Ebook Essentials of strategic management (2nd edition): Part 1

An Integrated Approach to Strategy
Running Case Featuring Wal-Mart
Wal-Mart’s Competitive Advantage (Chapter 1) ● Working Conditions at Wal-Mart (Chapter 2) ● Wal-Mart’s
Bargaining Power over Suppliers (Chapter 3) ● Human Resource Strategy and Productivity at Wal-Mart (Chapter 4) ● How Wal-Mart Became a Cost Leader (Chapter 5) ● Wal-Mart’s Global Expansion (Chapter 6) ● WalMart Internally Ventures a New Kind of Retail Store (Chapter 8) ● Sam Walton’s Approach to Implementing
Wal-Mart’s Strategy (Chapter 9)

Strategy in Action Features
A Strategic Shift at Microsoft (Chapter 1) ● The Agency Problem at Tyco (Chapter 2) ● Circumventing Entry
Barriers into the Soft Drink Industry (Chapter 3) ● Learning Effects in Cardiac Surgery (Chapter 4) ● How
to Make Money in the Vacuum Tube Business (Chapter 5) ● The Evolution of Strategy at Procter & Gamble
(Chapter 6) ● Diversification at 3M: Leveraging Technology (Chapter 7) ● News Corp’s Successful Acquisition
Strategy (Chapter 8) ● How to Flatten and Decentralize Structure (Chapter 9)

Practicing Strategic Management
Application-based activities intended to get your students thinking beyond the book.

Small-Group Exercises

Exploring the Web

Short experiential exercises that ask students to
coordinate and collaborate on group work focused on
an aspect of strategic management.

Internet exercises that require students to explore company
websites and answer chapter-related questions.

●
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●
●
●
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●
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Designing a Planning System (Chapter 1)
Evaluating Stakeholder Claims (Chapter 2)
Competing with Microsoft (Chapter 3)
Analyzing Competitive Advantage (Chapter 4)
How to Keep the Salsa Hot (Chapter 5)
Developing a Global Strategy (Chapter 6)
Comparing Vertical Integration Strategies
(Chapter 7)
● Identifying News Corp’s Strategies
(Chapter 8)
● Speeding Up Product Development
(Chapter 9)

Visiting 3M (Chapter 1)
Visiting Merck (Chapter 2)

Visiting Boeing and Airbus (Chapter 3)
Visiting Johnson & Johnson (Chapter 4)
Visiting the Luxury-Car Market (Chapter 5)
Visiting IBM (Chapter 6)
Visiting Motorola (Chapter 7)
Visiting UTC (Chapter 8)
Visiting Google’s Control System (Chapter 9)

Closing Cases
The Best-Laid Plans—Chrysler Hits the Wall (Chapter 1) ● Google’s Mission, Ethical Principles,
and Involvement in China (Chapter 2) ● The Pharmaceutical Industry (Chapter 3) ● Starbucks (Chapter 4) ●
Nike’s Business-Level Strategies (Chapter 5) ● IKEA—The Global Retailer (Chapter 6) ● United Technologies
Has an ACE in Its Pocket (Chapter 7) ● Oracle’s Growing Portfolio of Businesses (Chapter 8) ● Ford Has a New
CEO and a New Global Structure (Chapter 9)


Essentials of
Strategic
Management
Second Edition

CHARLES W. L. HILL
University of Washington

GARETH R. JONES
Texas A&M University

Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States

Essentials of Strategic Management,
Second Edition
Charles W. L. Hill, Gareth R. Jones
For my children: Elizabeth,
Charlotte, and Michelle
Charles W. L. Hill
For Nicholas and Julia
and Morgan and Nia
Gareth R. Jones

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Brief Contents
PART 1

INTRODUCTION TO STRATEGIC MANAGEMENT

Chapter 1 The Strategy-Making Process 1
Chapter 2 Stakeholders, the Mission, Governance, and
Business Ethics 26

PART 2

THE NATURE OF COMPETITIVE ADVANTAGE

Chapter 3 External Analysis: The Identification of Opportunities
and Threats 52
Chapter 4 Building Competitive Advantage 77

PART 3

BUILDING AND SUSTAINING LONG-RUN
COMPETITIVE ADVANTAGE

Chapter 5 Business-Level Strategy and Competitive Positioning 109
Chapter 6 Strategy in the Global Environment 137
Chapter 7 Corporate-Level Strategy and Long-Run Profitability 162

PART 4

STRATEGY IMPLEMENTATION

Chapter 8 Strategic Change: Implementing Strategies to Build and
Develop a Company 188

Chapter 9 Implementing Strategy Through Organizational Design

214

PART 5

CASES IN STRATEGIC MANAGEMENT

Case 1
Case 2
Case 3
Case 4
Case 5

Boeing Commercial Aircraft: Comeback? C1
Apple Computer C17
Amazon.com C33
Blockbuster’s Challenges in the Video Rental Industry C44
Whole Foods Market: Will There Be Enough Organic Food to
Satisfy the Growing Demand? C60
3M in 2006 C69
Philips versus Matsushita: A New Century, a New Round C85
Mired in Corruption—Kellogg Brown & Root in Nigeria C100

Case 6
Case 7
Case 8

iii

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Contents
Preface xiii

PART 1

INTRODUCTION TO STRATEGIC MANAGEMENT

Chapter 1 The Strategy-Making Process

1

Competitive Advantage and Superior Performance 2
Strategic Managers 3
● Running Case: Wal-Mart’s Competitive Advantage 4
Corporate-Level Managers 4
Business-Level Managers 6
Functional-Level Managers 6
The Strategy-Making Process 7
A Model of the Strategic Planning Process 7
The Feedback Loop 10
Strategy as an Emergent Process 10
Strategy Making in an Unpredictable World 11
Autonomous Action: Strategy Making by Lower-Level Managers 11
● Strategy in Action: A Strategic Shift at Microsoft 12
Serendipity and Strategy 12
Intended and Emergent Strategies 13

