CHAPTER 2

Strategy and Performance 

Introduction

Carefully crafted strategies often deliver only a fraction of their promised financial value. Why should this be so? Is it because CEOs press for better execution when they really need a sounder strategy? Or is it because they focus on crafting a new strategy when execution is the organization’s true weakness? Are there other reasons? And how can such errors be avoided? A good starting point is a better understanding of how strategy and performance are linked.

A plethora of research on this issue exists. Much of what we know about the determinants of industry, firm, and business (financial) performance is in the form of measures of individual relationships in models linking various hypothesized causal variables to various measures of performance. The causal variables usually describe some combination of elements of environment, firm strategy, and organizational characteristics. This type of research is conducted in disciplines such as economics, management, business policy, finance, accounting, management science, international business, sociology, and marketing. Comparing the results from these studies is difficult, principally because research methodologies, model specifications, and the definition and measurement of explanatory and dependent variables differ widely. Estimation techniques, ranging from simple cross tables to complex “causal” models, also differ substantially.

It is not surprising then that more has been learned about the impact of specific environmental, organizational, and strategic variables on (financial) performance than about the efficacy of entire (multidimensional) strategies in different settings. We know, for example, that all else being equal, the following hold true:

But knowing these relationships exist is a far cry from understanding how strategy and performance are linked, because no simple prescription involving one or just a few factors is likely to be helpful in crafting comprehensive effective strategies.

Two, widely cited studies shed a different light on how companies achieve superior, sustained performance. The first, by Jim Collins, entitled Good to Great: Why Some Companies Make the Leap . . . and Others Don’t, originally published in 2001, focused on what good companies can do to become truly great. Its findings have inspired many CEOs to change their views about what drives success. It shows, among other findings, that factors such as CEO compensation, technology, mergers and acquisitions, and change management initiatives played relatively minor roles in fostering the Good to Great process. Instead, successes in three main areas—disciplined people, disciplined thought, and disciplined action—were likely the most significant factors in determining a company’s ability to achieve greatness. The second, What Really Works: The 4+2 Formula for Sustained Business Success, by Joyce, Nohria, and Roberson, in association with McKinsey & Co., was aimed at identifying the must-have management practices that truly produce superior results. As part of this so-called Evergreen Project, more than 200 well-established management practices were evaluated as they were employed over a 10-year period by 160 companies. It concluded that eight management practices—four primary and four secondary—are directly correlated with superior corporate performance as measured by total return to shareholders. Winning companies achieved excellence in all four of the primary practices, plus any two of the secondary practices, suggesting the 4+2 Formula title. Losing companies failed to do so.

Although the two studies differ significantly in terms of their methodology, there is substantial agreement in the findings. As it turns out, a company’s strategy, execution, leadership and talent pool, organization, process, and corporate culture all are critical to sustained success. What is more, they all are inextricably linked and together determine performance.

Leverage: Economies of Scale and Scope 

Business historian Alfred D. Chandler argued that “to compete globally, you have to be big.”¹ Looking back over a century of corporate history, he noted that the “logic of managerial enterprise” begins with economics—and the cost advantages that come with scale and scope in technologically advanced capital-intensive industries. Large plants frequently produce products at a much lower cost than can small ones because the cost per unit decreases as volume goes up (economies of scale). In addition, larger plants can use many of the same raw- and semi-finished materials and production processes to make a variety of different products (economies of scope). What is more, these principles are not limited to the manufacturing sector. Procter & Gamble, through its multibrand strategies, benefits from economies of scope because of its considerable influence at the retail level. In the service sector, the scale and scope economies of the major accounting firms have enabled them to dominate the auditing services market for large companies by displacing a number of respectable local and regional accounting firms.

Economies of Scale 

More formally, economies of scale occur when the unit cost of performing an activity decreases as the scale of the activity increases. Unit cost can fall as scale is increased for reasons such as the use of better technologies in production processes or greater buyer power in large-scale purchasing situations. A different form of scale economics occurs when cost can be reduced as a result of finding better ways to perform a given task. In this scenario, the cumulative number of units processed or tasks performed drives the cost reduction. This is referred to as the economics of learning. The graphical representation of this phenomenon is called the learning or experience curve.

Economies of Scope 

Economies of scope occur when the unit cost of an activity falls because the asset used is shared with some other activity. When Frito-Lay Corporation, for example, uses its trucks to deliver not only Frito corn chips and Lay’s potato chips but also salsa and other dips to be used with the chips, it creates economies of scope. Decision opportunities for creating economies of scope fall into three broad classes: (1) horizontal scope, (2) geographical scope, and (3) vertical scope.

Horizontal scope decisions mainly concern choices of product scope. General Electric (GE) is a highly diversified company with interests in appliances, medical systems, aircraft engines, financing, and many other areas. Intangible assets such as knowledge—Sony’s expertise in miniaturizing products, for example—or brands—think of the Virgin brand—can also be sources of horizontal economies of scope when they are used in the development, production, and marketing of more than one product.

