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Strategic Management
in the 21st Century

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Strategic Management
in the 21st Century
Volume 1:
The Operational Environment

Timothy J. Wilkinson, Editor

Copyright 2013 by ABC-CLIO, LLC


All rights reserved. No part of this publication may be reproduced, stored in
a retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording, or otherwise, except for the inclusion
of brief quotations in a review, without prior permission in writing from the
publisher.
Library of Congress Cataloging-in-Publication Data
Wilkinson, Timothy J.
Strategic management in the 21st century / Timothy J. Wilkinson and Vijay R.
Kannan, editors.
v. cm.
v. 1. The Operational environment v. 2. Corporate strategy v. 3. Theories
of strategic management.
Includes index.
ISBN 978-0-313-39741-7 (hbk. : 3 vol. set : alk. paper) ISBN 978-0-313-39742-4
(ebook) 1. Strategic planning. 2. Strategic alliances (Business).
3. Management. I. Title.
HD30.28.W524 2013
658.4012dc23
2012041185
ISBN: 978-0-313-39741-7
EISBN: 978-0-313-39742-4
17

16

15

14

13

This book is also available on the World Wide Web as an eBook.


Visit www.abc-clio.com for details.
Praeger
An Imprint of ABC-CLIO, LLC
ABC-CLIO, LLC
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Santa Barbara, California 93116-1911
This book is printed on acid-free paper
Manufactured in the United States of America

Contents

Set Introduction
Timothy J. Wilkinson

vii

PART I: THE BASICS OF STRATEGY


1. The Origins of Strategy and Strategic Thought
Marc D. Sollosy
2. Marshaling Firm Resources in Order to Be
a Successful Competitor
Franco Gandolfi
3. SWOT Analysis and the Three Strategic Questions
Tom Hinthorne

29
55

PART II: THE STRATEGIC ENVIRONMENT


4. The Economy, the Government, and Managerial
Decision Making
R. Scott Harris

83

5. Navigating the Political Environment


Ronald J. Hrebenar

107

6. The Influence of Social Forces on Firm Strategy


Tracy L. Gonzalez-Padron

125

vi

Contents

7. Business-Government Dynamics in the Global Economy


Drew Martin and Loren M. Stangl

149

PART III: APPROACHES TO STRATEGIC


MANAGEMENT
8. Serendipity as a Strategic Advantage?
Nancy K. Napier and Quan Hoang Vuong
9. The Role of Supply Chain Management
in Corporate Strategy
James S. Keebler
10. Employee Engagement and Strategic Management:
A Case Study from Palestine
Yara Asad and Andrew R. Thomas
11. The Soft Stuff Is the Hard Stuff: How Relationships and
Communications Can Drive the Execution of
Business Strategy
Linda Clark-Santos and Nancy K. Napier

175

200

220

233

12. The New Reality for Business Institutions:


Societal Strategy
Robert Moussetis

254

13. Strategy and EntrepreneurshipA Discussion


of Strategic Entrepreneurs
Franco Gandolfi

276

Index

301

Set Introduction
Timothy J. Wilkinson

For such a new field of inquiry, strategic management exhibits a breadth


of ideas and robustness of thought that places it at the forefront of business disciplines. Unlike academic marketing, where A level journal
articles seem to apply ever-greater levels of statistical sophistication to increasingly trivial questions, strategy is theoretically rich and eminently
practical. Years ago I heard the CEO of Barcothe Belgian projection systems companyexplain the firms strategy with the use of terms such
as price premium, quality focus, and not wanting to get stuck in the
middle. After his presentation I asked if he had ever hired Michael Porter
as a consultant. He said that he hadnt, but that his management team had
read Porter and it was through Porters lens that they viewed company
strategy. Newer ideas from the strategy domain are also being embraced
as analytical tools by firms. The resource-based view, the dynamic capabilities perspective, and real options theory have each yielded insights
that have helped companies become more effective competitors. At the
same time, the conscious application of many strategic management theories to real-world situations remains limited for most business enterprises.
The most evident contribution of strategy theory may be its ability to
help us understand what has already happened in the past. The digital
overthrow of the analog worlds rigid industrial boundaries upended the
neat categories of Porters static analysis. Robert R. Wiggins and Frances
H. Fabians chapter on hypercompetition clearly explains this phenomenon, and demonstrates why theorizing in strategy is likely to remain a
work in progress. A world driven by constant change is not a comfortable

viii

Set Introduction

place for settled theories. At the same time, insights from older strategic
management theories can remain just as relevant today as when they appeared decades ago, as demonstrated by Tom Hinthornes SWOT analysis
of the Northrop Grumman Corporation.
Strategic Management in the 21st Century is divided into three volumes. Volume 1: The Operational Environment sets the stage upon which
businesses make their strategic decisions. The volume begins with a section on the history of strategy, which is followed by chapters explaining
the societal context that forms, and is formed, by the strategic decisions of
firms. Ron Hrebenars chapter on political strategy is a reminder (as well
as a primer) on how politics can be used to further the goals of businesses.
Given the resurgence of federal government statism, understanding lobbying is more important now than it ever has been. Corporate social responsibility, entrepreneurship, gathering firm resources, and strategic
alliances are also discussed in volume 1.
Volume 2: Corporate Strategy focuses on the practical implications of
strategic management for firms. The volume examines many of the nutsand-bolts issues that face managers as they endeavor to implement firm
strategy. Understanding competitors, mergers and acquisitions, human
resource management, and corporate financial strategies are among the
topics explored. Robert Winsors chapter on marketing is a primer on the
trade-offs that necessarily take place as managers prefer one strategy over
another. Amitava Mitras explanation of how quality became a major strategic objective in the 20th century and how firms must embrace it if they
are to be successful in the 21st century provides a link between strategic
objectives and the quality initiatives of firms. Other topics covered include
innovation, corporate culture, and outsourcing.
Volume 3: Theories of Strategic Management departs from the applied
focus of the volume set, and takes a thorough look at the frameworks that
have shaped strategic management ever since Ansfoff initiated the field
with his product-market growth matrix in 1957. The volume begins with a
history of strategic management, including an overview of the disciplines
roots in military strategy. After covering the basic theoretical trajectory
of the fieldstructure, conduct, performance, the resource-based view,
transaction cost economics, hypercompetition, and the likethe volume
diverges into an exploration of related topics. These include excurses into
areas such as trust, entrepreneurship, and corporate social responsibility.
My fellow editor, Vijay R. Kannan, and I believe that this set is a comprehensive and in-depth examination of the field of strategic management. Because it ranges from rich presentations of theory, to their practical
applications, it should prove to be a valuable resource to scholars, students, and business strategists. We are pleased to present to you Strategic
Management in the 21st Century.

Part I

The Basics of Strategy

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Chapter 1

The Origins of Strategy


and Strategic Thought
Marc D. Sollosy

COMPETITION LEADS TO STRATEGY


In 1934, Professor Gause of Moscow University published the results of
a series of experiments that led to Gauses principle of competitive exclusion. This principle contends that no two species can coexist when
they make their living in the identical way. When any pair, or more, of
species compete for essential resources, sooner or later one will overcome
the other. Without some form of intervening factor that helps to maintain equilibrium by providing each species an advantage in its own territory, only one of them will survive. For millions of years, this natural
competition required no strategy. Survival was based upon the laws of
probability. Strategy was not involved; rather, adaptation and survival of
the fittest was the modus operandi. This pattern of survival exists for all
living organisms.1
Gauses principlethat competitors making their living in the same
way cannot coexistexplains the phenomenon of competition. Similar
entities often required the same resources in order to exist. As competition among entities for these common resources became more intense,
ways to achieve an advantage became increasingly important. Each

Strategic Management in the 21st Century

entity needed to develop something, a feature, survival mechanism, approach, or other means of differentiation, that provided it with a unique
advantage. In the realm of human existence, competition first exhibited
itself in the need to protect and preserveto protect oneself and the other
members of the clan from the elements and nature, and later from those
who needed or coveted what they had. As the nature of man continued to
change, there became an increased desire to use or possess what belonged
to others. This often manifested itself in the form of forays into the territory, or raids on the possessions, of others. At first, these ventures were
most likely conducted in a manner that was random and disorganized.
As the powers of perception and cognitive abilities of human beings improved, the search for a better way began to emerge. This better way
entailed the achievement of the desired result in a more efficient and effective manner. This desire for a better way was the very foundation of what
was to become strategy.
The unique combination of acquired wisdom, craft, and later science,
has led to the creation of strategy and its use as a much sought after skill.
The utilization of strategy has changed the map of the world. Long before
its application to commerce, it was responsible for the rise and fall of nations and their people. The tap root of what we know as strategy can be
found in the history of the military arts. Looking back at this beginning
provides the foundation for a more thorough understanding of the genesis of the discipline.
STRATEGYA MARTIAL ART
The beginning of organized forms of strategy sprang from the need for
people either to defend themselves or to defeat their enemies. In keeping
with the earlier extrapolation of Gauses principle, this is really a manifestation of competition between similar entities requiring the same resources. At the extreme, competition presents itself as warfare. Among
the earliest acknowledged writings discussing the concepts of strategy is
the Taoist Sun Tzus The Art of War written around 400 BC. The title of
the work is somewhat misleading in as much as the text addresses the
concepts of strategy in a much broader fashion by also referencing public administration and planning. Although the text does outline theories
of battle, it also delves into the area of diplomacy and the need to cultivate relationships with other nations as being essential to the overall wellbeing of a state.2
The word strategy is derived from the Greek word strategos, which actually translates as general. As such, it was originally viewed in the
more narrow confines as the art of the general, or the the art of arrangement of troops.3,4 The term strategamata is the title of an early Latin work
attributed to Frontius. It describes a collection of strategema, or stratagems,

The Origins of Strategy and Strategic Thought

which literally translates as tricks of war. The Romans are also credited
with introducing the terms stragia in referring to the territories under the
control of a military commander, and strategus, referring to a member of
the council of war.5
Strategy as applied to the art of war was revolutionized at the time of
the French Revolution and the subsequent Napoleonic wars. Napoleon
capitalized upon the advancements in armament technology and the lessening of the costs associated with the tools of war. He employed a brutally
effective strategy of annihilation (read scorched earth) that placed little
value on the mathematical perfection of geometric strategy. His goal was
to achieve victory in the battlefield. His sole aim was the utter and total
destruction of his opponent, usually achieving this success through the
deployment of superior maneuvers.
The 19th century marked the beginning of a new era in warfare and
by extension in the development of strategy. The most notable contributors of the time are Carl von Clausewitz (17801831) and Antoine Jomini
(17791869). Clausewitzs seminal work, On War,6 stressed the close relationship between war and national policy. He emphasized the importance
of the principles of mass, economy of force, and the destruction of enemy
forces. In contrast, Jomini focused on the occupation of enemy territory
through a combination of carefully planned, rapid, and precise geometric
maneuvers.
The 19th century was an era of far-reaching technological changes
that radically altered the breadth and scope of both tactics and strategy.
Railroads and steamships extended the volume, reach, and speed of mobilization. Telegraphic communications linked widening theaters of operations and by extension made large-scale strategy and tactics both possible
and necessary. The impact of technology has only increased since the late
20th century, and will continue to increase as we proceed the 21st century.
Ultimately, the development of a strategy requires the ability to accept
uncertainty. Strategists must come to accept that they will not have all of
the information they need and will not be able to see the full spectrum of
events. Yet they must be committed to creating and implementing strategy. Uncertainties exist, not only from incomplete information, but also as
the result of the actions of a dynamic and thinking opponent. The design
of a strategy with a specific opponent in mind and undetermined actions
is what requires a strategist to accept, if not embrace, uncertainty. The inherent uncertainty associated with strategy is one of the key reasons why
so many military and business leaders cling to the tangible world of tactics
and options.
Strategys roots in the military have had a significant impact upon
their adoption and adaption in the world of business. Going as far back
as the works of Sun Tzu in the period of 400 BC, one sees that strategy
has been an important force in the shaping of political, sociological, and

