Analyzing the External Strategic Environment
Changes in the broader economic, technological, political, and sociocultural environment, which often are beyond the control of any single company, can have a profound effect on a company’s success. Environmental forces of change arise from the interactions between people and their environment, such as the growth in the world’s population or the phenomenon of urbanization. They impact resource management, health, and the quality of life for people around the world. Technological forces of change—advances in biotechnology, nanotechnology, and information systems—power economic growth and development, global integration, and the speed by which the global economy is becoming a “knowledge” economy. Societal forces of change represent shifts in international governance and in political and cultural values, such as the current wave of democratization, deregulation, and governance reform.
We focus on three forces that perhaps have had the greatest impact on strategic thinking.
Globalization has increased the interdependence between the world’s major economies and intensified competition in many industries. In the process, entire industries have been restructured based on deconstructed value chains, new forms of competition have emerged, and “virtual corporations” have become a reality. The technology revolution has changed the way we live, work, and unwind, spawning entirely new industries. And a growing concern for the environment has prompted many companies to research their “footprint,” restructure supply chains, or even radically change their business models, all because they recognize that a commitment to corporate social responsibility (CSR) has virtually become a business imperative.
Globalization as a political, economic, and social force appears all but unstoppable. The ever-faster flow of information across the globe has made people aware of the tastes, preferences, and life styles of citizens in other countries. Through this information flow, we are all becoming—at varying speeds and at least in economic terms—global citizens. This convergence is controversial, even offensive, to some who consider globalization a threat to their identity and way of life. It is therefore not surprising that globalization has evoked counterforces aimed at preserving differences and deepening a sense of local identity.
At the same time, we increasingly take advantage of what a global economy has to offer—we drive BMWs and Toyotas, work with an Apple or IBM notebook, communicate with a Samsung phone, wear Zara clothes or Nike sneakers, and drink Coca-Cola and Heineken beer. This is equally true for the buying habits of businesses. The market boundaries for IBM global services, GE aircraft engines, or PricewaterhouseCoopers are no longer defined in political or geographic terms. Rather, it is the intrinsic value of the products and services that defines their appeal. Like it or not, we are living in a global economy.
Globalization is not new. For thousands of years, people—and, later, corporations—have been buying from and selling to each other in lands at great distances, such as through the famed Silk Road across Central Asia that connected China and Europe during the Middle Ages. Likewise, for centuries, people and corporations have invested in enterprises in other countries. In fact, many of the features of the current wave of globalization are similar to those prevailing before the outbreak of the First World War in 1914.
The current wave of globalization is driven by policies that have opened economies domestically and internationally. In the years since the Second World War, a growing number of countries have adopted free-market economic systems, vastly increasing their own productive potential and creating myriad new opportunities for international trade and investment. Governments have also negotiated dramatic reductions in barriers to commerce and have established international agreements to promote trade in goods, services, and investment. Taking advantage of new opportunities in foreign markets, corporations have built foreign factories and established production and marketing arrangements with foreign partners. A defining feature of globalization, therefore, is an international industrial and financial business structure.
Technology has been the other principal driver of globalization. Advances in information technology, in particular, have dramatically transformed economic life. Information technologies have given all sorts of individual economic actors—consumers, investors, and businesses—valuable new tools for identifying and pursuing economic opportunities, including faster and more informed analyses of economic trends around the world, easy transfers of assets, and collaboration with far-flung partners.
How Global Are We?
Nevertheless, it would be wrong to conclude that we are inevitably moving toward a fully globalized, integrated, and homogenized future. There are regions and markets that resist globalization—especially Western globalization—evidence that differences between countries and cultures remain substantial, perhaps larger than is generally acknowledged and that “ semiglobalization ” is the real state of the world today and likely to remain so for the foreseeable future.1
Research by Moore and Rugman supports the notion of a semiglobalized world and suggest a more regional perspective. They note that while companies source goods, technology, information, and capital from around the world, business activity tends to be centered in certain cities or regions around the world and suggest that regions rather than global opportunity should be the focus of strategy analysis and organization. As examples, they cite recent decisions by DuPont and Procter & Gamble to roll their three separate country subsidiaries for the United States, Canada, and Mexico into one regional organization.2
The histories of Toyota, Wal-Mart, and Coca-Cola corroborate the diagnosis of a semiglobalized /regionally divided world. Toyota’s globalization has always had a distinct regional flavor. Its starting point was not a grand, long-term vision of a fully integrated world in which autos and auto parts can flow freely from anywhere to anywhere. Rather, the company anticipated expanded free-trade agreements within the Americas, Europe, and East Asia, but not across them.3
The globalization of Wal-Mart also illustrates the complex realities of a more nuanced global competitive landscape. It has been successful in markets that are culturally and economically closest to the United States: Canada, Mexico, and the United Kingdom. In others, it has failed to meet its profitability targets. The point is not that Wal-Mart should not have ventured into culturally more distant markets, but rather that such opportunities require a different competitive approach. For example, in India, which restricts foreign direct investment in retailing, Wal-Mart was forced to enter a joint venture with an Indian partner Bharti that operates the stores while Wal-Mart deals with the back-end of the business.
