Strategic Management: Creating Competitive Advantage
Strategic management is a continuous process which cannot be simplified by a single approach. The reason is that market conditions are constantly changing. That is why each of the four approaches of the classical, the evolutionary, the processual and the systemic school of thought, when taken on its own, proves inadequate. Before discussing why, it is important to establish the framework in which these approaches are applied.
The greatest challenge in business strategy formulation is to anticipate the movement of market forces. The difficulty arises from the fact that there are five market forces which interact in a complex framework to create unique scenarios. The first of these five forces is the threat of new entrants. It is possible to predict to some extent whether the threat is high or low depending on whether the industry in question is capital intensive or not.
If entering the industry requires a high level of resource investments, then potential entrepreneurs will think twice before investing in the industry because the risk will be very high. For example, the auto manufacturing industry will have a low threat of new entrants because it takes a lot of resources in terms of man and machinery to set up
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The second market force is the availability of substitute products. Business strategy has to be guided by the availability of substitute products because it has a direct bearing on profits. The business organization selling a product that has a lot of substitutes will not attract a lot of market attention because customers have many brands to choose from. The business strategy in this case is to develop a unique selling proposition. The three remaining forces, the threat of competitive rivalry, bargaining power of buyers and bargaining power of suppliers are equally influential in guiding formulation of business strategy.
As mentioned before, the five forces create a complex context for businesses to operate in. It is difficult for the management of a business organization to predict when there is going to be new entrant in the market or when a substitute product is going to be launched. However the management still has to do the best it can in trying to figure out where the industry will go in the future in terms of differentiation, cost minimization and quick delivery. These are the three areas excellence in which creates the competitive edge. Strategic focus has to be developed in one or the other of these three areas.
Differentiation is a matter of creating a unique selling proposition which differentiates a particular brand from the rest in the market and as a result the threat of substitute products is reduced. Cost leadership is directly related to profit maximization because the cost leader in the industry has discovered the means of production at the lowest possible cost. In other words, the cost leader has minimized the costs of production and thus maximized its profits. The third area of quick delivery is also critical in terms of its value to organizational strategic focus in that companies which can bring their products to the customers in the shortest span of time will win greater market share.
In the fast moving consumer goods industry, for example, consumer tastes and preferences are in a constant state of flux and the competitors are bringing out new packages all the time to keep pace with change. In this the company which can make new packages available fastest in the industry will enjoy the greatest share of the pie. Strategy formulation under the framework of differentiation, cost leadership and quick delivery thus enables business organizations to keep pace with market forces.
The three tools of differentiation, cost leadership and quick delivery simplify strategy formulation by creating a sense of direction. As mentioned before, they create a framework which can help the management of a business organization set strategic direction. They ensure that strategy formulation is targeted. This is not an easy task since external threats to business profits can come in any shape or size. A competitor might be investing heavily in promotional activities. Another competitor might be marketing a product that offers identical features at a lower price. A third competitor might be using a unique distribution channel which makes the products available everywhere.
A particular business organization facing these challenges will have to devise strategies to counter the threats from all three competitors. Before devising the strategies in this regard, the management has to set the goals and objectives which it deems sufficient in countering the competitive threat effectively. It is in the area of setting goals and objectives that the aforementioned tools of differentiation, cost leadership and quick delivery become particularly useful.
Without goals and objectives, strategy formulation has no direction and is not targeted. Thus it becomes a futile exercise. If the goal is to develop a competing brand with unique features, then the management will have to devise differentiation strategies. If the goal is to compete on the basis of price, then the management will have to conduct research on the efficiency of the internal processes of production and administration and thus keep the costs of operations down. In this the management is devising strategies the goal of which is to develop a position of cost leadership. So at this point, the management knows the threats it is facing and has set the goals and objectives of counter strategies.
But the question that still remains is how to set those strategies. In answering this question, the management has at its behest four approaches: classical, evolutionary, processual and systemic. However none of the approaches taken on its own is sufficient because the complex interactions characterizing the five market forces make sure that scenarios are always changing and that no one single approach is likely to be successful for long.
According to the classical approach to strategy formulation, profit maximization supersedes all else in terms of its importance to strategic focus. Thus if the management of a business organization is pursuing the classical approach, then all its strategic efforts in the areas of differentiation, cost leadership and quick delivery will be targeted towards maximizing profits. Profit maximization is a worthy goal since it ensures that the particular business organization following this approach stays on top of competition. In fact, the management, by pursuing this goal, might be addressing the very question of survival.
However, the question one should ask is whether this worthy goal should be addressed directly or indirectly. According to the classical approach, this should be addressed directly. Yet that is not always a sound strategy because in the relentless drive to maximize profits by either differentiating its products or minimizing costs or by increasing the speed of product or services delivery, the company management might be overlooking its obligations to the society.