Strategic Management in the 21st Century

commercial landscapes. The origin of modern strategy and its evolution over time can be found in the writings mentioned above, and more
demonstrably in military historys battles and wars. Moreover, the distinctions between strategy and tactics contribute to the militarys great and
unmistakable impact upon the development of the concept of strategy.7
STRATEGYFROM MARTIAL ART TO MARKETSTHE WHO
Historically, one of the first acknowledged uses of strategy in business
happened when Socrates counseled the Greek militarist, Nichomachides, after he had lost an election for the position of general to the Greek
businessman, Antisthenes. Comparing the duties of a general with that
of a businessman, Socrates demonstrated to Nichomachides that both instances required planning how to use ones resources to meet objectives.
Unfortunately, this viewpoint was apparently lost with the fall of the
Greek city-state and was not resurrected until after the beginnings of the
Industrial Revolution.8
Table 1.1 portrays the development of modern strategic thought. The
first vestiges of what would become modern strategy resulted as an outcome from the then newly emerging vertically integrated, multidivisional
corporations of the late 1800s and early 1900s. These corporations made
large investments in manufacturing and marketing and in managerial
hierarchies to coordinate those functions. Over time, the largest of these
companies managed to alter the competitive environment within their industries and to even cross industry lines.9 The need for a more formal
approach to corporate strategy was first brought to the forefront by top
executives of these large, vertically integrated and multidivisional corporations. Among the most notable were Alfred Sloan, chief executive of
General Motors from 1923 to 1946, who devised a strategy explicitly based
upon the perceived strengths and weaknesses of its competitor, Ford
Motor Company.10 Chester Barnard, a top executive with AT&T, argued in
the 1930s that managers need to pay especially close attention to strategic
factors, which depend on personal or organizational action.11,12
It wasnt until after World War II that the concept of strategy, as related to business, began to move to the forefront. It was at this time that
business moved from a relatively stable, if not static, environment into
one comprising increasingly rapid change and competition. Igor Ansoff,
considered by some as the father of modern strategic thought, has attributed this evolution to two significant factors: first, the marked increase in
the rate of change within and between firms, and second, the accelerated
application of science and technology to the process of management.13
This acceleration in the rate of change places a premium on the ability
to anticipate change, take advantage on new opportunities, and to proactively avoid threats to the firm. New technologies spawned interest in,

Alfred
Chandler

Igor Arcoff

Peter Drucker

Michael Porter

Kenichi
Ohmae

Peter Senge

Hammer &
Chempy

Henry
Mintzberg

Hamel &
Prahalad

When What

Who

Table 1.1
Development of Modern Strategic Thought

Strategy and
Structure

Corporate
Strategy

The Age of
Discontinuity

Competitive
Strategy

The Mind Of
the Strategist

The Fifth
Discipline

Reengineering
The
Corporation

The Rise And


Fall of Strategic
Planning

Competing
For the
Future

1952

1955

1959

1980

1982

1990

1993

1994

1994

Strategic Management in the 21st Century

and ultimately acceptance of, analytical and explicit approaches to decision making. This resulted in the increasing ability of management to deal
with the expanding uncertainties of the future.14
Viewing the development of strategic thought in a loose chronological order brings us to Von Neumann and Morgenstern, who were among
the first modern writers to relate the concepts of strategy to business in
their opus, Theory of Games and Economic Behavior.15 In that work, they
defined strategy as a series of actions by the firm decided upon according to the particular situation facing the firm. Since the release of Theory
of Games and Economic Behavior, numerous other writers have developed
subsequent concepts and theories of strategy.
In his work, The Practice of Management, Peter Drucker argued that
rather than being passive and adaptive, management is about taking action to achieve desirable results. He noted that prevalent economic theory had long viewed markets as impersonal forces, beyond the control
of the individual entrepreneur and organization. With the emergence
of the vertically integrated, multidivisional corporation, managing implies responsibility for attempting to shape the economic environment,
for planning, initiating, and carrying through changes in that economic
environment, for constantly pushing back the limitations of economic
circumstances on the enterprises freedom of action.16 In Druckers
view, strategy is about analyzing the present situation and changing it
if necessary. Underlying this view is the need for finding out what ones
resources are or what they should be.17
Philip Selznick first introduced the concept of matching the organizations internal factors with the external environment in 1957 with the
publication of Leadership in Administration: A Sociological View.18 This core
idea would later be developed by E. P. Learned, K. R. Andrews and others
at the Harvard Business School General Management Group into what
has more commonly become known as SWOT (strengths, weaknesses,
opportunities, and threats).19
Alfred Chandler expressed the importance, for the first time, of coordinating the various and often disparate aspects of management under
one all-encompassing strategic umbrella. Prior to Chandlers work, the
various functions of management were often separated with little, or
no, overall coordination or strategy. What interactions existed between
functions or departments were typically handled by a boundary position wherein one or two managers relayed information back and forth
between the departments. Chandler further emphasized the importance
of taking a long-term perspective when looking to the future. His work
Strategy and Structure20 posited that a long-term coordinated strategy
was required in order to give a company structure, direction, and focus.
Chandler viewed strategy as the determiner of the basic long-term goals
of an organization, and the adoption of courses of action and the allocation of resources necessary for carrying out those goals.

The Origins of Strategy and Strategic Thought

Igor Ansoff built upon the work of Chandler and others to develop the
keystone approach to the emerging field of corporate strategy through
a framework of theories, techniques, and models. In his book Corporate
Strategy: An Analytical Approach to Business Policy for Growth and Expansion,21 Ansoff presents a grid of elements that compare market penetration, product development, market development, and integration and
diversification. By understanding and using these strategic elements,
he felt management could systematically prepare for future opportunities and challenges. In this work, he developed Gap analysis, which
posits that management must try to understand the gap between where
they currently are and where they would like to be, and then develop
what he described as gap reduction actions.
Prior to Ansoff, there was little in the way of guidance for companies on how to plan for, or make decisions about, the future. Planning
was traditionally based upon existing budgeting systems, used for annual budgets, and was intended for just a few years into the future. This
approach largely ignored strategic issues. However, as competition increased, along with greater interest in acquisitions, mergers and diversification, and higher turbulence in the business environment, strategic
issues could no longer be overlooked. According to Ansoff, strategy development was essential and required the company to systematically
anticipate future environmental challenges, and to develop plans to appropriately respond to those challenges. To Ansoff, strategy is a rule for
making decisions determined by product/market scope, growth direction, competitive advantage, and synergy.22
If Igor Ansoff is considered the father of modern strategic thought,
then Michael Porter is its rock star. An economist by training, Porter made his mark in the area of strategy with the publication of How
Competitive Forces Shape Strategy.23 His principal and enduring contribution to the field of strategy is the concept of the five forces analysis,
where he identifies the forces that shape a firms strategic environment.
The five forces analysis is similar to Selznicks SWOT analysis with the
structure and purpose focusing on the external forces that shape a companys strategic environment. This approach portends to provide an approach for a company to obtain a sustainable competitive advantage.
Where Chandler presented the concept of structure following strategy,
Porter extended it by introducing a second level; organizational structure follows strategy, which in turn follows industry structure.
In addition to the five forces, Porter contributed to the strategic
knowledge base by writing about the generic strategies, the value chain,
strategic groups, and clusters. Porters work on generic strategies focuses on the interactions between cost-minimization strategies, productdifferentiation strategies, and market-focus strategies. Although he did
not conceive these terms or concepts, his work does highlight the importance of choosing one over another rather than trying to position the

10

Strategic Management in the 21st Century

company between them. Porter proposes that a firm will only be successful to the extent that it contributes to the industrys value chain. As
such, management must look at the operations of their companies from
the viewpoint of the customer. Every operational facet of the company
needs to be examined in light of the value it adds in the eyes of the customer. This view is grounded in Porters economic training of supply
and demand, where the buyer will purchase a given quantity at a given
price, where the price differential is equal to the perceived incremental
added value of the product or service.
A principal criticism of Porters view of the firm is that it is based on a
rather static perception of the world, with the size of markets being fixed.
In essence, companies compete in a zero-sum game where one companys gain in market share comes at the loss of another companys.24
As the nature of the economy and its technological underpinnings
began to change so did perceptions of strategy and strategic activities.
One of the earliest thinkers who reexamined the paradigm of strategy
was Kenichi Ohmae. Ohmaes view was that successful strategy stems
from creative minds, not from some rote formula. In his seminal work,
The Mind of the Strategist, published in 1982, Ohmae wrote that successful
strategy comes from a thought process that is creative and intuitive rather
than simply from step-by-step analysis. He defines strategy as the way
a corporation attempts to differentiate itself positively from its competitors, using its relative strengths to better satisfy customer needs. He goes
on to assert that strategy is really no more than a plan of action for maximizing ones strengths against the forces at work in the environment.25
Ohmae focuses on how organizations allocate and utilize resources. To
be effective, a companys strategy should be difficult to imitate, and to
achieve this, the company must either develop a completely new product
or make use of a position of relative superiority. Jay Barney, a strong proponent of the criticality of the organizations internal resources, would
later extend this view and suggest strategy as assembling the optimum
mix of resources, including technological, human, and supplier relations,
and then configuring them in unique and sustainable ways.26 This is
what is known as the resource-based view.
The delineation between strategy and strategic planning is exemplified by the works of Henry Mintzberg. In Crafting Strategy,27 Mintzberg
likens the strategic process to a craft. He presents the position that strategies are not necessarily deliberate acts, but that they can also emerge
through circumstances; and that they can form as much as they are formulated. He also goes on to expand upon the old adage those who cannot remember the past are condemned to repeat it,28 with his assertion
that organizations must make sense out of the past if they hope to manage
the future. He asserts that only by understanding the patterns of past behavior does an organization come to know its capabilities and potential.

The Origins of Strategy and Strategic Thought

11

To Mintzberg, strategy provides a vehicle for organizations and individuals to examine their internal and external worlds.29 Finally, Mintzbergs
contention that because analysis is not synthesisimplying that strategic
planning is not strategy formulationhas been the source of much intellectual discourse, particularly by Ansoff.30
Continuing along the line of thought started by Ohmae and Mintzberg,
Gary Hamel and C. K. Prahalad question the more traditional approach
to strategy development. In Competing for the Future,31 they suggest
that companies need to spend less time talking about strategy and planning and more time thinking about strategizing, which entails the concepts
of strategic intent, strategic architecture, industry foresight, and
core competencies. The last of these may be the best known and most
important concept to come from their work.32 Core competencies are those
one or two key things a company does better than any of its competitors.
Around the same time that Hamel and Prahalad were writing about
core competencies, Michael Hammer and James Champy published Reengineering the Corporation,33 where they proposed that the internal resources of the company need to be restructured around whole processes
rather than just tasks. They asserted the benefits of having a team of people see a project through, from inception to completion. They posited that
this approach avoids functional silos where isolated departments seldom
communicate with each other, as is so often found in organizations. They
felt that this approach had the benefit of eliminating waste due to functional overlap.
The next logical step in the evolution of strategic thought was presented
by Peter Senge. He examined the impact of the Information Age upon a
companys performance. In The Fifth Discipline,34 Senge presents the
theory that a companys ability to gather, analyze, and use information is
necessary for success in the Information Age. In what is an extension of
the work of his predecessors, Senge proposes that an organization needs
a structure through which people can continuously expand their capacity
to learn and be productivenew patterns of thinking are nurtured, collective aspirations are encouraged, and people are encourage to see the
whole picture together. Thinking strategically starts with reflection on
the deepest nature of the undertaking and on the central challenge that
it possesses.35 The most commonly cited barrier to the implementation of
what Senge proposes is that few organizations come close to having the
characteristics that he identifies with a learning organization. However,
with the growth in the focus of knowledge management in an increasingly globalized economy, an organization might begin to increase focus
and attention on the development and growth of its employees, who primarily create the intellectual capital of the organization.
The list of contributors to the development and advancement of the
study of strategy is extensive. The preceding group is by no means

12

Strategic Management in the 21st Century

intended to be all inclusive. Rather it attempts to touch upon those whose


contributions, some argue, had the most impact, if by no other measure
than their respective popularity and notoriety.
The preceding thinkers and authors shaped the discussion on strategy during the last half of the 20th century. Their respective contributions
are indisputable and provide the foundation for any further discussion
regarding strategy. However, with the transition from the 20th to the
21st century came a transformation.
The age of the Internet, the networked world, has brought about a
major, some suggest a tectonic, shift in the way commerce is viewed and
conducted. What became known as the dot-com world defied longestablished economic principles. The rush was to Web enable the enterprise in some manner regardless of its economic value. The mantra
of the time, to quote the movie Field of Dreams, was if you build it they
will come. However, the era of the dot-com quickly became the age of
the dot-gone. Although visibility on the Web was, and is, increasingly
important, profits still matter. Carl Shapiro and Hal R. Varian in their
work Information Rules: A Strategic Guide to the Network Economy,36 stress
that you ignore basic economic principles at your own risk. Technology
changes, but economic laws do not. The book addresses a number of issues, including pricing and versioning information, rights management,
recognizing and managing lock-in, switching costs, and how to account
for government policy and regulation in strategy development.37
Although Shapiro and Varian examined the impact of the Internet,
another phenomena had been entrenching itself in the landscape of
commerce. Historically, capital was viewed as a physical or financial
itemit manifests itself as building and equipment, or what could
be found in corporate balance sheets. Beginning in the 1990s, the
emergence of a more elusive form of asset, the intangible asset often
identified as intellectual capital, began to command attention. Senge
addressed the issue in The Fifth Discipline: The Art and Practice of the
Learning Organization,38 and in 1994 Drucker wrote that the true investment in the knowledge society is not in machines and tools but in
the knowledge of the knowledge worker.39
Intellectual Capital by Thomas Stewart40 serves as a guide to understanding and managing intangible assets. Steward posits that merely
understanding what intellectual capital comprises is only part of the
issue. The real value of intellectual capital, and other intangible assets,
comes from the organizations ability to capture and deploy these assets.
The effective strategic utilization of intellectual capital can serve as a
competitive differentiator in the market. Knowledge assets, like money
or equipment, exist and are worth cultivating only in the context of strategy. You cannot define and manage intellectual assets unless you know
what you to do with them.41, 42

