Learning MBA Master Degree

TEACHER: Hi, Student. In the previous Module we described how to use the tools of industry and competitive analysis to think strategically about a company's external situation.

In this Module we discuss how to size up a company's strategic position in that environment.

Company situation analysis centers on five questions:

1. How well is the present strategy working?

2. What are the company's strengths, weaknesses, opportunities, and threats?

3. Are the company's prices and costs competitive?

4. How strong is the company's competitive position?

5. What strategic issues does the company face?

STUDENT: I seem to recall that there are several analytical techniques to answer these questions, one of them called SWAT. Am I wrong?

TEACHER: Partially. The name of the technique is SWOT, not SWAT! It stands for "Strengths, Weaknesses, Opportunities, And Threats".

Anyway, let me continue. To explore these questions, four new analytical techniques need to be mastered: SWOT analysis, value chain analysis, strategic cost analysis, and competitive strength assessment. These techniques are basic strategic management tools because they expose the pluses and minuses of a company's situation, the strength of its competitive position, and whether the present strategy needs to be modified.

The Concepts And Techniques Of Strategic Management

Question 1: How Well Is The Present Strategy Working?

In evaluating how well a company's present strategy is working, a manager has to start with what the strategy is and what the company's strategic and financial objectives are.

STUDENT: Sure, this is rather obvious, isn’t it?

TEACHER: Yes, I just wanted to check if you were paying attention. Anyway, the point is that the first thing to pin down is the company's competitive approach -whether it is

* (1) striving to be a low-cost leader,
* (2) stressing ways to differentiate its product offering from rivals, or

(3) concentrating its efforts on a narrow market niche.

Another strategy-defining consideration is the firm's competitive scope within the industry -how many stages of the industry's production-distribution chain it operates in (one, several, or all), the size and diversity of its geographic market coverage, and the size and diversity of its customer base. The company's functional strategies in production, marketing, finance, human resources, and so on further characterize company strategy.

In addition, the company may have initiated some recent strategic moves (for instance, a price cut, stepped-up advertising, entry into a new geographic area, or merger with a competitor) that are integral to its strategy and that aim at securing a particular competitive advantage and/or improved competitive position.

Reviewing the rationale for each piece of the strategy –for each competitive move and each functional approach -clarifies what the present strategy is.

STUDENT: OK, we know what the strategy is, but do we know it is effective?

TEACHER: Good point, Student. While there's merit in evaluating the strategy from a qualitative standpoint (its completeness, internal consistency, rationale, and suitability to the situation), the best evidence of how well a company's strategy is working comes from studying the companies recent performance.

Obvious indicators of strategic and financial performance include:

* (1) the firm's market share ranking in the industry,
* (2) whether the firm's profit margins are increasing or decreasing and how large they are relative to rival firms' margins,
* (3) trends in the firm's net profits and return on investment,
* (4) the company's credit rating,




* (5) whether the firm's sales are growing faster or slower than the market as a whole,
* (6) the firm's image and reputation with its customers, and
* (7) whether the company is regarded as a leader in technology, product innovation, product quality, customer service, and the like. The stronger a company's current overall performance, the less likely the need for radical changes in strategy. The weaker a company’s strategic and financial performance, the more its current strategy must be questioned. Weak performance is usually a sign of weak strategy or weak execution or both.


Question 2: What Are The Company’s Strengths, Weaknesses, Opportunities, And Threats?

Sizing up a firm’s internal strengths and weaknesses and its external opportunities and threats is commonly known as SWOT analysis. It is an easy-to-use technique for getting a quick overview of a firm's strategic situation. SWOT analysis underscores the basic principle that strategy must produce a good fit between a company's internal capability (its strengths and weaknesses) and its external situation (reflected in part by its opportunities and threats).

A strength is something a company is good at doing or a characteristic that gives it an important capability. A strength can be a skill, important expertise, a valuable organizational resource or competitive capability, or an achievement that puts the company in a position of market advantage (like having a better product, stronger name recognition, superior technology, or better customer service). A strength can also result from alliances or cooperative ventures with a partner having expertise or capabilities that enhance a company's competitiveness.
Student, can you imagine what a weakness is?