Finally, consider the history of Coca-Cola which, in the late 1990s under CEO Roberto Goizueta, fully bought into the notion that a fully globalized, homogeneous future was imminent. Goizueta embarked on a strategy that involved focusing resources on Coke’s megabrands, an unprecedented amount of standardization, and the official dissolution of the boundaries between Coke’s U.S. and international organization. Years later and under new leadership, Coke’s strategy looks very different and is no longer always the same in different parts of the world: In big emerging markets, such as China and India, Coke has lowered price points, reduced costs by localizing inputs and modernizing bottling operations, and upgraded logistics and distribution, especially in rural areas. The boundaries between the U.S. and international organizations have been restored recognizing the fact that Coke faces very different challenges in the United States than it does in most of the rest of the world since per capita consumption is an order of magnitude higher in the United States.
The Persistence of Distance4
The notion of a semiglobalized world exemplifies the persistence of distance. Ghemawat analyzes distance between countries or regions in terms of four dimensions: cultural, administrative, geographic, and economic, each of which influences business in different ways.
Cultural Distance. A country’s culture shapes how people interact with each other and with organizations. Differences in religious beliefs, race, social norms, and language can quickly become barriers; that is, “create distance.” The influence of some of these attributes is obvious. A common language, for example, makes trade much easier and therefore more likely. The impact of others is much more subtle, however. Social norms, the set of unspoken principles that strongly guides everyday behavior, are mostly invisible. Japanese and European consumers, for example, prefer smaller automobiles and household appliances than Americans, reflecting a social norm that highly values space. The food industry must concern itself with religious attributes; Hindus do not eat beef because it is expressly forbidden by their religion. Thus, cultural distance shapes preference and ultimately choice.
Administrative or Political Distance. Administrative or political distance is created by differences in governmental laws, policies, and institutions, including international relationships between countries, treaties, and membership in international organizations. The greater the distance, the less likely it is that extensive trade relations develop. This explains the advantage shared historical colonial ties, membership in the same regional trading bloc, and the use of a common currency can confer. The integration of the European Union over the last half-century is probably the best example of deliberate efforts to reduce administrative distance among trading partners. Bad relationships can increase administrative distance, however. Although India and Pakistan share a colonial past, a land border, and linguistic ties, their long-standing mutual hostility has reduced official trade to almost nothing.
Geographic Distance. Geographic distance is about more than how far away a country is in miles. Other geographic attributes include the physical size of the country, average within-country distances to borders, access to waterways and the ocean, and topography, and such man-made as a country’s transportation and communication infrastructure. Geographic attributes most directly influence transportation costs and therefore are particularly relevant to businesses with low value-to-weight or bulk ratios, such as steel and cement. Likewise, costs for transporting fragile or perishable products become significant across large distances. Intangible goods and services are affected by geographic distance as well; cross-border equity flows between two countries fall off significantly as the geographic distance between them rises. This is a direct result of differences in information infrastructure—telephone, Internet, and banking.
Economic Distance. Disposable income is the most important economic attribute that creates distance between countries. Rich countries engage in proportionately higher levels of cross-border economic activity than poorer ones. The greater the economic distance is between a company’s home country and the host country, the greater the likelihood that it must make significant adaptations to its business model. Wal-Mart in India, for instance, would be a very different business from Wal-Mart in the United States. But Wal-Mart in Canada is virtually a carbon copy.
Industry Globalization Drivers
Four sets of “industry globalization drivers”—underlying conditions in each industry that create the potential for that industry to become global—affect the viability of a global approach to strategy formulation.5 Market drivers—the degree to which customer needs converge around the world, customers procure on a global basis, worldwide channels of distribution develop, marketing platforms are transferable, and “lead” countries can be identified in which most innovation takes place—define how customer behavior distribution patterns evolve. Cost globalization drivers—the opportunity for global scale or scope economics, experience effects, sourcing efficiencies reflecting differentials in costs between countries or regions, and technology advantages—shape the economics of the industry. Competitive drivers are defined by the actions of competing firms—the extent to which competitors from different continents enter the fray, globalize their strategies and corporate capabilities, and the degree to which they create interdependence between geographical markets. Government drivers include such factors as favorable trade policies, a benign regulatory climate, and common product and technology standards.
Globalization Has Changed Competition’s Center of Gravity
The rapid emergence of the developing economies—led by the so-called BRIC countries (Brazil, Russia, India, and China)—has shifted the global competitive center of gravity. For the last 50 years, the globalization of business has primarily been interpreted as the expansion of trade from developed to emerging economies. Today this view is no longer tenable—business now flows in both directions, and increasingly also from one developing economy to another. Or, as the authors of “Globality,” consultants at the Boston Consulting Group (BCG), put it: Business these days is all about “competing with everyone from everywhere for everything.”6
The evidence that this shift in the global competitive landscape will have seismic proportions is already formidable. Consider, for example, the growing number of companies from emerging markets that appear in the Fortune 500 rankings of the world’s biggest firms. It now approaches 100, mostly from the BRIC economies, and is set to rise further. If current trends persist, emerging-market companies may well account for one-third of the Fortune list within 10 years.