The Origins of Strategy and Strategic Thought

13

It becomes increasingly evident that the field of strategy is a discipline that is still evolving and will continue to evolve to keep pace with the
dynamic nature of modern commerce. There are no clear indications as to
where strategy may be heading over the coming years. As Yogi Berra once
famously said, The future aint what it used to be. There does appear
to be a growing consensus in the strategy field that the world is unpredictable and by extension, the future is inherently unknowable because
of the chaotic nature of events.
An area of potential applicability is the field of chaos theory. Chaos
theory examines the underlying behaviors of systems, which are ruled
by simple physical laws, but where the actual events appear so unpredictable they might as well be random. The field studies the complex
relationships that underlie the everyday systems we encounter and
observe in the real world. The greatest contribution of chaos theory is
the revelation that even simple systems seem to create extraordinarily
difficult problems of predictability. The universe is chaotic, ruled by entropy, and a never-ending tendency toward disorder. Long-term planning has been notoriously ineffective in predicting the future. In fact,
detailed planning systems, and their underlying economic support systems, cannot be effective because of lack of certainty about what will
happen next. Strategy needs to borrow from the physical sciences, most
notably physics and biology. These lenses stress adaptability, flexibility,
and speed of change. The old order of static positioning and long-term
competitive advantage are no longer adequate. It is not just running
faster but thinking faster that makes a difference.43
STRATEGIC THINKING VERSUS STRATEGIC PLANNING
The concept of strategy is often used interchangeably for the concept
of strategy formation. Although it is easy to blend, even confuse the two,
in reality, they are distinct, but related activities. In fact, the standard
dictionary definition of the word strategy only contributes to the lack of
clarity. On the www.merriam-webster.com/dictionary Website, the definition of strategy is as follows:
1a (1): the science and art of employing the political, economic, psychological, and military forces of a nation or group of nations to
afford the maximum support to adopted policies in peace or war
(2): the science and art of military command exercised to meet the
enemy in combat under advantageous conditions
b: a variety of or instance of the use of strategy
2a: a careful plan or method: a clever stratagem
b: the art of devising or employing plans or stratagems toward
a goal

14

Strategic Management in the 21st Century

It is not until you get to 2a of the definition that the meaning of strategy as
applied in the context of business becomes evident.
In order to clarify the definition, it becomes appropriate to consider the
concept of strategy separately from the process of strategy formation. To
start, strategy embraces almost all of the critical activities of a firm. That
is, strategy provides a sense of unity, direction, and purpose, as well as accommodating the changes necessitated by the firms environment. Hax44
suggests that the following six dimensions need be included in any unifying definition of strategy:
1. Strategy as a coherent, unifying, and integrative pattern of decisions. Strategy gives rise to the plans that assure that the basic objectives of the enterprise are met, and that it is conscious, explicit, and
proactive.
2. Strategy needs to be considered as a means of establishing an organizations purpose in terms of its long-term objectives, action programs, and resource-allocation priorities. This clearly indicates that
resource allocation is a firms most critical aspect of strategic implementation and effectiveness.
3. Strategy needs to be considered as a definition of a firms competitive domain. One of the principal concerns of strategy is defining
the businesses a firm is in or intends to be in, and relates back to
dimension (1) mentioned earlier.
4. Strategy needs to be considered as a response to external opportunities and threats and in internal strengths and weakness as a
means of achieving competitive advantage. A central objective of
strategy is the achievement of a long-term sustainable advantage
over a firms key competitors.
5. Strategy needs to be considered as a logical system for differentiating managerial tasks at corporate, business and functional levels.
This point recognizes the various hierarchical levels in most organizations, and that each level has differing managerial responsibilities
in terms of their contribution in both defining and operationalizing
the strategy of the firm.
6. Strategy is a definition of the economic and noneconomic contribution the firm intends to make to its stakeholders. It is easy for managers to fall into the trap of bottom line/short-term profitability as
the ultimate driving force. Sustained profitability is the legitimate
and desired outcome of a well-executed strategy.
It becomes apparent from the previously mentioned text that strategy
encompasses the overall purpose of the organization. As such, defining
it properly entails examining all of the multiple aspects that comprise
the whole. Strategy becomes a framework by which an organization

The Origins of Strategy and Strategic Thought

15

asserts it continuity, while managing to adapt to the changing environment in order to achieve competitive advantage.45
Further examination of the literature on the difference between strategic thinking and strategic planning provides little clarity. Strategic planning is often associated with a programmatic, analytical thought process,
whereas strategic thinking refers to a creative, divergent thought process.
The source of the confusion lies in the fact that although the terms are
frequently used, they are often used in fundamentally different ways
by different authors. For some, strategic thinking and planning are distinct modes that are both useful at different stages in the strategic management process (e.g., Mintzberg); others posit that strategic thinking
is not so much creative as analytical (Porter). Still for some, strategic
planning remains an analytical activity, but the organizational practices
surrounding it have been transformed, whereas others believe the real
purpose of the analytical tools of strategic planning is to facilitate creativity, which is a part of strategic thinking. Last, for a select group, strategic planning is a useless activity that should be scrapped in favor of
strategic thinking.46
Heracleous47 proposes that strategic planning and strategic thinking are two distinct thinking modes, and that strategic thinking needs
to precede strategic planning. This view is based upon the premise that
planning cannot produce strategies because its focus is programmatic,
formalized, and analytical. Planning is what happens after the strategy
has been decided upon, discovered or purely emerges. Mintzberg48 endorses this view by suggesting that the concept of strategic planning
is based upon three principal fallacies. First is the fallacy of prediction,
the belief that planners can accurately predict what will happen in the
marketplace. Second is the fallacy of detachment, the basis of which is
that effective strategies can be produced through formalized processes
by planners who are detached from business operations and the market.
Last is the fallacy of formalization, a disputable concept suggesting that
formalized procedures can produce strategies, whereas their appropriate
function is to operationalize existing strategies.
The preceding view stresses that strategic thinking and strategic planning involve distinctly different thought processes. Strategic planning
is analytical, systematic, and convergent, whereas strategic thinking is
synthetic and divergent. This view challenges conventional wisdom regarding strategic planning by seeking to limit planning to the operationalization of existing strategies as opposed to being able to generate new
or creative strategies. In contrast, Porter and others believe that strategic thinking is analytical. Porter supports this view with his analytical frameworks of five forces analysis, the value chain, the diamond
model of national competitive advantage, and strategy as an activity
system. In this view, strategic thinking is not a synthetic and divergent

16

Strategic Management in the 21st Century

thought process; rather, it is convergent and analytical, and therefore


used interchangeably with the term strategic planning.49
In reality, although an organization may begin with a rational plan,
what evolves may be something very different than what was actually intended. These emergent strategies evolve as part of a pattern in a stream
of actions, as opposed to any preconceived plan.50
Liedtka51 suggests that in the face of unpredictable, highly volatile, and
competitive marketplaces, a capacity for innovative, divergent strategic
thinking at multiple levels of the organization is central to creating and
sustaining competitive advantage.
Liedtkas52 examination of strategic thinking led her to present five
major attributes of strategic thinking, as follows:
1. Strategic thinking reflects a system or holistic view that appreciates how the different parts of an organization influence each other,
as well as their different environments.
2. Strategic thinking embodies a focus on intent. This contrasts with
the traditional approach that focuses on creating a fit between
existing resources and emerging opportunities. Strategic intent
intentionally creates a substantial misfit between them.
3. Strategic thinking involves the ability to think in the time continuum. Strategic thinkers understand the interconnectivity of past,
present, and future.
4. Strategic thinking is hypothesis driven. By asking the question
what if followed by the critical question if then, strategic thinking spans the analytical-intuitive chasm Mintzberg refers to in his
definition of thinking as synthesis and planning as analysis.
5. Strategic thinking raises the capacity to be intelligently opportunistic. It means to recognize and take advantage of newly emerging
opportunities.
The ability to think strategically facilitates another dimension of the
process of strategy making. It recognizes that strategic thinking and
planning are distinct, but interrelated and complementary thought processes.53,54 Heracleous55 asserts that thinking and planning must sustain
and support each other for effective strategic management. He observes
that creative groundbreaking strategies emerging from strategic thinking
still must be operationalized through convergent and analytical thought
(strategic planning).
The previously mentioned view suggests that the real purpose of strategic planning is to facilitate strategic thinking, where the structured planning tools of strategic planning are used to aid creative thinking. One of
the principal tools associated with this view is scenario planning, a
process for examining appropriate responses to a spectrum of possible

The Origins of Strategy and Strategic Thought

17

futures. The tool facilitates managers in questioning their underlying


assumptions, and sensitizes their thinking to potential competitive arenas
substantially different from their current ones. Schoemaker56 describes scenario planning as a thinking tool and communication devise that aids the
managerial mind rather than replace it. It is particularly valuable in times
of high uncertainty and complexity in that it challenges the status quo.
Scenario planning is a tool that aids an organizations ability to identify
trends and uncertainties in the macro-environment. It provides a means
for sketching possible futures by capturing a range of options, stimulating thinking about alternatives, and challenging the prevailing mindset.57
De Geus58 suggests that value of planning does not reside in the plan itself,
but in changing the mental models of managers involved in the process.59
The ability to think strategically gives meaning and insight to the process of strategic planning. It recognizes that strategic thinking and planning are distinct, but interrelated and complementary thought processes,
that must sustain and support each other for strategic management. Creative, groundbreaking strategies that emerge from strategic thinking still
have to be operationalized through convergent and analytical thought
(strategic planning). Planning is vital, but cannot produce unique strategies that challenge existing boundaries, unless it stimulates the creative
mindset in the process.60
STRATEGIC PLANNING VERSUS STRATEGIC MANAGEMENT
The previous section discusses the differences between strategic
thinking and strategic planning. Although the differences between the
concepts seem subtle, it is important to understand and recognize them.
The same is true when it comes to the differences between strategic planning and strategic management. Although very closely related, and to
some interchangeable, there are important distinctions between them.
One can actually look at the variations as a continuum, where strategic
thinking begets strategic planning, which in turn begets strategic management. However, in reality the process is a continuous loop, not a continuum with a beginning and an end.
As discussed earlier, Mintzberg61 calls the phrase strategic planning
an oxymoron. He argues that real strategies are rarely the result of paneled conference room meetings, but are more likely to result informally
from real-time hallway conversations, casual work groups, or casual moments of reflection.62 Mintzberg sees strategic management as encompassing both strategic thinking and strategic planning, where strategic
thinking is synthetic and divergent and strategic planning is analytical,
systematic, and convergent. Taking this view, one can see that strategic
management is the result of both the thinking and planning processes.
However, it should not be viewed as the end; rather it is the action and

18

Strategic Management in the 21st Century

subsequent checkpoint of the previous steps that then serves as the new
beginning to the recursive cycle.
Having examined some of the differences between thinking and planning, with an emphasis on thinking, lets examine the more intricate aspects of planning. Hax and Majluf63 suggest three levels of planning:
corporate, business, and functional. The corporate strategic plan is the
result of a disciplined and well-defined organization-wide effort aimed
at completely specifying corporate strategy. Andrews64 expressed corporate strategy as the pattern of decisions in a company that determines
and reveals its objectives, purposes, or goals, produces the principle
policies and plans for achieving those goals, and defines the range of
business the company is to pursue, the kind of economic and human organization it is or intends to be, and the nature of the economic and noneconomic contribution it intends to make to its shareholders, employee,
customers, and communities. . . . [it] defines the businesses in which a
company will compete, preferably in a way that focuses resources to
convey distinct competences into competitive advantages.
The planning process entails three major tasks that need to be updated and revised at every planning cycle. These three tasks are strategy
formulation, strategic programming, and strategic and operational budgeting. Planning at the corporate level should not be considered a topdown or a bottom-up process. Rather, it is a complex, integrative activity
requiring participation by all the key members of the organization who
propose objectives from the top; and equally, participation from business and functional levels of the organization for specific pragmatic alternatives. It provides a rich communication mechanism giving voice to
managers about their personal beliefs regarding the conduct of the firm.
It offers key participants a valuable shared experience.65
A cornerstone of the strategic planning process involves segmenting
the organizations various activities in terms of business units. This requires asking and answering the question: What business are we in? On
the surface, this question is deceptively simple, yet in practice, it represents one of the most challenging and vexing questions faced by most organizations and requires creative and extensive analysis to fully answer.
This criterion of segmentation may be valid for a vertically integrated,
multidivisional corporation. However, most companies have difficulty
breaking their businesses into totally unrelated units. In general, businesses within the same organization share resources in order to exploit
economies of scale and maximize resource utilization. As such, most
business activities need to be properly and adequately coordinated.66
It should be noted that general planning and strategic planning are
not the same. Although the role of planning in general is indisputable,
the value of formal strategic planning is subject to something less than

The Origins of Strategy and Strategic Thought

19

unanimity. However, there seems to be little doubt that most managers find it extremely useful, if not outright essential. What then is the
real value of formal strategic planning? The extant literature seems to
conclude that its principal role is to help an organization make better
strategies using systematic, logical, and more rational approaches to
strategic choices.67 Henry68 describes the functions of a fully developed
strategic planning system to:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Determine organizational purpose and management philosophy,


Identify internal strengths and weaknesses,
Monitor changes in the external environment,
Forecast future conditions and establish planning premises,
Determine threats and opportunities,
Formulate specific goals,
Identify and evaluate alternative policies and strategies,
Select the best strategic plan,
Prepare functional action plans, and
Prepare action plans.