Strategic Planning in Practice 14
Scenario Planning 14
Decentralized Planning 15
Strategic Intent 16
Strategic Decision Making 17
Cognitive Biases 17
Improving Decision Making 18
Strategic Leadership 19
Vision, Eloquence, and Consistency 19
Commitment 19
Being Well Informed 20
Willingness to Delegate and Empower 20
The Astute Use of Power 20
Emotional Intelligence 20
Summary of Chapter ● Discussion Questions
● Practicing Strategic Management 22
Small-Group Exercise: Designing a Planning System ●
Exploring the Web: Visiting 3M
● Closing Case: The Best-Laid Plans—Chrysler Hits the Wall 23
Test Prepper 25

v


vi

Contents

Chapter 2 Stakeholders, the Mission, Governance, and
Business Ethics 26

Stakeholders 27
The Mission Statement 28
The Mission 28
Vision 30
Values 30
Major Goals 30
Corporate Governance and Strategy 31
The Agency Problem 32
● Strategy in Action: The Agency Problem at Tyco 35
Governance Mechanisms 36
Ethics and Strategy 40
Ethical Issues in Strategy 40
● Running Case: Working Conditions at Wal-Mart 42
The Roots of Unethical Behavior 44
Behaving Ethically 45
Final Words 47
Summary of Chapter ● Discussion Questions
● Practicing Strategic Management 49
Small-Group Exercise: Evaluating Stakeholder Claims ●
Exploring the Web: Visiting Merck
● Closing Case: Google’s Mission, Ethical Principles, and Involvement in China
Test Prepper 51

PART 2

49

THE NATURE OF COMPETITIVE ADVANTAGE

Chapter 3 External Analysis: The Identification of Opportunities

and Threats 52
Analyzing Industry Structure 53
Risk of Entry by Potential Competitors 54
● Strategy in Action: Circumventing Entry Barriers into the Soft Drink Industry 56
Rivalry Among Established Companies 57
The Bargaining Power of Buyers 60
The Bargaining Power of Suppliers 61
● Running Case: Wal-Mart’s Bargaining Power over Suppliers 62
Threat of Substitute Products 63
Summary 63
Strategic Groups Within Industries 63
Implications of Strategic Groups 64
The Role of Mobility Barriers 65
Industry Life Cycle Analysis 65
Embryonic Industries 66
Growth Industries 66
Industry Shakeout 67
Mature Industries 68
Declining Industries 68
Summary
68


vii

Contents

The Macroenvironment 69
Macroeconomic Forces 69
Global Forces 70

Technological Forces 70
Demographic Forces 71
Social Forces 71
Political and Legal Forces 71
Summary of Chapter ● Discussion Questions
● Practicing Strategic Management 73
Small-Group Exercise: Competing with Microsoft ●
Exploring the Web: Visiting Boeing and Airbus
● Closing Case: The Pharmaceutical Industry 74
Test Prepper 75

Chapter 4 Building Competitive Advantage

77

Competitive Advantage: Value Creation, Low Cost, and Differentiation 78
The Generic Building Blocks of Competitive Advantage 80
Efficiency 80
Quality as Excellence and Reliability 81
Innovation 83
Customer Responsiveness 83
The Value Chain 84
Primary Activities 84
Support Activities 86
Functional Strategies and the Generic Building Blocks of
Competitive Advantage 86
Increasing Efficiency 87
● Strategy in Action: Learning Effects in Cardiac Surgery 89
● Running Case: Human Resource Strategy and Productivity at Wal-Mart 91
Increasing Quality 94

Increasing Innovation 96
Achieving Superior Customer Responsiveness 99
Distinctive Competences and Competitive Advantage 100
Resources and Capabilities 101
The Durability of Competitive Advantage 102
Summary of Chapter ● Discussion Questions
● Practicing Strategic Management 105
Small-Group Exercise: Analyzing Competitive Advantage ●
Exploring the Web: Visiting Johnson & Johnson
● Closing Case: Starbucks 105
Test Prepper 107

PART 3

BUILDING AND SUSTAINING LONG-RUN
COMPETITIVE ADVANTAGE

Chapter 5 Business-Level Strategy and Competitive Positioning
The Nature of Competitive Positioning 110
Customer Needs and Product Differentiation

110

109


viii

Contents

Customer Groups and Market Segmentation 110
Distinctive Competences 111
Choosing a Business-Level Strategy 111
Cost-Leadership Strategy 111
● Running Case: How Wal-Mart Became a Cost Leader 113
Differentiation Strategy 114
Cost Leadership and Differentiation 116
Focus Strategy 117
Stuck in the Middle 119
Competitive Positioning in Different Industry Environments 120
Strategies in Fragmented and Growing Industries 121
Strategies in Mature Industries 123
Strategies in Declining Industries 128
● Strategy in Action: How to Make Money in the Vacuum
Tube Business 130
Summary of Chapter ● Discussion Questions
● Practicing Strategic Management 133
Small-Group Exercise: How to Keep the Salsa Hot ●
Exploring the Web: Visiting the Luxury-Car Market
● Closing Case: Nike’s Business-Level Strategies 134
Test Prepper 135

Chapter 6 Strategy in the Global Environment 137
The Global Environment 138
Increasing Profitability Through Global Expansion 139
● Running Case: Wal-Mart’s Global Expansion 140
Expanding the Market: Leveraging Products and Competences 140
Realizing Economies of Scale 142
Realizing Location Economies 142
Leveraging the Skills of Global Subsidiaries 143