Look also at the recent sharp increase in the number of emerging-market companies acquiring established rich-world businesses and brands, proof that “globalization” is no longer just another word for “Americanization.” For instance, Budweiser, the maker of United States’ favorite beer, was bought by a Belgian–Brazilian conglomerate. And several of United States’ leading financial institutions avoided bankruptcy only by being bailed out by the sovereign-wealth funds (state-owned investment funds) of various Arab kingdoms and the Chinese government. As these examples suggest, “Globality” is creating huge opportunities—as well as threats—for developed-world multinationals and new champions from developing countries alike.
Globalization Pressures on Companies
Gupta, Govindarajan, and Wang identify five “imperatives” that drive companies to become more global: to pursue growth, efficiency, or knowledge, to better meet customer needs, and to preempt or counter competition.7
Growth. In many industries, markets in the developed countries are maturing at a rapid rate limiting the rate of growth. Consider household appliances. In the developed part of the world, most households have or have access to appliances, such as stoves, ovens, washing machines, dryers, and refrigerators. Industry growth is therefore largely determined by population growth and product replacement. In developing markets, in contrast, household penetration rates for major appliances are still low compared to Western standards thereby offering significant growth opportunities for manufacturers.
Efficiency. A global presence automatically expands a company’s scale of operations giving it larger revenues and larger asset base. A larger scale can help create a competitive advantage if a company undertakes the tough actions needed to convert scale into economies of scale by (1) spreading fixed costs, (2) reducing capital and operating costs, (3) pooling purchasing power, and (4) creating critical mass in a significant portion of the value chain. On the demands side, increasing or decreasing the scope of marketing and distribution by entering new markets or regions, or by increasing the range of products and services offered offers opportunities to realize economies of scope. The economic value of global scope can be substantial when serving global customers through providing coordinated services and the ability to leveraging a company’s expanded market power.
Knowledge. Foreign operations can be a reservoir of knowledge. Some locally created knowledge is relevant across multiple countries and, if leveraged effectively, can yield significant strategic benefits to a global enterprise, such as (1) faster product and process innovation, (2) lower cost of innovation, and (3) reduced risk of competitive preemption. For example, Fiat developed Palio—its global car—in Brazil; Texas Instruments uses a collaborative process between Indian and U.S. engineers to design its most advanced chips; and Procter & Gamble’s liquid Tide was developed as a joint effort by U.S. employees (technology to suspend dirt in water), the Japanese subsidiary (cleaning agents), and the Brussels operations (agents that fight mineral salts found in hard water). Most companies tap only a fraction of the full potential in realizing the economic value inherent in transferring and leveraging knowledge across borders. Significant geographic, cultural, linguistic distances often separate subsidiaries. The challenge is to create systematic and routine mechanisms to uncover opportunities for knowledge transfer.
Globalization of Customer Needs and Preferences. When customers start to globalize their behavior, a firm has little choice but to follow and adapt its business model to accommodate them. Multinationals such as Coca-Cola, GE, and DuPont increasingly insist that their suppliers—from raw material suppliers to advertising agencies to personnel recruitment companies—become more global in their approach and be prepared to serve them whenever and wherever required. Individuals are no different; global travelers insist on consistent worldwide service from airlines, hotel chains, credit card companies, television news, and others.
Globalization of Competitors. Just as the globalization of customers compels companies to consider globalizing their business model, so does the globalization of one or more major competitors. A competitor who globalizes early may have a first-mover advantage in emerging markets, greater opportunity to create economies of scale and scope, and an ability to cross-subsidize competitive battles thereby posing a greater threat in the home market. A good example of these forces at work is provided by the global beer market. Over the past decade, the beer industry has seen significant consolidation and this trend continues. On a pro forma basis, beer sales by the top 10 players now total approximately 65 percent of total global sales compared to less than 40 percent at the start of the century.
Global Strategy and Risk8
Even with the best planning, globalization carries substantial risks. Many globalization strategies represent a considerable stretch of the company’s experience base, resources, and capabilities. The firm might target new markets, often in new—for the company—cultural settings. It might seek new technologies, initiate new partnerships, or adopt market-share objectives that require earlier or greater commitments than current returns can justify. In the process, new and different forms of competition can be encountered, and it could turn out that the economic model that got the company to its current position is no longer applicable. Often, a more global posture implies exposure to different cyclical patterns, currency, and political risk. In addition, there are substantial costs associated with coordinating global operations. As a consequence, before deciding to enter a foreign country or a continent, companies should carefully analyze the risks involved. In addition, companies should recognize that the management style that proved successful on a domestic scale might turn out to be ineffective in a global setting.
Technological advances continue to challenge and surprise us in all dimensions of life—from social to economic to political and personal. Advances in biotechnology will enable us to identify, understand, manipulate, improve, and control living organisms (including ourselves). The information revolution continues to profoundly change how we work, interact, and relax. And smart materials, agile manufacturing, and nanotechnology are altering the way we create products and processes. Soon, all these may be joined by “wild cards” such as molecular manufacturing—the idea of assembling objects atom-by-atom (or molecule-by-molecule) from the bottom-up (rather than from the top-down using conventional fabrication techniques)—if barriers to their development are resolved in time.