The ultimate success of strategic planning is very much dependent


upon the willingness and abilities of senior managers to make strategic decisions in the first place. It may well be that strategic planning is
felt necessary by managers, analysts, and lower-level professionals in
the organization because of a leadership vacuum. The call for strategic
planning is really a call for leadership and direction. Because strategic
planning is viewed primarily as a means for making strategic decisions,
it is often mistakenly imagined that a mere formal process can generate
a strategy.69
The path of strategic planning has been less than smooth. At the end
of the 1970s, it had suffered a downturn in popularity and influence.
This was attributable, in large part, to the apparent inability of strategic
planning tools to deliver what was expected of them. The 1970s were
a period of turmoil and firms had begun to learn that what was then
called long-range planning and less ambitiously, strategic planning,
did not lead to the requisite adaptability or even survival. During the
1990s, strategy and strategic planning had regained some of the reputation and influence they previously lost. A contributing reason may
well have been the increasing belief that practical strategic advice can
be based on sound deduction and systematic observation.70 This resurgence of practical strategy making may be attributable to the development of Barneys71 resource-based view of strategy. The core implication
to management of this view is that a firm may secure a strong performance with the acquisition of unique or scarce resources.72

20

Strategic Management in the 21st Century

Quinn73 suggests that the real contribution of the corporate strategic


planning systems is actually the process itself, rather than the decision.
The main role of the planning session is to create a network of information, to force managers to focus on the future, to encourage rigorous communications about strategic issues, to raise the comfort level of
managers, and to confirm earlier strategic decisions. Formal strategic
planning and strategic planners do not make strategic decisions; rather,
people and organizations make strategic decisions. Sometimes they use
strategic planning as a discipline to facilitate the outcome. It appears
that formal strategic planning is as much a social as a rational analytical
process that varies according to organizational type. This view is supported by Boyd74 who notes that strategic planning is one tool to manage
environmental turbulence. Others, notably Sinha75 and Ramanujam and
Venkatraman,76 argue that it is the act of planning that is the real value.
TOOLS OF THE TRADE
The paradigm of strategic management derived from the world of
strategic planning is founded on a rational approach to provide strategic
direction to the actions of an organization in an increasingly dynamic
business environment.77 Andersen78 suggests that strategic management
is often considered synonymous with strategic planning. This approach
has become a dominant framework in the wide array of strategic literature as represented by: Setting Strategic Goals and Objectives;79 Setting
Strategic Goals and Objectives;80 Setting Strategic Goals and Objectives;81
Competitive Strategy: Techniques for Analyzing Industries and Competitors;82
and Setting Strategic Goals and Objectives.83
Many of the contemporary textbooks on strategy support the duel
theme of planning and emergence. These books usually present some formal strategic planning model while simultaneously recognizing that important strategic initiatives often emerge from within the organization;
two among these are Strategic Management: An Integrated Approach84 or
Crafting and Executing Strategy.85 Although the various aspects of strategic
planning are generally recognized, it is also important to recognize, and
attempt to understand, the complexities of the integrative strategy process
and the dynamics of the interaction between emergence and planning.86
The spectrum of tools and techniques utilized by firms in strategic
planning is extensive. An examination of these tools and techniques reveals four commonly utilized types. They include scenario or what if
analysis, analysis of key or critical success factors, financial analysis of competitors, and SWOT analysis. The first, scenario or what if
analysis is formed by describing a future situation and the corresponding course of events enabling the firm to progress from the original
situation to the future situation. There are two major types of scenarios:

The Origins of Strategy and Strategic Thought

21

exploratory, starting from past and present trends and leading to likely
futures, and anticipatory or normative, built on the basis of alternative
visions of the future. The major activities of the scenario approach include:
identifying the key variables, which is the purpose of a structural analysis, identifying and analyzing the potential actions of those external to the
organization, thus identifying key questions about the future, and attempting to reduce uncertainty about those key questions and then to
pick the most probable course of action or scenario.87
As demonstrated previously, the scenario approach requires the analysis of key or critical success factors internal to the organization. This
coupled with financial analysis of competitors imply consideration for the
external influences on the organization. These activities, when taken together, are also reflected in the assessment of the opportunities and threats
driving the SWOT analysis often employed by firms. The internal analysis
is that portion of the SWOT associated with the strengths and weaknesses,
whereas the external analysis examines the opportunities and threats presented to the firm.
Another frequently used tool that expands the external analysis to the
broader view of the industry is Porters five forces/industry attractiveness analysis. At its simplest, Porters five forces model examines existing rivals and the threat of new entrants, potential for substitutes, and
the power or force exerted by the suppliers and customers on the organization. This approach provides integral components of the external
appraisal of the organization, leading to a more considered view of the
opportunities and threats facing the firm.88
Another tool that has contributed to the strategic planning process is
the balanced scorecard, as conceptualized by Kaplan89 and further expanded upon by Norton.90 What the balanced scorecard does is to extend
traditional financial measures of the firms performance by injecting the
perspective of the firms customers, the performance of internal business processes, and the ability of the firm to continue to learn and grow.
It enables companies to track their financial results while simultaneously
monitoring their progress in building the capabilities and acquiring the
intangible assets they need for future growth. The balanced scorecard is
not a replacement for the financial measures of a firm. It rather complements them by integrating accounting and financial information into a
management system that focuses the entire organization on implementing
its long-term strategic plan and strategy.
The preceding text touches upon a few of the more prevalent tools used
in the realm of strategic planning. It is by no means an all-inclusive study
of the field of strategic planning, and the tools and approaches accompanying it continue to evolve and develop. Just as the environment in which
business and commerce operates takes on new dimensions and complexities, so too must the tools that allow firms to successfully compete

22

Strategic Management in the 21st Century

adapt. Keeping in mind Gauses principle, as discussed at the very beginning of this chapter, competitors making their living in the same
way cannot coexist. Similar entities often required the same resources in
order to exist. As competition among entities for these common resources
became more intense, ways to achieve an advantage became increasingly
important. Each entity needs to develop something, a feature, survival
mechanism, approach, or other means of differentiation, which provided
it a unique advantage. In other words, each organization needs a strategy, a strategic plan, and a strategic management approach that enables it
to survive among its competitors in its given environment.
NOTES
1. B. D. Henderson, The Origin of Strategy, Harvard Business Review 67,
no. 6 (1989), 13943.
2. M. McNeilly, Sun Tzu and the Art of Modern Warfare (New York: Oxford
University Press, 2003).
3. M. Matloff, American Military History (Cambridge, MA: Da Capo Press,
1996).
4. A. Wilden, Man and Woman, War and Peace: The Strategists Companion
(London: Routledge, 1987).
5. Rich Horwath, The Origin of Strategy (Barrington Hills, IL: Strategic Thinking Institute, 2006).
6. C. Von Clausewitz and C.J.J. Graham, On War (Digireads.Com, 2008).
7. Horwath, The Origin of Strategy.
8. Jeffrey Bracker, The Historical Development of the Strategic Management Concept, The Academy of Management Review 5, no. 2 (1980), 21924.
9. A. D. Chandler, Strategy and Structure: Chapters in the History of the American
Industrial Enterprise (Frederick, MD: Beard Books, 1962).
10. A. P. Sloan Jr., My Years with General Motors (New York: Doubleday/Anchor,
1963).
11. C. I. Barnard, The Functions of the Executive (Cambridge, MA: Harvard
University Press, 1968).
12. Pankaj Ghemawat, Competition and Business Strategy in Historical
Perspective, Business History Review 76, no. 1 (2002), 3774.
13. H. I. Ansoff, Business Strategy: Selected Readings (New York: Penguin Books,
1969).
14. Bracker, The Historical Development of the Strategic Management Concept, 21924.
15. O. Morgenstern and J. von Neumann, Theory of Games and Economic Behavior, Vol. 3 (Princeton, NJ: Princeton University Press, 1947).
16. P. Drucker, The Practice of Management (New York: Harper & Brothers, 1954),
364.
17. Bracker, The Historical Development of the Strategic Management Concept, 21924.
18. P. Selznick, Leadership in Administration: A Sociological View (New York:
Harper & Row, 1957).

The Origins of Strategy and Strategic Thought

23

19. E. P. Learned, et al., Business Policy: Text and Cases (Homewood, IL: R. D.
Irwin, 1969).
20. Chandler, Strategy and Structure.
21. H. I. Ansoff, Corporate Strategy: An Analytic Approach to Business Policy for
Growth and Expansion (New York: McGraw-Hill, 1965).
22. Bracker, The Historical Development of the Strategic Management Concept, 21924.
23. E. Porter Michael, How Competitive Forces Shape Strategy, Harvard
Business Review, Boston 57, no. 2 (1979).
24. J. Middleton, The Ultimate Strategy Library: The 50 Most Influential Strategic
Ideas of All Time (Oxford: Capstone Publishing, 2003).
25. K. Ohmae, The Mind of the Strategist (New York: McGraw-Hill Professional,
1982).
26. J. B. Barney, Firm Resources and Sustained Competitive Advantage, Journal of Management 17, no. 1 (1991), 99120.
27. H. Mintzberg, Crafting Strategy, Harvard Business Review 65, no. 4 ( July/
August 1987), 6675.
28. G. Santayana, The Life of Reason; Or, the Phases of Human Progress: Introduction, and Reason in Common Sense (New York: C. Scribners Sons, 1917).
29. Middleton, The Ultimate Strategy Library.
30. H. Igor Ansoff, Critique of Henry Mintzbergs The Design School: Reconsidering The Basic Premises of Strategic Management, Strategic Management
Journal 12, no. 6 (1991), 44961.
31. Gary Hamel and C. K. Prahalad, Competing for the Future, Harvard
Business Review 72, no. 4 ( July 1994), 122.
32. Middleton, The Ultimate Strategy Library.
33. M. Hammer and J. Champy, Reengineering the Corporation (New York: HarperCollins, 1993).
34. P. M. Senge, The Fifth Discipline, Measuring Business Excellence 1, no. 3
(1993), 4651.
35. Ibid.
36. C. Shapiro and H. R. Varian, Information Rules: A Strategic Guide to the
Network Economy (Cambridge, MA: Harvard Business Press, 1999).
37. Middleton, The Ultimate Strategy Library.
38. P. M. Senge, The Fifth Discipline: The Art and Practice of the Learning Organization (New York: Doubleday, 1990).
39. Middleton, The Ultimate Strategy Library.
40. T. A. Stewart, Intellectual Capital (London: Brealey, 1997).
41. Ibid.
42. Middleton, The Ultimate Strategy Library.
43. Ibid.
44. Arnoldo C. Hax, Redefining the Concept of Strategy and the Strategy
Formation Process, Strategy & Leadership 18, no. 3 (1990), 34.
45. Arnoldo C. Hax and Nicolas S. Majluf, The Corporate Strategic Planning Process, Interfaces 14, no. 1 (1984), 4760.
46. Loizos Heracleous, Strategic Thinking or Strategic Planning? Long Range
Planning 31, no. 3 (1998), 48187.
47. Ibid.