STUDENT: A weakness is something a company lacks or does poorly (in comparison to others) or a condition that puts it at a disadvantage.

TEACHER: Correct. A weakness may or may not make a company competitively vulnerable, depending on how much the weakness matters in the marketp1ace.

Once managers identify a company's internal strengths and weaknesses, the two compilations need to be carefully evaluated from a strategy-making perspective. Some strengths are more important than others because they matter more in determining performance, in competing successfully, and in forming a powerful strategy. Likewise, some internal weaknesses can prove fatal, while others are inconsequential or easily remedied. Sizing up a company's strengths and weaknesses is akin to constructing a strategic balance sheet where strengths represent competitive assets and weaknesses represent competitive liabilities.

The strategic issues are whether the company's strengths/assets adequately overcome its weaknesses/liabilities (50-50 balance is definitely not the desired condition!), how to meld company strengths into an effective strategy, and whether management actions are needed to tilt the company's strategic balance more toward strengths/assets and away from weaknesses/liabilities.

From a strategy-making perspective, a company's strengths are significant because they can form the cornerstones of strategy and the basis for creating competitive advantage. If a company doesn't have strong capabilities and competitive assets around which to craft an attractive strategy, managers need to take decisive remedial action to develop organizational strengths and competencies that can underpin a sound strategy. At the same time, managers have to correct competitive weaknesses that make the company vulnerable, hurt its strategic performance, or disqualify it from pursuing an attractive opportunity. The strategy-making principle here is simple: a company's strategy should be well-suited to its strengths, weaknesses, and competitive capabilities.

STUDENT: I can see your point clearly: it is foolhardy to pursue a strategic plan that cannot be competently executed with the skills and resources a company can marshal or that can be undermined by company weaknesses.

TEACHER: Exactly. As a rule, managers should build their strategies around what the company does best and avoid strategies that place heavy demands on areas where the company is weakest or has unproven ability.

Core Competencies

One of the "trade secrets" of first-rate strategic management is consolidating a company’s technological, production, and marketing know-how into core competencies that enhance its competitiveness. What do you think is the meaning of "core competency"?

STUDENT: A core competence is something a company does especially well in comparison to its competitors.

TEACHER: Very well. In practice, there are many possible types of core competencies: excellent skills in manufacturing a high quality product, know-how in creating and operating a system for filling customer orders accurately and swiftly, the capability to provide better after-sale service, a unique formula for selecting good retail locations, unusual innovativeness in developing new products, better skills in merchandising and product display, superior mastery of an important technology, a carefully crafted process for researching customer needs and tastes and spotting new market trends, an unusually effective sales force, outstanding skills in working with customers on new applications and uses of the product, and expertise in integrating multiple technologies to create whole families of new products.

Typically, a core competence relates to a set of skills, expertise in performing particular activities, or a company's scope and depth of technological know-how; it resides in a company's people, not in assets on the balance sheet.

The importance of a core competence to strategy-making rests with:

* (1) the added capability it gives a company in going after a particular market opportunity,
* (2) the competitive edge it can yield in the marketplace, and
* (3) its potential for being a cornerstone of strategy.


It is always easier to build competitive advantage when a firm has a core competence in performing activities important to market success, when rival companies do not have offsetting competencies, and when it is costly and time-consuming for rivals to match the competence. Core competencies are thus valuable competitive assets, capable of being the mainsprings of a company's success.

Identifying External Opportunities And Threats

Market opportunity is a big factor in shaping a company's strategy. Indeed, managers can't match strategy to the company's situation without first identifying each industry opportunity and appraising the growth and profit potential each one holds. Depending on industry conditions, opportunities can be plentiful or scarce and can range from wildly attractive (an absolute "must to pursue) to marginally interesting (low on the company's list of strategic priorities).