The results will likely be astonishing. Effects may include longer life spans, a redistribution of wealth, shifts in power from nation states to nongovernmental organizations and individuals, mixed environmental effects, improvements in quality of life, and the possibility of human eugenics and cloning.
The actual realization of these possibilities will depend on a host of factors, including local acceptance of technological change, levels of technology and infrastructure investments, market drivers and limitations, and technology breakthroughs and advancements. Since these factors vary across the globe, the implementation and effects of technology will also vary, especially in developing countries. Nevertheless, the overall revolution and trends will continue through much of the developed world.
The Internet Has Changed Business
The Internet has revolutionized the way business is conducted. Some of the major changes brought about by the Internet relate to the way we purchase products and services, obtain information, and conduct our banking. Customers can quickly find product and price information and obtain advice from a wide variety of sellers. Online visitors can check product availability, place an order, check the status of an order, or pay electronically. This so-called “e-tailing” has increased competition by pitting local against national and international competitors.
Internet-based technologies have significantly reduced the marginal cost of producing and distributing digital goods such as software, news stories, music, photographs, stock quotes, horoscopes, sports scores, and health tips. Some firms such as America Online are selling large aggregations of such digital goods for a low flat monthly fee. Such aggregation of so many products would be extremely expensive using traditional distribution media. Such bundling offers economies of scale and scope that favor large distributors and make it difficult for smaller companies that sell unbundled products to compete effectively.10 The Internet also enables customization of products. Online customers can purchase personal computers on the Internet in a variety of combinations by choosing the appropriate features. Music retailers can create CDs containing songs ordered by customers. And search engines such as Google and Yahoo recommend relevant products or services on the basis of keywords supplied by users.
Online companies have successfully created strong e-brands and highly satisfied customers by providing them with a positive experience and with the use of traditional advertising and promotional efforts. Many of the factors that lead to higher customer satisfaction and loyalty in traditional businesses also work in e-businesses. Delivering excellent service and value is equally important for customer satisfaction, customer loyalty, and retention in offline and online businesses. Companies hoping to attract and most importantly retain visitors to their website need to offer online customers superior value and satisfaction. Branding is becoming important in Internet-based businesses because online consumers prefer to buy from well-known and reputable e-companies. Companies such as Amazon.com and Schwab are widely known, recognized, and trusted by online consumers. Gaining people’s trust is a major challenge for Internet companies as many online visitors are reluctant to provide credit-card information because they do not trust the sites they visit. Traditional retailers with established names usually have an advantage over certain Internet-only companies because they have been known for years and enjoy a higher degree of trust by consumers. The reputation and image of the website may have an impact on the offline business.
The Impact of “Big Data”
We have entered the era of “big data.” Today companies collect and process an exponentially growing volume of transactional data about their customers, suppliers, and operations. To capture these data, millions of networked sensors are being embedded in devices such as mobile phones, smart energy meters, automobiles, and industrial machines that sense, create, and communicate. Social media sites, smartphones, and other consumer devices including PCs and laptops have allowed billions of individuals around the world to contribute to the amount of big data available. Many citizens regard this collection of information with deep suspicion, fearing a growing potential for invasion of their privacy. But there is another side to this coin—big data has the potential to create significant value and enhance competitiveness.11
ShopAlerts, developed by PlaceCast of San Francisco and New York, is a location-based “push SMS” product that companies including Starbucks, North Face, Sonic, REI, and American Eagle Outfitters are using to drive traffic to their stores. Advertisers define a geographic boundary in which to send opted-in users a push SMS typically in the form of a promotion or advertisement to visit a particular store; in general, a user would receive no more than three such alerts a week. ShopAlerts claims 1 million users worldwide. In the United States, the company says it can locate more than 90 percent of the mobile phones in use nationwide. The company reports that 79 percent of consumers surveyed say that they are more likely to visit a store when they receive a relevant SMS; 65 percent of respondents said they made a purchase because of the message; and 73 percent said they would probably or definitely use the service in the future.12
Tesco—a major grocery chain in the United Kingdom—credits its use of big data for capturing market share from its local competitors. Its loyalty program generates a tremendous amount of customer data that the company mines to inform decisions from promotions to strategic segmentation of customers. Similarly, Amazon uses customer data to power its recommendation engine “you may also like . . .” based on a type of predictive modeling technique called collaborative filtering. By making supply and demand signals visible between retail stores and suppliers, Wal-Mart was an early adopter of vendor-managed inventory to optimize the supply chain. Harrah’s, the U.S. hotels and casinos group, compiles detailed holistic profiles of its customers and uses them to tailor marketing in a way that has increased customer loyalty. Progressive Insurance and Capital One are both known for conducting experiments to segment their customers systematically and effectively and to tailor product offers accordingly.
New Business Models
The arrival of big data, coupled with other advances in business, is enabling the emergence of innovative business models that threaten traditional ones. In the retail sector, for example, two new business models with the most traction today are price-comparison services and web-based markets.