24

Strategic Management in the 21st Century

48. Mintzberg, Crafting Strategy.


49. F. Graetz, Strategic Thinking versus Strategic Planning: Towards Understanding the Complementarities, Management Decision 40, no. 5 (2002), 45662.
50. Ibid.
51. J. M. Liedtka, Linking Strategic Thinking with Strategic Planning, Strategy and Leadership 26, no. 4 (1998), 3035.
52. Ibid.
53. Heracleous, Strategic Thinking or Strategic Planning? 48187.
54. Graetz, Strategic Thinking versus Strategic Planning, 45662.
55. Heracleous, Strategic Thinking or Strategic Planning? 48187.
56. P.J.H. Schoemaker, When and How to Use Scenario Planning: A Heuristic
Approach with Illustration, Journal of Forecasting 10, no. 6 (1991), 54964.
57. Graetz, Strategic Thinking versus Strategic Planning, 45662.
58. A. P. De Geus, Planning as Learning, Harvard Business Review (MarchApril
1988).
59. D. A. Nadler, Collaborative Strategic Thinking, Strategy & Leadership 22,
no. 5 (1993), 3044.
60. Heracleous, Strategic Thinking or Strategic Planning? 48187.
61. Mintzberg, Crafting Strategy.
62. Eric D. Beinhocker and Sarah Kaplan, Tired of Strategic Planning?
McKinsey Quarterly, no. 2 (2002), 4857.
63. Hax and Majluf, The Corporate Strategic Planning Process, 4760.
64. K. R. Andrews and D. K. David, The Concept of Corporate Strategy (Homewood, IL: R. D. Irwin, 1987).
65. Hax and Majluf, The Corporate Strategic Planning Process, 4760.
66. Ibid.
67. Ann Langley, The Roles of Formal Strategic Planning, Long Range Planning 21, no. 3 (1988), 4050.
68. H. W. Henry, Strategic Management: A New View of Business Policy
and Planning, in Commentary on Lorange, eds. D. Schendel and C. W. Hofer
(Boston: Little, Brown, 1979), 245.
69. Langley, The Roles of Formal Strategic Planning, 4050.
70. N. J. Foss, Resources, Firms, and Strategies: A Reader in the Resource-Based
Perspective (New York: Oxford University Press, 1997).
71. Barney, Firm Resources and Sustained Competitive Advantage, 99120.
72. K. W. Glaister and J. R. Falshaw, Strategic Planning: Still Going Strong?
Long Range Planning 32, no. 1 (1999), 10716.
73. J. B. Quinn, Formulating Strategy One Step at a Time, Journal of Business
Strategy 1, no. 3 (1981), 4263.
74. B. K. Boyd, Strategic Planning and Financial Performance: A MetaAnalytic Review*, Journal of Management Studies 28, no. 4 (1991), 35374.
75. D. K. Sinha, The Contribution of Formal Planning to Decisions, Strategic
Management Journal 11, no. 6 (1990), 47992.
76. Glaister and Falshaw, Strategic Planning, 10716.
77. D. Schendel and C. W. Hofer, Strategic Management: A New View of Business
Policy and Planning (Boston: Little, Brown, 1979).
78. Torben Juul Andersen, Integrating Decentralized Strategy Making and
Strategic Planning Processes in Dynamic Environments, Journal of Management
Studies 41, no. 8 (2004), 127199.

The Origins of Strategy and Strategic Thought

25

79. J. C. Camillus, Strategic Planning and Management Control: Systems for


Survival and Success (New York: Simon & Schuster Trade Division, 1986).
80. M. Goold and J. J. Quinn, Strategic Control: Establishing Milestones for
Long-Term Performance (Boston: Addison-Wesley, 1993).
81. P. Lorange, M.S.S. Morton, and S. Ghoshal, Strategic Control Systems
(St. Paul, MN: West Group, 1986).
82. M. E. Porter, Competitive Strategy: Techniques for Analyzing Industries and
Competitors: With a New Introduction (New York: Free Press, 1980).
83. M.D.V. Richards, Setting Strategic Goals and Objectives, Vol. 2 (St. Paul, MN:
West Group, 1986).
84. C.W.L. Hill and G. R. Jones, Strategic Management: An Integrated Approach
(Independence, KY: South-Western, 2007).
85. A. A. Thompson, A. J. Strickland, and J. E. Gamble, Crafting and Executing
Strategy (New York: McGraw-Hill, 2007).
86. Andersen, Integrating Decentralized Strategy Making and Strategic
Planning Processes in Dynamic Environments, Journal of Management Studies 41,
no. 8 (December 2004), 127199.
87. Michel Godet, The Art of Scenarios and Strategic Planning: Tools and
Pitfalls, Technological Forecasting and Social Change 65, no. 1 (2000), 322.
88. Glaister and Falshaw, Strategic Planning, 10716.
89. Robert S. Kaplan, Devising a Balanced Scorecard Matched to Business
Strategy, Strategy & Leadership 22, no. 5 (1994), 15.
90. Robert S. Kaplan and David P. Norton, Strategic Learning and the
Balanced Scorecard, Strategy & Leadership 24, no. 5 (1996), 18.

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Ghemawat, Pankaj. Competition and Business Strategy in Historical Perspective. The Business History Review 76, no. 1 (2002): 3774.
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Chapter 2

Marshaling Firm Resources in


Order to Be a Successful Competitor
Franco Gandolfi

INTRODUCTION TO STRATEGIC MANAGEMENT


It is widely understood that strategic management, including strategic
planning, is more than a set of managerial tools and techniques. In fact, strategic management is a way of thinking, a mental framework or approach,
which continuously monitors, analyzes, and evaluates changes in the firms
internal and external environments. In order for strategic management
to be used effectively, organizational leaders must develop a strategic
mentality and outlook.1 At its very core, strategic management represents
the organizations efforts to create and sustain competitive advantages.
Essentially, this characterization of strategic management captures two
fundamental elements. First, the strategic management aspects of any
firm entail three ongoing processes: analyses, decision-making aspects,
and organizational actions. Strategic management is concerned with the
analysis of the firms strategic intent, including its vision, mission, and
strategic objectives, as well as with the ongoing monitoring and analysis
of the internal and external environments of the firm. Second, executives
must constantly engage in strategic decision-making activities. Broadly
speaking, these decision-driven processes address two foundational

30

Strategic Management in the 21st Century

questions: what industries and markets should we compete in, and how
should we compete in those designated industries and markets? Evidently, these questions often involve a firms domestic and global operations. Third, a firms organizational actions need to be reviewed and
evaluated constantly, as decisions alone are of no or little use unless they are
acted upon. Thus, firms must take the necessary actions in order to implement and evaluate their strategies. Leaders need to allocate the necessary
resources and design the organization to bring the intended strategies into
reality. It is clear that this has to be an ongoing, evolving process requiring
a great deal of interaction among those three defined processes.
Part of the DNA of strategic management is the inherent study of why
some firms outperform others. Thus, organizational leaders need to determine how a firm is to compete so that it can create competitive advantages
that are sustainable over a period of time. This, in itself, constitutes a significant challenge and poses a fundamental question: how should a firm
compete in order to create competitive advantages in the marketplace?
For example, a manager may find herself in a position where she needs
to determine if the firm should position itself as a low-cost producer, or
instead develop unique products and services that enable the firm to command premium prices. Managers may then ask themselves how such temporary advantages can be made sustainable in the marketplace. In other
words, how can a firm create competitive advantages in the marketplace
that are not only valuable and unique but also difficult for competitors to
emulate or substitute?
Anecdotal evidence suggests that successful, workable business ideas
are almost always imitable and emulated by competitive forces. Back in
the 1980s, U.S. carrier American Airlines tried to establish a competitive
advantage by introducing a frequent flyer program. Within weeks of its
launch, all the major U.S.-based airlines had developed and launched
their own programs. Literally, in a matter of weeks, instead of creating
and boasting a competitive advantage, frequent flyer programs became
an invaluable tool for competitive parity as opposed to creating a legitimate competitive advantage. Therefore, the key challenge for organizational leaders is to create a competitive advantage that is sustainable.
Harvard Business School (HBS) strategist Michael Porter argues that sustainable competitive advantages cannot be achieved through the pursuit
of operational efficiencies alone. Interestingly, most of the popular management innovations of the last three decades, including total quality
management (TQM), just-in-time, benchmarking, business process reengineering (BPR), outsourcing, delayering, and employee downsizing, are
concerned primarily with operational efficiencies. Operational efficiencies
denote performing similar activities faster, cheaper, and better than those
of a firms rivals.2 Admittedly, although each of these elements is important, none have shown to produce sustainable competitive advantages for

Marshaling Firm Resources in Order to Be a Successful Competitor

31

firms over time. This is primarily because everybody is embracing similar management practices. The nature of strategy forces firms to articulate
strategies that are distinct from those of competitors. Therefore, sustainable competitive advantage is possible only through performing activities
that are different from those of rivals or performing similar activities in
distinctly different ways.
Companies such as Southwest Airlines, Wal-Mart, Marks & Spencer,
and IKEA have developed unique, internally consistent, and difficultto-imitate systems and processes that have provided them with sustained
competitive advantages. A firm must be very clear about what it wishes
to accomplish. As a consequence, imitating rival products, services, and
behaviors will not lead to long-term competitive advantages, but to an
environment that is marked by mutually destructive price competition
practices.
A BRIEF HISTORY OF STRATEGIC MANAGEMENT
Back in the 1960s and 1970s, strategic planning was seen as one of the
finest tools to ensure high levels of employee effectiveness and corporate
profitability. The underlying assumption was that decision-making aspects pertaining to strategic planning processes could be quantified, subjecting those measurements to quantitative models, which would then
produce the best-possible strategies. It was during this time period that
HBS professors Andrews and Christensen asserted that strategy could be
made a powerful tool by linking it to business functions and by using it to
assess a firms strengths and weaknesses in relation with those of its rivals.
General Electric (GE) emerged as a pioneer in the area of corporate strategic planning. With the assistance of consulting firm McKinsey, GE was
organized into strategic business units (SBUs). During the same time, the
Boston Consulting Group popularized a number of its own strategic approaches, including the experience curve and the growth and marketshare matrix.3 Strategic planning gained further regard and popularity
among executives during the 1970s, peaking in the early 1980s with HBS
scholar Michael Porters seminal book publication entitled Competitive
Strategy.
In the early 1980s, a number of executives began voicing concerns regarding their investments in strategic planning processes. Their concerns
were related to dramatic changes in the now-globalized landscape, as
well as to the incredibly rapid technological developments leading to increased levels of complexities in the marketplace. It was once again GE
that led the way; its charismatic chairman Jack Welch championed the
cutting of his own firms planning departments. Other corporate executives followed his lead throughout the 1980s and 1990s. In many ways,
strategic planning was replaced by notions of improving quality and

32

Strategic Management in the 21st Century

productivity through operational innovation. Some of those techniques


included the quality philosophies of Deming, Juran, and Crosby. In the
1990s, firms shifted their focus and attention to improving efficiency,4 resulting in the emergence of strategic tools, including delayering, BPR,
downsizing, and rightsizing efforts.5 In the 1990s, strategic planning experienced a renaissance. Specifically, new strategies emerged, focusing upon
growth through joint ventures and mergers and acquisitions, the generation of innovative ideas through decentralized strategic endeavors within
the firm, emergent strategies, and the leveraging of core competencies to
create strategic intent.6
The dominant theme for firms in the early days of this new millennium
has been strategic and organizational innovation. Current issues include
reconciling a firms size with its flexibility and responsiveness.7 Strategic
alliances infer cooperative strategies, complexity, and changes in commitments of corporate social responsibility (CSR). Todays strategic planning
requires new forms and new models of leadership, more flexible organizational structures, and an increased commitment to self-direction.8
THE FAILURE OF TRADITIONAL STRATEGIC
MANAGEMENT
Some management scholars contend that the traditional strategic management models have failed for a variety of reasons.9 First, traditional
models do not distinguish between strategic thinking and strategic planning. Indeed, traditional models rely heavily upon scientific and quantitative analyses, whereas strategic thinking methods focus upon the synthesis
of a decision-makers creativity, intuition, and experience in the selection
of strategies. Second, traditional models overemphasize the role of strategy definition and formulation at the expense of aspects pertaining to
strategy implementation, execution, and evaluation. This is particularly
evident in business school curricula that focus heavily on strategy articulation and definition rather than the actual execution and evaluation of
selected strategies. Moreover, those individuals who were traditionally
tasked to translate strategy into workable tactics and operational action
plans have been largely removed from organizational hierarchies in the
1990s and beyond. The delayering phenomenon promised many organizational benefits, yet, as we have come to understand, has left a deep
vacuum in the translation and implementation of strategy.10 Additionally,
since traditional strategic planning occurs at the very top of organizations
and often with the guidance of consultants, strategic plans frequently are
handed down to managers with little or no material input and buy-in
from lower-ranked employees. Therefore, deep commitment to the successful execution of a chosen strategy, especially among lower-level managers and nonmanagerial employees, remains questionable.