In appraising industry opportunities and ranking their attractiveness, managers have to guard against equating industry opportunities with company opportunities. Not every company in an industry is well-positioned to pursue each opportunity that exists in the industry -some companies are more competitively situated than others and a few may be hopelessly out of contention or at least limited to a minor role. A company's strengths, weaknesses, and competitive capabilities make it better suited to pursuing some industry opportunities than others. The industry opportunities most relevant to a particular company are those that offer important avenues for profitable growth, those where a company has the most potential for competitive advantage, and those which the company h9s the financial resources to pursue. An industry opportunity that a company doesn’t have the capability to capture is an illusion.
Often, certain factors in a company's external environment pose threats to its well-being. Threats can stem from the emergence of cheaper technologies, rivals' introduction of new or better products, the entry of low-cost foreign competitors into a company's market stronghold, new regulations that are more burdensome to a company than to its competitors, vulnerability to a rise in interest rates, the potential of a hostile takeover, unfavorable demographic shifts, adverse changes in foreign exchange rates, political upheaval in a foreign country where the company has facilities, and the like.

Opportunities and threats not only affect the attractiveness of a company's situation but point to the need for strategic action. To be adequately matched to a company's situation, strategy must

* (1) be aimed at pursuing opportunities well-suited to the company's capabilities and
* (2) provide a defense against external threats.


SWOT analysis is therefore more than an exercise in making four lists. The important part of SWOT analysis involves evaluating a company's strengths, weaknesses, opportunities, and threats and drawing conclusions about the attractiveness of the company's situation and the possible need for strategic action. Some of the pertinent strategy making questions to consider, once the SWOT listings have been compiled, are:

• Does the company have any internal strengths or core competencies an attractive strategy can be built around?

• Do the company's weaknesses make it competitively vulnerable and/or do they disqualify the company from pursuing certain industry opportunities? Which weaknesses does strategy need to correct?

• Which industry opportunities does the company have the skills and resources to pursue with a real chance of success? Which industry opportunities are "best from the company's standpoint? (Remember: Opportunity without the means to capture it is an illusion.)

• What external threats should management be worried most about and what strategic moves should be considered in crafting a good defense?

Unless management is acutely aware of the company's internal strengths and weaknesses and its external opportunities and threats, it is ill-prepared to craft a strategy tightly matched to the company’s situation. SWOT analysis is therefore an essential component of thinking strategically about a company's situation.

Question 3: Are The Company’s Prices And Costs Competitive?

Company managers are often stunned when a competitor cuts price to "unbelievably low" levels or when a new market entrant comes on strong with a very low price. The competitor may not, however, be "dumping," buying market share, or waging a desperate move to gain sales; it may simply have substantially lower costs. One of the most telling signs of whether a company's market position is strong or precarious is whether its prices and costs are competitive with industry rivals.

Price-cost comparisons are especially critical in a commodity-product industry where the value provided to buyers is the same from seller to seller, price competition is typically the ruling market force, and lower-cost companies have the upper hand. But even in industries where products are differentiated and competition centers around the different attributes of competing brands as much as around price, rival companies have to keep their costs in line and make sure that any added costs they incur and price premiums they charge create ample buyer value.

Competitors usually don't incur the same costs in supplying their products to end users. The cost disparities can range from trivial to competitively significant and can arise from any of several factors:



* Differences in the prices paid for raw materials, components parts, energy, and other items purchased from suppliers.
* Differences in basic technology and the age of plants and equipment.
* (Because rival companies usually invest in plants and key pieces of equipment at different times, their facilities have somewhat different technological efficiencies and different fixed costs. Older facilities are typically less efficient, but if they were less expensive to construct or were acquired at bargain prices, they may still be reasonably cost competitive with modem facilities.)
* Differences in internal operating costs due to economies of scale associated with different-size plants, learning and experience curve effects, different wage rates, different productivity levels, different operating practices, different organization structures and staffing levels, different tax rates, and the like.




* Differences in rival firms' exposure to inflation rates and changes in foreign exchange rates (as can occur in global industries where competitors have plants located in different nations).
* Differences in marketing costs, sales and promotion expenditures, and advertising expenses.
* Differences in inbound transportation costs and outbound shipping costs.
* Differences in forward channel distribution costs (the costs and markups of distributors, wholesalers, and retailers associated with getting the product from the point of manufacture into the hands of end users).


For a company to be competitively successful, its costs must be in line with those of close rivals. While some cost disparity is justified so long as the products or services of closely competing companies are sufficiently differentiated, a high-cost firm's market position becomes increasingly vulnerable the more its costs exceed those of close rivals.