Price-Comparison Services. It is common today for third parties to offer real-time or near-real-time pricing and related price transparency on products across multiple retailers. Consumers can instantly compare the price of a specific product at multiple retail outlets. Where these comparisons are possible, prices tend to be lower. Studies show that consumers are saving an average of 10 percent when they can shop using such services. Retailers need to carefully think about how to respond to such price-comparison services. Those that can compete on price will want to ensure that they are the most visible on such services. Retailers that cannot compete on price will need to determine how to differentiate themselves from competitors in a price-transparent world, whether it is in the quality of the shopping experience, differentiated products, or the provision of other value-added services.
Web-Based Markets. Web-based marketplaces, such as those provided by Amazon and eBay, provide searchable product listings from a large number of vendors. In addition to price transparency, they offer access to a large number of niche retailers that otherwise would not have the marketing or sales horsepower to reach consumers. They also provide a tremendous amount of useful product information, including consumer-generated reviews that provide further transparency to consumers.
Beyond increasing productivity, big data is spawning innovative services and entirely new business models in manufacturing as well. For example, sensor data have made possible innovative after-sale services. BMW’s ConnectedDrive offers drivers directions based on real-time traffic information, automatically calls for help when sensors indicate trouble, alerts drivers of maintenance needs based on the actual condition of the car, and feeds operation data directly to service centers. The ability to exchange data across the extended enterprise has also enabled production to be unbundled radically into highly distributed networks. For example, Li and Fung, a supplier to apparel retailers, manages a network of more than 7,500 suppliers, each of which focuses on delivering a very specific part of the supply chain.
Corporate Social Responsibility—A New Business Imperative
CSR, concerned with better aligning a company’s activities with the social, economic, and environmental expectations of its stakeholders, has become an important strategic issue for most companies. Also sometimes referred to with terms such as corporate responsibility, corporate citizenship, responsible business, sustainability, eco-friendliness, or corporate social performance, CSR promotes the integration of a form of corporate self-regulation into a whole range of corporate business practices. Ideally, a focus on CSR would function as a built-in, self-regulating mechanism whereby companies would monitor and ensure their adherence to law, ethical standards, environmental standards, and international norms, and take full responsibility for the impact of their activities on the environment, consumers, employees, communities, stakeholders, and other citizens. CSR-focused businesses proactively promote the public interest by encouraging community growth and development, and voluntarily eliminate practices that are viewed as harmful, regardless of legality. CSR therefore reflects the deliberate inclusion of public interest into corporate decision making and the honoring of a triple bottom line: people, planet, and profit.
A New Compact Between Business and Society?
Given its recent origin and complexity, it is not surprising that CSR is often misunderstood. Is it a moral and ethical issue? Is it a new approach to compliance and risk management? Or is it a strategic issue—an opportunity to differentiate a company and build customer loyalty based on distinctive ethical values? The simple answer is that it can be all of the above.
Societal considerations increasingly force companies to rethink their approach to core strategy and business model design. Dealing more effectively with a company’s full range of stakeholders therefore has become a strategic imperative. Historically, the amount of attention paid to stakeholders, other than directly affected parties, such as employees or major investors, in crafting strategy has been limited. Issues pertaining to communities, the environment, the health and happiness of employees, human rights violations of global supply chains, and activist NGOs, among numerous other issues, were dealt with by the company’s public relations department or its lawyers.
Today, “business as usual” is no longer an option, and traditional strategies for companies to grow, cut costs, innovate, differentiate, and globalize are now subject to a set of new laws of doing business in relationship to society13:
1. Size means scrutiny. The bigger a company is, and the more market dominance it achieves, the more attention and demand it faces for exemplary performance in ethical behavior, good governance, environmental management, employee practices, product development that improves quality of life, support for communities, honest marketing, and so on.
2. Cutting costs raises compliance risk. The more companies use traditional means to cut costs—finding low-wage producers in less developed countries, pressuring suppliers, downsizing, cutting corners, and so on—the more potential there is for crises related to noncompliant ethical practices. The risks involved in successfully complying with society’s expectations for ethical behavior, safety, product liability, environmental practices, and good treatment of all stakeholders might well outweigh the benefits accrued from these kinds of cost savings.
3. Strategy must involve society. For forward-thinking companies, social and environmental problems represent the growth opportunities of the future. For example, GE is looking to solve challenges related to the scarcity of global natural resources and changing demographics, while IBM has made social innovation a priority alongside business product and process innovation.
4. Reducing risks means building trust. Classic risk management strategies must expand beyond financial and currency analysis to include destabilizing trends and events arising from society. Smart leaders realize that no company can manage these risks if it does not earn the trust of society’s leaders and of its communities.
5. Satisfying shareholders means satisfying stakeholders. In the long run, the company that pays attention to the business–society relationship ultimately serves its investors’ interests because (a) its antennae are better tuned to identifying risk, (b) it is able to build trust with its stakeholders, and (c) it is well positioned to develop goods and services that society values.
6. Global growth requires global gains. Increasingly, growth requires a global perspective that recognizes the importance of strong local communities that supply infrastructure; maintain stable business climates; attract investment capital; supply healthy, educated workers; and support growth that generates consumers with greater purchasing power. But long-term growth also requires development.