Cost Pressures and Pressures for Local Responsiveness 144
Pressures for Cost Reductions 145
Pressures for Local Responsiveness 145
Choosing a Global Strategy 147
Global Standardization Strategy 148
● Strategy in Action: The Evolution of Strategy at Procter & Gamble 149
Localization Strategy 149
Transnational Strategy 150
International Strategy 151
Changes in Strategy over Time 151
Choices of Entry Mode 152
Exporting 152
Licensing 153
Franchising 154
Joint Ventures 155
Wholly Owned Subsidiaries 155
Choosing an Entry Strategy 156
Summary of Chapter ● Discussion Questions


Contents

● Practicing Strategic Management 159
Small-Group Exercise: Developing a Global Strategy ●
Exploring the Web: Visiting IBM
● Closing Case: IKEA—The Global Retailer 160
Test Prepper 161

Chapter 7 Corporate-Level Strategy and Long-Run Profitability 162
Concentration on a Single Industry 163

Horizontal Integration 164
Benefits and Costs of Horizontal Integration 164
Outsourcing Functional Activities 167
Vertical Integration 168
Arguments for Vertical Integration 170
Arguments Against Vertical Integration 173
Vertical Integration and Outsourcing 174
Entering New Industries Through Diversification 175
Creating Value Through Diversification 175
● Strategy in Action: Diversification at 3M: Leveraging Technology 178
Related versus Unrelated Diversification 180
Restructuring and Downsizing 181
Why Restructure? 181
Exit Strategies 182
Summary of Chapter ● Discussion Questions
● Practicing Strategic Management 184
Small-Group Exercise: Comparing Vertical Integration Strategies ●
Exploring the Web: Visiting Motorola
● Closing Case: United Technologies Has an ACE in Its Pocket 185
Test Prepper 186

PART 4

STRATEGY IMPLEMENTATION

Chapter 8 Strategic Change: Implementing Strategies to Build and
Develop a Company 188
Strategic Change 189
Types of Strategic Change 189
A Model of the Change Process 190

Analyzing a Company as a Portfolio of Core Competences 193
Fill in the Blanks 194
Premier Plus 10 194
White Spaces 194
Mega-Opportunities 195
Implementing Strategy Through Internal New Ventures 195
Pitfalls with Internal New Ventures 196
Guidelines for Successful Internal New Venturing 198
● Running Case: Wal-Mart Internally Ventures a New Kind of
Retail Store 199

ix


x

Contents

Implementing Strategy Through Acquisitions 200
Pitfalls with Acquisitions 200
Guidelines for Successful Acquisition 202
● Strategy in Action: News Corp’s Successful Acquisition Strategy 203
Implementing Strategy Through Strategic Alliances 204
Advantages of Strategic Alliances 204
Disadvantages of Strategic Alliances 205
Making Strategic Alliances Work 206
Summary of Chapter ● Discussion Questions
● Practicing Strategic Management 210
Small-Group Exercise: Identifying News Corp’s Strategies ●
Exploring the Web: Visiting UTC

General Task 210
● Closing Case: Oracle’s Growing Portfolio of Businesses 210
Test Prepper 212

Chapter 9 Implementing Strategy Through Organizational Design 214
The Role of Organization Structure 215
Building Blocks of Organization Structure 216
Vertical Differentiation 216
Problems with Tall Structures 217
Centralization or Decentralization? 219
● Strategy in Action: How to Flatten and Decentralize Structure 220
Horizontal Differentiation 221
Functional Structure 221
Product Structure 223
Product-Team Structure 224
Geographic Structure 225
Multidivisional Structure 226
Integration and Organizational Control 230
Forms of Integrating Mechanisms 231
Differentiation and Integration 233
The Nature of Organizational Control 234
Strategic Controls 234
Financial Controls 236
Output Controls 238
Behavior Controls 238
● Running Case: Sam Walton’s Approach to Implementing Wal-Mart’s Strategy 242
Summary of Chapter ● Discussion Questions
● Practicing Strategic Management 244
Small-Group Exercise: Speeding Up Product Development ●
Exploring the Web: Visiting Google’s Control System

● Closing Case: Ford Has a New CEO and a New Global Structure 244
Test Prepper 246

PART 5
Case 1

CASES IN STRATEGIC MANAGEMENT

Boeing Commercial Aircraft: Comeback?

C1

Charles W. L. Hill, University of Washington
Has Boeing’s turnaround in 2005–2006 been merely cosmetic, or has it
fundamentally improved its strategic position?


Contents

Case 2

xi

Apple Computer C17
Charles W. L. Hill, University of Washington
The rise, fall, and resurrection of Apple Computer, focusing on its core
competences and resources.

Case 3

Amazon.com

C33

Gareth R. Jones, Texas A&M University
The business model and strategy of one of the most profitable Internetbased businesses and its emerging competitive challenges.

Case 4

Blockbuster’s Challenges in the Video Rental Industry C44
Gareth R. Jones, Texas A&M University
Blockbuster faces disruptive technologies and serious questions about the
continued viability of its business model.

Case 5

Whole Foods Market: Will There Be Enough Organic Food to Satisfy
the Growing Demand? C60
Patricia Harasta and Alan N. Hoffman, Bentley College
How an entrepreneurial idea takes on a life of its own, grows rapidly into a
multi-country phenomenon, and faces issues of stability and consolidation
of growth, without destroying its roots and culture.

Case 6

3M in 2006

C69

Charles W. L. Hill, University of Washington

A company known for innovation uses new products as the basis of
its corporate strategy, providing insight into its culture and evolving
global strategy.