Geographical scope decisions involve choices about geographical coverage. McDonald’s has operations in almost 100 countries, Whirlpool has production facilities in a few countries but markets its products in a large number of countries, and Internet-based companies such as eBay and Amazon have achieved geographical scope on a virtual basis.

Vertical scope decisions are concerned with how a company links its value chain activities vertically. In the computer industry, IBM has traditionally been highly vertically integrated. Dell, in contrast, does not manufacture anything. Rather, it relies on an extensive network of third-party suppliers in its value creation process.

Size alone, of course, is not enough to guarantee competitive success. To capitalize on the advantages that scale and scope can bring, companies must make related investments to create marketing and distribution organizations. They must also create the right management infrastructure to effectively coordinate the myriad activities that make up the modern multinational corporation. 

Defining the “Core” Business— Key to Sustained Performance 

A useful starting point for crafting a strategy is to define the core business. For most companies, the core is defined in terms of their most valuable customers, most valuable products, most important channels, and distinctive capabilities. The challenge is to define the company as different from others in a way that builds on real strengths and capabilities—that avoids “strategy by wishful thinking”—in a manner that is relevant to all stakeholders, with room for growth.² Here is where the art and science of strategy formulation meet and where CEOs have a unique opportunity to position their companies with customers, suppliers, alliance partners, and financial markets.

Not choosing what is core by default also is a choice. Not making a deliberate choice risks confusion about a company’s positioning in its served markets, however, and might make it more difficult to create value on a sustained basis. 

The story of Colgate-Palmolive illustrates what is possible when a company chooses to focus on building its core business and driving it to its full potential. Since 1984, Colgate’s share price has outperformed its peers and delivered a return three times that of S&P 500. These results are remarkable, because Colgate operates in low-to medium-growth segments. The company’s long history of strong performance stems from an absolute focus on its core businesses: oral care, personal care, home care, and pet nutrition. This has been combined with a successful global financial strategy. Around the world, Colgate has consistently increased gross margins while at the same time reducing costs in order to fund growth initiatives, including new product development and increases in marketing spending. These, in turn, have generated greater profitability. 

The Need for Growth 

Achieving consistent revenue and profit growth is hard—especially for large companies. To put this challenge in perspective, for a $30 billion company, about average for a Fortune 100 company, to grow 6 percent, it must spawn a new $2 billion company every year. What is more, a growth strategy that works for one company might not be appropriate for another. It might even be disastrous. A high percentage of mergers and acquisitions, for example, fail to meet expectations. Making the right acquisition, successfully integrating an acquired company into the acquirer’s operations, and realizing promised synergies is difficult even for experienced players such as GE. Companies that only occasionally make an acquisition have a dismal track record. Relying on internal growth alone to meet revenue targets can be equally risky, especially in years of slow economic growth. Few companies consistently achieve higher-than-GDP growth from internal sources alone.

To formulate a successful growth strategy, a company must carefully analyze its strengths and weaknesses, how it delivers value to customers, and what growth strategies its culture can effectively support. For price-value leaders like Wal-Mart, a growth strategy focused on entering adjacent markets is highly suitable. For performance-value players such as Intel or Genentech, on the other hand, continuous innovation might be a more effective platform for revenue growth. Selecting the right growth strategy, therefore, requires a careful analysis of opportunities, strategic resources, and cultural fit.³

Whether a company chooses to pursue growth through further investments in its core business or by expanding beyond its current core, it has only three avenues by which to grow its revenue base: (1) organic or internal growth, (2) growth through acquisition, and (3) growth through alliance-based initiatives. This is often referred to as the “Build, Buy, or Bond” paradigm. Wal-Mart primarily relies on organic growth. GE regularly makes strategic acquisitions in markets it deems attractive in order to achieve its growth objectives. Amazon and eBay have numerous alliances and supplier relationships that fuel their revenue growth. 

We characterize growth strategies using product–market choice as the primary criterion into three categories: (1) concentrated growth (2) vertical and horizontal integration, and (3) diversification. 

Concentrated Growth Strategies 

Existing product markets often are attractive avenues for growth. A corporation that continues to direct its resources to the profitable growth of a single product category, in a well-defined market and possibly with a dominant technology, is said to pursue a concentrated growth strategy.⁴ The most direct way of pursuing concentrated growth is to target increases in market share. This can be done in three ways: (1) increasing the number of users of the product, (2) increasing product usage by stimulating higher quantities of use or by developing new applications, and/or (3) increasing the frequency of the product’s use.

Concentrated growth can be a powerful competitive weapon. A tight product–market focus allows a company to finely assess market needs, develop a detailed knowledge of customer behavior and price sensitivity, and improve the effectiveness of marketing and promotion efforts. High success rates of new products are also tied to avoiding situations that require undeveloped skills, such as serving new customers and markets, acquiring new technologies, building new channels, developing new promotional abilities, and facing new competition. Corporations that successfully use concentrated growth strategies include Allstate, Amoco, Avon, Caterpillar, Chemlawn, KFC, John Deere, and Goodyear. 