Marshaling Firm Resources in Order to Be a Successful Competitor

33

Management writer Mintzberg posits further reasons why traditional


strategic planning efforts have failed, namely, the fallacy of prediction, the
fallacy of detachment, and the fallacy of formalization:11
The fallacy of prediction: Traditional strategic planning is based on the
premise that all variables relevant to the future of a business are measurable, analyzable, and predictable. Once the results are available, strategies could be based upon those predictions, thus ensuring future success.
However, even the most sophisticated predictive models are unable to
foresee economic, industry, market, and social shifts. Economic cycles do
not behave in a linear fashion. The fallacy of prediction, according to Mintzberg, has contributed extensively to the downfall of traditional strategic
planning since it was unable to deliver predictable success.
The fallacy of detachment: Traditional strategic planning is based on the
notion that strategists ought to be detached from middle managers and
employees when analyzing the data in order to remain objective and to
prevent bias. However, this approach decontextualizes relevant data and
detaches the strategy champions from the strategy implementers. Also,
qualitative information is often ignored by the scientific community, creating blind spots in the overall strategy planning.
The fallacy of formalization: Traditional strategic planning is based on the
belief that formal systems for information processing and decision making
are superior to human systems. Although computerized systems are able
to process large quantities of data, it is individuals who integrate, synthesize, and create new directions, patterns, and trends from such analyses.
Naturally, there are other management writers who have theorized
about the failure of traditional strategic planning. For instance, the Icarus
Paradox, which refers to Icarus of Greek mythology, who flew too close to
the sun and melted his own wings, is a neologism coined and popularized by Danny Miller. The Icarus Paradox epitomizes an observed business
phenomenon whereby the strengths and apparent victories of successful
firms can be the very cause of their own strategic failures. Indeed, the paradox of Icarus was that his skill and technology, which in the story led him
to freedom, ultimately also led him to his own death.12
Clayton M. Christensen, in his book The Innovators Dilemma, reported
that even if firms follow established management principles and practices, they are nonetheless exposed to events, problems, and complexities
that can cause strategic failures. Christensen posits that the innovators
dilemma is that the logical and competent decisions of management that
are critical to the success of their firms are also the reasons why they lose
their positions of leadership. He asserts that good management practice involves sustaining the successes of services, products, and processes,
and that firms generally succeed in this. These same companies, however,
become vulnerable by the emergence of disruptive technologies, which appear harmless in the marketplace to the successful firm. Since they do not

34

Strategic Management in the 21st Century

pose an immediate threat, they are ignored. As such, disruptive technologies may grow to become powerful forces and successful firms may be ill
prepared to respond to the changed competitive landscape. Christensen
affirms that successful firms are caught in the routine of maintaining the
status quo (i.e., the current success) and often fail to perceive or understand the threat of disruptive technologies. The objective then is to build
and sustain successful services, products, and processes, while possessing
the ability to recognize, evaluate, and develop disruptive technologies.13
PORTERS WORK
A review of the strategic management literature reveals that there is
a great deal of interest in the study of environmental forces that impact
upon the firm. In fact, there is even a greater interest in the factors that
can potentially be harnessed to provide competitive advantage. Interestingly, the
models, frameworks, and ideas that emerged during the 1970s and 1980s
were primarily based upon the notion that a firms competitive advantage was derived from its ability to earn a return on investment (ROI) that
exceeded the average return for the industry sector.14
Porters five forces model, one of the most recognized strategic frameworks for industry analysis and business strategy development, draws
upon industrial organization (IO) economics to derive five forces that determine the competitive intensity and attractiveness of a market. At its
core, Porters five forces model deals with factors outside an industry
that influence the nature of competition within the industry (i.e., macroenvironment), as well as the forces inside the industry (i.e., microenvironment) that affect the way in which organizations compete. Undoubtedly,
a firm must understand the dynamics of its industry and markets in order
to compete successfully and effectively in the marketplace.15 Porters competitive forces model identified five distinct forces that impact upon a
firms behavior in the market. They are the following:

The threat of new entrants;


The threat of substitute products or services;
The intensity of competitive rivalry;
The bargaining power of buyers; and
The bargaining power of suppliers.

Porters five forces include three forces from horizontal competition: the
threat of substitute products (or services), the threat of established rivals,
and the threat of new entrants; and two forces from vertical competition:
the bargaining power of suppliers and the bargaining power of customers. It has been claimed that a deeper understanding of each of these forces

Marshaling Firm Resources in Order to Be a Successful Competitor

35

provides firms with the necessary insights to enable them to formulate appropriate strategies to succeed in their respective markets.16
Force #1The threat of new entrants: Average industry profitability is
impacted by both existing and potential competitors. New entrants to
an industry can raise the level of competition, thereby reducing its attractiveness. The threat of new rivals is based on the markets entry barriers, which can take various forms and may be used to prevent firms
into the market. Strictly speaking, an entry barrier exists when it is difficult or economically unfeasible for an outsider to replicate the position
of the incumbent. Common obstacles include cost of entry (e.g., investment into technology), economies of scale, access to industry distribution
channels, and brand differentiation. Other aspects include legal barriers to
entry, such as licensing laws, environmental regulations, and intellectual
property rights. High entry barriers exist in certain industries (e.g., shipbuilding), whereas other industries tend to be easier to enter into (e.g., restaurants, real estate agencies).
Force #2The threat of substitute products or services: The presence of substitute products or services can lower industry attractiveness and profitability by limiting price levels. The threat of substitute products or services
depends upon the buyers willingness to substitute, the relative price and
performance of substitutes, and the costs of switching to substitutes.
Force #3The intensity of competitive rivalry: The intensity or degree of
rivalry will depend on the structure of competition (e.g., rivalry is more
intense in the presence of small or equally sized rivals), the structure of
industry costs (e.g., industries with high fixed costs encourage rivals to
fill unused capacity by price cutting), degree of differentiation (e.g., industries where competitors can differentiate their products display reduced rivalry), switching costs (e.g., rivalry is reduced where buyers have
high switching costs), strategic objectives (e.g., when firms pursue growth
strategies, rivalry tends to be more intense), and exit barriers (e.g., when
barriers to leaving an industry are high, rivals tend to exhibit greater
rivalry).
Force #4The bargaining power of buyers: Buyer power is determined
by the size and the concentration of customers. The bargaining power
of buyers tends to be greater when there are few dominant buyers and
many sellers in the industry, products are standardized, buyers threaten to
integrate backward into industry, and suppliers do not threaten to integrate forward into the buyers industry.
Force #5The bargaining power of suppliers: In many ways, supplier
power mirrors buyer power in that the analysis of supplier power typically focuses first on the relative size and concentration of suppliers relative to industry participants and on the degree of differentiation in the
inputs supplied. The bargaining power of suppliers is high when there
are few dominant suppliers and many buyers, there are undifferentiated,

36

Strategic Management in the 21st Century

highly valued products, suppliers threaten to forward integrate into the


industry, and buyers do not threaten to integrate backward into supply.
Reflecting on Porters Work
As one of the worlds best known management strategists, Porter has
significantly contributed to our understanding of organizational strategy
and the competitiveness of nations and regions. Porters five forces model,
in particular, has established itself as a leading strategic tool that enables
managers to determine whether new businesses, products, or services
have the potential to be profitable.
It comes as no surprise that Porters work has been subject to much
criticism over the years. The main criticism stems from the historical context in which his models were created. Back in the 1980s, the global business landscape was characterized by strong competition, relatively stable
market structures, cyclical developments, and predictable growth. Thus,
the key focus was on the optimization of strategy in relation to the external environment, with the primary business tenets constituting profitability and corporate survival. Second, Porters background is business
economics and his theoretical work assumes a perfect market. Thus, it
seems that his models are most applicable for analyses of simple market
structures. Third, some authors have criticized Porters work for its simplicity and unrealistically basic assumptions, which seem unable to deal
with dynamic environments characterized by complex industries with
a multitude of interrelations, products, and by-product groups. Fourth,
the model is based on the notion of competition presupposing that firms
try to obtain competitive advantages over all players in the market, including suppliers and customers. Thus, Porters model does not take into
consideration corporate strategic endeavors, such as strategic coalitions
and alliances, as well as the pursuit of virtual enterprise-type networks.
Fifth, Porters work focuses upon the analysis of the actual situation (e.g.,
customers, suppliers, and competitors) and on predictable developments
(e.g., new entrants and substitute products). Thus, Porter claims that competitive advantages develop from strengthening a firms position within
the framework. These criticisms suggest strongly that the models lack
the capacity to explain todays unrelenting and ever-changing environment where seemingly subtle changes have the power to transform entire
industries.
Beyond Porter
Porters work was extended by Brandenburger and Nalebuff in the
1990s who added the concept of complementary, enabling the authors
to explain the reasoning behind the emergence of strategic coalitions and

Marshaling Firm Resources in Order to Be a Successful Competitor

37

alliances. This sixth force is the relative power of other stakeholders, including complementors (i.e., businesses providing complementary
products and services), the government, the public, and a firms employees and shareholders.17
Downes claims that the basic assumptions underlying Porters work
are no longer viable. He identified three forces that necessitate a new
framework and a new set of tools: digitalization, globalization, and deregulation. First, digitalization recognizes that the power of information technology will continue to expand and that all players in the market will have
increased access to information. As a result, new business models will
emerge, enabling external playerseven rivals from outside the industry
to transform completely the basis of competition. Second, businesses and
consumers are in a position to operate on a global scale. Therefore, everybody with access to modern-day technology can participate in the global
marketplace even if they do not export or import themselves. Third, deregulation has taken place in many industries and countries, forcing businesses to restructure their businesses and to reemerge with new business
plans and models. Downes concludes that the difference between the current technologically driven world and the old Porter world is technology. Furthermore, whereas in the past technology was used as a tool for
implementing change endeavors, it is now the most important driver for
change.18
Others have been more pragmatic about the limitations of Porters
work stating that it is not prudent to develop a strategy solely on the basis
of Porters model. What needs to be done is to adopt the model with the
full knowledge of its limitations and utilize it as part of a larger framework of management tools, techniques, and theories, which is advisable
for the application of any business model.19
THE RESOURCE-BASED VIEW (RBV) OF THE FIRM
An alternative perspective and a more recent entrant into the theoretical discussion of strategic management is the RBV of the firm. In essence,
the RBV of the firm significantly differs from Porters environmentally
focused strategic management paradigm in that it emphasizes the firms
internal resources as the fundamental determinants of competitive advantage and performance. Thus, the RBV of competitive advantage is firm
specific, whereas Porters work had a decided industry-environment
focus. With its historical roots in the organizational economics literature
and the works of Ricardo, Schumpeter, and Penrose, one of the fundamental aspects of RBV is that the ultimate purpose of the firm is to maximize
economic rent.20 This encourages corporations to continually extract resources from less-valuable legacy operations and steer them toward profitable innovation.21

38

Strategic Management in the 21st Century

The traditional business literature, which includes Porters work, assumes that firms competing in the same industry are homogenous and
that the firms adaptation to the characteristics of its product market is
the key determinant of a firms performance and success.22 In stark contrast, the RBV of the firm is based on the notion that firms are unique and
composed of distinct bundles of resources. Barney posits that a firm is regarded as a bundle of tangible and intangible resources and capabilities.23
Within a pure RBV framework, internal resources are considered the ultimate source of sustained competitive advantage. Thus, strategy is primarily
concerned with obtaining an alignment, or fit, between the organizations
internal resources and external opportunities.24
At its core, the RBV of the firm operates on two assumptions. First, it
assumes that firms within an industry are heterogeneous with respect to
the resources they control. Second, it assumes that resource heterogeneity
persists over time since the resources required to implement a firms strategies are not perfectly mobile over time. Therefore, resources uniqueness,
or heterogeneity, is considered a necessary condition for the resources to
contribute to a competitive advantage. This is reflected in Dierickx and
Cools argument in that if all firms in a market have the same resources,
no strategy is available to one firm that would not also be available to all
other firms in the market.25 As with the Chicago school tradition, the RBV
of the firm presupposes an efficiency-based explanation for differences in
a firms performance.26
Critical to our understanding of the RBV of the firm is the definition
of resources, competitive advantage, and sustained competitive advantage. First, Barney asserts that resources fall into three categories: physicalcapital resources (e.g., a firms plant, equipment, and geographical location), human-capital resources (e.g., experience, judgment, and intelligence
of individuals), and organizational-capital resources (e.g., a firms structure, planning, controlling, and coordinating systems).27 Second, in the
RBV of the firm, these resources can potentially be sources of competitive
advantages. However, Barney warns that competitive advantages can only
occur in situations of firm resource heterogeneity (i.e., resources vary across
firms) and firm resource immobility (i.e., the inability of competing firms
to obtain resources from other firms or resource markets). This is in stark
contrast with the environmentally focused strategy models, as espoused
by Porter, where resources are deemed mobile and where resources can
be purchased or created by competing rivals. Third, a sustained competitive advantage is different from a competitive advantage in that a sustained competitive advantage only exists when rival firms are incapable of
duplicating the benefits of a competitive advantage.28
A competitive advantage cannot be viewed as a sustained competitive
advantage until all efforts by competing rivals to duplicate the advantage have failed. In the RBV of the firm, a source of sustained competitive