Strategic Cost Analysis And Value Chains

Given the numerous opportunities for cost disparities, a company must thus be alert to how its costs compare with rivals. This is where strategic cost analysis comes in. Strategic cost analysis focuses on a firms cost position relative to its rivals.

The Value Chain Concept

The primary analytical tool of strategic cost analysis is a detailed value chain, a list identifying the activities, functions, and business processes that have to be performed in designing, producing, marketing, delivering, and supporting a product or service . The chain of value-creating activities starts with raw materials supply and continues on through parts and components production, manufacturing and assembly, wholesale distribution, and retailing to the ultimate end-user of the product or service.

A company's value chain shows the linked set of activities and functions it performs internally. Below is an example:

Primary Activities

* Purchased Supplies and lnbound Logistics -Activities, costs, and assets associated with purchasing fuel, energy raw materials, parts components, merchandise, and consumable items from vendors; receiving, storing, and disseminating inputs from suppliers; inspection; and inventory management.

* Operations -Activities, costs, and assets associated with converting inputs into final product form (production, assembly, packaging, equipment maintenance, facilities, operations, quality assurance, environmental protection).

* Outbound Logistics -Activities, costs, and assets dealing with physically distributing the product to buyers (finished goods warehousing, order processing, order picking and packing, shipping, delivery vehicle operations).

* Sales and Marketing -Activities, costs, and assets related to sales force efforts, advertising and promotion, market research and planning, and dealer-distributor support.

* Service -Activities, costs, and assets associated with providing assistance to buyers, such as installation, spare parts, delivery, maintenance and repair, technical assistance, buyer inquiries, and complaints.


Support Activities

* Research, Technology, and Systems Development -Activities, costs, and assets relating to product R&D, process R&D, process design improvement, equipment design, computer software development, telecommunications systems, computer-assisted design and engineering, new database capabilities, and development of computerized support systems.

* Human Resources Management -Activities, costs, and assets associated with the recruitment, hiring, training, development, and compensation of all types of personnel; labor relations activities; development of knowledge-based skills.

* General Administration -Activities, costs, and assets relating to general management, accounting and finance, legal and regulatory affairs, safety and security, management information systems, and other "overhead functions.

Source: Adapted from Michael E. Porter, Competitive Advantage (New York: The Free Press, 1985), pp. 37-43.

STUDENT: Sorry to interrupt, I was rather quite for a long time. What about a profit margin as part of the value chain?

TEACHER: Good observation. The chain includes a profit margin because a markup over the cost of performing the firm's value-creating activities is customarily part of the price (or total cost) borne by buyers -creating value that exceeds the cost of doing so is a fundamental objective of business.

By dis-aggregating a company's operations into strategically relevant activities and business processes, it is possible to better understand the company's cost structure and to see where the major cost elements are. Each activity in the value chain incurs costs and ties up assets; assigning the company's operating costs and assets to each individual activity in the chain provides cost estimates for each activity.

The costs a company incurs in performing each activity can be driven up or down by two types of factors: structural drivers (scale economies, experience curve effects, technology requirements, capital intensity, and product line complexity) and exceptional drivers (how committed the work force is to continuous improvement, employee attitudes and organizational capabilities regarding product quality and process quality, lead time in getting newly developed products to market, utilization of existing capacity, whether internal business processes are efficiently designed and executed, and how effectively the firm works with suppliers and/or customers to reduce the costs of performing its activities). Understanding a company's cost structure means understanding:


* Whether it is trying to achieve a competitive advantage based on (1) lower costs (in which case managerial efforts to lower costs along the company's value chain should be highly visible) or (2) differentiation (in which case managers may deliberately spend more performing those activities responsible for creating the differentiating attributes).

* Cost behavior in each activity in the value chain and how the costs of one activity spill over to affect the costs of others.

* Whether the linkages among activities in the company's value chain present opportunities for cost reduction (for example, Japanese VCR producers were able to reduce prices from $1,300 in 1977 to under $300 in 1984 by spotting the impact of an early step in the value chain, product design, on a later step, production, and deciding to drastically reduce the number of parts).


STUDENT: Well, this Module’s subject is rather complicated and long, dear Teacher. I’d say we both need a rest, don’t you think so?

TEACHER: Yes, I agree. We will continue our discussion on Company Situation Analysis in the following Module.