Vertical and Horizontal Integration 

If a corporation’s current lines of business show strong growth potential, two additional avenues for growth—vertical and horizontal integration—are available.

Vertical integration describes a strategy of increasing a corporation’s vertical participation in an industry’s value chain. Backward integration entails acquiring resource suppliers or raw materials or manufacturing components that used to be sourced elsewhere. Forward integration refers to a strategy of moving closer to the ultimate customer, for example, by acquiring a distribution channel or offering after-sale services. Vertical integration can be valuable if the corporation possesses a business unit that has a strong competitive position in a highly attractive industry—especially when the industry’s technology is predictable and markets are growing rapidly. However, it can reduce a corporation’s strategic flexibility by creating an exit barrier that prevents the company from leaving the industry if its fortunes decline.

Decisions about vertical scope are of key strategic importance at both the business unit and corporate levels because they involve the decision to redefine the domains in which the firm will operate. Vertical integration, therefore, also affects industry structure and competitive intensity. In the oil industry, for example, some companies are fully integrated from exploration to refining and marketing, whereas others specialize in one or more “upstream” or “downstream” stages of the value chain. 

How profitable is vertical integration? The evidence is not clear cut but suggests that backward integration has a greater potential for raising Return on Investment (ROI) than forward integration, whereas partial integration generally hurts ROI. Studies also show that the impact of vertical integration on profitability varies with the size of the business. Larger businesses tend to benefit to a greater extent than smaller ones. This suggests that vertical integration might be a particularly attractive option for businesses with a substantial market share in which further backward integration has the potential for enhancing competitive advantage and increasing barriers to entry. Finally, with respect to the question of what other factors should be considered, the results suggest that (1) alternatives to ownership, such as long-term contracts and alliances, should actively be considered; (2) vertical integration almost always requires substantial increases in investment; (3) projected cost reductions do not always materialize; and (4) vertical integration sometimes results in increased product innovation.

Horizontal integration involves increasing the range of products and services offered to current markets or expanding the firm’s presence into a wider number of geographic locations. Horizontal integration strategies are often designed to leverage brand potential. In recent years, strategic alliances have become an increasingly popular way to implement horizontal growth strategies.

Diversification 

The term diversification has a wide range of meanings in connection with many aspects of business activity. We talk about diversifying into new industries, technologies, supplier bases, customer segments, geographical regions, or sources of funds. In a strategic context, however, diversification is defined as a strategy of entering product markets different from those in which a company is currently engaged. Berkshire Hathaway is a good example of a company engaged in diversification; it operates insurance, food, furniture, footwear, and a host of other businesses.

Diversification strategies pose a great challenge to corporate executives. In the 1970s, many U.S. companies, facing stronger competition from abroad and diminished growth prospects in a number of traditional industries, moved into industries in which they had no particular competitive advantage. Believing that general management skill could offset knowledge gained from experience in an industry, executives thought that because they were successful in their own industries, they could be just as successful in others. A depressing number of their subsequent experiences showed that these executives overestimated their relevant competence and, under these circumstances, bigger was worse, not better. 

Diversification strategies can be motivated by a variety of factors, including a desire to create revenue growth, increase profitability through shared resources and synergies, and reduce the company’s overall exposure to risk by balancing the business portfolio, or an opportunity to exploit underutilized resources. A company might see an opportunity to capitalize on its current competitive position—leveraging a strong brand name, for example—by moving into a related business or market. Entering a new business may also counterbalance cyclical performance or use excess capacity. 

Relatedness or the potential for synergy is a major consideration in formulating diversification strategies. Related diversification strategies target new business opportunities, which have meaningful commonalities with the rest of the company’s portfolio. Unrelated diversification lacks such commonalities. Relatedness or synergy can be defined in a number of ways. The most common interpretation defines relatedness in terms of tangible links between business units. Such links typically arise from opportunities to share activities in the value chain among related business units, made possible by the presence of common buyers, channels, technologies, or other commonalities. A second form of relatedness among business units is based on common intangible resources, such as knowledge or capabilities. Sony’s expertise in “miniaturizing” products is a good example. A third form of relatedness concerns the ability of business units to jointly gain or exercise market power. Examples of this form of relatedness include a company’s ability to cross-subsidize competitive battles across product markets or geographies; take advantage of reciprocal buying opportunities; provide complementary products or “total solutions,” rather than individual products; and confront challenges from societal stakeholder groups or regulatory bodies. Strategic relatedness is a fourth type of relatedness. It is defined in terms of the similarity of the strategic challenges faced by different business units. For example, a company might have developed a special expertise in operating businesses in mature, low-tech, slow-growing markets. All these scenarios offer companies an opportunity to exploit the different types of relatedness—which are not available to single-business competitors—for competitive advantage.

