend on continually improving and inventing new products. Buy smart. Acquisitions need to be purposeful, that is, aimed at helping companies become better at what they already do. Supply the suppliers. Sell to those companies that are working hard to strike it rich. They need things to keep working. Hitch your wagon to a star. Some winning companies maintain relationships with the powerful; others make contracts with the federal government, which is all but immune to the business cycle. Have a backup plan. In unpredictable times, you have to be prepared to scramble. Source: Thomas, O. 2002. Seven Secrets of Success. Business 2.0, October, p. 87.

Discussion Question 36: How might the suggestions made in the example above be applied to your personal career planning and efforts?

Issue for Debate

Mazda is pursuing a different path than many other automakers by looking to build a gasoline engine that has a similar carbon footprint than an electric car. 1-432 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 37: Is Mazda’s strategy to innovate to improve on internal combustion engine vehicles a valuable direction to go? Students may differ on how they see this. From one perspective, Mazda is able to build an affordable car with better fuel mileage and lower emissions. Also, this vehicle doesn‘t require the development of battery recharging stations. Drivers can use existing gas stations. Thus, Mazda may be able to attract a sizable customer base who desires an economical car that is environmentally responsible. From a different perspective, if environmentally conscious customers see this as a half-measure and not as environmentally responsible as an electric car, Skyactiv-X vehicles may be stuck in the middle, too reliant on the environmental angle and too small for many drivers, and not environmentally responsible enough for more environmentally conscious car buyers. Also, Mazda risks being too slow in pursuing the electric car trajectory and missing out on the growth of that market. One additional point to bring up with students is that this could be seen as a shrewd move for a smaller auto manufacturer. With its limited size, Mazda has fewer resources to invest in long-term, uncertain technologies, such as lithium-ion battery electric cars. There is great uncertainty about how quickly electric cars will seize a sizable share of the auto market. As of now, due to their costs, they remain niche vehicles. Mazda could be looking to extract value from its existing technologies, waiting to pursue electric cars until a dominant technology for this market emerges and costs come down to the point that they will be cost competitive with gasoline engine cars. They will just need to time their entry into this market well. Discussion Question 38: If you were choosing between a Mazda with their more efficient engine or a similar-sized electric car, which would you select? Why? You are likely to get varying thoughts from students. This points to two issues. First, what are the value propositions that different customers have? Different potential customers value different things. This allows firms to differentiate themselves and pursue different segments of the market. Second, how big are the different segments that emerge from these varying value propositions? Students can see what the breakout of the views are in class, but the instructor should push them to think outside this sample base. The class‘s preferences may be biased due to student age and geographic area. It may be fruitful to discuss different customer segments in this market and how they each may view this technology relative to electric car technology. Discussion Question 39: What can Mazda do to have the best chance of succeeding with their more efficient gasoline engine vehicles? This discussion should include which geographic markets to pursue, which type of vehicles they should launch with the Skyactiv-X engine, and whether they should keep the technology proprietary or license it out to other manufacturers. As for geographic markets, it is likely that this type of product will be more attractive in markets where the economic conditions are not affluent enough for electric cars and where the charging infrastructure is less mature. Additionally, it likely has the greatest potential in markets 1-433 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

where consumers prefer smaller cars since the initial vehicle outfitted with the Skyactiv-X engine is a small sedan. Notably, they did not launch this product in the United States. The initial target markets were Japan and Europe, both markets that prefer smaller cars. As for types of cars, their initial vehicle is the Mazda 3, a small sedan, but one might argue that this technology has the greatest potential in SUVs and small trucks since the engine produces higher torque, a key attribute for towing and hauling heavier objects. Finally, the choice of whether to license the technology is a critical question. If students truly think this is a highly valuable differentiator for the market, the firm should likely keep it proprietary and strive to fully leverage its value. However, if students see this as an incremental technology that will only be valuable for a short window of time until electric cars mature, they should license it to other firms to extract as much value as they can until electric cars take a big share of the market.

VI.

Reflecting on Career Implications

PowerPoint Slide 38: Reflecting on Career Implications Below, we provide some suggestions on how you can lead the discussion on the career implications for the material in Chapter 12.  Innovation: Identify the types of innovations being pursued by your company. Do they tend to be incremental or radical? Product-related or process-related? Are there ways in which you can add value to such innovations, no matter how minor your contributions are? Ask students to identify specific innovation initiatives in their companies. Some may not be able to, and that lack of awareness is an issue to be addressed. Instructors can supplement the discussion by noting the constant stream of new product innovations across all industries that characterize the business environment. Radical innovations are most obvious, but incremental innovations matter, such as fixing a defective software package, or making a smart phone more reliable. Process innovations are also common. Companies have to innovate both to succeed and to keep up with competitors. It may be relevant to give students an assignment of investigating their firms‘ innovations. The point of the discussion is to increase students‘ awareness of their companies‘ innovation efforts.

Awareness of their companies‘ innovations is the first step in students‘ efforts to contribute to the innovation effort. The ways to contribute are as varied and numerous as there are employees. Students could participate in focus groups that discuss new product designs or do work on innovation initiatives. Usually, employees can make suggestions about how to improve products and processes. Because innovation is so important to firms‘ strategies, contributions from employees show initiative on the part of the students and set them up for participating in projects that will contribute to their firms‘ future growth.  Cultivating Innovation Skills: Exhibit 12.2 describes the five traits of an effective innovator (associating, questioning, observing, experimenting, and networking). Assess yourself on each of these traits. Practice the skills in your work and professional life to build your skills as an innovator. If you are interviewing for a job with an organization that is considered high on innovation, it might be in your interest to highlight these traits. Ask students to self-assess their innovation skills. It may be useful to ask students what their strongest trait is and defend their choice with a personal anecdote. Ask students if these innovation traits are worth building as they pursue their careers. The point is to emphasize to students the importance of innovation skills and to get them to understand the five dimensions of the concept. People with strong innovation skills tend to question everything and bring new approaches to their activities. In organizations that are considered high on innovation, these traits may tend to be recognized and appreciated. Students who exhibit these skills in the interview may have an advantage. Ask students how they could prepare for the interview. Some relevant answers may be to examine the firm‘s product offerings and suggest appropriate diversifications, consider using new media for advertising and selling, or consider an effort to improve interaction between the firm‘s divisions. Bringing these ideas to the interview may help to differentiate students from other, less well-prepared candidates.  Real Options Analysis: Success in your career often depends on creating and exercising career ―options.‖ However, creation of options involves costs as well, such as learning new skills, obtaining additional certifications, and so on. Consider what options you can create for yourself. Evaluate the cost of these options. In today‘s business environment, most executives have careers that involve multiple paths. And many successful people end up in rewarding careers that they did not intend to pursue when they were in school. (Perhaps the instructor has a similar career story.) Ask students how these career changes could happen. To some extent, they happen because of personal crises such as losing a job and then taking a new one in a different field. But preparing for career path changes may be worth considering. Such preparations may include getting new certifications, participating in new entrepreneurial ventures, or taking a challenging new assignment such as an expatriate posting. These experiences will broaden students‘ skill sets and capabilities and expose them to new possibilities. Some of these preparations will be worth considering, and some will not. Ask students how they can choose between a desirable and an undesirable career decision. What information will they need to consider? What trends would help them in their new career 1-435 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

trajectory? Rewarding career options can take many forms. It is not always so simple to just follow what everyone else is doing. A few years ago, many people saw IT as a growth field and now that field is oversupplied, and job prospects are low. It may pay off to develop options in less popular fields, but fields where students can develop and exploit their unique skills and capabilities. The costs of deciding to take a challenging new job, such as an expatriate posting, are significant and worth considering. Such a posting may take the employee away from headquarters and a seemingly stable career path. The major cost is the risk that the posting will not pay off in career success. Ask students what they can do to reduce the risk. Perhaps they could look at the careers of others who took similar postings in the past. They could seek a contractual guarantee of a position upon repatriation. During their posting, they could make efforts to keep up with events at the home office through a mentor. With today‘s global communication technology, geographical distance is not the barrier it used to be.  Entrepreneurial Orientation: Consider the five dimensions of entrepreneurial orientation. Evaluate yourself on each of these dimensions (autonomy, innovativeness, proactiveness, competitive aggressiveness, and risk taking). If you are high on entrepreneurial orientation, you may have a future as an entrepreneur. Consider the ways in which you can use the experience and learning from your current job to become a successful entrepreneur in later years. On way to begin the discussion is to emphasize that entrepreneurs are the lifeblood of economic growth, so they are an important part of the economy. Then ask students if they want to be an entrepreneur, or maybe participate in an entrepreneurial venture at some point in their careers. Even if they do not want to participate, they may have to at some point. The point is that entrepreneurial activities are an ingrained part of business. Ask students to evaluate themselves on the five parts of the entrepreneurial orientation. Ask them which part is their strength and support their claim with a personal anecdote. This exercise will establish that students understand the concept and can apply it to themselves. The next step may be to ask students what plans they have for developing their entrepreneurial capabilities. Students may offer a range of answers, so ask them which plan would be most effective. During the discussion, it may be useful to point out that all entrepreneurial activities, even just dreaming about starting new ventures, are significant. The most effective plan may be to actually start a new business venture. The point here is to get students to think about incorporating entrepreneurial activities into their professional plans.

VII. SUMMARY To remain competitive in today‘s economy, established firms must find new avenues for development and growth. This chapter has addressed how innovation and corporate entrepreneurship can be a means of internal venture creation and strategic renewal, and how an entrepreneurial orientation can help corporations enhance their competitive position.

Innovation is one of the primary means by which corporations grow and strengthen their strategic position. Innovations can take several forms ranging from radical breakthrough type innovations to incremental improvement type innovations. Innovations are often used to update products and services or for improving organization processes. Managing the innovation process is often challenging because it involves a great deal of uncertainty, and there are many choices to make about the extent and type of innovations to pursue. By defining the scope of innovation, managing the pace of innovation, staffing to capture value from innovation, and collaborating with innovation partners, firms can more effectively manage the innovation process. We also discussed the role of corporate entrepreneurship in venture development and strategic renewal. Corporations usually take either a focused or dispersed approach to corporate venturing. Firms with a focused approach usually separate the corporate venturing activity from the ongoing operations of the firm in order to foster independent thinking and encourage entrepreneurial team members to think and act without the constraints imposed by the corporation. In corporations where venturing activities are dispersed, a culture of entrepreneurship permeates all parts the company in order to induce strategic behaviors by all organizational members. In measuring the success of corporate venturing activities, both financial and strategic objective should be considered. Real options analysis is often used to make better quality decisions in uncertain entrepreneurial situations. However, a real options approach has potential drawbacks. Most entrepreneurial firms need to have an entrepreneurial orientation: the methods, practices, and decision-making styles that strategic managers use to act entrepreneurially. Five dimensions of entrepreneurial orientation are found in firms that pursue corporate venture strategies. Autonomy, innovativeness, proactiveness, competitive aggressiveness, and risk taking each make a unique contribution to the pursuit of new opportunities. When deployed effectively, the methods and practices of an entrepreneurial orientation can be used to engage successfully in corporate entrepreneurship and new venture creation. However, strategic managers must remain mindful of the pitfalls associated with each of these approaches.

End-of-Chapter Teaching Notes Chapter 12: Managing Innovation and Fostering Corporate Entrepreneurship Summary Review Questions 1. What is meant by the concept of a continuum of radical and incremental innovations? (In text, Managing Innovation, LO 12-1) Response: Innovations are the use of new knowledge to transform organizational processes or create commercially viable products and services. Radical innovations fundamentally change existing practices, and incremental innovations enhance existing practices or make small improvements in products and processes. Some innovations are barely incremental, such as frozen yogurt, which is a bit different from ice cream. More radical innovations include laparoscopic surgery, which radically changes the patient preparation and recovery and surgeon skill set needed for many surgical procedures. Most innovations fall in between these extremes along a continuum based on how much the innovation changes existing practices. There is no set formula for determining the extent of radicalness of an innovation. (Note to instructor) It may be interesting to engage students on the question of the degree of radicalness of an innovation. Debating different perspectives will reinforce the concept. 2. What are the dilemmas that organizations face when deciding what innovation projects to pursue? What steps can organizations take to effectively manage the innovation process? (In text, Managing Innovation, LO 12-2) Response: When firms pursue innovations, they have to make several choices that have uncertain outcomes and can affect the innovation‘s likelihood of success. Five of these choices involve critical tradeoffs and include:  Seeds versus weeds—or the choice between a likely successful innovation project (seed) and one that will not be successful (weed)  Experience versus initiative—or the choice in project manager between an experienced top executive, with credibility and knowledge, or a midlevel employee who has enthusiasm and perhaps more specialized expertise  Internal versus external staffing—internal staffing will be closely connected with the organization and its culture but may not have the best expertise and will have to have their current positions replaced.  Building capabilities versus collaborating—internal development will minimize organizational disruptions but will cost time and money to learn the innovation. Collaborating with partners will enable the firm to use the resources and skills of other 1-438 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.



firms, but can create dependencies, incur transaction costs, and reduce the potential benefit from the innovation because profits will be shared. Incremental versus preemptive launch—incremental launch is less costly and enables firms to develop and test the innovation, but it takes longer and gives competitors a chance to enter the market.