This is the area of corporate social responsibility which the classical approach seems to completely ignore in goal-setting. The external environment in which businesses currently operate has come a long way since the day when Henry Ford issued his ultimatum. Now reputation is the key to profit maximization and the only way to develop that reputation is to make contributions in the area of social development. However the classical approach makes no mention of corporate social responsibility.
According to the classical approach, the management maintains complete control over strategy formulation independent of market forces. This is a fundamental shortcoming of the classical approach. As mentioned before, the management is not in a position to predict industry dynamics resulting from the complex interactions between the market forces. The interactions are so complex that the management certainly cannot control them. Yet the classical approach assumes that the management can set the direction of an entire industry by setting a long-term strategy.
Thus the assumption is that the management has all the data and the information which enables it to forecast the direction of the industry in the long term. Of course this might be true if competition came solely from the domestic market. However the global economy ensures that business organizations no longer have the luxury of limiting themselves to the domestic economy. Thus the importance of analyzing the repercussions of political, economic, sociological and technological change becomes apparent.
Globalization has opened up the world economy and as a result competition has become intense. As mentioned before, business organizations now have to compete internationally. The phenomenon of globalization is a threat and an opportunity in equal measure. On the one hand, business organizations now have much more information to analyze in terms of staying competitive. On the other hand it has opened up new markets and new patterns of demand. For example economies in the West have matured and demand for traditional products and services is stagnating. The result is exactly the opposite in the emerging economies in China and India and the Pacific Rim.
The rising middle class particularly in China and India are generating a lot of demand for products and services which are not enjoying success in the West. Companies in the West which have been manufacturing these goods and services for a long time are in the best position to fill this demand. So globalization is an opportunity for these businesses. However this opportunity will pass a business organization by if it makes the mistake of adopting the classical approach to strategy formulation. The classical approach to strategy formulation completely ignores the highly complex environment of international business.
Changes in the political environment or the sociological environment or the economic environment or the technological environment will have a direct effect on business performance. If the business organization is limiting itself to the domestic economy then the challenges involved are limited and the management can get away with following the classical approach. The management for example will be well acquainted with the political environment in its home country. The same holds for the sociological environment because in this respect cultural considerations have a key role to play and the management can afford to ignore cultural differences the magnitude of which in a single country will be minimal.
However when it comes to international business, cultural considerations vary significantly from one country to another and the business organization involving itself in international business has to take those differences into critical consideration. Of course cultural considerations have one advantage in that they are static.
Cultures are not dynamic entities and therefore the management can afford to formulate strategies in the long term with the current cultural traits in the analytical framework. However when it comes to political and economic considerations of doing international business, then the complexities multiply and the management certainly cannot afford to rest easy with its predictions of political and economic stability in the rest of the world. One case in example is the Asian financial crisis in 1997.
The Asian financial crisis is a prime example of how strategy formulation can go awry when the management is following the classical approach. The crisis hit when nobody was expecting it. During the eighties and the early nineties, the three governments in South Korea, Indonesia and Thailand were following economic development programs which seemed to be immune to be any sort of economic shocks. During this time the international investors decided that the best place to put their money in were the three economies in South Korea, Indonesia and Thailand.
What further facilitated this process was the liberalization of the international financial market which allowed capital to flow from one nation to another smoothly. A further stimulant in motivating the international investor to invest in the three economies was that the economies were following a growth strategy the engine of which was investments in assets of different categories and these investments were being financed by foreign debt. These foreign debts were investments made by the international investors.
The three economies were sending a massive volume of exports to the US and the governments in South Korea, Indonesia and Thailand were keeping their currencies pegged to the US dollar so that the exchange rate was kept fixed. As the economies continued to grow the asset prices in the three countries continued to appreciate when the basic economic fundamentals were not there to justify the appreciation. This was the formation of an asset bubble. The bubble burst overnight when the investors suddenly decided that the Thai currency was overvalued and they requested the Thai government to devalue the currency. The investors fled with their money when the Thai Government refused.
As a result, the Thai government suddenly found itself burdened with a massive pile of foreign debt which it was unable to process because nobody was interested in the Thai currency and it had plunged overnight. Similar circumstances in South Korea and Indonesia led to similar debacles and the three economies were on the verge of collapse. However international businesses adopting the classical approach would have received a nasty shock in their goals and objectives of profit maximization because the financial crisis came as a shock to everyone and the management following the classical approach would certainly not have factored the financial crisis into its long term equations.
The evolutionary approach to business strategy formulation seems to correct this shortcoming in the classical approach by discouraging long term planning. According to the evolutionary approach, there are too many fundamentals in the business environment behaving too expectedly for the management of a business organization to be able to plan for them in advance long term. As a result, business organizations adopting the evolutionary approach emphasize day-to-day planning. The shortcoming of this approach is that as a result, the organization will not have a strategic focus because it is discouraging strategic planning which is long term.