7. Productivity requires sustainability. Companies have seen that commitment to environmental management and safety in the workplace has been a driver of lower costs and greater productivity. In addition, companies that take on the challenge of constraining their behavior through commitments to corporate citizenship find new incentive to innovate to compete. The more companies innovate, the more productive and sustainable they become.
8. Differentiation relies on reputation. In the United States, an estimated 50 million people, representing over $225 billion a year in purchasing power, comprise the emerging “lifestyles of health and sustainability” consumer base. As the influence of these activist consumers grows, they will demand companies to demonstrate sterling reputations and commitment to society.
9. Good governance needs good representation. A spate of corporate scandals has generated stricter controls and comprehensive governance reforms. These changes reflect an underlying revolution calling for companies to include stakeholders in formal governance.
These “laws” are likely to play a key role in strategy formulation in the years ahead. Companies that accept, understand, and embrace them will find that being a “good citizen” has significant strategic value and does not detract from but actually enhances business success.
How “Going Green” Can Pay Off14
One area where a concern for society and strategic opportunity can be seen to be firmly aligned is the environment. Thanks to aggressive leadership by some of the world’s biggest companies—Wal-Mart, GE, and DuPont among them—green growth has risen to the top of the agenda for many businesses. From 2007 to 2009, eco-friendly product launches increased by more than 500 percent. A recent IBM survey found that two-thirds of executives see sustainability as a revenue driver, and half of them expect green initiatives to confer competitive advantage. This dramatic shift in corporate mind-set and practices over the past decade reflects a growing awareness that environmental responsibility can be a platform for both growth and differentiation.15
Reducing energy use, for example, is one environmental tenet that is a virtual no-brainer. United Parcel Service (UPS), one of the world’s largest package delivery companies, began adding hybrid vehicles to its fleet in 2006 to test whether the introduction of these vehicles might reduce their fuel costs (about 5 percent of their operating expenditures in 2006). UPS has demonstrated that a shift in consumer sentiment toward environmental preservation can be good for the company’s bottom line. For almost a decade, it has managed fuel consumption and greenhouse gas emissions as a business opportunity—one that can improve the bottom line, reduce the company’s impact and on the environment, and increase the long-term viability of the company.
In addition, with pressure increasing for the government to make regulations to curb corporate pollution, many companies are moving toward adopting some environmental practices before such regulations are put in place. Companies like Alcoa and Dupont, for example, have established systems to reduce carbon emission and other harmful chemicals, the most likely targets for government intervention. Leading the way, these companies, while reducing their impact on the environment, are also mitigating the future risks of regulatory shocks in the future.
Today, manufacturers, service sector companies, professional service firms, retailers, and Internet and telecommunication companies are all focused on finding smart ways to make sustainability work in their businesses. For example:
• General Mills redesigned the packaging of Hamburger Helper to conserve paperboard without reducing the product content. Thanks to increased shipping efficiency, product distribution now requires 500 fewer trucks per year.
• Interface, one of the world’s leading interior furnishing companies, formed an “Eco Dream Team” to design a safer and healthier way to run the business. The team helped the company cut the use of fossil fuels by 45 percent and landfill use by 80 percent.
• Hubbard Hall, a leading chemical distributor, has developed a series of green services to help customers track their chemical inventories, handle regulatory paperwork, and properly dispose of hazardous containers. These services make a valuable contribution to the environment. They also help Hubbard Hall compete effectively with Internet direct marketers.
• 3M’s Pollution Prevention Pays (3P) program has helped eliminate more than 2 billion pounds of pollutants from the environment. When it was launched in 1970, it achieved $1 billion in savings the very first year.16
Improved public relations and positive public perception can also have a major impact on a company’s bottom line. Nike Inc., which set targets to reduce waste and packaging and become “climate neutral,” and Hewlett-Packard (HP), which is working toward reducing waste and setting up recycling services for electronic waste, made the Global 100 Most Sustainable Corporations in the World list based on how well they managed environmental risks and opportunities compared to their competitors. The Global 100 compares companies to peers in their sectors and selects companies on a “best-in-class” basis. Global 100 analysts believe these sustainable corporations will create long-term value for shareholders through cost reduction, innovation, and other competitive advantages that result from sustainable practices. This suggests that, if constructively approached, getting ahead of the curve by being green actually represents an opportunity for companies to create a competitive advantage over their rivals.
Many strategic choices involve future events that are difficult to predict. The success of a new product introduction, for example, can depend on such factors as how current and potential competitors will react, the quality of components procured from outside suppliers, and the state of the economy. To capture the lack of predictability, decision-making situations are often described along a continuum of states ranging from certainty to risk to uncertainty. Under conditions of certainty, accurate, measurable information is available about the outcome of each alternative considered. When an event is risky, we cannot predict its outcome with certainty but have enough information to assess its probability. Under conditions of uncertainty, little is known about the alternatives or their outcomes.