Firms can use four methods to manage the innovation process and keep it from becoming too expensive, taking too long, and/or incurring too much risk. First is defining the scope of the innovation, which puts boundaries on the project to ensure that it does not develop into an area outside the firm‘s interests and ability to support. Second is to manage the pace of innovation, which involves the firm‘s timeline for developing the innovation, and committing appropriate funds, staff, and other resources to the project. Third is staffing to capture value from innovation—which involves identifying the skills, knowledge, and expertise needed to complete the project and committing the appropriate set of employees. Fourth is collaborating with innovative partners—or identifying the capabilities that the firm needs but does not have--and working with the right partners to access needed capabilities. Structuring the relationship to develop the innovation is an important part of the collaboration. 3. What is the difference between focused and dispersed approaches to corporate entrepreneurship? (In text, Corporate Entrepreneurship, LO 12-3) Response: Corporate entrepreneurship is the creation of new value for a corporation through investments that create either new sources of competitive advantage or renewal of the value proposition. Focused approaches mean that the entrepreneurship activities are isolated from the rest of the corporation and worked on in independent work units. Dispersed approaches have all parts of the organization engaged in intrapreneurial activities. 4. How are business incubators used to foster internal corporate venturing? (In text, Entrepreneurial Orientation, LO 12-6) Response: Business incubators, a type of focused corporate entrepreneurship, are corporate new venture groups that support and nurture fledgling entrepreneurial ventures until they can thrive on their own as stand-alone businesses. Business incubators are designed to ―hatch‖ new businesses by providing support such as funding, physical space, business services, mentoring, and networking. 5. What is the role of the product champion in bringing a new product or service into existence in a corporation? How can companies use product champions to enhance their venture development efforts? (In text, Corporate Entrepreneurship, LO 12-3)

Response: Product champions, a type of dispersed corporate entrepreneurship, are individuals working within corporations who bring entrepreneurial ideas forward, identify what kind of markets exist for the products or services, find resources to support the ventures, and promote the venture concepts to upper management. To be successful, product champions must clearly define the project, its potential to create value, and its fit within the existing corporate mission and other strategic objectives. And product champions must win project impetus or support from senior managers who have experience with similar projects. Companies can use product champions to overcome reluctance or skepticism of innovative ventures. Champions can contact potential customers, demonstrate the need for the product or service, construct budgets, and contact a few sympathetic other managers. As a result, the product champion creates a bridge between product definition and product impetus. After sufficient time and development, the product champion can present top management with a convincing proposal in which the innovation has a market, a feasible design, and a fit within the company‘s other strategic objectives. 6. Explain the difference between proactiveness and competitive aggressiveness in terms of achieving and sustaining competitive advantage. (In text, Entrepreneurial Orientation, LO 12-6) Response: Entrepreneurial orientation is the strategy-making practices that businesses use in identifying and launching new ventures, consisting of autonomy, innovativeness, proactiveness, competitive aggressiveness, and risk taking. Proactiveness is a forward-looking perspective characteristic of a marketplace leader that has the foresight to seize opportunities in anticipation of future demand. Competitive aggressiveness is an intense effort to outperform industry rivals characterized by a combative posture or an aggressive response aimed at improving position or overcoming a threat in a competitive marketplace. Proactiveness achieves and sustains competitive advantage through first mover advantages. It is a response to market opportunities. First movers can establish brand identity with customers, prevent competitors from access to key resources, move down the experience curve, and set industry standards for technology, product performance, and distribution. Competitive aggressiveness is directed at threats in the environment, namely competitors. Rather than being forward-looking, competitive aggressiveness achieves and sustains competitive advantage by using a business model that enables either lower costs or higher quality than competitors can match. For example, a firm that uses open-source software will have lower software development costs than a competitor that develops software in house. With reference to SWOT analysis, proactiveness addresses the ―O‖ part—opportunities. Competitive aggressiveness addresses the ―T‖ part—threats. 1-440 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

7. Describe how the entrepreneurial orientation (EO) dimensions of innovativeness, proactiveness, and risk taking can be combined to create competitive advantages for entrepreneurial firms. (In text, Entrepreneurial Orientation, LO 12-6) Response: Entrepreneurial orientation is the strategy-making practices that businesses use in identifying and launching new ventures, consisting of autonomy, innovativeness, proactiveness, competitive aggressiveness, and risk taking. Innovativeness is the willingness to introduce novelty through experimentation and creative processes aimed at developing new products and services as well as new processes. Proactiveness is a forward-looking perspective characteristic of a marketplace leader that has the foresight to seize opportunities in anticipation of future demand. Risk taking is making decisions and taking action without certain knowledge of probably outcomes; some undertakings may also involve making substantial resource commitments in the process of venturing forward. Entrepreneurial firms can develop strategies of continuously developing new products and innovations that anticipate consumer demands. The strategy is to exploit first mover advantages for the new product. When competitors manage to enter the industry with similar products, the firm has learned enough about consumers to launch its next innovative product(s). This strategy is proactive because it is forward looking and exploits opportunities in the marketplace. It is innovative because the products are new, experimental, and different. It is risk taking, but not gambling, because the firm does careful research of customer preferences and latent needs and uses its findings to develop educated guesses as to what customer needs it can feasibly meet with future innovations. Experiential Exercises and Application Questions 1. Select two different major corporations from two different industries (you might use Fortune 500 companies to make your selection). Compare and contrast these organizations in terms of their entrepreneurial orientation. Response: The table below is suggestive. There are no right or wrong answers to the question. But the points are supported with examples. Entrepreneurial Orientation Autonomy

Innovativeness

Proactiveness

Company A (Walmart) Low—most operations are centered in Bentonville, Arkansas

Moderate—new products frequently introduced, including pharmacies and photography studios. Moderate—some entrepreneurial

Company B (Google) High—independent divisions enter new businesses and operate them in different manners. All new businesses are complementary and fit the organizational mission. High—cutting edge technologies and services offered. New advertisingbased business model developed. High—Very forward-looking in its

activities are designed to respond to competitors. But basic strategy of offering low cost products remains.

Competitive Aggressiveness

High—Near fanatic devotion to offering lower prices than the competition.

Risk Taking

High—New ventures are thoroughly investigated before launch

approach to the industry. Working to set standards in areas such as advertising, and combining various types of information (examples: YouTube, Google Earth, and Gmail). Moderate—aggressive in entering new markets and combining services, but has allowed competitors in the search engine business to catch up. Moderate—Perhaps because the customer base is so variable and the technology uncertain, it is difficult to calculate risks. Some ventures do not seem reasonable and have hurt Google, such as the effort that led to recording of private information.

Based on Your Comparison: 

How is the corporation’s entrepreneurial orientation reflected in its strategy?

Response: In both cases, the strategy does fit with EO. Walmart is a cost-cutter, so it emphasizes competitive aggressiveness. Google emphasizes innovativeness. (Note to instructor) We suggest you first establish the degree of entrepreneurial orientation in each firm. Ask students to identify each firm‘s new ventures in the past two to three years. Then ask students to link the new venture activities with each of the five EO strategy-making practices. 

Which corporation would you say has the stronger entrepreneurial orientation?

Response: Google seems to be the more entrepreneurial firm. It is more reliant on a stream of new ventures for its success. Walmart relies to a great extent on tried and true strategies for reducing costs. (Note to instructor) After the student answers this question, ask which of the EO strategy-making practices accounts for the firm‘s overall EO strength. Then ask the student for examples that demonstrate the claim. 

Is the corporation with the stronger entrepreneurial orientation also stronger in terms of financial performance?

Response: That is unclear. Walmart is much larger in terms of revenue, but Google is higher in profitability. It‘s probably invalid to compare profitability metrics like return on sales due to industry differences. However, Google relies on its corporate entrepreneurship for profits more than Walmart. 1-442 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

(Note to instructor) The purpose of this question is to ask students to investigate the link between entrepreneurial orientation and financial performance. After hearing students‘ answers to the question, ask them to identify the competitive advantages that generate each firm‘s financial performance. For the more entrepreneurial firm, ask how entrepreneurial ventures contributed to revenues (usually firms breakdown revenues by product and geographic market, so students should be able to estimate an answer to this question). Then ask about the costs of the new ventures. (Usually, costs for new ventures exceed revenues early on, and only after a couple of years or so do new ventures generate profits.) Will the new ventures generate more profits in future years? 2. Select a firm known for its corporate entrepreneurship activities. Research the company and discuss how it has positioned itself relative to its close competitors. Does it have a unique strategic advantage? Disadvantage? Explain. Response: (Note to instructor) Students should be able to tell if the firm has lower prices, higher quality products, brand equity, and first mover advantage. This competitive position will allow students to infer the firm‘s entrepreneurial orientation and the extent to which it exploits innovativeness, proactiveness, competitive aggressiveness, and risk taking. Students should be able to identify a strategic advantage. If not, then ask, ―Why do customers buy the firm‘s product or service, and not the competition‘s?‖ Then ask, ―How does the firm create and maintain that advantage?‖ and ―Why can‘t competitors imitate this advantage?‖ These questions should lead to discussion that will focus student‘s thinking about how corporate entrepreneurship leads to competitive advantages. 3. Explain the difference between product innovations and process innovations. Provide examples of firms that have recently introduced each type of innovation. What are the types of innovations related to the strategies of each firm? Response: Product innovations result in improvements to the product such as new features, new design, incorporation of new materials, or new functionality. These innovations are observable to customers and the market. Process innovations result in improvements to the manufacturing process, factory layout, use of automation, new logistics, or supply chain improvements. Process improvements are not generally observable to the market or to competitors. Product improvements associate with proactiveness. As a market leader, a proactive firm will be forward looking and offer the market improved products. Process improvements associate with competitive aggressiveness, as the result is often the firm‘s ability to offer the same product at a lower price. An example would be a firm that uses open-source software instead of developing its own software, as a competitor might. This process improvement would lower costs. Competitive aggressiveness can also pertain to product improvements, as another way to compete is by offering products with higher quality than the competition. And autonomy, innovativeness, and risk taking can pertain to both product innovations and process innovations. 1-443 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

4. Select a company that is listed on the NASDAQ or New York Stock Exchange. Research the extent to which the company has an entrepreneurial culture. Does the company use product champions? Does it have a corporate venture capital fund? Do you believe its entrepreneurial efforts are sufficient to generate sustainable advantages? Response: (Note to instructor) In the discussion regarding product champions, ask the student how he or she identified the product champion? What products have benefited from product champions? What did the product champion do? Then link the activities of the product champion to the need for product definition and the need to convince others in the firm, especially top management, of the value of the product (or achieve project impetus). The question on corporate venture fund refers to business incubators. If the student identifies a corporate venture fund, ask about its activities. How many ventures and what types of ventures have been ―hatched‖ by the fund? What other types of support has the firm provided, such as physical space, business services, mentoring, and networking. As for sustainable advantages, it might be useful to investigate three types: low cost, product quality (including perceived quality), and first mover advantages. For low cost, the advantage is not likely to be sustainable unless the firm can achieve and maintain greater market share than the competition and make sufficient investments in scale efficient facilities. For product quality, the advantage is sustainable to the extent that the firm can generate brand equity. But again, the advantage is likely to be imitated by competitors in most significant markets. For both low cost and product quality advantages, ask how entrepreneurial efforts contribute to the firm‘s ability to compete. Usually students will realize that exploiting market power and brand equity have more to do with other types of competitive advantage than corporate entrepreneurship. First mover advantages have a different assessment. Entrepreneurial firms can generate new products and exploit first mover advantages such as (a) build a reputation, (b) control scarce resources, (c) patent innovations, (d) exploit experience curve effects, and (e) set industry standards. These first mover advantages should enable the firm to dominate the new market for enough time to recoup its investment. While the advantage in any particular product market may not be sustainable, the entrepreneurial activities may be. At any time, the firm will be developing new innovative products that will generate a stream of first mover advantages and use the profits from its existing products to fund these new ventures. 5. How can an established firm use an entrepreneurial orientation to enhance its overall strategic position? Provide examples. Response: An entrepreneurial orientation is designed to generate a stream of innovations. These innovations can support a number of strategies. To illustrate, we can look at the three generic strategies of overall cost leadership, differentiation, and focus. For overall cost leadership strategies, an 1-444 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