A well-known study links a company’s performance to the degree of relatedness among its various businesses. It identifies three categories of relatedness based on a firm’s specialization ratio, defined as the proportion of revenues derived from the largest single group of related businesses: dominant business companies, related business companies, and unrelated business companies.⁵ Dominant business companies, such as Microsoft and IBM, derive a majority of their revenues from a single line of business. Related business companies, such as General Foods, Eastman Kodak, and DuPont, diversify beyond a single type of business but maintain a common thread of relatedness throughout the portfolio. The components of the portfolios of unrelated business companies, or diversified conglomerates, have little in common. Rockwell International and Textron are examples of conglomerates that lack synergistic possibilities in products, markets, or technologies. The study concluded that companies with closely related portfolios tend to outperform widely diversified corporations.

Porter suggests three tests for deciding whether a particular diversification move is likely to enhance shareholder value: 

Diversification is a powerful weapon in a corporation’s strategic arsenal. It is not a panacea for rescuing corporations with mediocre performance, however. If done carefully, diversification can improve shareholder value, but it needs to be planned carefully in the context of an overall corporate strategy. 

Mergers and Acquisitions. Companies can implement diversification strategies through internal development; joint ventures or alliances; or mergers and acquisitions. Internal development can be slow and expensive. Alliances involve all of the complications and compromises of a renegotiable relationship, including debates over investments and profits. As a result, permanently bonding with another company is sometimes seen as the easiest way to diversify. Two terms describe such relationships: mergers and acquisitions. A merger signifies that two companies have joined to form one company. An acquisition occurs when one firm buys another. To outsiders, the difference might seem small and related less to ownership control than to financing. However, the critical difference is often in management control. In acquisitions, the management team of the buyer tends to dominate decision making in the combined company.

The advantages of buying an existing player can be compelling. An acquisition can quickly position a firm in a new business or market. It also eliminates a potential competitor and therefore does not contribute to the development of excess capacity. 

Acquisitions, however, are generally expensive. Premiums of 30 percent or more over the current value of the stock are not uncommon. This means that, although sellers often pocket handsome profits, acquiring companies frequently lose shareholder value. The process by which merger and acquisition decisions are made contributes to this problem. In theory, acquisitions are part of a corporate diversification strategy based on the explicit identification of the most suitable players in the most attractive industries as targets to be purchased. Acquisition strategies should also specify a comprehensive framework for the due diligence assessments of targets, plans for integrating acquired companies into the corporate portfolio, and a careful determination of “how much is too much” to pay. 

In practice, the acquisition process is far more complex. Once the board has approved plans to expand into new businesses or markets, or once a potential target company has been identified, the time to act is typically short. The ensuing pressures to “do a deal” are intense. These pressures emanate from senior executives, directors, and investment bankers, who stand to gain from any deal; shareholder groups; and competitors bidding against the firm. The environment can become frenzied. Valuations tend to rise as corporations become overconfident in their ability to add value to the target company and expectations regarding synergies reach new heights. Due diligence is conducted more quickly than is desirable and tends to be confined to financial considerations. Integration planning takes a back seat. Differences in corporate cultures are discounted. In this climate, even the best-designed strategies can fail to produce a successful outcome, as many companies and their shareholders have learned.

What can be done to increase the effectiveness of the merger and acquisition process? Although there are no formulas for success, six themes have emerged: 

Cooperative Strategies. Cooperative strategies—joint ventures, strategic alliances, and other partnering arrangements—have become increasingly popular in recent years. For many corporations, cooperative strategies capture the benefits of internal development and acquisition while avoiding the drawbacks of both.

Globalization is an important factor in the rise of cooperative ventures. In a global competitive environment, going it alone often means taking extraordinary risks. Escalating fixed costs associated with achieving global market coverage, keeping up with the latest technology, and increased exposure to currency and political risk all make risk sharing a necessity in many industries. For many companies, a global strategic posture without alliances would be untenable. 

Cooperative strategies take many forms and are considered for many different reasons. However, the fundamental motivation in every case is the corporation’s ability to spread its investments over a range of options, each with a different risk profile. Essentially, the corporation is trading off the likelihood of a major pay off against the ability to optimize its investments by betting on multiple options. The key drivers that attract executives to cooperative strategies include the need for risk sharing, the corporation’s funding limitations, and the desire to gain market and technology access.⁷

Risk Sharing. Most companies cannot afford “bet the company” moves to participate in all product markets of strategic interest. Whether a corporation is considering entry into a global market or investments in new technologies, the dominant logic dictates that companies prioritize their strategic interests and balance them according to risk.

Funding Limitations. Historically, many companies focused on building sustainable advantage by establishing dominance in all of the business’ value-creating activities. Through cumulative investment and vertical integration, they attempted to build barriers to entry that were hard to penetrate. However, as the globalization of the business environment accelerated and the technology race intensified, such a strategic posture became increasingly difficult to sustain. Going it alone is no longer practical in many industries. To compete in the global arena, companies must incur immense fixed costs with a shorter payback period and at a higher level of risk.

Market Access. Companies usually recognize their lack of prerequisite knowledge, infrastructure, or critical relationships necessary for the distribution of their products to new customers. Cooperative strategies can help them fill the gaps. For example, to further its growth strategy in Latin America, GE Money, the consumer lending unit of GE Company, acquired a minority position in Banco Colpatria–Red Multibanca Colpatria S.A., a consumer and commercial bank based in Bogota, Colombia. Banco Colpatria, a member of the Mercantil Colpatria S.A. group, has over $2.4 billion in assets and is the second largest credit card issuer in Colombia. With 139 branches, the bank serves more than one million customers. The new partnership positions the two companies to deliver enhanced consumer credit products to the growing Colombian financial services market.