Case 7

Philips versus Matsushita: A New Century, a New Round C85
Christopher A. Bartlett, Harvard Business School
A contrast of the strategy development and operations of a European and a
Japanese electronic conglomerate.

Case 8

Mired in Corruption—Kellogg Brown & Root in Nigeria

C100

Charles W. L. Hill, University of Washington
A profile of the difference between legal and ethical acts and an evaluation
of KBR’s actions and systems with regard to ethical and legal conduct.
Notes N1
Test Prepper Answers
Index I1

A1


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Preface
he first edition of Essentials of Strategic Management was well received by instructors and students alike. Based on the feedback of users and reviewers, we
revised our book in ways that help students understand the importance of
strategic management in today’s global world. It is clear that strategic management
instructors share with us a concern for currency in text and examples to ensure that
cutting-edge issues and new developments in strategic management are addressed.
And, in the revision, we have updated all the text material and the cases at the end of
the book to present a clear and current account of strategic management.
Our goal in this revision is to explain in a clear, comprehensive, but concise
way why strategic management is important to people, the companies they work for,
and the societies in which they live. Often people are unaware of how the strategymaking process affects them. We are all used to going to work and visiting companies such as restaurants, stores, and banks to buy the goods and services we need
to satisfy our many needs. However, the actual strategic management activities and
processes that are required to make these goods and services available to us commonly go unappreciated. Similarly, we know that companies exist to make a “profit,”
but what is profit, how is it created, and what is it used for? Moreover, what are the
actual strategic management activities involved in the creation of goods and services, and why is it that some companies seem to be more effective and more “profitable” than others? Our goal is to provide the “big picture” of what strategic management is, what strategic managers do, and how the strategy-making process affects
company performance. The book provides a focused, integrated approach that gives
students a solid understanding of the nature, functions, and main building blocks of
strategic management.

T

Organization of the Book
The book presents a broad overview of the nature and functions of strategic management in nine chapters. Part 1, Introduction to Strategic Management, explains
what strategic management is and provides a framework for understanding what
strategic managers do. Chapter 1 discusses the relationship between strategic management and strategic leadership and shows how competitive advantage results in
superior performance. It also describes the plan of this book and discusses the principal functions of strategic managers. Chapter 2 discusses the ways in which companies affect their stakeholders and why it is necessary to create corporate governance
mechanisms that ensure that strategic managers work to further the interests of
stakeholders and behave ethically.
In Part 2, The Nature of Competitive Advantage, we discuss the factors and forces
both external and internal to an organization that determine its choice of strategies

for creating a competitive advantage and achieving above-average profitability.

xiii


xiv

Preface

Chapter 3 looks at opportunities, threats, and competition in the external environment. Chapter 4 examines how a company can build competitive advantage by
achieving superior efficiency, quality, innovation, and responsiveness to customers.
It also discusses how managers can craft functional-level strategies that will allow an
organization to achieve these goals.
In Part 3, Building and Sustaining Long-Run Competitive Advantage, we provide a
streamlined discussion of the different levels of strategy that must be developed to
build and sustain a long-term competitive advantage. Chapter 5 considers how to
use business-level strategies to optimize competitive positioning and outperform industry rivals. Chapter 6 discusses how to strengthen competitive advantage by expanding globally into new national markets. Chapter 7 then examines the various
corporate-level strategies, such as vertical integration, diversification, and outsourcing, that are used to protect and strengthen competitive advantage and sustain longrun profitability.
Finally, in Part 4, Strategy Implementation, we examine the many operational issues involved in putting all these strategies into action simultaneously. Chapter 8
first discusses the importance of strategic change in today’s fast-moving global environment and the issues and problems involved in managing the change process effectively. Then it outlines how to build and develop a company’s business through
the use of internal new venturing, acquisitions, and strategic alliances and considers
the pros and cons of these different methods. Chapter 9 discusses how to implement
strategy through the design of organization structure and the operational issues involved in selecting structures to match the needs of particular strategies. It also looks
at the organizational control systems necessary to fit strategy to structure and the
role of organizational culture in developing competitive advantage.
As you can see by perusing the table of contents, the approach we take in Essentials of Strategic Management parallels that of our other book, Strategic Management:
An Integrated Approach. Our goal is to offer a contemporary, integrated account of
strategic management, but one that is streamlined and focused only on the essentials
of this complex and fascinating subject.

Learning Features
Nothing makes the practice of strategic management come alive more than vivid
stories and examples about people and companies that demonstrate clearly the
meaning of the chapter material. Hands-on exercises offer students the opportunity
to actively think about and engage in strategic-management issues and decision
making. We paid considerable attention to creating and developing both in-chapter
and end-of-chapter features and exercises that would offer the most learning value
to students while economizing on their valuable learning time.
Each of the chapters has been revised. Several new Strategy in Action boxes have
been carefully selected and written to raise students’ interest; these have been integrated seamlessly into the text so as not to disrupt its flow. Many books have examples
that disrupt students’ thought processes or distract them with enormous amounts of
unnecessary detail; Essentials of Strategic Management avoids these pitfalls.
Similarly, in the revised edition, the end-of-chapter learning features include four
types of exercises, each of which offers additional insight into the chapter material to
build students’ learning experience. Exercises are designed to create lively discussion


Preface

xv

at the level of either the whole class, small groups, or the individual. In practice, instructors will have to decide which of these exercises to use in any particular class period and which to use as homework assignments. Frequently, instructors find that
varying the exercises they use over the semester is the best way to engage students.
●

Discussion Questions. Among these chapter-related questions and points for reflection are some that ask students to research actual management issues and
learn firsthand from practicing managers.