entrepreneurial orientation can support efforts to reduce costs through experience curve effects. Incremental process innovations can facilitate these cost reductions. For differentiation strategies, an entrepreneurial orientation can facilitate keeping ahead of the competition in terms of product uniqueness. An entrepreneurial orientation can facilitate product innovation and exploring new markets. For focus strategies, an entrepreneurial orientation can facilitate both product and process innovations that enable firms to effectively and efficiently serve narrow market segments. And the entrepreneurial orientation dimensions of innovativeness, proactiveness, and risk taking facilitate first mover advantages that can contribute to the success of differentiation and focus strategies. (Note to instructor) The above discussion is structured by generic strategies. It may be useful to structure by the five dimensions of entrepreneurial orientation. The objective of the question is to have students think about how entrepreneurial orientation contributes to strategic position, and either the generic strategies or the entrepreneurial dimensions are suitable. In either case, it is useful to ask students to classify all of their examples into one of these taxonomies of strategies. Ethics Questions 1. Innovation activities are often aimed at making a discovery or commercializing a technology ahead of the competition. What are some of the unethical practices that companies could engage in during the innovation process? What are the potential longterm consequences of such actions? Response: Possible unethical practices related to innovation activities include violation of others‘ intellectual property rights, pirating other companies‘ personnel, inadequately developing an innovation to ensure that it is safe, and neglecting productive personnel. Violating others‘ intellectual property rights means that the innovation incorporates patents, copyrights, trademarks, or trade secrets without the owners‘ permission. Pirating other companies‘ personnel means hiring talent from other companies. The primary problem with this practice is that the pirated personnel may share their former employers‘ secrets, thus subjecting them and the firm to violation of trade secrets laws. Inadequately developing an innovation to ensure that it is safe would be a possible result of getting the innovation to market too quickly and can result in injury or other harm to customers. And neglecting productive personnel means that key individuals in the firm are not properly rewarded and recognized for their innovative efforts. The potential long-term consequences of these unethical actions are generally a reduction in the firm‘s ability to innovate in the future. Legal action from patent and trade secret infringement can be very costly and result in injunctions, corporate restructuring, and any action that courts deem suitable. Harm to customers can also result in damaging lawsuits. And neglected personnel are likely to lose motivation and commitment to the firm, resulting in their possible migration to competitors. All these consequences are likely to carry a cost in reputation and the associated damage to brand equity, consumer goodwill, and investor confidence. 1-445 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

2. Discuss the ethical implications of using entrepreneurial policies and practices to pursue corporate social responsibility goals. Are these efforts authentic and genuine or just an attempt to attract more customers? Response: Best Buy can be used as an example. It has three entrepreneurial corporate social responsibility programs. First is recycling of old electronics equipment. Second is auditing suppliers to ensure that they don‘t exploit workers or damage the environment. Third is promoting diversity among employees by setting up social networks for groups of employees such as women, AsianAmericans, African Americans, and gays & lesbians. There are multiple benefits of these policies. Best Buy is leveraging new technologies, environmentally friendly ventures, and entrepreneurial practices to motivate workers in their firm, meet the interests and demands of their customers, and differentiate themselves from their rivals—while also meeting their societal responsibilities. On the one hand, these policies have a business side. The recycling program generates traffic for Best Buy stores. The social networks are designed to extend to customer groups. So these efforts are not all altruistic. Other examples of entrepreneurial policies and practices that pursue corporate social responsibility goals include Whirlpool‘s development of energy-conserving appliances and partnership with NaturalStep, Interface, Inc.‘s carpet recycling program that saves on materials, and Green Mountain Coffee Roasters‘ efforts to promote coffee growers and fair trade. Utilities have also been accused of falsely promoting green power or starting programs aimed at energy conservation or renewable energy, that do not fulfill promises. In some cases, customers may pay extra for a green energy project, but the funds are largely diverted to other purposes. The ethical implications of firms making token social responsibility efforts include loss of reputation. There are savvy environmental groups and ethical authorities, such as Business Ethics magazine, that oversee and rate firms‘ social responsibility efforts. Token efforts are likely to be criticized as attempts to deceive the public regarding the firm‘s true (lack of) commitment to social responsibility.

CONNECT RESOURCES Case Analysis IBM’s Innovative Jam Real Options at Intel Keeping It Real at Atlassian Comprehension Case Real Options at Intel

Chapter 13 Analyzing Strategic Management Cases................................................13-2 1-446 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Why Analyze Strategic Management Cases? .......................... 13-2 How to Conduct a Case Analysis............................................... 13-5 Become Familiar with the Material ......................................................... 13-6 Identify Problems ...................................................................................... 13-6 Conduct Strategic Analyses ...................................................................... 13-7 Propose Alternative Solutions .................................................................. 13-8 Make Recommendations........................................................................... 13-9

How to Get the Most from Case Analysis ................................ 13-9 Useful Decision-Making Techniques in Case Analysis ........... 13-11 Integrative Thinking ................................................................................. 13-11 Asking Heretical Questions ...................................................................... 13-12 Conflict-Inducing Techniques .................................................................. 13-12

Following the Analysis-Decision-Action Cycle in Case Analysis ..13-14 Summary ...................................................................................... 13-17 Experiential Exercise 1 ............................................................... 13-18 Experiential Exercise 2 ............................................................... 13-33

Chapter 13

Analyzing Strategic Management Cases Summary/Objectives PowerPoint Slide 2: Learning Objectives Case analysis uses real-life situations to present the processes of analysis, formulation, and implementation that have been addressed in this textbook. By studying and analyzing the strategic predicaments posed by a case, students can see that the circumstances businesses confront are often difficult and complex. Case analysis also challenges students to make decisions that address the dilemmas in the case and evaluate how their recommendations will affect the situation in the case. The chapter is divided into five major sections. 7.

The first section addresses the question Why analyze strategic management cases? It describes how case analysis can develop proficiencies in critically evaluating business situations and improves the ability to differentiate, speculate, and integrate.

The second section addresses how to conduct a case analysis. It describes five steps—become familiar with the material, identify problems, conduct strategic analyses, propose alternative solutions, and make recommendations.

The third section discusses how to get the most from case analysis. It provides ten guidelines for using case analysis to enhance learning.

10.

The fourth section addresses integrative thinking, conflict-inducing discussion techniques that are often used to stimulate conversation. It describes how these approaches can lead to better decisions.

11.

The fifth section illustrates the parallels between the analysis—decision—action sequence used to organize this text and the case analysis process. Questions from each chapter that may be salient to a case analysis are introduced.

Lecture/Discussion Outline I.

Why Analyze Strategic Management Cases?

PowerPoint Slide 4: Strategic Case Analysis PowerPoint Slide 5: Strategic Case Analysis: Questions 1-448 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

PowerPoint Slide 7: Strategic Case Analysis: Requirements PowerPoint Slide 8, 9, and 10: Strategic Case Analysis: Skills

Strategic managers and business leaders evaluate options, make choices, and find solutions to the challenges they face every day. To do so, they must learn to ask the right questions. These include Why do some firms succeed and others fail? Why are some companies higher performers than others? What information is needed in the strategic planning process? How do competing values and beliefs affect decision making? What skills and capabilities are needed to implement a strategy effectively? How does a student of strategic management answer those questions? By strategic case analysis. Case analysis simulates the real-world experience that strategic managers and company leaders face. A case is a detailed description of a challenging situation faced by an organization. It usually includes a chronology of events and extensive support materials such as financial statements, product lists, and transcripts of interviews. Cases usually report the facts of a situation as authentically as possible. One of the main reasons to analyze strategic management cases is to develop an ability to critically evaluate business situations. Three capabilities that can be learned by conducting case analysis are the ability to differentiate, speculate, and integrate: Differentiate

Effective strategic management requires that many different elements of a situation be evaluated at once. When analyzing cases, it is important to isolate critical facts, evaluate whether assumptions are useful or faulty, and to distinguish between good and bad information.

Speculate

Being able to imagine different scenarios or contemplate the outcome of a decision can aid the analysis. Case materials often seem to be missing data or the information provided is contradictory. An ability to speculate about details that are unknown or the consequences of an action can be helpful.

Integrate

Strategy involves looking at the big picture and having an organizationwide perspective. Integration involves comprehending how all the factors of a case will interact. Changes made in one part of an organization affect other parts. Thus, a holistic perspective that integrates the impact of various decisions and environmental influences on all parts of the organization is needed.

Discussion Question 1: How can you both differentiate and integrate at the same time? These seem like “opposite” tasks. Can it really benefit an organization to simultaneously engage in these opposites?

Discussion Question 2: What are some examples of executives who have used these abilities—differentiating, speculating, and integrating—to strengthen or transform their companies? In summary, case analysis asks students to ―walk a mile in the shoes‖ of the strategic decision maker and learn to critically evaluate situations. STRATEGY SPOTLIGHT 13.1 describes how Sapient Health Networks, a business faced with an immediate crisis, analyzed its situation, made tough decisions, and took strategic action. The SUPPLEMENT below emphasizes that companies use strategic analysis techniques in everyday practice. It presents the example of Butterfield Fabrics, a British manufacturing firm, and the process it went through to analyze, formulate, and implement new strategies. Extra Example: Analysis, Decision, and Action at Butterfield Fabrics Butterfield Fabrics (a disguised name) is the largest producer in Europe of coated and laminated fabrics. But in 1995, amid a growing market, the company‘s sales were stagnant. More nimble competitors were out-flanking Butterfield‘s high-margin specialty products, and lower cost rivals were seizing market share in the standard pricecompetitive end of its product line. Butterfield had never formalized a strategy, but it clearly had one: to reap the economies of scale, scope, and reputation that come from being the largest competitor in its industry. By the mid1990s, however, the strategy was no longer working. After several failed attempts to reinvigorate the company, Butterfield finally engaged in an intense process of analysis that led to a detailed strategy that included explicit guidance about what the company would and would not do, and generated the support of key players responsible for implementing the many interrelated parts of the strategy. The process Butterfield went through included three major stages: Stage 1: Identify the driving forces in the company‘s competitive environment. Stage 2: Formulate strategy that addresses the driving forces. Stage 3: Create a plan to implement the strategy. In the process of going through these stages, Butterfield used several analytical techniques that helped it assess and keep track of the many issues involved with the change. One of these was to map the driving forces. Mapping is a visual tool that makes managers‘ assumptions explicit. Once the mapping process is complete, the implications for strategic action are often quite obvious. A second technique was to create a strategy matrix. The matrix shows how the company might address each driving force. Across the top of the matrix are listed all of the driving forces. Down the side are the functional areas or projects that are involved in implementing action. The matrix is used to identify responsibilities and allocate resources across all the functional areas. Here is one example (not in matrix format): Driving Force 1: ―Butterfield‘s costs are high relative to competitors because new technologies enable cost-effective manufacturing at low volumes and because of the complexity of managing our broad product line.‖ Response: Manufacturing:

Divide plant into three ―factories within a factory‖ each focusing on a few product families. Buy new equipment to reduce set-up and waste costs in low-volume runs.

Marketing and Sales:

Broaden product line further as soon as process capability and plant configuration are ready.

Business Development:

Where local volumes are sufficient, open small regional plants that are close to the customer.

Finance and accounting:

Implement an activity-based costing system.

Quality and process

Develop expertise in fast set-up and changeover on existing and new equipment to engineering: handle greater variety without suffering cost penalties.

The point of the lengthy strategic process undertaken by Butterfield was to create a plan of action that would lead to renewed strengths and new core competencies. Whether the recommended actions will lead to the desired outcomes will depend on the commitment and cooperation of the entire organization. Source: Christensen, C. M. 1997. Making strategy: Learning by doing. Harvard Business Review, 75(5): 129–143.

Discussion Question 3: What are the benefits of engaging in a strategic process such as Butterfield undertook? Are there any disadvantages? Explain? Discussion Question 4: How could the steps that Butterfield used be applied in the case analysis process? Teaching Tip: Many instructors present the case analysis chapter to students early in the course as a way to introduce the case method approach to learning strategy. This is often useful for providing students with not only a method for analyzing cases but also a means to understand the context and purpose of in-depth evaluations of business situations. The Sapient Health Network spotlight in the chapter and the Butterfield Fabrics example in the Instructor's Manual are examples of real world situations that demonstrate how companies actually use a process very much like case analysis to solve strategic problems.