Technology Access. A large number of products rely on so many different technologies that few companies can afford to remain at the forefront of all of them. Automakers increasingly rely on advances in electronics; application software developers depend on new features delivered by Microsoft in its next-generation operating platform, and advertising agencies need more and more sophisticated tracking data to formulate schedules for clients. At the same time, the pace at which technology is spreading globally is increasing, making time an even more critical variable in developing and sustaining competitive advantage. It is usually beyond the capabilities, resources, and good luck in R&D of any corporation to garner the technological advantage needed to independently create disruption in the marketplace. Therefore, partnering with technologically compatible companies to achieve the prerequisite level of excellence is often essential. The implementation of such strategies, in turn, increases the speed at which technology diffuses around the world.

Other reasons to pursue a cooperative strategy are a lack of particular management skills; an inability to add value in-house; and a lack of acquisition opportunities because of size or geographical or ownership restrictions.

Cooperative strategies cover a wide spectrum of nonequity, cross-equity, and shared-equity arrangements. Selecting the most appropriate arrangement involves analyzing the nature of the opportunity, the mutual strategic interests in the cooperative venture, and prior experience with joint ventures of both partners. The essential question is: How can we structure this opportunity to maximize the benefit(s) to both parties? 

The airline industry provides a good example of some of the drivers and issues involved in forging strategic alliances. Although the U.S. industry has been deregulated for some time, international aviation remains controlled by a host of bilateral agreements that smack of protectionism. Outdated limits on foreign ownership further distort natural market forces toward a more global industry posture. As a consequence, airline companies have been forced to confront the challenges of global competition in other ways. With takeovers and mergers blocked, they have formed all kinds of alliances—from code sharing to aircraft maintenance to frequent-flier plans. 

Disinvestments: Sell-Offs, Spin-Offs, and Liquidations 

At times, companies are faced with the prospect of having to retrench in one or more of their lines of business. A sell-off of a business unit to a competitor or its spin-off into a separate company makes sense when analysis confirms the corporation is the wrong corporate parent for the business. In such circumstances, value can be realized by giving the markets the opportunity to decide the fate of the business. If there are no potential buyers, liquidation might have to be considered. 

Strategy and Performance: A Conceptual Framework 

Although some of the conclusions of the studies cited differ in emphasis or detail, there is a remarkable consistency to these findings. They clearly show that in today’s complex business environment, no single individual—or even the top two or three people—can do all that is required to make a company successful. Corporate success increasingly depends on the willingness and ability of every manager to not just meet their own functional or divisional responsibilities but to think about how their actions influence the performance of the company as a whole. Viewed this way, organizational performance is ultimately the result of thousands of decisions and trade-offs made every day by individuals at all levels of an organization. The choices that these individuals make reflect their aspirations, knowledge, and incentives, and usually are sensible in the context of what each knows, sees, and understands.⁸

When strategies are not effective, it is therefore not very useful to question peoples’ rationality. Merely restating the organization’s aspirations or exhorting employees to do better is equally unproductive. Instead, the focus should be on changing the organizational environment to encourage decision making that is aligned with the overall objectives of the company. This means reexamining who makes what decisions and what information, constraints, tools, and incentives affect the way they evaluate those decisions. Understanding why and where suboptimal decisions are made is the first step to realigning the organizational environment with the chosen strategy. 

Success requires that the right people—armed with the right information and motivated by the right incentives—have clear authority to make critical decisions. Developing the right organizational model thus, requires identifying which activities are critical to achieving a chosen strategy and then defining the organizational attributes that must be present to encourage the right behaviors. Therefore, companies must focus on three critical dimensions: people, knowledge, and incentives. 

Figure 2.1 shows a conceptual framework for understanding the complex links between strategy and a company’s performance. It has three interrelated components. The first links corporate purpose to strategy and leadership. The second describes the organizational environment in terms of five interacting components: structure, systems, processes, people, and culture. The third links a company’s definition of performance with two distinct philosophies of exercising control. This framework is helpful in identifying actual or potential challenges and obstacles to successfully implementing a chosen strategic direction. It can also be used to analyze the process of strategic change. 

Strategy, Purpose, and Leadership 

The so-called strategy–structure–systems paradigm dominated thinking about the role of corporate leaders for many years. Developed in the 1920s, when companies such as General Electric began to experiment with diversification strategies, it held that the key to successfully executing a complex strategy was to create the right organizational structure and disciplined planning and control support systems. Doing so, it was thought, would systematize behavior and minimize ineffective and counter-effective actions, thereby helping managers cope with the increased complexity associated with a multibusiness enterprise.