Marshaling Firm Resources in Order to Be a Successful Competitor

39

advantage must meet four criteria: they must add value to the firm, they
must be rare (or unique), they must be imperfectly imitable, and the resource
cannot be substitutable with another resource.29 In other words, when resources meet these criteria, they become potential sources of sustained
competitive advantages. Barney and Wright add that whether or not such
sustained competitive advantages are realized or not depends entirely on
the extent to which a firm is organized to exploit them.30
Reflecting on the RBV of the Firm
The RBV of the firm is one of the most widely cited theories in the
management literature. Its central proposition connotes that if a firm is to
achieve sustainable competitive advantage, it is required to acquire and
control resources that are valuable, rare (unique), inimitable, and nonsubstitutable.31 Although the core theory of the RBV of the firm is appealing,
it has been criticized for its weaknesses and shortcomings over the years.
These criticisms fall into four categories:
Criticism #1: The RBV has no managerial implications: The RBV of the
firm has been criticized for its lack of managerial implications and operational validity. Managerial leaders have been counseled to acquire and develop resources without a clear prescription of how this should be done.
Thus, there is a tension between descriptive and prescriptive theorizing.
However, the RBV of the firm aspires to explain why some firms have
sustainable competitive advantages over others. As such, the theorizing
was never intended to provide managerial prescriptions.32 Selected writers assert that we should continue to focus on a discussion on the impact on managerial practice as opposed to a focus on a lack of managerial
implications.33
Criticism #2: The RBVs applicability is too limited: A second criticism concerns the applicability of the RBV. Some authors argue that the notion of
resource uniqueness denies the RBV of the firm any potential for generalization,34 whereas others contend that it is feasible to create useful insights
about degrees of resource uniqueness.35 Another criticism pertains to the
claim that the RBV insights are limited only to large firms with significant market power. However, a more realistic perspective is that insights
from the RBV analysis are only applicable to firms that are not satisfied
with their competitive position and actively pursue sustainable competitive advantages.
Criticism #3: Sustainable competitive advantage is not achievable: One of the
key foci of the RBV of the firm is the notion of achieving a sustainable
competitive advantage that exceeds other firms capacity to duplicate or
eliminate it. This has become a hotly debated issue. Can a sustainable competitive advantage really be achieved? A number of studies suggest that
competitive advantages can only be sustained at the firm level through

40

Strategic Management in the 21st Century

organizational learning or dynamic capabilities, which enable the firm to


adapt faster than its competitors.36 Other studies have demonstrated that
static unique resources can lead to sustainable competitive advantages in
static environments, whereas dynamic environments demand dynamic
resources and capabilities.37
Criticism #4: The definition of resource is unworkable: A fourth criticism
posits that the RBV of the firm may not adequately address the fundamental differences in how various types of resources contribute in a different manner to a firms sustainable competitive advantage. Although
the RBV of the firm recognizes three categories of resources, it treats them
equally. In a recent publication, Barney and Clark suggest that the offered
typologies are mere labels for which the basic logic of the RBV of the firm
still holds.38 They propose that different labels would only be appropriate if these referred to an alternative logic of linking a firms assets with
its sustainable competitive advantage favoring a single logic and terminology. These, for instance, could be labeled resource based, capability based, or competence based. Other writers have concluded that
the image and applicability of the RBV of the firm would improve if its
basic logic would be refined by explicitly recognizing differences between
types of resources, that is, static-dynamic; tangible-intangible; financialhuman-technological; deployed-in reserve; and perishable-nonperishable,
and between the types of resource ownership.39
An RBV of Human Resources
and Competitive Advantage
Thus far, this chapter has established that, within an RBV of the firm, for
a resource to qualify as a potential source of sustainable competitive advantage, the resource must add value to the firm, the resource must be
rare or unique, the resource must be imperfectly imitable, and the resource
cannot be substituted with another resource. Do human resources qualify
as potential sources of sustainable competitive advantages?
Human resources add value to the firm: Most people would intuitively
agree that human resources add value to the firm. Does this necessarily
hold true? What does theory suggest? Firm-specific human-capital theory
presents an explanation about the conditions under which human value
creation is possible. Specifically, when the demand for labor is homogenous
(i.e., individual employees are perfectly substitutable) and the supply for
labor is also homogenous (i.e., all individual employees are seen as equal
in their productive capacities), then there is no variance in the individual
contributions to the firm and it is thus impossible to create value through
human resources. Steffy and Maurer are of the opinion that the demand
for labor is heterogeneous (i.e., different jobs require different skills) and
the supply for labor is also heterogeneous (i.e., individuals possess different

Marshaling Firm Resources in Order to Be a Successful Competitor

41

types and levels of skills), thereby arguing that human resources can add
value to the firm.40
Human resources are rare: The RBV of the firm holds that human resources must be rare (or unique) in order to be viewed as a potential source
of sustainable competitive advantage. With unemployment and underemployment at high levels, people would instinctively argue that there must
be an excess of labor and that human resources are therefore not rare. Historically speaking, the scientific management paradigm has traditionally
embraced the idea that firms need to focus on producing jobs that do not
require employees with specialized skills. Therefore, within this mindset,
the notion of special skills becomes largely irrelevant and employees are
considered a commodity rather than a resource.
Assuming, however, that jobs do require specified skills and a variance in individual contributions, such rare, or unique, skills are distributed within the population. Therefore, human resources are believed to
be a rare resource. Indeed, there are various measures on how to appraise
the quality of human resources. Cognitive ability, for instance, is probably
one of the most pervasive and consistent predictors of employee performance in firms.41 Thus, it has been concluded that firms with employees
holding high levels of cognitive ability possess more quality human resources than those of rivals. Furthermore, since the total human resource
(HR) pool is believed to be finite, firms that have a high level of cognitive
ability among their employees have gained this resource at the expense of
rivaling firms.42
Human resources are inimitable: For a resource to be considered a source
of potential sustainable competitive advantage, it must be inimitable. Indeed, if the competitive advantage derived from having high-skilled employees could be copied, then human resources would not be a source
of sustained competitive advantage. How can rivals imitate human resources? First, competitors must be able to identify the exact source of
competitive advantage. In other words, the actual components would
need to be known in order to be imitated. Second, the rivaling firm would
need to be able to copy the actual components and the contexts under
which these human resources operated. Interestingly, it has been pointed
out that having the necessary skills among individual employees per se
does not ensure that the firm has gained a sustainable competitive advantage. What is pivotal then is that employees must possess the skills and
have the ability to exhibit the required behaviors to exercise those skills.43
A managerial implication in this discussion of resource inimitability is the
notion of resource mobility. In certain countries, especially in the United
States, human resources have historically been very mobile. However, employees are not perfectly mobile since there are sizeable transaction costs
involved in moving individual employees.44 As such, if employees are indeed highly mobile (or perfectly mobile), rivaling firms would not need to

42

Strategic Management in the 21st Century

imitate them since they could simply lure and hire them away. However,
firms may not know exactly which employees provide a source of competitive advantage. Thus, firms would need to hire away entire teams or
groups of individuals. This, however, would still not guarantee that the
competitive advantage could be imitated as the human resources might
be coupled to other resources (i.e., physical and organization resources)
within the firm.45
Human resources are nonsubstitutable: Human resources must not have
substitutes if they are to be a source of sustained competitive advantage.
Human resources are believed to have the potential to avoid obsolescence
and to be transferable across technologies, products, and markets.46 Ongoing training and development (T&D) among employees ensure that HR
skills do not become obsolete. A brief study of human resources practices
reveals that cognitive ability is transferable across technologies, products, and services. A central element to this discussion is the question of
whether or not technology has the potential for offsetting any competitive
advantages that can be attributed to the utilization of human resources.
It is probably safe to say that although technological changes have rendered certain technical skills obsolete, there is infinitely more to the inherent character of human resources than the technical elements that can be
substituted. For any resource to replace human resources, it must be valuable, rare, inimitable, and nonsubstitutable. It appears that only human resources have the capacity to fulfill that requirement.
The Human Resource Equation: Cost versus Value
Firms feel increasingly compelled to invest significant resources into
human capital in order to become successful and remain competitive. As
the pressures of todays labor markets continue to intensify, the HR function is often perceived as a cost center within firms, although corporate
rhetoric espousing that our people are our most important asset has remained
conspicuously fashionable.
Wayne Cascio, a business professor at the University of Colorado, has
examined the financial costs associated with employees. He argues that
although firms recognize the financial value and benefit that people can
bring into a firm, the unfortunate view that employees are costs to be cut,
as opposed to assets to be developed, is still a widely held perspective. This
view has seen the importance of accounting for the financial costs of employees become a vital part of the HR function and a newly found responsibility that firms owe to their respective investors.47
Labor costs can be extensive, especially in labor-intensive industries
such as consulting firms, law firms, and universities. From a purely cost
perspective, the people function often accounts for two-thirds or more
of total operational expenses. Other factors, including cost per hire,

Marshaling Firm Resources in Order to Be a Successful Competitor

43

wage-and-benefits costs, cost per incident of absenteeism, and cost per


incident of voluntary turnover are widely used metrics. On a more sobering note, there are immediate costs associated with the mismanagement of
employees, including costs associated with lawsuits and costs associated
with resolving industrial disputes. Thus, the role of HR has become linked
to the accounting for such human-capital-related costs.48
An ongoing challenge for HR is to concentrate efforts on its peopleinvestment approaches and steer away from models focusing primarily
on the cost side of the equation.49 The focus ought to be on HR output as
opposed to HR input. Cascio contends that one of the greatest challenges
for modern-day HR is to advance from a compliance-driven HR model
to a service model. More specifically, in the former, HR focuses primarily on complying with laws and regulations and the policing of management processes. In the latter, HR provides HR-related service to support
line managers in their operations. Finally, a movement toward a decisionoriented model focusing on the utilization and deployment of talent has
been observed, thereby surpassing the traditional compliance and service
frameworks.50
Research shows that firms struggle with the concept of ROI in the context of the HR functions. This thinking applies to a variety of HR activities, including career management, T&D, and work-life balance practices.
What is pivotal is the ability to capitalize on those practices that create
the highest value for the firm and employees and to identify HR practices
that contribute positively to business performance and overall business
strategy.51
Although it might seem good business practice to keep operational
costs low and to reduce costs at all levels, this approach may not prove to
be successful. Cascio stresses the importance of identifying and developing pivotal talent within the firm thereby fostering human-capital investment and creating strategic value for the firm. For example, a purposeful
focus on staffing, training, and compensation in a call center where employees take orders for merchandise can provide positive financial returns
for the firm and all stakeholders.52
Cascio posits that research has consistently shown that core quality employees are critical to the survival, growth, and overall success of a firm,
and generate benefits that outweigh their operational costs. Treating employees well and reducing employee turnover may have a positive side
effect. In his Harvard Business Review article, Cascio argues that firms can
learn from the U.S. retail industry where shrinkage (i.e., losses due to
employee theft, fraud, and administrative errors) account for up to two
percent of annual sales, which, in some cases, can constitute millions of
lost dollars. Research shows that retailers with low employee turnover
also have a tendency to have low shrinkage rates. U.S. retailer Costco, for
instance, maintains labor pay rates that average 40 percent higher than