II.

How to Conduct a Case Analysis

PowerPoint Slide 11: Conducting a Case Analysis: Preparation PowerPoint Slide 12: Conducting a Case Analysis: Step 1 PowerPoint Slide 13: Conducting a Case Analysis: Step 2 PowerPoint Slide 14: Conducting a Case Analysis: Step 3 PowerPoint Slide 15 and 16: Strategic Case Analysis Tools PowerPoint Slide 17: Conducting a Case Analysis: Step 4 PowerPoint Slide 18: Conducting a Case Analysis: Step 5 The process of analyzing strategic management cases involves several steps. In this section, we review five steps to follow in preparing a case analysis. Before beginning, point out that there are two prerequisites for effective case analysis. First, unless students prepare for a case discussion, there is little they can gain from the discussion and even less that they can offer. 1-452 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Second, to get the most out of case analysis, students need to place themselves ―inside‖ the case in order to think like an actual participant in the case situation. Before beginning the analysis, it may be helpful to envision assuming one of these roles: Strategic Decision Maker

The position of the senior executive responsible for resolving the situation that the case describes. It may be the CEO, the business owner, or a strategic manager in a key executive position.

Board of Directors

The Board of Directors has a responsibility to step in when a management crisis threatens the company. A board member may be in a unique position to solve problems.

Outside Consultant

Consultants often have an advantage because they can look at a situation objectively. But they may also be at a disadvantage since they have no power to enforce changes.

Discussion Question 5: Why would participants in a case analysis interpret the facts or see the situation differently? For example, how might an outside consultant see the problem in a case differently than a CEO or owner? What would make a board member have a different perspective than a top executive? (One reason might be the existence of an agency problem—Chapter 4) STRATEGY SPOTLIGHT 13.2 draws a parallel between the task of preparing a business plan and the steps involved in conducting a case analysis. A. Become Familiar with the Material Written cases often include a lot of material. The following technique can enhance comprehension:

Read through the case once quickly to get an overall sense of the material. Use the initial read-through to assess possible links to strategic concepts. Read through the case again, in depth. Make written notes as you read. Evaluate how strategic concepts might inform key decisions or suggest alternative solutions. After formulating an initial recommendation, thumb through the case again to assess the consequences of the actions you propose. Identify Problems

One of the main reasons to conduct case analysis is to find solutions. Unless you know the problem, however, it is meaningless to attempt to find an answer. Some cases have more than one problem. Even so, emphasize that the problems are usually related. When trying to determine the problem, it is easy to get hung up on symptoms. Emphasize the importance of seeing beyond the immediate symptoms to the more fundamental problems. 1-453 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Another tip when preparing a case analysis is to articulate the problem. Point out that writing down a problem statement provides a reference point to turn to as the case analysis proceeds. Sometimes, problems are not apparent until after the case has been analyzed. Discussion Question 6: How can writing down the problem(s) in a case help with the analysis? Explain.

Discussion Question 7: Why is it that a company’s problems would emerge only after the case analysis? Aren’t they immediately apparent? Conduct Strategic Analyses

This textbook has presented numerous analytical tools (such as five-forces analysis and value-chain analysis), contingency frameworks (such as when to use related rather than unrelated diversification strategies), and other techniques that can be used to evaluate strategic situations. Emphasize that the best way to understand these methods is to apply them by conducting case analyses. The first step is to determine which strategic issues are involved. Remind students that most real-life case situations involve issues that are highly interrelated. Even in cases where there is just one major problem, the strategic processes required to solve it may involve several parts of the organization. Once the issues that apply to the case have been identified, conduct the analysis. That means to actually apply the tools of analysis (such as five-forces analysis, value-chain analysis, etc.). In this part of the analysis, point out that it is important to test one‘s assumptions about the case. First, what assumptions are being made about the case content? Second, what assumptions are being made about the best way to resolve the problems? Discussion Question 8: Why is it important to understand the assumptions that are being used to make decisions and take action? The SUPPLEMENT below presents Peter F. Drucker‘s views about the critical importance of making valid and informed assumptions in resolving the strategic issues that many businesses face. Extra Example: How Assumptions Drive the Theory—and Success—of a Business Peter F. Drucker is a highly notable management expert whose books and articles on management have had an enormous impact on modern management practices. In this article, Drucker describes how important it is for businesses to understand the assumptions that underlie the actions they take. 1-454 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

―The root cause of nearly every [management crisis] is not that things are being done poorly. It is not even that the wrong things are being done. Indeed, in most cases, the right things are being done—but fruitlessly. What accounts for this apparent paradox? The assumptions on which the organization has been built and is being run no longer fit reality. These are the assumptions that shape any organization‘s behavior, dictate its decisions about what to do and what not to do, and define what the organization considers meaningful results. These assumptions are about markets. They are about identifying customers and competitors, their values and behavior. They are about technology and its dynamics, about a company‘s strengths and weaknesses. These assumptions are about what a company gets paid for. They are what I call a company‘s theory of the business.‖ ―It usually takes years of hard work, thinking and experimenting to reach a clear, consistent, and valid theory of the business. Yet to be successful, every organization must work one out. What are the specifications of a valid theory of the business? There are four: 1.

The assumptions about environment, mission, and core competencies must fit reality.

The assumption in all three areas [in #1] have to fit one another.

The theory of the business must be known and understood throughout the organization.

The theory of the business has to be tested constantly.‖ Source: Drucker, P. F. 1994. The theory of the business. Harvard Business Review, 72(5): 95–104.

Discussion Question 9: What are some examples of assumptions that businesses make? Pick a company and research their assumptions about customers, competitors, suppliers, buyers, and so forth. Discussion Question 10: What might be the consequences if you interpreted the content of a case differently—or made different assumptions—than your team members or classmates? How might similar consequences affect a business decision if you were an executive in the business you are analyzing? EXHIBIT 13.1 presents a summary of the financial ratio analysis techniques that are presented in APPENDIX 1 to Chapter 13. By the end of this stage in the process, the problem(s) should be identified and a thorough analysis should have been conducted. D. Propose Alternative Solutions Emphasize that in strategic management case analysis there is rarely one right answer or one best way. Therefore, it is helpful to consider several different solutions. After conducting strategic analysis and identifying the problem(s), develop a list of options. What are the possible solutions? What are the alternatives? Point out that it is during this step of a case analysis that choices and the implications of those choices are evaluated. The aim of considering the implications of various alternative solutions is to find a solution that both solves the problem and is realistic. 1-455 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Discussion Question 11: What is the point of developing alternative solutions? Discuss.

Discussion Question 12: Is it possible to have more than one solution that is realistic and viable? Why or why not? Make Recommendations

The basic aim of case analysis is to find solutions. Emphasize that the analysis is not complete until a course of action has been recommended. The task is to make a set of recommendations that is consistent with the analysis and explain why the recommended course of action will solve the problem. The recommendation should also include suggestions for how best to implement the proposed solutions. Remind students that the proposed solution must solve the problem that was identified. This point cannot be overemphasized—too often students make recommendations that only treat symptoms or fail to tackle the central problems in the case. Encourage students to make a logical argument that shows how the problem led to the analysis and the analysis led to the recommendations. Discussion Question 13: What is meant by the phrase “an analysis is not an end in itself?” Why is it important to follow an analysis with a set of recommendations? Discussion Question 14: Research examples of action plans that companies have developed in order to implement a new strategy or undertake a company renewal. EXHIBIT 13.2 provides some guidelines for preparing an oral case presentation.

III.

How to Get the Most from Case Analysis

PowerPoint Slide 19: Getting the Most from Case Analysis Strategic management is a highly integrative task that draws on many areas of specialization at several levels, from the individual to the whole society. Thus, case analysis is enriching as a learning tool because it taps into many resources and skills besides what‘s in the textbook. Encourage students to go beyond the concepts in this text and seek insights from their personal reservoirs of knowledge when conducting case analysis. In this section, we present ten guidelines for how to get the most from case analysis: 1.

Keep an open mind.

Take a stand for what you believe.

Draw on your personal experience.

Participate and persuade.

Be concise and to the point.

Think out of the box.

Learn from the insights of others.

Apply insights from other case analyses.

Critically analyze your own performance.

10.

Conduct outside research. (NOTE: We caution students to check with the instructor first to be sure outside research is encouraged since it may conflict with the learning objectives).

APPENDIX 2 to Chapter 13 provides an overview of important and widely available sources of company and industry information. This has been extensively updated for the eleventh edition. EXHIBIT 13.3 provides several suggestions for how to apply these guidelines, and other techniques suggested in this chapter, to the preparation of a written case analysis. Teaching Tip: It is often difficult for students to appreciate a “how-to” chapter such as the one on Analyzing Strategic Management Cases until they have actually done it—that is, actually analyzed a case. However, the section in Chapter 13 on How to Get the Most from Case Analysis can be used to draw out students about the importance of discussion and debate in general. Using the ten guidelines as a framework, engage the students in a discussion of “why”? That is, ask students to explain why they need to keep an open mind (#1), why they need to take a stand for what they believe (#2), why they need to draw on personal experience (#3), and so forth. This can be done in student dyads, student teams, or as a discussion by the whole class. The SUPPLEMENT below addresses several of the reasons why conducting strategic case analysis is important. Case analysis requires decision making and the choices that are made reveal a great deal about one‘s outlook and attitudes. Likewise, the outcome of most business situations eventually comes down to how businesses and business leaders make choices. Extra Example: Making Tough Choices—Jim Collins on Decision Making Jim Collins, author of the best-selling business book Good to Great, believes that good decisions often begin by saying, ―I don‘t know.‖ That is, executives who approach situations by asking good questions, doing some research, and getting multiple opinions typically make better decisions. He learned this from studying leaders when writing Good to Great. ―They were just marvelous at igniting dialogue and debate,‖ says Collins. For example, ‗When Colman Mockler at Gillette is trying to decide whether to go with cheaper, disposable plastic razors or more expensive ones, he asks marvelous questions. He‘s Socratic. He pushes people to defend their points of view.‘‖ In other words, analysis and debate are critical aspects of business decision making.

Once the debate is finished a decision must be made. And it‘s rarely, if ever unanimous. ―No major decision we‘ve studied was ever taken at a point of unanimous agreement,‖ says Collins. ―There was always some disagreement in the air.‖ Behind those executive decisions is another factor that also makes a huge difference in how decisions are made. It has to do with the decision-makers outlook on life. Some refer to it as ―locus of control.‖ When asked about the role of ―psychology‖ in business decision making, Collins mused: ―Do you believe that our ultimate outcomes in life are externally determined—for example, ‗I came from a certain family, I got the right job‘? Or do you believe that how your life turns out is ultimately up to you, that despite all the things that happen, you are ultimately responsible for your outcomes?‖ ―Consider the airline industry, and think of all the events and factors outside managerial control that have hit it since 1972: fuel shocks, interest rate spikes, deregulation, wars, 9/11. And yet the No. 1 performing company of all publicly traded companies in terms of return to investors for a 30-year period from 1972 to 2002 is an airline. According to Money magazine‘s retrospective look in 2002, Southwest Airlines beat Intel, Wal-Mart, GE—all of them! Now what would have happened if the folks at Southwest had said, ‗Hey, we can‘t do anything great because of our environment‘? You could say, ‗Yeah, the airline industry is terrible. Everyone in it is statistically destined to lose money.‘ But at Southwest, they say, ‗We are responsible for our own outcomes.‘‖ Source: Useem, J. 2005. Jim Collins on Tough Calls. Fortune, October: 89–94.

IV.

Useful Decision-Making Techniques in Case Analysis

PowerPoint Slide 20: Case Analysis Decision-Making Techniques: Integrative Thinking PowerPoint Slide 21: Case Analysis Decision-Making Techniques: Heretical Questions PowerPoint Slide 22: Case Analysis Decision-Making Techniques: Conflict Inducing PowerPoint Slide 23: Case Analysis Decision-Making Techniques: Conflict Inducing Example A. Integrative Thinking We introduce the concept of ―integrative thinking‖ that was developed by Roger Martin in his book The Opposable Mind. Rather than make choices between competing ideas from a limited set of alternatives, the objective is to identify more creative solutions. EXHIBIT 13.4 illustrates the four stages of integrating thinking and deciding processes. STRATEGY SPOTLIGHT 13.3 provides the example of integrating thinking by the founder of Red Hat, Bob Young. Teaching Tip: We have found that it can be very illuminating for students to apply integrative thinking to a decision that they have encountered in the past—or are presently faced with. Assign them to groups of four or five and ask them to come up with a decision situation—and then ask them how using integrative thinking may have helped. One example that students occasionally come up with is deciding what job offer to take. Such a decision context serves to illustrate the importance of all of the four steps in the decision process. For example, what are the key elements of “salience”? (e.g., challenge, growth opportunities, compensation, location, etc.). And, regarding “causality,” what might be some nonlinear relationships? (e.g., although compensation may be important,

after a certain level the utility may “level off”; some travel may be exciting and enjoyable, but too much time on the “road” may be burdensome, etc.).