Figure 2.1 Strategy and performance: A conceptual framework

This doctrine remained dominant for most of the twentieth century. It helped companies cope with high growth, integrate their operations horizontally, manage their diversified business portfolios, and expand internationally. The advent of global competition and the technology revolution greatly reduced its effectiveness, however. What had been its principal strength—minimizing human initiative—became its major weakness; the new competitive realities called for a different managerial thrust that was focused on developing corporate competencies such as innovation, entrepreneurship, horizontal coordination, and decentralized decision making.⁹

To deal with more intense global competition, corporate leaders began to articulate a broader, long-term strategic intent rooted in a clear sense of corporate purpose. In effect, they redefined their task from being the “chief strategist” to being the “chief facilitator” and sought ways to involve employees at all levels in the strategic management process. Top executive agendas started to include such items as creating organizational momentum, instilling core values, developing human capital, and recognizing individual accomplishment. In the process, the preoccupation with structural solutions was replaced by a focus on process, and the rationale behind systems was redirected toward supporting the development of capabilities and unleashing human potential rather than guiding employee behavior.¹⁰ This broader, more humanistic view of strategic leadership recognizes that strategic discipline and control are secured through commitment, not compliance.

The top portion in Figure 2.1 summarizes these important relationships among a company’s strategy, leadership, and sense of purpose. Successful strategy development and implementation require that these elements mutually reinforce each other as a basis for obtaining commitment, focus, and control at all levels of the organization.

Strategy and Organizational Change 

A host of factors—from structural and cultural rigidities to a lack of adequate resources to an adherence to dysfunctional processes—can reduce a company’s capacity for absorbing change. It is important, therefore, for executives charged with developing and implementing new strategic directions to understand the dynamics of the various organizational forces at work. 

The middle portion of Figure 2.1 shows five organizational variables—structure, systems, processes, people, and culture—that are key to creating effective organizational change. As shown, they are interrelated, which explains why the successful implementation of a new strategy often requires change in all variables. In other words, an implementation effort or corporate reorganization that is focused on just one of these variables is doomed to fail. Style, skills, and superordinate goals—values around which a business is built—are as important as strategy or structure in bringing about fundamental change in an organization.

Structure. To become more competitive, many companies have shed layers of management and adopted flatter organizational structures. As organizations became leaner, the problem of “how to organize” changed from one of dividing up tasks to one focused on issues of coordination. The issue of structure, therefore, is not just one of deciding whether to centralize or decentralize decision making. Rather, it involves identifying dimensions that are crucial to an organization’s ability to adapt and evolve strategically and then adopting a structure that allows it to refocus as and when necessary.

Choosing the right organizational model is difficult. Most organizations were not created to support a specific strategy, but evolved over time in response to a host of known, as well as unknown, market forces. Finding the right model becomes more difficult as companies become larger, because growth increases complexity. As complexity increases, aligning the interests of an individual with the interests of the company becomes much more difficult. Nevertheless, the goal should be to create an organizational environment that allocates resources effectively and is naturally self-correcting as strategic changes need to be made.¹¹

In considering structural options, it is important to realize that there is no “one right form of organization”; each structural solution has specific advantages and drawbacks. What is more, organizations are not homogeneous entities; what is right for one part of an organization or set of tasks might not be the preferred solution for another. No matter what form of organization is used, however, transparency is critical; effective strategy implementation cannot occur if lines of authority are blurred or responsibility is ill defined.

Corporate structures typically reflect one of five dominant approaches to organization: (1) Functional organizational structures make sense when a particular task requires the efforts of a substantial number of specialists. (2) Geographically based structures are useful when a company operates in a diverse set of geographical regions. (3) Decentralized (divisional) structures have been found to reduce complexity in a multibusiness environment. (4) Strategic business units help define groupings of businesses that share key strategic elements. (5) Matrix structures allow multiple channels of authority and are favored when coordination among different interests is key.

The growing importance of human and intellectual capital as a source of competitive advantage has encouraged companies to experiment with new organizational forms. Some companies are creating organizational structures centered on knowledge creation and dissemination. Others, in a drive to become leaner and more agile, are restricting ownership or control to only those intellectual and physical assets that are critical to their value-creation process. In doing so, they are becoming increasingly virtual and more dependent on an external network of suppliers, manufacturers, and distributors. 

Systems and Processes. Having the right systems and processes enhances organizational effectiveness and facilitates coping with change. Misaligned systems and processes can be a powerful drag on an organization’s ability to adapt. Checking what effect, if any, current systems and processes are likely to have on a company’s ability to implement a particular strategy is therefore well advised.

Support systems, such as a company’s planning, budgeting, accounting, information, and reward and incentive systems, can be critical to successful strategy implementation. Although they do not by themselves define a sustainable competitive advantage, superior support systems help a company adapt more quickly and effectively to changing requirements. A well-designed planning system ensures that planning is an orderly process, gets the right amount of attention by the right executives, and has a balanced external and internal focus. Budgeting and accounting systems are valuable in providing accurate historical data, setting benchmarks and targets, and defining measures of performance. A state-of-the-art information system supports all other corporate systems and facilitates analysis as well as internal and external communication. Finally, a properly designed reward and incentive system is key to creating energy through motivation and commitment.