●

Small-Group Exercise. Each interactive experiential exercise is designed to be utilized in groups of three to four students. The instructor calls on students to
break up into small groups simply by turning to people around them, and all
students participate in the exercise in class. In each chapter, the exercise deals
with a chapter-related issue guaranteed to lead to debate among students. A
mechanism is provided for the different groups to share what they have learned
with one another.

●

Exploring the Web. This exercise asks the student to visit the website of a company and use the information contained on that website to answer a series of
chapter-related questions.

Each chapter also ends with a short case, which can be used for further analysis
of chapter issues. These cases have been carefully chosen to reflect contemporary issues and problems in strategic management and to offer further information on
chapter issues. The accompanying discussion questions encourage students to read
about and analyze how managers approach real problems in the strategic management world.
Finally, in the revised edition, a new set of eight longer cases is included at the
end of the book to allow students to perform an in-depth analysis of the way a company has formulated and implemented its strategy. These cases are often focused on
a specific strategic management topic—for example, analyzing the competitive environment (Blockbuster’s Challenges in the Video Rental Industry; Whole Foods Market: Will There Be Enough Organic Food to Satisfy the Growing Demand?); building
competitive advantage (3M in 2006); developing business-level strategy (Apple
Computer; Amazon.com); changing corporate and global strategy over time (Boeing
Commercial Aircraft: Comeback?; Philips versus Matsushita: A New Century, a
New Round); and evaluating ethical and legal conduct (Mired in Corruption—
Kellogg Brown & Root in Nigeria). Students can be asked to collect additional information on the companies in these cases, both to bring the analysis up to date and to
see how managers have worked to increase competitive advantage and performance
over time.

Acknowledgments
Finding a way to integrate and present an overview of the rapidly changing world of
strategic management and strategic management activities and make it interesting

and meaningful for students is not an easy task. In writing Essentials of Strategic
Management, we have been fortunate to have had the assistance of several people
who contributed greatly to the book’s final form. First, we are grateful to Michele
Rhoads, our acquisitions editor, for her support and commitment to the project,
which led to its realization, and for finding ways to provide the resources that are


xvi

Preface

needed to continually improve and refine a new product. Then we are grateful to
Suzanna Bainbridge for taking on the task of ensuring that the book would meet the
needs of its users and satisfy students and for providing us with useful feedback and
information from professors and reviewers that have allowed us to shape the book
to meet the needs of its intended market. Third, we are grateful to Margaret Bridges
for so ably coordinating the book’s progress. All these people have been instrumental in creating a product we hope will meet its goal of helping students better understand strategic management and the many ways in which it affects companies and
the people who work in them.
Finally, we are indebted to the many colleagues and reviewers who provided us
with useful and detailed feedback, perceptive comments, and valuable suggestions
for improving the manuscript.
Kevin Banning, Auburn University
Robert D’Intino, Rowan University
Scott Droege, Western Kentucky University
Deborah Francis, Brevard College
Sanjay Goel, University of Minnesota
Leslie Haugen, University of St. Thomas
Todd Hostager, University of Wisconsin—Eau Claire
John Humphreys, Eastern New Mexico University
Deborah Johnson, Franklin University

Kevin L. Johnson, Baylor University
Elene Kent, Capital University
Subodh Kulkarni, Howard University
Kamalesh Kumar, University of Michigan—Dearborn
Paul Mallette, Colorado State University
Josetta McLaughlin, Roosevelt University
Tom Morris, Radford University
David Olson, California State—Bakersfield
William Ritchie, Florida Gulf Coast University
Tim Rogers, Ozarks Technical College
Stuart Rosenberg, Dowling College
Manjula Salimath, University of North Texas
Thomas Sgritta, University of North Carolina—Charlotte
Chanchai Tangpong, North Dakota State University
Michael Wakefield, Colorado State University—Pueblo
Edward Ward, St. Cloud State University
Kenneth Wendeln, University of San Diego
Garland Wiggs, Hamline University
Jun Zhao, Governors State University

Charles W. L. Hill, Seattle, Washington
Gareth R. Jones, College Station, Texas


Chapter 1
Learning
Objectives

The Strategy-Making Process

After reading
this chapter, you
should be able to

Chapter Outline

1. Explain what is meant by
“competitive advantage”
2. Discuss the strategic role
of managers at different
levels in an organization
3. Identify the main steps in
a strategic planning
process
4. Discuss the main pitfalls
of planning, and how
those pitfalls can be
avoided
5. Outline the cognitive
biases that might lead to
poor strategic decisions,
and explain how these
biases can be overcome
6. Discuss the role played
by strategic leaders in the
strategy-making process

Overview

I. Competitive Advantage

and Superior Performance
II. Strategic Managers
a. Corporate-Level
Managers
b. Business-Level
Managers
c. Functional-Level
Managers
III. The Strategy-Making
Process
a. A Model of the Strategic
Planning Process
b. The Feedback Loop
IV. Strategy as an Emergent
Process
a. Strategy Making in an
Unpredictable World
b. Autonomous Action:
Strategy Making by
Lower-Level Managers
c. Serendipity and
Strategy

d. Intended and Emergent
Strategies
V. Strategic Planning in
Practice
a. Scenario Planning
b. Decentralized Planning
c. Strategic Intent

VI. Strategic Decision Making
a. Cognitive Biases
b. Improving Decision
Making
VII. Strategic Leadership
a. Vision, Eloquence, and
Consistency
b. Commitment
c. Being Well Informed
d. Willingness to Delegate
and Empower
e. The Astute Use of
Power
f. Emotional Intelligence

Why do some companies succeed while others fail? In the fast-evolving world of the
Internet, for example, how is it that companies like Yahoo!, Amazon.com, eBay, and
Google have managed to attract millions of customers, while others like online grocer Webvan, software retailer Egghead.com, and the online pet supplies retailer
Pets.com all went bankrupt? Why has Wal-Mart been able to do so well in the
fiercely competitive retail industry, while others like Kmart have struggled? In the
personal computer industry, what distinguishes Dell from less successful companies
such as Gateway? In the airline industry, how has Southwest Airlines managed to
keep increasing its revenues and profits through both good times and bad, while rivals such as US Airways and United Airlines have had to seek bankruptcy protection? What explains the persistent growth and profitability of Nucor Steel, now the
largest steel maker in America, during a period when many of its once larger rivals
have disappeared into bankruptcy?