Asking Heretical Questions

We have added this section for the eleventh edition. In brief, heretical questions are those that challenge conventional wisdom. We provide examples of UPS‘s ―no left turns,‖ dyeing clothing without water, and toilet rolls without cardboard tubes.

Discussion Question 15: Can you think of how “heretical questions” may have led to useful innovations? Conflict-Inducing Techniques

Although the word ―conflict‖ often has a negative connotation, it can be very helpful in arriving at better solutions to cases. It can provide an effective means for new insights, as well as rigorously questioning and analyzing assumptions and strategic alternatives. In fact, if you don‘t have constructive conflict, you may get only consensus. When this happens, decisions tend to be based on compromise rather than collaboration. STRATEGY SPOTLIGHT 13.4 provides guidelines for making team-based approaches to case analysis more effective. In this section, we look at the phenomenon known as ―groupthink‖ and suggest ways of preventing groupthink. Then, we will suggest some conflict-inducing decision-making techniques—devil‘s advocacy and dialectical inquiry—that can help to prevent groupthink and lead to better decisions. 1.

Symptoms of Group Think and How to Prevent It

Irving Janis identified several symptoms of groupthink. These include An illusion of vulnerability. A belief in the inherent morality of the group. Stereotyped views of members of opposing groups. The application of pressure to members who express doubts about the group‘s shared illusions or who question the validity of arguments proposed. The practice of self-censorship. An illusion of unanimity. The appointment of mindguards. Janis also provided several suggestions for preventing groupthink: 1. Leaders must encourage group members to address their concerns and objectives. 2. When higher-level managers assign a problem for a group to solve, they should adopt an impartial stance—not mention their preferences.

3. Before a group reaches its final decision, the leader should encourage members to discuss their deliberations with trusted associates and then report the perspectives back to the group. 4. The group should invite outside experts and encourage them to challenge the group‘s viewpoints and positions. 5. The group should divide into subgroups and various times, under different chairpersons, and then get together to resolve differences. 6. After reaching a preliminary agreement, the group should hold a ―second chance‖ meeting, which provides members a forum to express any remaining concerns and rethink the issue prior to making a final decision. 2.

Using Conflict to Improve Decision-Making

Two conflict-inducing decision-making approaches that have become quite popular include devil‘s advocate and dialectical inquiry. With the devil’s advocate approach, the devil‘s advocate tries to come up with problems with a proposed alternative and suggest reasons as to why it should not be adopted. The role of the devil‘s advocate is to create dissonance and bring out criticisms that might otherwise not be made. Dialectical inquiry attempts to accomplish the goals of the devil‘s advocate in a more constructive manner. Here, a problem is approached from two alternate points of view. The goal is that by critiquing opposing perspectives—a thesis-antithesis approach—a creative synthesis will occur. Dialectical inquiry involves the following steps: 1. A proposal and the information that was used to derive it are identified. 2. The underlying assumptions of the proposal are stated. 3. A counter plan (antithesis) is identified that is believed to be feasible, politically viable, and generally credible. However, it rests on assumptions that are opposite to the original proposal. 4. A debate ensues in which individuals favoring each plan provide their arguments and support. 5. A ―synthesis‖ emerges, which, hopefully, includes the best components of each alternative. EXHIBIT 13.5 provides a graphical representation of the devil‘s advocate and dialectical inquiry decision-making techniques. The SUPPLEMENT below presents four different methods of conducting a class discussion that can be used to enhance learning in the case analysis process. Extra Example: Approaches to Structuring Class Discussion (Excerpt) 1. Discussion Question Format:

When the class begins, the instructor may call the names of the two students who have been chosen to open the class (the students chosen normally do not

know the instructor‘s choice ahead of time). Each is asked a separate question drawn from the prepared assignment. By having initial questions limited to those assigned, students learn that homework preparation pays off. The quality of the opening is of primary importance, because a good initial contribution made by well-prepared students can substantially improve the depth of the class session. The instructor can help ensure a successful opening by carefully choosing the two students who begin each class, reviewing the class cards and seating chart to identify the most appropriate choice. 2. The Vote Format:

Some cases lead to clear-cut ―yes‖ or ―no‖ decisions. A few may lead to three or four mutually exclusive or clear-cut decisions. In such situations, the instructor can heighten the students‘ commitment to a decision by having them vote. During the vote, the instructor should note those taking an ―unpopular‖ view or who are on the minority side as well as those who are abstaining. The instructor usually draws a laugh upon asking, ―Who are the diplomats? Who did not vote?‖ The two opening contributors can then be chosen on the spot, usually a student representing the minority viewpoint as the first opener and the second contributor from the majority. The tone of the discussion is then set and contributors are encouraged to argue persuasively in order to influence peers to change their positions on the issue. Some students will change their minds, and their explanations of the change often prove to be a tremendous learning experience. Before class is concluded, the teacher should take another vote to determine whether the class is shifting its position.

3. Role-Playing Format:

Prior to class or spontaneously, class members can be assigned different managerial roles and asked to discuss a case from the viewpoint of their assigned roles. Such an approach is likely to bring out the interpersonal aspects of the situation more effectively than other formats. While role-playing is often exciting, it may be inefficient because it is extremely time-consuming. For this approach to be effective, the instructor should summarize or ask students to summarize the key insights and concepts derived from such a class discussion.

4. Audio-Visual Format:

Another format that is especially useful toward the end of the course is to have small study groups tape their case analyses. The tapes can be evaluated either by the group that made the tape or by the entire class. Such presentations provide students an opportunity to work in groups, supplement the preparation they must do for the comprehensive written analysis of cases, and improve their presentation skills. In the absence of audio-visual taping equipment, the same objectives can be achieved by having students make flip charts or slide presentations for class review.

Source: Charan, R. 1976. Classroom techniques in teaching by the case method. Academy of Management Review, 1: 116–123.

Following the Analysis-Decision-Action Cycle in Case Analysis

PowerPoint Slide 24: Strategic Case Analysis Process: Goals & Objectives PowerPoint Slide 25: Strategic Case Analysis Process: External Environment 1-462 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

PowerPoint Slide 26: Strategic Case Analysis Process: Internal Environment PowerPoint Slide 27: Strategic Case Analysis Process: Intellectual Assets PowerPoint Slide 28: Strategic Case Analysis Process: Business-Level Strategies PowerPoint Slide 29: Strategic Case Analysis Process: Corporate-Level Strategies PowerPoint Slide 30: Strategic Case Analysis Process: International-Level Strategies PowerPoint Slide 31: Strategic Case Analysis Process: Entrepreneurial Strategies PowerPoint Slide 32: Strategic Case Analysis Process: Strategic Control PowerPoint Slide 33: Strategic Case Analysis Process: Organizational Design PowerPoint Slide 34: Strategic Case Analysis Process: Learning and Ethical Organization PowerPoint Slide 35: Strategic Case Analysis Process: Corporate Entrepreneurship In Chapter 1, we defined strategic management as the analyses, decisions, and actions that organizations undertake in order to create and sustain competitive advantages. Emphasize that the analysis—decision—action sequence of words was chosen because it corresponds to the sequence of events that typically occurs in the strategic management process. Each of the thirteen chapters of this book includes techniques and/or information that may be useful in a case analysis. However, not all of the issues presented will be important in every case. Remind students that one of the challenges of case analysis is to identify the most critical points and sort through material that may be ambiguous or unimportant. In this section, we draw on the material presented in each of the thirteen chapters of the text to show how it informs the case analysis process. Analyzing organizational goals and objectives. A company’s vision, mission, and objectives keep organization members focused on a common purpose. They also influence how an organization deploys it resources, relates to its stakeholders, and matches its short-term objectives with its long-term goals. The goals may even impact how a company formulates and implements strategies. Analyzing the external environment. The business environment has two components. The general environment consists of demographic, sociocultural, political/legal, technological, economic, and global conditions. The competitive environment includes rivals, suppliers, customers and other factors that may directly affect a company’s success. Strategic managers must monitor the environment to identify opportunities and threats that may impact on performance. Analyzing the internal environment. A firm’s internal environment consists of its resources and other value-adding capabilities. Value-chain analysis and a resourcebased approach to analysis can be used to identify a company’s strengths and weaknesses and determine how they are contributing to its competitive advantage. Evaluating firm performance can also help make meaningful comparisons with competitors. Assessing a firm’s intellectual assets. Human capital is a major resource in today’s knowledge economy. As a result, attracting, developing, and retaining talented workers is a key strategic challenge. Other assets such as patents and trademarks 1-463 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

are also critical. How companies leverage their intellectual assets via social networks and strategic alliances and how technology is used to manage knowledge may be major influences on a firm’s competitive advantage. Formulating business-level strategies. Firms use the competitive strategies of differentiation, focus, and overall cost leadership as a basis for overcoming the five competitive forces and developing sustainable competitive advantages. Combinations of these strategies may work best in some competitive environments. Additionally, an industry’s life cycle is an important contingency that may affect a company’s choice of business level strategies. Formulating corporate-level strategies. Large firms often own and manage portfolios of businesses. Corporate strategies address methods for achieving synergies among these businesses. Related and unrelated diversification techniques are alternative approaches to deciding which business should be added to or removed from a portfolio. Companies can diversify via mergers, acquisitions, joint ventures, strategic alliances, and internal development. Formulating international-level strategies. Foreign markets provide both opportunities and potential dangers for companies that want to expand globally. To decide which entry strategy is most appropriate, companies have to evaluate the tradeoffs between two factors that firms face when entering foreign markets—cost reduction and local adaptation. To achieve competitive advantages, firms will typically choose one of three strategies: global, multidomestic, or transnational. Formulating entrepreneurial strategies. New ventures add jobs and create new wealth. To do so, they must identify opportunities that will be viable in the marketplace, as well as gather resources and assemble an entrepreneurial team to enact the opportunity. Entrepreneurial strategies are needed to successfully enter new markets. However, new entrants often evoke a strong competitive response from incumbent firms in a given marketplace, which requires them to alter their initial strategies. Achieving effective strategic control. Strategic controls enable a firm to implement strategies effectively. Informational controls involve comparing performance to stated goals and scanning, monitoring, and being responsive to the environment. Behavioral controls emerge from a company’s culture, reward systems, and organizational boundaries. Creating effective organization designs. Organizational designs that align with competitive strategies can enhance performance. As companies grow and change, their structures must also evolve to meet new demands. In today’s economy, firm boundaries must be flexible and permeable to facilitate smoother interactions with external parties such as customers, suppliers, and alliance partners. New forms of organizing are becoming more common.

Creating a learning organization and an ethical organization. Strong leadership is essential for achieving competitive advantages. Two leadership roles are especially important. The first is creating a learning organization by harnessing talent and encouraging the development of new knowledge. Second, leaders play a vital role in motivating employees to excellence and inspiring ethical behavior.

Fostering corporate entrepreneurship. Many firms continually seek new growth opportunities and avenues for strategic renewal. In some corporations, autonomous work units such as business incubators and new venture groups are used to focus corporate venturing activities. In other corporate settings, product champions and other firm members provide companies with the impetus to expand into new areas. Real options analysis may be used to make better quality decisions in entrepreneurial contexts. The chapter concludes with STRATEGY SPOTLIGHT 13.5. It provides an example of a ―live‖ business case competition across all of the strategic management sections. It was conducted at the College of Business and Economics at Towson University. The ―Description‖ and ―Case Competition Checklist‖ include many of the elements of the ADA (analysis-decisionaction) cycle analysis that we have discussed in this chapter. There are two very useful appendices to Chapter 13. These are: Appendix 1: Financial Ratio Analysis Appendix 2: Company and Industry Analysis (We appreciate the expertise of Ms. Lauren Henry [University of Texas at Dallas] in updating this material for our eleventh edition.)

VI.

Summary

Strategic management case analysis provides an effective method of learning how companies analyze problems, make decisions, and resolve challenges. Strategic cases include detailed accounts of actual business situations. The purpose of analyzing such cases is to gain exposure to a wide variety of organizational and managerial situations. By putting yourself in the place of a strategic decision maker, you can gain an appreciation for the difficulty and complexity of many strategic situations. In the process, you can learn how to ask good strategic questions and enhance your analytical skills. Presenting case analyses can also help develop oral and written communication skills. In this chapter, we have discussed the importance of strategic case analysis and described the five steps involved in conducting a case analysis—becoming familiar with the material, identifying problems, analyzing strategic issues, proposing alternative solutions, and making recommendations. We have also discussed how to get the most from case analysis. Finally, we have described how the case analysis process follows the analysis—decision—action cycle of strategic management and outlined issues and questions that are associated with each of the previous twelve chapters of the text.