A process is a systematic way of doing things. Processes can be formal or informal; they define organizational roles and relationships and can facilitate or obstruct change. Some processes look beyond immediate issues of implementation to an explicit focus on developing a stronger capacity for adapting to change. Processes aimed at creating a learning organization and fostering continuous improvement are good examples.

People. Attracting, motivating, and retaining the right people have become important strategic objectives. After several episodes of mindless downsizing and rightsizing, many companies have recognized how expensive it is to replace knowledge and talent. As a result, much greater emphasis is being placed on attracting, rewarding, and retaining talent at all levels of the organization. A focus on continuous improvement through skill development is an important element of this strategy. Many companies have come to realize that developing tomorrow’s skills—individually and collectively—is key to strategic flexibility. Leadership skills, in particular, are in increasing demand. Increased competitive intensity has created a greater need for leadership at all levels of the organization. The rapid pace of change and greater uncertainty in the strategic environment also have increased the difficulty of providing effective leadership.¹²

Culture. Performance is linked to the strength of a company’s corporate culture. Common elements of strong culture include leaders who demonstrate strong values that align with the competitive conditions; a company commitment to operating under pervasive principles that are not easily abandoned; and a concern for employees, customers, and shareholders. Conversely, below-average profit performance is associated with weak corporate cultures. Employees in these cultures report experiencing separateness from the organization, development of fiefdoms, prevalence of political maneuvering, and hostility toward change.

A company’s corporate culture is a shared system of values, assumptions, and beliefs among a firm’s employees that provides guidance on how to think, perceive, and act. It is manifested through artifacts, shared values, and basic assumptions. Artifacts are visible or audible processes, policies, and procedures that support an important cultural belief. Shared values explain why things should be as they are. Shared values often reinforce areas of competitive advantage and can be found in internal corporate language. The words can be well defined within mission statements and codes of ethics or ambiguously embedded within company lingo. Either way, these words and phrases are used to define the image a firm wants to portray. Microsoft, for example, supports a culture of high energy, drive, intellect, and entrepreneurship. The day-to-day company language is filled with “nerdisms” such as “supercool” and “totally random.” Employees touted as having “high bandwidth” (energetic and creative thinkers) are the most respected.¹³ Finally, basic assumptions are invisible reasons why group members perceive, think, and feel the way they do about operational issues. They are sometimes demonstrated in corporate myths and stories that highlight corporate values. These legends are of considerable value because employees can identify with them and easily share them with others.

Because of its pronounced effect on employee behavior and effectiveness, companies increasingly recognize that corporate culture can set them apart from competitors. At United Parcel Service (UPS), for instance, culture is considered a strategic asset, ever growing in importance: “Managing that culture to competitive advantage involves three key priorities: recruiting and retaining the right people, nurturing innovation, and building a customer mindset.”¹⁴ UPS executives believe that the firm’s culture is so important that the company spends millions of dollars annually on employee training and education programs, with a great deal of the expenditures involving the introduction of the company’s culture to new employees.

A pronounced corporate culture can be an advantage or an impediment in times of rapid change. On the one hand, the continuance of core values can help employees become comfortable with or adjust to new challenges or practices. On the other hand, a company’s prevailing organizational culture can inhibit or defeat a change effort when the consequences of the change are feared. For example, in a company in which consensus decision making is the norm, a change to more top–down decision making is likely to be resisted. Similarly, an organization focused on quarterly results will culturally resist a shift to a longer-term time horizon. These reactions do not constitute overt resistance to change. Rather, they represent expected responses fostered by the cultural elements ingrained over a long period of time in the organization. The failure to recognize and work within the prevailing cultural elements can doom a change agenda. For example, a large global pharmaceutical company discovered that R&D professionals resisted their promotions to management. An examination revealed that the resistance stemmed from an organizational culture bias that prevented them from competing with their peers for career rewards.¹⁵

Evaluating Strategic Options 

Criteria 

Estimating the likely specific impact of different broad strategy options on the long-term value or profitability of a corporation is extremely difficult. Quantifying such judgments is difficult because the impact of strategic intent and proposals aimed at realizing such intent cannot always be reduced to a cash-flow forecast. Clearly, the financial effect on the corporation of specific strategy options, such as acquisitions at the corporate level or specific new product or market entries at the business unit level, can and should be quantified. A good argument can be made, however, that broader strategic thinking does not lend itself to purely quantitative assessments. Think, for example of making a commitment to a long-term R&D program or adopting a new positioning/branding platform for the company. An alternative is to focus on a firm’s future competitiveness and ask whether the long-term objectives that have been set are appropriate; whether the strategies chosen to attain such objectives are consistent, bold enough, and achievable; and whether these strategies are likely to produce a sustainable competitive advantage with above-average returns. 

Nevertheless, executives face enormous pressure from within the organization and from external sources such as the financial community to forecast business unit and corporate performance and, implicitly, to quantify anticipated strategic outcomes. Traditionally, Return on Investment (ROI) was the most common measure for evaluating a strategy’s efficacy. Today, shareholder value is one of the most widely accepted yardsticks.