1


2

PART 1

Introduction to Strategic Management

strategy
A set of actions that
managers take to increase
their company’s
performance relative to
rivals.

In this book, we argue that the strategies a company’s managers pursue have a
major impact on its performance relative to rivals. A strategy is a set of actions that
managers take to increase their company’s performance relative to rivals. If a company’s strategy does result in superior performance, it is said to have a competitive
advantage.
Much of this book is about identifying and describing the strategies that managers can pursue to achieve superior performance. A central aim of this book is to
give you a thorough understanding of the analytical techniques and skills necessary
to identify and implement strategies successfully. The first step toward achieving this
objective is to describe in more detail what superior performance and competitive advantage mean.

Competitive Advantage and Superior Performance

profitability
The return that a company
makes on the capital
invested in the enterprise.

competitive advantage
The advantage over

rivals achieved when a
company’s profitability is
greater than the average
profitability of all firms in
its industry.

sustained competitive
advantage
The competitive
advantage achieved when
a company is able to
maintain above-average
profitability for a number
of years.

Superior performance is typically thought of in terms of one company’s profitability
relative to that of other companies in the same or a similar kind of business or industry. The profitability of a company can be measured by the return that it makes
on the capital invested in the enterprise.1 The return on invested capital that a company earns is defined as its profit over the capital invested in the firm (profit/capital
invested). By profit, we mean after-tax earnings. By capital, we mean the sum of
money invested in the company—that is, stockholders’ equity plus debt owed to
creditors. This capital is used to buy the resources a company needs to produce and
sell goods and services. A company that uses its resources efficiently makes a positive
return on invested capital. The more efficient a company is, the higher are its profitability and return on invested capital.
A company’s profitability—its return on invested capital—is determined by the
strategies its managers adopt. For example, Wal-Mart’s strategy of focusing on the
realization of cost savings from efficient logistics and information systems, and then
passing on the bulk of these cost savings to customers in the form of lower prices,
has enabled the company to gain ever more market share, reap significant economies of scale, and further lower its cost structure, thereby boosting profitability (for
details, see the Running Case on Wal-Mart).
A company is said to have a competitive advantage over its rivals when its profitability is greater than the average profitability for all firms in its industry. The

greater the extent to which a company’s profitability exceeds the average profitability
for its industry, the greater is its competitive advantage. A company is said to have a
sustained competitive advantage when it is able to maintain above-average profitability for a number of years. Companies like Wal-Mart, Southwest, and Dell have
had a significant and sustained competitive advantage because they have pursued
firm-specific strategies that result in superior performance.
It is important to note that, in addition to its strategies, a company’s performance
is also determined by the characteristics of the industry the company competes in.
Different industries are characterized by different competitive conditions. In some,
demand is growing rapidly, while in others it is contracting. Some might be beset by
excess capacity and persistent price wars, others by excess demand and rising prices.
In some, technological change might be revolutionizing competition. Others might
be characterized by a lack of technological change. In some industries, high profitability among incumbent companies might induce new companies to enter the in-


CHAPTER 1

The Strategy-Making Process

3

dustry, and these new entrants might depress prices and profits. In other industries,
new entry might be difficult, and periods of high profitability might persist for a considerable time. Thus, average profitability is higher in some industries and lower in
other industries because competitive conditions vary from industry to industry.2

Strategic Managers
general managers
Managers who bear
responsibility for the
overall performance of the
company or for that of one

of its major self-contained
subunits or divisions.

functional managers
Managers responsible for
supervising a particular
function—that is, a task,
activity, or operation like
accounting, marketing,
R&D, information
technology, or logistics.

multidivisional company
A company that competes in
several different businesses
and has created a separate
self-contained division to
manage each of them.

Managers are the linchpin in the strategy-making process. It is individual managers
who must take responsibility for formulating strategies to attain a competitive advantage and putting those strategies into effect. They must lead the strategy-making
process. Here we look at the strategic roles of different types of managers. Later in
the chapter, we discuss strategic leadership, which is how managers can effectively
lead the strategy-making process.
In most companies, there are two main types of managers: general managers,
who bear responsibility for the overall performance of the company or for one of its
major self-contained subunits or divisions, and functional managers, who are responsible for supervising a particular function—that is, a task, activity, or operation
like accounting, marketing, R&D, information technology, or logistics.
A company is a collection of functions or departments that work together to
bring a particular product or service to the market. If a company provides several

different kinds of products or services, it often duplicates these functions and creates
a series of self-contained divisions (each of which contains its own set of functions)
to manage each different product or service. The general managers of these divisions
then become responsible for their particular product line. The overriding concern of
general managers is the health of the whole company or division under their direction; they are responsible for deciding how to create a competitive advantage and
achieve high profitability with the resources and capital they have at their disposal.
Figure 1.1 shows the organization of a multidivisional company—that is, a company that competes in several different businesses and has created a separate selfcontained division to manage each of these. As you can see, there are three main