EXPERIENTIAL EXERCISES Exercise 1

Plastico, Inc.: A Strategic Decision-Making Exercise I. INTRODUCTION/LEARNING OBJECTIVES Plastico is a role-play exercise designed to provide participants with a ―hands-on‖ appreciation for important strategic management concepts such as the importance of vision, mission, and objectives; total quality management, cross-functional coordination, reward structures, and strategic leadership. Participants assume the role of managers faced with a major problem: A forthcoming Consumer Reports article contends that one of the firm's major new product lines is substandard. Immediate action is required. Further, the role play is designed to stimulate conflict caused by the characters‘ parochial functional area perspectives, diverse backgrounds, and hidden agendas. To aggravate the situation, Kim Johnson (vice president and the principal character in the role play) is portrayed as an aloof, bottom-line-oriented executive, with little concern or awareness for the operation for which he/she is responsible and accountable. This role play can be used at any point in the course. However, because issues relating to both strategy formulation and implementation are important learning objectives, we suggest that it is most effective after most of the chapters have been assigned. Accordingly, the major learning objectives are: 1. the importance of a clearly articulated vision, mission statements, and strategic objectives, 2. why quality must be an organization-wide effort, 3. the advantages of cross-functional coordination, 4. the importance of effective reward structures, and 5. important activities essential to successful leadership.



Prepared By Gregory G. Dess, University of Texas at Dallas; Laura Cardinal, Tulane University and David Arnott, Dallas Baptist University.

II. PROCEDURES: CONDUCTING THE ROLE PLAY EXERCISE The following four steps are a useful approach for conducting the role play. Guidelines are provided for allocating time. If your class sessions are 50 minutes or less, conduct the role play and the ―debriefing/discussion‖ in separate sessions. Step 1:

(5 minutes)

Distribute the two-page scenario to all participants (overview, the scenario, major players, organization chart). Step 2:

(15 minutes) Participant preparation

Divide participants into five equal groups. Distribute the same role to all members in each group.

Have each group study the role assigned to them. Encourage the participants to actively ―assume the role,‖ i.e., use the information provided to ―become the character.‖

With two or three minutes to go, select one person from each group to act out the role in front of the room. d. Select outgoing people, otherwise, the role play may bog down. This is especially important for the role of Kim Johnson. Suggest to the group playing Kim Johnson that they should begin the role play by asking the other characters what they perceive the problem to be—otherwise the role play may become a dialogue between two people.

Step 3:

(30 minutes) Acting out the role play

Have the players take seats in a semi-circle in the front of the room. Kim Johnson should open the meeting. Approximately 10 minutes into the role play, you may consider asking the players to go back to their groups and spend about 5 minutes discussing how to complete the rest of the role play. (You can assign different people to continue their group's role—this usually piques interest/enthusiasm.) Note: Make sure each participant is provided with a nameplate. Otherwise, the exercise will become “bogged down” as the role players become confused. Step 4:

(30 minutes) Debriefing/Discussion

III. LEADING THE DISCUSSION After the role playing is completed, the discussion consists of two parts. First, the instructor may pose the three questions in (A) below to stimulate discussions. Here, class members who did not ―act out‖ one of the roles are given the opportunity to provide insights on what they observed. We have found that students often tend to focus more on symptoms (e.g., interpersonal conflict) than on underlying problems (e.g., lack of cross functional coordination, unclear and inconsistent strategic objectives). The students‘ preoccupation with symptoms can become a ―strawman‖ which can be used by the instructor to stress the importance of a strategic management orientation. This, and other important issues, is the focus of the more in-depth discussion (B) that follows the three ―lead-off‖ questions below. A.

Lead-off Questions: Getting the Discussion Started

Pose the following questions: 1)

Is the situation depicted in the role play realistic?

The role play invariably elicits a high level of emotional involvement and some students may feel that the intensity of conflict is greater than that which occurs in the ―real world.‖ However, point out that in the ―real world‖ practicing managers often have hidden agendas, functional area biases and perceptions of inequities. Also, emphasize that emotions would definitely run much higher if actual careers and livelihoods were at stake. 2)

What are Plastico's key problems?

Students tend to focus more on symptoms than on underlying problems. Often, poor interpersonal relationships are emphasized instead of issues related to a firm's strategy and structure. For example, the resentment that many of the managers express toward Kim Johnson may actually be attributed to his personal characteristics (symptoms) instead of his being the only manager who participants in profit sharing (problem). 3)

What are the sources of conflict?

Here, as with question 2, students often tend to focus on interpersonal sources of conflict (e.g., the hiring of an old college friend, differences in educational background, and tenure with the company). Again, strategic issues such as poorly defined objectives, lack of coordination among functional areas, and inappropriate reward systems are seldom mentioned by role play participants.

Relating the Role Play to Strategic Management.

We find it useful to focus the discussion on the five issues below. These issues cover a range of topics on both strategy formulation and strategy implementation.

Importance of a clearly articulated vision, mission statement, and strategic objectives.

These are the three critical attributes necessary for a firm to achieve ―coherence in strategic direction‖ (addressed in the latter part of Chapter 1). In the case of Plastico, there did not appear to be an adequate emphasis on any of these three elements. A great deal of conflict and dysfunctional behavior, as well as declining performance, can reasonably be attributed to this. 

How might “coherence in strategic direction” improve Plastico's effectiveness?

A vision, mission statement, and strategic objectives would help to reduce conflict, clarify direction, and instill motivation toward common ends, and so on. Further, it should be pointed out that mission statements serve to provide standards for ethical behavior—a potentially key issue given that Plastico may have to decide what to do with ―substandard‖ products. (Exhibit 1 provides a summary of this question.) 2)

The advantages of cross-functional coordination.

Several chapters point out the benefits of cross-functional coordination, i.e., integration across value chain activities.  How might Plastico benefit from cross-functional coordination/integration of value chain activities? (Exhibit 2 may help to structure discussion on this issue.) First, it lists some of the types of conflicts that may arise among functional departments. Here, it may be useful to ask participants for examples of such conflicts. The second part of Exhibit 2 provides three potential benefits of cross-functional coordination/integration of value chain activities. Clearly, at Plastico, one department is responsible for quality control and this is a source of much of the conflict. Point out, or ask for, the potential benefits of the Quality Control Department working more directly with the other departments—Engineering and R&D, Manufacturing, and Marketing. A key point would be the greater emphasis on Total Quality Management, i.e., all departments would have greater input and the likelihood of quality being designed and built into the products would be greater. 3)

The importance of reward structures. The importance of effective reward systems is addressed in Chapter 9.

The reward system at Plastico caused resentment among the top management team, because Kim Johnson was the only manager receiving a bonus. Since the other managers' compensation was not tied to the attainment of strategic goals, motivation and morale seemed to suffer. 

How can Plastico's reward system be improved?

Compensation could be tied more directly to the attainment of overall organizational goals.

More, if not all, managers could be involved in incentive compensation programs.

Greater control systems could be implements to detect and monitor performance. (Recall that Plastico's quality problems that were revealed in the Consumer Reports article seemed to catch management by surprise.)

Successful strategic leadership.

This final issue—the central focus of Chapter 11—helps to synthesize many of the learning objectives of this exercise. 

Assess Kim Johnson's approach to leadership. How can it be improved?

(Use Exhibit 3.) At first glance, this may appear to be a relatively difficult question to address. After all, a role play implicitly provides different perspectives to each role player on a variety of issues. However, students typically find fault with Kim Johnson‘s leadership regarding his/her aloofness, lack of direction, favoritism (i.e., his hiring of Kerry Smith as Manger of Quality Control—an ―old college friend‖), too ―bottom-line oriented,‖ and so on. It may be useful to use Exhibit 3 to illustrate the activities essential to successful strategic leadership when addressing the question of how Kim's leadership can be improved.

Kim Johnson might consider: SETTING A DIRECTION. 

Focus on the ―essentials‖ of the business, i.e., quality and efficient production. (Note: Given the strong desire of Pat Ackerman, CEO, to expand the business, this will likely involve persuading him to limit growth.)



Developing a contingency plan to deal with problems such as the bad press associated with the upcoming Consumer Reports article. (This could include retaining a public relations firm, or assessing the quality of finished goods inventory using statistical sampling techniques.)

DESIGNING THE ORGANIZATION. 

Enhancing coordination across functional areas via committees, task forces, etc. (Addressed in issue #2 above.)



Implementing reward systems that motivate individuals toward desired objectives. (Addressing issue #3 above.)



Providing functional managers more input into the budgeting process. (This may alleviate feelings of inequity perceived by Robin Cooper in Engineering.)

INSTILLING A CULTURE COMMITTED TO EXCELLENCE AND ETHICAL BEHAVIOR. 

Restoring Plastico‘s commitment to excellence in quality through periodic meetings, newsletters, awards, incentives, etc.



Developing a company credo that guides ethical behavior. (For example, without ethical guidelines to the contrary, managers may have a strong temptation to ship shoddy merchandise if they feel intense pressure to meet production quotas. Such poor-quality goods would undermine the public's trust in Plastico.)

Exhibit 1

ENSURING COHERENCE IN STRATEGIC DIRECTION VISION  Describes aspirations for the future without specifying means to achieve ends. 

Must be inspirational



Must be communicated through a mission statement and through persuasive leadership

MISSION STATEMENTS  Mission statements establish boundaries to guide strategy formulation. 

Mission statements establish standards for organizational performance along multiple dimensions.



Mission statements suggest standards for individual ethical behavior.

STRATEGIC OBJECTIVES  Address both financial and non-financial issues 

Can be reached with a stretch



Incorporate the dimension of time



Facilitate reasoned tradeoffs



Reduce conflict



Avoid unintended consequences

Exhibit 2

THE IMPORTANCE OF CROSSFUNCTIONAL COORDINATION/INTEGRATION OF VALUE CHAIN ACTIVITIES EXAMPLES OF INTERDEPARTMENTAL CONFLICTS: 

R&D versus Manufacturing



Sales versus Logistics



Marketing versus Quality Control

CROSS-FUNCTIONAL COORDINATION: 

Can break down barriers between functional departments



Recognized that all departments are responsible for quality (not just a quality control department)



Can help a firm achieve all forms of competitive advantages—differentiation, overall cost leadership, and integrated differentiation and overall cost leadership

Exhibit 3

THREE KEY LEADERSHIP ACTIVITIES 

Setting a direction



Designing the organization



Instilling a culture committed to excellence and ethical behavior

PLASTICO, INC.: OVERVIEW It is February 15 and Kim Johnson, who is the vice president of the outdoor toys division, has assembled the division management team to address an urgent problem. For the next 30 minutes, you will assume the role of either Kim Johnson or one of Kim‘s four managers. Immediate action has been mandated by Pat Ackerman, CEO of Plastico. THE SCENARIO Plastico, Inc. was started 10 years ago as a manufacturer of heavy-duty outdoor plastic toys (sandboxes, playhouses, pool toys) by Pat Ackerman, a highly driven entrepreneur with a background in marketing. To cope with the extreme seasonality of the business and to ensure its continued growth, three years ago Ackerman acquired two manufacturers: a producer of children‘s clothes and a manufacturer of children‘s furniture. For the last two years, sales and profits have increased 20 percent and 10 percent respectively—a level of performance that Ackerman has come to expect. The breakdown for each of the division last year was: outdoor toys, $65 million; children‘s clothes, $20 million; and children‘s rurniture, $10 million. However, this year‘s sales for the toy division are expected to decrease to $55 million, the first sales decrease in the company's history. Ackerman is more concerned about the reason for the sales decrease than ―just the numbers.‖ Sales of the new line of picnic tables/patio furniture had appeared to be very promising at the Winter Trade Show where $10 million in retail orders were accepted. This trade show is particularly important because it is where manufacturers introduce new lines to major retailers who, in turn, place orders for the summer selling season. However, Ackerman has recently heard rumors about Plastico‘s faltering quality. Just this morning, February 15, he was stunned when he received a fax of a forthcoming Consumer Reports article stating that the new outdoor toys‘ spring product line was substandard. The timing of the Consumer Reports article could not be worse. Although no shipments have been sent to retailers, 50 percent of the initial orders have been manufactured and are in the warehouse awaiting shipments to retailers. The balance of the production is expected to be completed by the end of the month. New product lines have always accounted for a large portion of annual sales increases, so the bad press will dramatically hurt sales and will erode Plastico's excellent quality image. Furthermore, outdoor toys‘ lower sales (and profits) will substantially reduce funds available for the growth of the other two divisions. Kim Johnson has been summoned to report to Ackerman‘s office to explain the reason for decreased sales and the negative Consumer Reports rating. Ackerman has also made it clear he wants immediate solution to these problems. Johnson‘s four managers have been assembled and informed that ―hard answers‖ are needed within 30 minutes. (Exhibit 1 provides an organization chart and an introduction to the major players.)