Shareholder Value

The shareholder value approach (SVA) to strategy evaluation holds that the value of the corporation is determined by the discounted future cash flows it is likely to generate. In economic terms, value is created when companies invest capital at returns that exceed the cost of that capital. Under this model, new strategic initiatives are treated as any other investment the company makes and evaluated on the basis of shareholder value. A whole new managerial framework—value-based management (VBM)—has been created around it.¹⁶

The use of shareholder value or related measures, such as economic value added (EVA), defined as after-tax operating profit minus the cost of capital, as the principal yardstick for evaluating alternative strategy proposals is somewhat contentious. Besides implementation problems, there are issues of transparency in the relationship between shareholder value on the one hand and positioning for sustained competitive advantage on the other. Even though shareholder value and strategy formulation are ultimately about the same thing—generating long-term sustained value—they use different conceptions of value and view the purpose of strategy from a fundamentally different point of view.

Strategists focus on creating a sustainable competitive advantage through value delivered to customers. But SVA measures value to shareholders. Though in the long run the two should be highly correlated, individual strategy proposals can force short-term trade-offs between the two. This explains why shareholder value has not been universally embraced as the preferred method for measuring a strategy’s potential and has encouraged the development of new less restrictive, but also possibly less rigorous, evaluation schemes, such as the Balanced Scorecard, discussed next, in the last few years.¹⁷

The Balanced Scorecard 

The Balanced Scorecard is a set of measures designed to provide strategists with a quick, yet comprehensive, view of the business.¹⁸ Developed by Robert Kaplan and David Norton, the Scorecard asks managers to look at their business from customer, company capability, innovation and learning, and financial perspectives. It provides answers to four basic questions:

The Balanced Scorecard approach requires managers to translate a broad customer-driven mission statement into factors that directly relate to customer concerns such as product quality, on-time delivery, product performance, service, and cost. Measures are defined for each factor based on customers’ perspectives and expectations, and objectives for each measure are articulated and translated into specific performance metrics. Apple Computer Corporation uses the Balanced Scorecard to introduce customer satisfaction metrics. Historically, Apple was a technology and product-focused company that competed by designing better products. Getting employees to focus on customer satisfaction metrics enabled Apple to function more as a customer-driven company.

Customer-based measures are important, but they must be translated into measures of what the company must do internally to meet customer expectations. Once these measures are translated into operational objectives such as cycle time, product quality, productivity, and cost, managers must focus on the internal business processes that enable the organization to meet the customers’ needs.

Customer-based and internal business process measures directly relate to competitive success. The ability to create new products, provide value to customers, and improve operating efficiencies provides the basis for entering new markets that drive incremental revenue, margins, and shareholder value. Financial performance measures signal whether the company’s strategy and its implementation are achieving the company objectives that relate to profitability, growth, and shareholder value. Measures such as cash flow, sales growth, operating income, market share, return on assets, ROI, return on equity, and stock price quantify the financial effects of strategies and link them to other elements of the Balanced Scorecard. A failure to convert improved operational performance, as measured in the scorecard, into improved financial performance should spur executives to rethink the company’s strategy. 

The application of the Balanced Scorecard has evolved into an overall management system. In essence, the scorecard encompasses four management processes: translating a vision, communicating goals and linking rewards to performance, improving business planning, and gathering feedback and learning. Separately, and in combination, the processes contribute to linking long-term strategic objectives with short-term actions.¹⁹

The objective of translating a vision is to clarify and gain employee support for that vision. For people to be able to act effectively on a vision statement, that statement must be expressed in terms of an integrated set of objectives and measures that are based on recognized long-term drivers of success. The application of the scorecard also is useful in highlighting gaps in employee skill sets, information technology, and processes that can hamper an organization’s ability to execute a given strategy.

Thorough and broad-based communication is essential to ensure that employees understand the firm’s objectives and the strategies that are designed to achieve them. Business unit and individual goals must then be aligned with those of the company to create ownership and accountability. Linking rewards to the Balanced Scorecard is a direct means of measuring and rewarding contributions to strategic performance. Clearly defined, objective performance measures and incentives are key to creating the right motivational environment.

Creating a Balanced Scorecard forces companies to integrate their strategic planning and budgeting processes. The output of the business-planning process consists of a set of long-term targets in all four areas of the scorecard (customer, internal, innovation/learning, and financial), a set of clearly defined initiatives to meet the targets, an agreed-upon allocation of resources to support these initiatives, and a set of appropriate measures to monitor progress. In this process, financial budgeting remains important but does not drive or overshadow the other elements. Finally, managers must constantly gather feedback on the Balanced Scorecard’s short-term measurements to monitor progress in achieving the long-term strategy and to learn how performance can be improved. Deviations from expected outcomes indicate that assumptions regarding market conditions, competitive pressures, and internal capabilities need to be revisited. As such, this feedback assists in assessing whether a chosen strategy needs to be revised in light of updated information about competitive conditions.