Figure 1.1
Levels of Strategic
Management

Head
Office

Corporate Level
CEO, board of
directors, and
corporate staff
Business Level
Divisional
managers
and staff

Division A

Division B

Division C

Functional Level
Functional
managers

Business
functions

Business
functions

Business
functions

Market A

Market B

Market C


4

PART 1

Introduction to Strategic Management

RUNNING CASE
Wal-Mart’s Competitive Advantage
Wal-Mart is one of the most extraordinary success stories in
business history. Started in 1962 by Sam Walton, Wal-Mart has

grown to become the world’s largest corporation. In the financial year ending January 31, 2007, the discount retailer, whose
mantra is “everyday low prices,” had sales of nearly $345 billion, 7,600 stores in fifteen countries (some 4,600 are in the
United States), and 1.9 million employees. Some 8% of all retail sales in the United States are made at a Wal-Mart store.
Wal-Mart is not only large; it is also very profitable. In 2006,
the company earned a return on invested capital of 14.1%, doing better than its well-managed rivals Costco and Target,

which earned 11.9% and 12.6%, respectively (another major
rival, Kmart, emerged from bankruptcy protection in 2004). As
shown in the accompanying figure, Wal-Mart has been consistently more profitable than its rivals for years, although of late
its rivals have been closing the gap.
Wal-Mart’s persistently superior profitability reflects a
competitive advantage that is based upon a number of strategies. Back in 1962, Wal-Mart was one of the first companies to
apply the self-service supermarket business model developed by
grocery chains to general merchandise (two of its rivals, Kmart
and Target, were established in the same year). Unlike its rivals,

Return on Invested Capital (%)

18
16
14
12
10
8
6
4
2
0
94 995 996 997 998 999 000 001 002 003 004 005 006
2

2
2
2
1
2
1
2
1
1
1
2

19

Wal-Mart

Costco

Target

Profitability in the U.S. Retail Industry, 1994–2006
Source: Data from Value Line Investment Survey.

levels of management: corporate, business, and functional. General managers are
found at the first two of these levels, but their strategic roles differ depending on
their sphere of responsibility.

●

Corporate-Level

Managers

The corporate level of management consists of the chief executive officer
(CEO), other senior executives, the board of directors, and corporate staff. These individuals occupy the apex of decision making within the organization. The CEO is
the principal general manager. In consultation with other senior executives, the role


CHAPTER 1

which focused on urban and suburban locations, Sam Walton’s
Wal-Mart concentrated on small southern towns. Wal-Mart
grew quickly by pricing lower than local mom-and-pop retailers, often putting them out of business. By the time Kmart and
Target realized that small towns could support a large discount
general merchandise store, Wal-Mart had already pre-empted
them. These towns, which were large enough to support one
discount retailer, but not two, provided a secure profit base for
Wal-Mart.
The company was also an innovator in information systems, logistics, and human resource practices. Taken together,
these strategies resulted in higher productivity and lower costs,
which enabled the company to earn a high profit while charging low prices. Wal-Mart led the way among American retailers
in developing and implementing sophisticated product tracking systems using bar-code technology and checkout scanners.
This information technology enabled Wal-Mart to track what
was selling and adjust its inventory accordingly, so that the
products found in a store matched local demand. By avoiding
overstocking, Wal-Mart did not have to hold periodic sales to
shift unsold inventory. Over time, Wal-Mart linked this information system to a nationwide network of distribution centers,
where inventory was stored and then shipped to stores within a
400-mile radius on a daily basis. The combination of distribution centers and information centers enabled Wal-Mart to reduce the amount of inventory it held in stores, thereby devoting more of that valuable space to selling and reducing the
amount of capital it had tied up in inventory.
With regard to human resources, the tone was set by Sam

Walton, who held a strong belief that employees should be respected and rewarded for helping to improve the profitability
of the company. Underpinning this belief, Walton referred to

The Strategy-Making Process

5

employees as “associates.” He established a profit-sharing
scheme for all employees and, after the company went public
in 1970, a program that allowed employees to purchase WalMart stock at a discount to its market value. Wal-Mart was rewarded for this approach by high employee productivity, which
translated into lower operating costs and higher profitability.
As Wal-Mart grew larger, the sheer size and purchasing
power of the company enabled it to drive down the prices that
it paid suppliers. Passing on those savings to customers in the
form of lower prices enabled Wal-Mart to gain more market
share and hence demand even lower prices. To take the sting
out of the persistent demands for lower prices, Wal-Mart
shared its sales information with suppliers on a daily basis, enabling them to gain efficiencies by configuring their own production schedules to sales at Wal-Mart.
By the time the 1990s came along, Wal-Mart was already the
largest general seller of general merchandise in America. To keep
its growth going, Wal-Mart started to diversify into the grocery
business, opening 200,000-square-foot supercenter stores that
sold groceries and general merchandise under the same roof.
Wal-Mart also diversified into the warehouse club business with
the establishment of Sam’s Club. The company began expanding
internationally in 1991 with its entry into Mexico.
For all its success, however, Wal-Mart is now encountering
very real limits to profitable growth. The U.S. market is approaching saturation, and growth overseas has proved more
difficult than the company had hoped. The company was
forced to exit Germany and South Korea after losing money

there, and it has found it tough going in several other developed nations such as Britain. Moreover, rivals Target and
Costco have continued to improve their performance and are
now snapping at Wal-Mart’s heels.a

of corporate-level managers is to oversee the development of strategies for the whole
organization. This role includes defining the goals of the organization, determining
what businesses it should be in, allocating resources among the different businesses,
formulating and implementing strategies that span individual businesses, and providing leadership for the entire organization.
Consider General Electric (GE) as an example. GE is active in a wide range of
businesses, including lighting equipment, major appliances, motor and transportation equipment, turbine generators, construction and engineering services, industrial electronics, medical systems, aerospace, aircraft engines, and financial services.