EXHIBIT 1: MAJOR PLAYERS AND ORGANIZATION CHART MAJOR PLAYERS Kim Johnson, Vice President of Outdoor Toys Division Johnson, 45-years-old, came to Plastico five years ago. Kim has a BS degree from a large state university and extensive manufacturing experience. Kim has become accustomed to the ―creature comforts‖ that annual profit-sharing bonuses have supported. The profit-sharing plan, in which only Mr. Ackerman the divisional vice presidents participate has, in some recent years, effectively doubled Johnson‘s annual compensation. Johnson believes in hiring good people and providing them with as much autonomy as possible. Robin Cooper, Director of Engineering and R&D. Cooper is a 32-year-old who has been with Plastico for four years. Robin has an MS degree in Mechanical Engineering from a small, private college. Chris Baker, Manager of Manufacturing. With eight years of service, Baker has the longest tenure of the four managers. Chris completed only two years of college and is 50 years old. Kerry Smith, Manager of Quality Control. Kim Johnson hired an ―old college friend,‖ Smith, to be quality control manager six months ago. Kerry is 45 years old and as a BBA degree. Lynn Robertson, Manager of Marketing. Lynn Robertson is a hard-charging, aggressive 25-year-old with an MBA from a prestigious Ivy League school. Lynn has been with Plastico for two years.

PLASTICO, INC.: ORGANIZATION CHART Pat Ackerman Chief Executive Officer

Corporate Staff

Kim Johnson Vice President Outdoor Toys Division

Robin Cooper Director Engineering/R&D

Chris Baker Manager Manufacturing

Vice President Children‘s Clothing Division

Kerry Smith Manager Quality Control

Vice President Children‘s Furniture Division

Lynn Robertson Manager Marketing

Plastico, Inc.: Role of “Kim Johnson,” Vice President, Outdoor Toys Division Wow! I‘ve never heard Pat Ackerman so angry and upset. I‘m afraid the Consumer Reports article may be a symptom of broader problems. And now, in 30 minutes, I‘m supposed to solve all of them. But frankly, I‘ve overextended myself financially and must do everything I can to salvage some profit-sharing compensation this year. I‘ve always resented the way he wants my division to fund the growth of the clothes and furniture divisions. As I see it, these are nothing more than Pat‘s pet projects intended to boost his ego. I‘d like to suggest to Pat that he divest them, but first I‘d better build a heck of a strong case. If Ackerman hadn‘t taken his eye off the ball by buying these two new companies three years ago, I wouldn‘t be faced with the prospect of losing out on my bonus for the first time in five years. I do have some nagging concerns: Was I correct in cutting Robin Cooper‘s R&D budget by 20 percent? Is Chris Baker just coasting to retirement? With that much experience, Chris should have known something was wrong. Should I have hired a close friend like Kerry Smith as QC manager? Maybe Kerry doesn‘t understand our products well enough, and the other managers are reluctant to confront Kerry because they know about our friendship. I also wonder a little about Lynn Robertson in Marketing. All Lynn seems to be concerned about is protecting sales. We need an aggressive person in Marketing, but pushing products through R&D may hurt our quality in the long run. All I know is, we better have solid, specific answers in 30 minutes.

Plastico, Inc.: Role of “Chris Baker,” Manager of Manufacturing If Pat Ackerman hadn‘t decided three years ago to acquire the clothes and furniture divisions, we‘d be in a lot better shape. We used to make quality products. Now, we have to speed up production of our outdoor toy products just to provide money for these two new divisions. Johnson‘s no better. Kim‘s just interested in the ―bottom line.‖ I guess I would be too if I were getting that bonus each year! I had a hunch that these products had problems. But let Johnson‘s buddy, Kerry, in Quality Control earn that new salary. If there were problems, they should have been caught in QC— that‘s their job. Maybe it‘s not all Kerry‘s fault. If Lynn Robertson in Marketing hadn‘t pushed these products through R&D, we wouldn't be in this fix. Cooper and I introduced plenty of new product lines before Robertson and Smith arrived on the scene. Their very short-term orientation is going to ruin this company. We should either rework or scrap this batch of poor-quality goods in the warehouse waiting to be shipped. It's better to take a small hit now to preserve our long-term viability. But I‘d better not say too much. I have two kids in college and I‘m counting on a pension from this place.

Plastico, Inc.: Role of “Robin Cooper,” Director of Engineering and R&D I can just see it coming now! Kerry Smith is going to point the finger at me for the problem with the picnic table line, something to do with my skimping on the development process of the plastic. Smith was hired by Kim Johnson and can do no wrong. I do not understand the loyalty anyway—all Smith cares about is Smith, Smith, and Smith! Kim Johnson knows I‘m committed to the firm and really want to leave my mark. I always said, ―Plastico is my second family.‖ I've always put in the extra hours without complaining to get new product lines out in time for the Winter Trade Snow—even when Johnson cut my budget twice to boost profits and reallocate funds to Quality Control to hire Kerry Smith. And I‘ve constantly tried to keep the firm at the forefront of plastic technology used for ―playtime‖ activities and devices. Even on a drastically reduced budget, we did a good job developing that plastic. I still do not see how R&D is the problem. I think it has to be something manufacturing is doing in the production process. I tried to explain to Chris Baker that the production process and molding of the plastic for the picnic tables could not be sped up or the plastic would not set properly. Of course, that would mean getting approval to change the production line and Baker is afraid to do anything that might be new or different from the old way of doing things. All Baker cares about is keeping the plant at a certain capacity and not one unit of production less. All I know is that I am not taking the fall—no matter what ―Fancy‖ Quality Control Kerry Smith has to say in today‘s meeting.

Plastico, Inc.: Role of “Lynn Robertson,” Manager of Marketing If I hadn‘t pushed this new product line through R&D, we would have missed this selling season altogether. If it were up to Robin Cooper in R&D, they‘d still be testing and developing this product. It would be nice if Chris Baker were more concerned about manufacturing quality products instead of just hanging on until retirement. Also, I guess I really resent Kerry Smith. To get this job, I had to put myself $40,000 in debt getting my MBA; Kerry just had to be Kim‘s friend! If Kerry had only known something about our products, we wouldn‘t have produced those lousy picnic tables and patio furniture. I know one thing for sure; Johnson is going to expect an answer from me. I guess that‘s why he hired me—this organization needs some fresh blood. Let‘s face it: In business, you have to take risks. I bet Baker will suggest we just dump these defective products—even though they are 50 percent of our initial orders! Consumer Reports doesn‘t run this company! If we sell them overseas, we would at least get something for them. Well, I‘m not going to get an ulcer over it. If things don‘t work out, I'll take my degree elsewhere and get a better job! Maybe even one with profit sharing!

Plastico, Inc.: Role of “Kerry Smith,” Manager of Quality Control Even though Kim Johnson and I go way back, I am not sure that Kim or any of the managers of Plastico are really committed to quality. I am not taking the fall for this crisis. I have had four good jobs prior to this one and I can easily get another. Quality Control is such a hot area right now with the Japanese firms breathing down everyone's necks, that I can find a job—no problem! I think Kim wanted to be like everyone else and show to corporate headquarters, the board, and industry analysts that Plastico was committed to quality. I think that hiring me was really window dressing. Kim never really made any changes at Plastico to show commitment to quality and never got the other managers involved. Kim also never really made it clear how I was supposed to go about making this a quality firm. Everyone here is just concerned with getting the new product line out in time for the Winter Trade Show to get the summer orders—no matter what! The conversations I have had with Robin Cooper have been barely civil and no matter what I say, Cooper shoots it down. I guess Cooper is bitter about losing some R&D funds and blames me. Chris Baker is really easy to talk to and will ―yes-you-to-death‖ about ideas that could improve quality in production, but never takes any action. Baker does not want to do anything that might rock the boat and change the status quo. Baker‘s only concern is keeping the production line at full capacity. Forget Lynn Robertson—all Robertson cares about is looking good at the trade show and getting the orders in. Of course, Robertson thinks the answer to everything is that fancy MBA and does not need input from anyone else to get his job done. Kim Johnson is probably the worst offender here. I‘ve never worked with someone concerned about a profit-sharing bonus enough to avoid changes toward quality that may disrupt the bonus pool in the short-term. Well, I will just have to see what Kim has to say at this meeting.

Exercise 2

Forced Retrenchment at Atkinson I. INTRODUCTION/LEARNING OBJECTIVES This exercise illustrates the importance of a strategic management perspective in organizational decision making. Students take the role of Lynn Jackson, National Sales Manager. They are first asked individually and then in small groups (of four to six, generally) to determine the rank order of layoff for eight regional sales managers. Various personal and work-related information is provided for all eight regional sales managers in such a manner that conflict (sometimes rather intense!) is inevitable. For example, some students may consider family obligations as an important criterion, while others base their decisions solely on a manager's performance. Students typically begin the rating process without considering broad criteria implicit in a stakeholder perspective, an essential attribute in strategic management orientation. Much can be learned by students when they realize that they should have considered such issues as: How can a decision involve ―individual rationality‖ instead of ―organizational rationality?‖ (Chapter 1, Section: ―The Four Key Attributes of Strategic Management,‖ 11th edition of Strategic Management) How is the ranking decision oriented toward achieving broad organizational goals? How does it affect various organizational stakeholders? How integrative is this decision to the overall strategic objectives? How will this decision affect the organization in the short run as well as in the long run? How does the decision relate to achieving efficiency as well as effectiveness? Although the role play can be used at any time during the course, we have found it to be most useful if it is used early. It provides a means of reinforcing many of the central issues in Chapter 1 and stressing the need for a strategic management perspective throughout the organization. II.

PROCEDURES: CONDUCTING THE EXPERIENTIAL EXERCISE

The following three steps are helpful in conducting this exercise. If classes are conducted in sessions of 50 minutes or less, the ―debriefing/discussion‖ step can be conducted during the first part of the following class session.

Step 1:



(20 minutes)

Prepared by Gregory G. Dess, University of Texas at Dallas and Stephanie Newport, Austin Peay State University.

Distribute the three pages that contain the overview (page 1), organization structure and U.S. map with sales regions (page 2), and employee information (page 3) to all participants. Have each participant rank the eight regional managers individually.

Step 2:

(30 minutes)

Form the class into groups of four to six individuals each. Have each group rank the eight managers by group consensus. Step 3:

(20-30 minutes)

It is often helpful to select one student to observe each group. (These individuals do not participate in the decision-making. Instead, they are each asked to spend a few minutes sharing their insights with the entire class after their group completes the exercise.) An ―observation sheet‖ is provided with seven suggested items. Note: examples of a ―Novel Solution‖ would include combining/redrawing regional boundaries, offering the managers salary reductions (if necessary) to prevent layoff, etc. III.

LEADING THE DISCUSSION

It is usually helpful to ask the ―observer‖ to share their insights prior to beginning the discussion. Typically, some groups sense that they performed better (or worse) and this can enhance interest and enthusiasm for the exercise. Also, occasionally, students may disagree with the observer and such interaction not only intensifies interest but also arouses curiosity as to the "optimal decision-making process" and overall learning objectives. We suggest that you first pose the question below (Part A) concerning the ―realism‖ of the exercise and then (Part B) discuss how the exercise serves to illustrate the relevance and importance of a strategic management orientation. A.

Lead-off Questions: Getting the Discussion Started Ask: 

Is this decision situation realistic?

Invariably, you will get a ―split‖ of opinions on this issue. Some students will contend that decision-making in actual organizations is much more rational, i.e., more information is available, more time is available, decisions are based on much more ―objective criteria,‖ and the like. On the other hand, some students will contend that it is very realistic in that managers must make rapid decisions with limited information, and that personal biases play a key role. Point out that the perceived realism of this exercise depends, to some extent, on one's experiences in organizations and general frame of reference. However, most would agree that the politics and ―horse trading‖ would have been much more intense in real organizations when livelihoods are at stake. Note: Many students will strongly believe that more time would have been helpful in the making of a better decision. Although we agree, it is useful to point out that most of the learning objectives of the assignment are generally fulfilled in 25 to 30 minutes of group interaction. 1-484 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Relating the Exercise to Strategic Management Concepts We have found it useful to orient the discussion toward the three major issues below that correspond to central themes in Chapter 1. To further student understanding of important ideas, we also pose questions that we have found to be helpful in stimulating discussion.