To make analysis of the strategic environment actionable, we must be able to assess the degree of uncertainty associated with relevant events, the speed with which changes are likely to occur, and the possible outcomes they foreshadow. Conditions of certainty and risk lend themselves to formal analysis; uncertainty presents unique problems. Some changes take place gradually, and are knowable, if not predictable. We might not be able to determine exactly when and how they affect a specific industry or issue, but their broad effect is relatively well understood. The globalization of the competitive climate and most demographic and social trends fall into this category. The prospect of new industry regulations creates a more immediate kind of uncertainty—the new regulatory structure will either be adopted or it will not. The collapse of boundaries between industries constitutes yet another scenario: The change forces themselves may be identifiable, but their outcomes might not be totally predictable. Finally, there are change forces such as the sudden collapse of foreign governments, outbreaks of war, or major technological discoveries that are inherently random in nature and cannot be easily foreseen.
Analyzing Uncertainty17
Courtney, Kirkland, and Viguerie argue that a binary approach to dealing with uncertainty in which the future is either thought to be known or unknown can be dangerous and that forcing precise predictions in inherently uncertain situations can lead to seriously deficient strategic thinking. Instead, they suggest we focus on the degree of residual uncertainty present in the strategic environment—the uncertainty that remains after all knowable change forces have been analyzed and distinguished between four levels of residual uncertainty:
Level 1: A clear-enough future: Some strategic environments are sufficiently transparent and stable that a single forecast of the future can be made with a reasonable degree of confidence. A number of mature, low-technology industries fall into this category. It also applies to more narrowly defined strategic challenges such as countering a specific competitor in a specific market or region.
Level 2: Alternate futures: At times, the future can be envisioned in terms of a small number of discrete scenarios. In such cases, we may not be able to forecast with any precision which outcome will occur, but the set of possible outcomes is fully understood. Businesses that are affected by major legislative or regulatory changes fall into this category.
Level 3: A range of futures: This level defines a higher level of uncertainty in which we can identify the key variables that are likely to shape the future, but we cannot reduce this knowledge to a few discrete, plausible outcomes. Instead, a range of almost continuous outcomes is possible. Courtney et al. cite the example of a European consumer goods company trying to decide whether to introduce its products to the Indian market. The best available market research might identify only a broad range of potential market shares.
Level 4: True ambiguity: At this level, even the driving forces that are likely to shape the future are hard to identify. As a consequence, no discrete scenarios or even ranges of outcomes can be predicted. While level four situations are rare, they do exist. Take, for example, the challenges faced by companies doing business in the Middle East: Every aspect of the strategic environment is fraught with uncertainty. There is uncertainty about the legal aspects of doing business, about the availability of raw materials and components, about the likely demand for various products and services, and about the political stability of the region. In such situations, traditional analysis techniques and forecasting tools are of little assistance.
Situations characterized by level one uncertainty lend themselves to conventional analysis. Simple trend extrapolation may be sufficient to identify what is happening in the broader sociopolitical, economic, and technological environment; standard techniques of competitor analysis can also be used to clarify the picture at the industry level. At level two, standard techniques can be used for analyzing each discrete set of outcomes, but a different analysis may be needed for different scenarios. This can make it difficult to compare them. In addition, we must then assess the likelihood that each scenario will occur with the use of decision-analysis techniques. Level three situations are prime candidates for techniques such as scenario planning, described earlier. Level four environments are most difficult to analyze. At best a partial, mostly qualitative analysis can be performed. In these situations, it may be useful to analyze comparable, past environments and extract strategic lessons learned.
Implications for Strategy
Courtney et al. use the terms strategic posture—a company’s strategic intent—and strategic moves to construct a generic framework for formulating strategy in uncertain environments. In characterizing how firms deal with uncertainty, they distinguish between shapers, adapters, and companies reserving the right to play.
Shapers drive the industry toward a structure that is to their benefit. They are out to change the rules of the competitive game and try to control the direction of the market. An example is Amazon’s goal to fundamentally change the way people shop for broad classes of products.
Adapters are companies that exhibit a more reactive posture. They take the current industry structure as given and often bet on gradual, evolutionary change. In strategic environments characterized by relatively low levels of uncertainty, adapters position themselves for competitive advantage within the current structure. At higher levels of uncertainty, they may behave more cautiously and fine-tune their abilities to react quickly to new developments. The airline industry provides examples of this type of strategic behavior.
The third posture, also reactive in nature, reserves the right to play. Companies pursuing this posture often make incremental investments to preserve their options until the strategic environment becomes easier to read or less uncertain. Making partial investments in competing technologies, taking a small equity position in different start-up companies, and experimenting with different distribution options are examples of reserving the right to play. Universities hedging their bets about the future of higher education and investing in online course delivery exemplify this strategic posture.
Strategic moves are action patterns aimed at realizing strategic intent. Big bets are large commitments mostly used by companies with shaping postures such as Tesla in the automotive industry. They often carry a high degree of risk: Potential payoffs are large but so are potential losses. Options target high payoffs in best-case scenarios while minimizing losses in worst-case situations. Licensing an alternative technology in case it proves superior to current technology is a good example. Finally, a no-regret move has a positive or neutral outcome under all scenarios and is often associated with a reserve-the-right-to-play posture.