6

PART 1

Introduction to Strategic Management

The main strategic responsibilities of its CEO, Jeffrey Immelt, are setting overall
strategic goals, allocating resources among the different business areas, deciding
whether the firm should divest itself of any of its businesses, and determining
whether it should acquire any new ones. In other words, it is up to Immelt to develop strategies that span individual businesses; his concern is with building and
managing the corporate portfolio of businesses to maximize corporate profitability.
It is not Immelt’s specific responsibility to develop strategies for competing in
the individual business areas, such as financial services. The development of such
strategies is the responsibility of the general managers of these different businesses,
or business-level managers. However, it is Immelt’s responsibility to probe the strategic thinking of business-level managers to make sure that they are pursuing strategies that will contribute toward the maximization of GE’s long-run profitability, to
coach and motivate those managers, to reward them for attaining or exceeding
goals, and to hold them to account for poor performance.
Corporate-level managers also provide a link between the people who oversee the strategic development of a firm and those who own it (the shareholders).

Corporate-level managers, and particularly the CEO, can be viewed as the agents of
shareholders.3 It is their responsibility to ensure that the corporate and business
strategies that the company pursues are consistent with maximizing profitability and
profit growth. If they are not, then ultimately the CEO is likely to be called to account by the shareholders.
●

Business-Level
Managers

business unit
A self-contained division
(with its own functions—
for example, finance,
purchasing, production,
and marketing
departments) that provides
a product or service for a
particular market.

●

Functional-Level
Managers

A business unit is a self-contained division (with its own functions—for example,
finance, purchasing, production, and marketing departments) that provides a product or service for a particular market. The principal general manager at the business
level, or the business-level manager, is the head of the division. The strategic role of
these managers is to translate the general statements of direction and intent that
come from the corporate level into concrete strategies for individual businesses.
Thus, whereas corporate-level general managers are concerned with strategies that

span individual businesses, business-level general managers are concerned with
strategies that are specific to a particular business. At GE, a major corporate goal is
to be first or second in every business in which the corporation competes. Then the
general managers of each division work out for their business the details of a business model that is consistent with this objective.
Functional-level managers are responsible for the specific business functions or operations (human resources, purchasing, product development, customer service, and
so on) that constitute a company or one of its divisions. Thus, a functional manager’s sphere of responsibility is generally confined to one organizational activity,
whereas general managers oversee the operation of a whole company or division. Although they are not responsible for the overall performance of the organization,
functional managers nevertheless have a major strategic role: to develop functional
strategies in their area that help fulfill the strategic objectives set by business- and
corporate-level general managers.
In GE’s aerospace business, for instance, manufacturing managers are responsible for developing manufacturing strategies consistent with the corporate objective
of being first or second in that industry. Moreover, functional managers provide
most of the information that makes it possible for business- and corporate-level
general managers to formulate realistic and attainable strategies. Indeed, because
they are closer to the customer than the typical general manager is, functional managers themselves may generate important ideas that subsequently become major


CHAPTER 1

The Strategy-Making Process

7

strategies for the company. Thus, it is important for general managers to listen
closely to the ideas of their functional managers. An equally great responsibility for
managers at the operational level is strategy implementation: the execution of corporate- and business-level plans.

The Strategy-Making Process
Now that we know something about the strategic roles of managers, we can turn our
attention to the process by which managers formulate and implement strategies.

Many writers have emphasized that strategy is the outcome of a formal planning
process and that top management plays the most important role in this process.4
Although this view has some basis in reality, it is not the whole story. As we shall see
later in the chapter, valuable strategies often emerge from deep within the organization without prior planning. Nevertheless, a consideration of formal, rational planning is a useful starting point for our journey into the world of strategy. Here we
consider what might be described as a typical formal strategic planning model for
making strategy.
● A Model of the
Strategic Planning
Process

The formal strategic planning process has five main steps:
1. Select the corporate mission and major corporate goals.
2. Analyze the organization’s external competitive environment to identify opportunities and threats.
3. Analyze the organization’s internal operating environment to identify the organization’s strengths and weaknesses.
4. Select strategies that build on the organization’s strengths and correct its weaknesses in order to take advantage of external opportunities and counter external
threats. These strategies should be consistent with the mission and major goals
of the organization. They should be congruent and constitute a viable business
model.
5. Implement the strategies.

strategy formulation
Analyzing the
organization’s external and
internal environments and
then selecting appropriate
strategies.

strategy implementation
Putting strategies into
action.

The task of analyzing the organization’s external and internal environments and
then selecting appropriate strategies is known as strategy formulation. In contrast,
strategy implementation involves putting the strategies (or plan) into action. This
includes taking actions consistent with the selected strategies of the company at the
corporate, business, and functional levels, allocating roles and responsibilities
among managers (typically through the design of organization structure), allocating
resources (including capital and people), setting short-term objectives, and designing the organization’s control and reward systems. These steps are illustrated in Figure 1.2 (which can also be viewed as a plan for the rest of this book).
Each step in Figure 1.2 constitutes a sequential step in the strategic planning
process. In step 1, each round or cycle of the planning process begins with a statement of the corporate mission and major corporate goals. As shown in Figure 1.2,
this statement is shaped by the existing business model of the company. The mission
statement is followed by the foundation of strategic thinking: external analysis, internal analysis, and strategic choice. The strategy-making process ends with the design of the organization structure, culture, and control systems necessary to implement the organization’s chosen strategy.