Strategic Management as a Set of Skills Used Throughout the Organization. a. Strategic Management Directs the Organization Toward Overall Goals and Objectives.

Ask: 

Did your group explicitly address important organization-wide goals in making your decision?

In most cases, the response will be ―no‖ and this provides an opportunity to state how organizational goals such as profitability (i.e., annual 10 percent of sales) and growth (i.e., only 3 percent annual increase) would affect the making of the ―layoff decision.‖ Here, for example, the relative importance of criteria such as managerial productivity, affirmative action, tenure with the company, family obligations, and so on could be more explicitly addressed in deciding who should be laid off. Thus, decision makers would address an organization-wide perspective instead of a marrow functional perspective and consider economic as well as non-economic considerations. Another issue to address regarding organizational goals is the relative importance of sales growth versus profitability for Atkinson—a subsidiary of a larger corporation. Although generating profits (to provide cash flow) is more important than increasing sales, all of the sales managers‘ performance data is in terms of how much sales were increased. Point out that it is possible for a sales manager to have a rather nominal increase in sales, but he/she could be concentrating on high margin products and services. Clearly, such a sales manager would likely be contributing more in terms of profitability and cash flow to the organization than a sales manager who concentrated solely on increases sales in low-margin products and services. This example helps to point out that evaluating performance at either the organizational or subunit level is quite problematic. b. Strategic Management Involves the Inclusion of Multiple Stakeholders in Decision Making.

Ask: 

What are some of the key stakeholders that must be taken into account in the making of this decision?

This would include stockholders, governmental agencies, employees, customers, and so on. Point out that ―laying off‖ several regional sales managers may have potentially very negative effects on customer relations with many who have established long-term relationships with the affected managers. Also, a poorly made decision may lead to negative ―fallout‖ from governmental agencies such as EEOC for violation of affirmative action guidelines. Retained employees may not only experience lowered morale and decreased productivity, but also suffer ―survivor guilt‖ even after detailed explanations are provided. Clearly, a broad rang of stakeholders must be considered. c. Strategic Management Incorporates Both Short-Term and Long-Term Perspectives

Ask: 

What could be the long-term negative repercussion of laying off several regional sales managers?

Point out that although, in the short-run, salaried labor costs (and some associated expenses) would decrease, in the long run there could be negative outcomes. For example:    

Customers may feel alienated if ―close ties‖ are severed that they have established with some of the laid off managers. It may be very expensive to train new regional sales managers when the economy improves. Morale may decline throughout the organization when other managers and employees wonder if they are the next to be laid off. How will the various regions be ―covered‖ by the remaining regional sales managers? Will the short-term labor savings offset the potential loss in sales revenue and customer goodwill in the long run?

d. Strategic Management Recognizes Tradeoffs between Efficiency and Effectiveness

Many of these issues were addressed in the point above. The key issue is: will short-term labor savings in a functional area (Sales/Marketing) be more than offset by reductions in the viability of the organization's overall operation in the long-term? 2) The Strategic Management Process (Show Exhibit 1.3 from text; 11th edition of Strategic Management) You could use this exercise to point out the three ongoing processes—analysis, decisions, and actions—that are central to the strategic management process. Below, we offer a few questions to pose that can help to illustrate this process in the context of Atkinson Company. Note: Some of the issues below necessitate some “reading into” or “inference” from the materials associated with the exercise, but it should help to stimulate discussion.

Some of the questions you could ask include:  How does this exercise illustrate what can go wrong when an organization’s vision/mission/objectives are not clearly articulated? (Without such goals and objectives it is difficult to assess such issues as: the importance of employee retention and development as well as customer relationships; short-term versus longterm performance; and effectiveness versus efficiency)  What aspects of strategy formulation are important at Atkinson? (We have little understanding of how important differentiation and/or overall low cost is to Atkinson. If Atkinson Company is under extreme cost constraints it may be more likely to immediately make some personnel cuts. However, if they are striving to develop a reputation for outstanding service to their customers, the firing of regional sales managers could severely erode customer relationships. This would make it more difficult to charge premium prices. Another issue you could address is from the perspective of corporate-level strategy. That is, if Atkinson Paper Company is viewed only as a ―cash cow,‖ they may have little opportunity for growth since resources will be siphoned off to subsidize other business units in the corporate-family—such as ―stars‖ and ―questions marks‖—using the Boston Consulting Group (BCG) framework. Thus, APC may have strong constraints placed on them by the corporate office that make it more difficult for them to increase their revenues.) 1-486 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

 What aspects of strategy implementation should Atkinson address? (Clearly, there is the issue of the reward and evaluation systems. Perhaps, performance has decreased because people are not properly motivated. Also, a poor organizational design may prevent information from being effectively communicated throughout the organization; thus, problems are not solved in a timely matter that could further aggravate a deteriorating situation. And, of course, the leadership in the organization may not be demanding excellence and ethical behavior, which could lead to deteriorating performance. This could be especially true if Atkinson is under extreme pressures to lower expenses as a means to increase short-term profits.)

Getting the Regional Sales Managers Directly Involved in the Strategic Management Process.

This exercise can also be linked to Chapter 1 by stressing the need for firm-wide involvement in the reorganization of the sales organization. Thus, instead of directing Lynn Jackson to recommend the ―order of the layoff,‖ the problem associated with decreasing sales could be taken directly to the regional sales managers. The managers could be charged with determining how to solve the problem. Getting everyone involved in the strategic management process could produce better solutions. Among these might be: ▪ Keeping all managers—but at reduced pay—until sales improve ▪ "redrawing" regional areas to provide help to areas particularly hard-hit by adverse economic conditions ▪ sharing sales and marketing ideas and developing new sales promotions ▪ changing the product mix, e.g., 20 percent of the product line may be generating 80% of the firm‘s revenues and profit margins! Point out that strategic managers should separate problems from symptoms. Declining profits and sales are the underlying problem. There are many ways to address that. Focusing only on firing sales managers, at best, only addresses a symptom. Note: Although empowerment seems like a very good idea in this particular situation, it is surprising how seldom it is suggested by students. Ask the class why this is the case (perhaps it is because it is human nature to work toward solving a problem assigned without clearly defining it). Point out that often it is useful to “step back” and discuss the nature of a problem before moving toward a solution. Here is a good time to “drive home” this point in the context of case analysis.

Forced Retrenchment — Observation Sheet 1.

Time used. (very small, small, medium, long, very long)

Conflict?

Reached decision (yes, no)

Who ranked No. 1 (i.e., to be laid off first)?

Criteria used? (e.g., manager’s performance, family obligations, education)

Novel solution? If so, describe.

General comments about participant behavior.

FORCED RETRENCHMENT AT ATKINSON: OVERVIEW Atkinson Paper Company (APC) was founded nearly 50 years ago. It was originally a family-owned company until 2010 when it was acquired by Continental Corporation (CC)—a large conglomerate dealing with a wide range of products including home furnishings, packaging materials, specialty paint products, and automobile accessories. APC specializes in a wide variety of highquality office supplies including computer paper and letterhead stationery. CC acquired APC from the Atkinson family during adverse economic condition. APC‘s sales had decreased from $150 million to $90 million during the five years (2009–2014) prior to the acquisition. CC invested approximately $5 million per year in order to turn around APC during the three years (2015–2018) immediately following the acquisition. Once APC‘s financial viability was somewhat assured, CC began to channel APC‘s cash flow into other subsidiaries with greater growth potential. Thus, CC began to view APC as a ―cash cow‖ (in the SCG corporate portfolio vernacular.) Not surprisingly, Atkinson‘s profitability goals for the coming two years (annual 10 percent of sales) are much more challenging than its sales growth goal (annual 3 percent increase). The parent company has come to depend on Atkinson‘s profitability to generate cash for to other subsidiaries. You are to assume the role of Lynn Jackson, the national sales manager (refer to the attached organization chart and associated information). Last month, Pat Ingram, the vice president of sales and marketing (your immediate superior) informed you that to cut expenses you must reorganize your sales organization into a smaller number of regional offices. As a first step, you are directed to develop a priority list in which you will rank order all regional sales managers in terms of a ―lay off schedule.‖ Please rank the individuals according to the order in which they should be laid off—that is, the person to be laid off first is ranked one, etc. Pat Ingram has assured you that you will have input into many aspects of the ―retrenchment.‖ What ―personal‖ and ―professional‖ strategies should you start thinking of?

Atkinson Paper Co.: Organization Structure President

VP Finance & Accounting

VP Manufacturing

Director of Marketing

New England Alice Franklin

Atlantic Fred Donaldson

Southeast Connie Cortez

VP Director Human Resources

VP Sales & Marketing Pat Ingram

Midwest Les Arvidson

Director Engineering & Development

National National Sales Sales Manager Manager Lynn LynnJackson Jackson Southwest Sean Elliott

Mountain Mary Hobbs

Pacific* Ralph Gonzales

Northwest Kenneth Boyd

* Includes AK & HI

EMPLOYEE INFORMATION Ranking (1, first to lay off; 8, last to lay off): __Les Arvidson is a 30-year-old white male who has been with APC for five years. He manages the Midwest region where the three-year sales growth average of 2016–2018 was 8%. The three-year average for 201–2021 was 5%, but Les has performed above management‘s expectations, given the Midwest‘s general economic distress. Les is single and has an MBA from the University of Michigan. __Kenneth Boyd is a white, 42-year-old Iraq veteran who is married and has four children. Ken began working for APC immediately after his discharge from the U. S. Army. He is a high school graduate and has managed the Northwest region for 11 of his 21 years with APC. Regional sales growth average for 2019–2021 was flat (0% growth) compared to a sales decline (-2% growth) for the 2014–2016 period. __Connie Cortez was recruited from the University of Florida where she earned her BBA, with honors, 10 years ago. Connie manages the Southeast region where the sales growth for 2019–2021 was +1%. For 2016–2018 the figure was -1%. Connie, a Hispanic, has one child and is married to a textile executive who is currently unemployed because of economic problems in that industry. __Fred Donaldson, 37, manages the Atlantic sales region. Average sales growth in 2016–2018 was +2% and for 2019–2021 was +1%. Fred is black and holds a Bachelor of Science degree from VMI. He and his wife, Colette, who has a professional career, have adopted two ―special needs‖ children. Fred has been employed with APC for two years. __Sean Elliott is the manager of the Southwest region where the three-year sales growth average (2016– 2018) was +5% and for the 2019–2021 period was +7%. Sean is white, 53 years old, and holds an Associate of Arts degree from a community college. He came to work for APC 5 years ago after his wife died. Sean recently completed a company sponsored substance abuse program. __Alice Franklin is black, 48, and a loyal, 25-year employee of APC. Although Alice never went to college, she has a high school diploma and has worked her way up in the organization from a file clerk‘s position. Alice manages the New England sales region where the three-year sales growth average (2019– 2021) was -2%. Growth average over the previous three-year period (2016–2018) was -4%. Alice is divorced, has two grown children, and is the sole support of her elderly parents. __Ralph Gonzales, 28, manages the Pacific sales region and was hired 3 years ago after successfully completing a two-summer internship with APC. The internship was served while he completed his MBA at San Diego State University. Ralph is Hispanic, is married, and has two children; he is active in the Boy Scouts of America and the Jaycees. The Pacific region sales growth average for the last three years (2019–2021) was -1%, an improvement over the average -5% growth for the 2014 to 2016 period. __Mary Hobbs is white, 45 years old, and joined APC two years ago. She holds a Bachelor of Science degree from the University of Minnesota and is currently attending night classes for her MBA. Mary manages the Mountain region and for the three years 2019–2021 recorded an average sales growth of 3%. The average in Mary's region for 2016–2018 was -3%. She is currently separated from her husband of 24 years and has two grown children.

KEY QUESTIONS TO POSE: 1.

Is the situation realistic?

Did your organization consider important organization-wide goals?

What are some of the key stakeholders to take into account?

What could be the long-term repercussions of laying off several regional sales managers?

How could the sales managers become directly involved in the decision? (i.e., use of empowerment)

SUMMARY OF KEY LEARING POINTS: 1.

Define the problem.

Develop criteria.

Use multiple indicators of performance.

Identify key stakeholders.

Consider the short-term and long-term implications of decisions.

Evaluate opportunities for empowerment.