In level one strategic environments—a clear-enough future—most companies are adapters. The industry structure is fairly stable and its evolution is relatively predictable. In this environment, conventional analysis techniques can assist with positioning the company for sustained competitive advantage. Because of the relatively high degree of predictability, such strategies by definition consist of a sequence of no-regret moves. This state of relative tranquility typically is maintained until a shaper upsets the apple cart, usually with a big bet move. Consider, for example, the actions of Wayne Huizinga’s Republic Industries in the movie rental and waste management industries, and now with automobile dealerships.
Whereas shapers in level one environments raise the level of uncertainty by challenging the existing order, at levels two, three, and four their objective is to reduce uncertainty through determined action. At level two—alternate futures—a shaping strategy is designed to tilt the probabilities toward a specific outcome. Making a big commitment to building new capacity as a way of deterring a potential rival from entering the industry is illustrative of a shaping strategy. A heavy lobbying effort for or against a piece of legislation is an example of a non–market shaping posture. At level two, adapting or reserving the right to play is easier than at higher levels of uncertainty because the forces of change are known and only a few discrete scenarios are thought to occur.
Whereas at level two shaping was about forcing a particular outcome, at level three no discrete outcomes can be identified. As a result, at this level of uncertainty shaping strategies focus on limiting the range of possible outcomes to a smaller set of more desirable futures. Consider the earlier example of a European manufacturer wishing to enter the Indian market. A shaping strategy might involve a local partnerships or tie-ins with already-established products. Adapter and reserving the right to play strategic postures are more common at this level. Both are aimed at keeping the company’s options open: Adapters are generally more aggressive and will craft strategy in real time as opportunities emerge; companies adopting a reserve-the-right-to-play posture often wait until a more definitive strategy can be adopted. At this level, options and no-regret moves are more common than big bets.
Level four environments are the most uncertain. Extreme uncertainty, however, may represent enormous opportunities to shapers who can exploit it. When true ambiguity prevails, the situation invites new rules and a sense of order. As a consequence, shaping strategies may not require big bets and in fact can be less risky at this level than at level two or three. Alternatively, adaptive strategies or a reserve-the-right-to-play posture may represent opportunities lost. Battles for technological standards, discussed earlier, come to mind.
Scenario Analysis
Originally developed at Royal Dutch/Shell in London, scenario analysis is one of the most widely used techniques for constructing alternative plausible futures of a business’s external environment. Its purpose is to analyze the effects of various uncontrollable change forces on the strategic playing field and to test the resiliency of specific strategy alternatives. It is most heavily used by businesses that are highly sensitive to external forces such as energy companies.
Scenario analysis is a disciplined method for imagining and examining possible futures.18 It divides knowledge into two categories: (1) things we believe we know something about and (2) elements we consider uncertain or unknowable. The first category mainly focuses on the forward projection of knowable change forces. For example, we can safely make assumptions about demographic shifts or the substitution effects of new technologies. Obvious examples of uncertain aspects—the second category—are future interest rates, oil prices, results of political elections, and rates of innovation. Because scenarios depict possible futures but not specific strategies to deal with them, it makes sense to invite into the process outsiders, such as major customers, key suppliers, regulators, consultants, and academics. The objective is to see the future broadly in terms of fundamental trends and uncertainties and to build a shared framework for strategic thinking that encourages diversity and sharper perceptions about external changes and opportunities.
The scenario-building process involves four steps:
1. Deciding what possible future developments to probe, which trends—technological change, demographic change, or resource issues—to include, and what time horizon to consider.
2. Identifying what forces or developments are likely to have the greatest ability to shape the future.
3. Constructing a comprehensive set of future scenarios based on different combinations of possible outcomes. Some combinations will be of greater interest than others, either because they have a greater effect on the strategic issue at hand or because they are more or less likely to occur. As a result, a few scenarios usually emerge that become the focus of a more-detailed analysis.
4. Generating scenario-specific forecasts that allow an assessment of the implications of the alternative futures for strategic postures and choices.
Limitations of Scenario Planning
Although scenario planning has gained much adherence in industry, its subjective and heuristic nature leaves many executives uncomfortable. How do we know if we have the right scenarios? And how do we go from scenarios to decisions?
Apart from some inherent subjectivity in scenario design, the technique can suffer from various process and content traps. These traps mostly relate to how the process is conducted in organizations (such as team composition and role of facilitators) as well as the substantive focus of the scenarios (long term vs. short term, global vs. regional, incremental vs. paradigm shifting, etc.). One might think of these as merely challenges of implementation, but since the process component is integral to the scenario experience, they can also be viewed as weaknesses of the methodology itself. Limited safeguards exist against political derailing, agenda control, myopia, and limited imagination when conducting scenario planning exercises within real organizations.
A third limitation of scenario planning in organizational settings is its weak integration into other planning and forecasting techniques. Most companies have plenty of trouble dealing with just one future, let alone multiple ones. Typically, budgeting and planning systems are predicated on single views of the future, with adjustments made as necessary through variance analysis, contingency planning, rolling budgets, and periodic renegotiations. The reality is that most companies do not handle uncertainty well and that researchers have not provided adequate answers about how to plan under conditions of high uncertainty and complexity.