This is a serious shortcoming because identifying the strategic focus of the company is directly related to identifying the core competencies of a company. Unless the organization has a good idea of its core competencies, it will not be able to assess the strengths and weaknesses of its organizational structure. An assessment of the strengths and the weaknesses of the existing organizational structure is vital if the organization is to stay on top of competition. That will not happen if the management of the organization follows the evolutionary approach to the exclusion of all other approaches.
At the heart of the evolutionary approach is the belief that an organizational structure of strengths and weaknesses develops in response to market forces. As a result what the management is doing in following the evolutionary approach is following a reactive approach. The business organization following the evolutionary approach is always reacting to what is happening in the market. However in the modern business environment, business organizations may not have the luxury of extended reaction times.
In most cases, the industry changes so fast that by the time the management has developed a tactic in response to a particular market development, the market will have moved in another direction, leaving the evolutionary organization with a tactic that is of no value to the existing context. As a result, by following the evolutionary response, an organization runs the risk of being left behind in the scheme of things. The risk is particularly intense if the market is particularly competitive. In a particularly competitive market, the organization would gain by following the classical approach and certainly not by following the evolutionary approach.
However, as mentioned before, the shortcoming with the classical approach is that it overemphasizes strategic planning to the exclusion of tactical planning. So the question is not one of whether the organization should follow one approach or the other but to what extent the organization should follow which approach. But given the shortcoming of the evolutionary approach, which is its complete emphasis on short-term planning, the management should not focus its resources on following this approach.
So far the shortcomings of the classical approach and the evolutionary approach have been discussed. The fundamental difference between the two approaches is related to how objectives are set. According to the classical approach, the management follows a static objective which is profit maximization regardless of the competitive scenario currently prevailing in the market. According to the evolutionary approach, the management cannot have any fixed objectives because objectives are a function of what is happening in the market and the management has to adapt as it sees fit. Mention of setting objectives is made here because it is this area to which the processual approach is relevant.
According to the processual approach, objectives arise out of the political events taking place in the organization. So the difference between the processual approach and the evolutionary approach is that while the latter looks without for inspiration in setting objectives, the former looks within. As a result, the processual approach suffers from the shortcomings that the evolutionary approach did: lack of strategic focus. The processual approach implies that it is the employees of the organizations which know best as to which direction to steer in.
However that is not always the case. Most employees who have been working in a particular organization for a long period of time will be reluctant to change their work practices. However change management is an important ongoing process which keeps an organizational structure evolving, thus competitive. When it comes to change management, the bottom-up approach is advocated in many cases because then the management will not have deal with the phenomenon of employee resistance. According to the top down approach, the management decides to restructure the organization as it sees fit in alignment with the strategic focus of the company.
Once the management has decided what the scope of the change will be, it has the equally challenging task of convincing the employees to adopt the new practices. Employees will naturally feel resistant to change because change entails abandoning practices which they have been gaining experience in for a long time. In that respect, getting employees’ inputs on how to manage change is a critical area of concern. However, employees are not always in the best position to judge what changes are best for improving the overall strategic focus of the organization. Their analytical framework will necessarily be confined to their own sub-units and work processes.
As a result, it is advisable for the management to set a long term direction for the organizations which will guide the nature of the politics within the organization. It is a question of the degree to which the management allows the political events within the organization to shape, or be shaped by, change. If the organization is undergoing a technological change, then the nature of social relations will necessarily have to affect it for the change to be acceptable to the employees. However, both market forces and the management have a greater capacity for sharpening strategic focus and the processual approach denies the existence of that hierarchical context by attaching equal importance to the politics organizationwide. At the very least, the shortcoming of this approach is that it totally ignores the external environment in setting targets for change.
This shortcoming is corrected in the systemic approach. According to this approach, the business organization which is adopting this approach has to take into consideration the society in which it is operating. Thus the concept of corporate social responsibility plays an integral part in this approach. As mentioned before, reputation is the key to continuing profitability in the current business environment.
As a result, a business organization has to maintain good social relations in the interests of developing good customer relations. However the shortcoming in this case is that the management might lose sight of the fact that maximizing profits is its main objective and not maintaining social relations. Maintaining social relations is critical to maximizing profits but its importance cannot supersede that of strategic focus which has to be targeted towards maximizing profits.
From the discussion above, it is clear that a business organization cannot hope to succeed by adopting a single approach. If the organization were to follow only the classical approach, it would find itself unprepared for unexpected turns and corners taken by the market from time to time. If it were to follow only the evolutionary approach, it would have no strategic focus.
If it were to follow only the processual approach, it would not be able to cope with changes in the external environment. And if it were to follow only the systemic approach, then it would run the risk of pushing the objective of profit maximization to the back. There is no question that a business organization must have a strategic focus to which change management is aligned. The question is how to plan in the short term and in the long term to further the strategic focus. The best answer may be to follow a mix of the four approaches.
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