44

Strategic Management in the 21st Century

those of its rivals, yet its shrinkage rate is a mere 0.2 percent, which is
significantly lower than that of its closest competitors. Therefore, there
appears to be value in ensuring competitive pay rates. Cascio concludes
that in Costcos case the costs that it does not incur, in the form of reduced
employee turnover and reduced shrinkage, clearly offsets its higher labor
rates. Thus, it has been shown at Costco that labor costs as a percentage of
sales per employee are lower than those of Sams Club, its closest rival.53
Human Resources Management (HRM) and Pfeffers Work
HRM as an academic discipline has developed dramatically over the
past two decades. There is ample evidence supporting the observation
that the development of HRM theory and practice have transformed and
elevated the HRM function from a purely reactive functionmainly on
administration and bureaucracyto a proactive function actively pursuing strategy and integration. Thus, HRM is increasingly seen as a legitimate business activity linked to organizational strategy and to the
achievement of competitive advantages.54 It has been noted that one of the
reasons for such a shift in emphasis is that some of the traditional sources
of competitive advantage, including technology, economies of scale, and
patents, have greatly diminished in value over time.55 At the same time, it
is the employees per se, or the workforce in general, who have emerged as
an important source of competitive advantage. This has had a direct impact on the practice of HRM in that effective HRM is widely considered
to be the key to realizing this potential from the employees for the firm.56
In line with the perspective that human resources are a critical source
of competitive advantage for a firm, HRM, as a discipline, has developed
a strategic focus. Strategic HRM, or simply SHRM, is primarily concerned
with the alignment of HRM policies, practices, and plans with the overall business strategy. More practically, the HR function looks at how the
firm selects policies, practices, and structures that best fit the particular
business strategies being pursued, enabling the effective management
of people within the firm so that firm-specific goals can be pursued and
attained.57
A number of best practices regarding the practice of implementation
of SHRM have emerged. In fact, the overriding objective of best SHRM
practice is to promote employee commitment and employee motivation
that is expected to produce employee development and positive economic
performance, thus yielding a competitive advantage for the firm.58
For some scholars the underlying guiding principle of best practice is
the adequate valuing and rewarding of employee performance.59 Huselid
developed a list of 13 high-performance work characteristics that he believed constituted best practice.60 Inspired by Huselids work, Pfeffer outlined seven best HR practices of successful firms, including employment

Marshaling Firm Resources in Order to Be a Successful Competitor

45

security, selective hiring, extensive training, communication, self-managed


teams, high compensation relative to performance, and the removal of
barriers.61 These are further elaborated:
1. Employment security: Pfeffer argues that employment security is
underpinned by the other six HRM elements asserting that it would
be unreasonable to require employees to commit to the firm if the
company in turn could not offer some form of ongoing employment
security to the employee. A reciprocal arrangement fosters mutuality between the firm and the employee and has the propensity to
contribute to the development of a positive psychological contract
between the parties,62 encouraging an employment relationship
characterized by openness and trust.63
2. Selective hiring: Utilizing selective hiring practices is the second HR
area addressed and viewed as a potent way to achieve competitive
advantages.64 Although Pfeffer asserts that firms must hire individuals who have the required knowledge, skills, and abilities, firms also
need to ensure that prospective employees possess the necessary
characteristics of trainability and commitment.65 The latter has been
a practice of high-performing firms in that they hire for attitude and
train for skills.66 Of particular relevance is the notion that firms need
to employ candidates who fit the culture of the firm.67
3. Extensive training: It comes as no surprise that organizations expend
considerable efforts and resources in ensuring that they are sourced
with the best-possible talent. Once a pool of talent is hired, firms
need to ensure that the employees are fully harnessed and utilized.
In order to execute this well, firms must be in a position to provide
T&D opportunities that enable the employees to remain at the cutting edge in their respective fields. Thus, a long-term orientation
and commitment to T&D, although costly from a purely financial
perspective, is an absolute must do for leading-edge firms.68 Various
scholars have pointed out different T&D emphases, including training in interpersonal skills and teamwork giving rise to multiskilling, which enables them to perform across functions,69 technical
training,70 and training in knowledge and skills suited to the nature
and strategy of the business.71 In any case, the provision of T&D generates a sense of mutuality, showcasing the firms commitment to
ongoing, purposeful, and involved employment longevity.72
4. Communication: Communication and information sharing is the
fourth dimension outlined by Pfeffer. Open, honest two-way communication must be encouraged at all levels. This provides a number of benefits: First, it ensures that employees are informed about
financial, strategic, and operational aspects. Second, it conveys both
symbolic and substantive messages about equitable and fair treat-

46

Strategic Management in the 21st Century

ment of employees, thereby creating trust. Third, it encourages


active employee contribution. Fourth, it has been noted that effective communication has the capacity to raise workforce awareness of
organizational objectives and imperatives and to encourage greater
commitment toward the attainment of strategic goals.73
5. Team working: The active utilization of self-managed teams and
team-working aspects as the dominant modes of structuring work
are deemed vital to organizational success. Specifically, the adoption of such structural elements encourages more efficient and faster
decision making, promotes creativity and innovation, and fosters a
culture of collaboration and inclusiveness.74
6. Compensation: Pfeffer presented the compensation element as the
sixth dimension of best HR practices. At its most basic, compensation
as a strategy rewards individuals with high compensation related to
individual and/or team performance. Research shows that there are
many forms of rewarding employees, including but not limited to
stock ownership, profit sharing, merit pay, as well as a variety of
individual- and team-performance-based compensation schemes.
Such a strategy purports to convey a message to employees that their
contributions to organizational goals are deeply valued and that a
high compensation culture is consistent with a hiring approach that
attempts to attract and retain the highest-quality workers.
7. Removal of barriers: The last dimension concerns the removal of barriers within firms, also called harmonization. Harmonization can
be attained by implementing standardized terms and conditions of
employment across the entire workforce. These uniform practices
apply to benefits, including holiday entitlements, sick-pay schemes,
pensions, and hours of work, which lead to the removal of artificial
barriers between different groups, thereby encouraging a teamenvironment-type philosophy. Pfeffer asserts that organizational
symbols such as language, labels, physical space, and dress convey
messages to employees about their intrinsic value within the firm.
For instance, symbols that purport to promote egalitarianism suggest that all employees are equally valued, thus promoting a culture
of collaboration and ideas sharing.75
IMPLEMENTATION OF HR ACTIVITIES AND PRACTICES
Distinct perspectives on HR strategy and implementation aspects have
emerged, namely, the universal, contingency, and configurational perspectives. First, the universal perspective holds the view that the adoption
of best HR practice will inevitably result in improved organizational
performance. Therefore, this perspective does not require the purposeful
integration between organizational strategy and HR plans, policies, and

Marshaling Firm Resources in Order to Be a Successful Competitor

47

practices.76 Second, the contingency perspective suggests that the potency


and effectiveness of HR aspects hinge upon corporate strategy in that a
firm adopting HR elements that are fitting for its competitive strategies
will be more effective. Organizational performance should thus be positively impacted when HR activities mutually reinforce the firms choice of
strategy.77 Third, the configurational perspective embraces the view that
a fit between HR activities and organizational strategy is vital. Thus, HR
practices become a key factor in the attainment of organizational goals
and performance.78 The configurational view assumes that HR practices
must be characterized by their consistency with external, organizational,
and strategic conditions (i.e., vertical fit) and internally consistent (i.e.,
horizontal fit). This dual form of integration has a synergistic effect for the
firm.79 Hitherto, there is limited evidence regarding the role, relevance,
and effectiveness of these three perspectives. Nonetheless, some evidence
has been reported on the synergistic benefits from an alignment of HR
policies and practices with one another and with the overall organizational strategy.80 It has been reported that growth and profitability are ultimately the result of alignment between people, customers, strategy, and
processes. More specifically, firms that consistently land on their feet during turbulent times are managed by people who keep everyone focused
and centered on a few key business objectives. They do so in a way that
creates a self-aligning and self-sustaining culture that distributes leadership and energy throughout their firms and unleashes a kind of organizational power and focus on alignment.81
HR scholars have examined and questioned the basis of some of the
universal claims made about a possible correlation between the implementation of HR strategies and improved organizational performance.
There is concern about the prescriptive nature of HR interventions applicable to firms, irrespective of context and priorities, with the expectation
of similar level responses and results.82 There is still an ongoing debate
among and between HR scholars and professionals as to what exactly constitutes best practice.83 In other words, what established HR methods
and techniques will most likely produce superior organizational results?
It has been suggested that organizational activities and practices that are
designed to empower and develop the employee in addition to positively
affect the bottom line of the firm are considered best practice.84
THE ROLE OF ORGANIZATIONAL CULTURE
Organizational culture has traditionally been considered a form of organizational capital.85 Researchers agree that the concept of corporate
culture is difficult to imitate or duplicate86 due to its inherent tacitness,
complexity, and specificity.87 Barney characterizes organizational culture as valuable, rare, and imperfectly imitable, thereby possessing high

48

Strategic Management in the 21st Century

potential for creating sustainable competitive advantage for a firm.88 It


may be deduced that organizational culture can have a direct impact on
achieving higher levels of firm performance.89 Organizational culture is
seen as an intangible component of a firm,90 encompassing social phenomena, including beliefs, values, behaviors, and assumptions, which
become entrenched within organizational members.91 These social phenomena constituting organizational culture shape the way a firm conducts its business, how the firm interacts with the external environment,
and how a firm deals with its internal processes.92
There is some debate within the management literature arguing that
HR practices do not directly impact organizational performance.93 There
are assertions that there is a missing link between the two variables leading to the emergence of a black box, which explains an interest in the
study of organizational culture. It has been noted that organizational culture is entrenched in the everyday working lives of cultural members94
and manifested in the behavior of a firms employees.95 The organizational culture of a firm is believed to have a significant impact on employees job attitudes as well as their efficiency and productivity levels.96
A firms culture also has the capacity to help it execute its plans and meet
its strategic goals.97
Barney, who championed the development of the RBV of the firm,
argues that certain firm-specific resources and capabilities can lead to
sustainable competitive advantages and, thus, increase organizational
performance. He affirms that a firms culture can in fact be one of these
resources. If a firms culture meets the four criteria of being valuable, rare,
imperfectly imitable, and nonsubstitutable, then it has an enhanced opportunity to be a source of sustained competitive advantage.98 An appropriate HR system has the capacity to create and foster capabilities that
themselves become sources of competitive advantages.99 For example,
Nordstrom, an upscale department store in the United States, attributes
its successes to its culture with a focus on customer service, thereby generating a source of sustainable competitive advantage for the firm and its
stakeholders. Another prominent example is Southwest Airlines, which
is one of the few U.S. airlines that have maintained profitability in an industry notorious for financial losses. Southwest Airlines stresses the importance of a strong work environment focusing on all its stakeholders,
including employees. In the words of its current CEO Gary Kelly, People
arent an expenseour People are our heart and soul.
Finally, it has been stated that a firms culture and its HR systems can be
a valuable resource for the firm.100 Thus, they play a significant role in the
overall performance and business success of the entire organization.101 Although it has been stated that HR practices affect organizational culture,
which in turn, impact a firms performance, we need to be careful as to the
exact nature of possible claims of correlations and relationships between

Marshaling Firm Resources in Order to Be a Successful Competitor

49

organizational variables. Most likely, there are a number of other internal and external variables that explain possible links between HR systems
and firm performance. What is certain, though, is that organizational culture shapes the work environment in which performance occurs, and it is
this performance that drives the firms bottom line.

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to Layoffs (San Francisco: Berrett-Koehler Publishers and the Society for Human
Resource Management, 2002).
53. Cascio, W. The High Cost of Low Wages, Harvard Business Review,
March 3, 2006: 2326.
54. Alcazar, F. M., Fernandez, P.M.R., & Gardey, G. S. Researching on SHRM:
An Analysis of the Debate over the Role Played by Human Resources in Firm
Success, Management Revue, 16:2 (2005): 21341.
55. Browning, V., Edgar, F., Gray, B., & Garrett, T. Realising Competitive Advantage through HRM in New Zealand Service Industries, The Service Industries
Journal, 29:6 (2009): 74160.
56. Haynes, P., & Fryer, G. Human Resources, Service Quality and Performance: A Case Study, International Journal of Contemporary Hospitality Management, 12:4 (2000): 24048.
57. Boselie, J., Dietz, G., & Boon, C. Commonalities and Contradictions in
HRM and Performance Research, Human Resource Management Journal, 15:3
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58. Hutchinson, S., Kinnie, N., Purcell, J., Rayton, B., & Swart, J. People Management and Performance (London: Routledge, 2000).
59. Johnson, E. The Practice of Human Resource Management in New Zealand: Strategic and Best Practice, Asia Pacific Journal of Human Resources, 38:2
(2000): 6983.
60. Huselid, M. The Impact of Human Resource Management Practices on
Turnover and Productivity and Corporate Financial Performance, Academy of
Management Journal, 38 (1995): 63572.
61. Pfeffer, J. Seven Practices of Successful Organizations, California Management Review, 40:2 (1998): 96124.
62. Browning, V., Edgar, F., Gray, B., & Garrett, T. Realising Competitive Advantage through HRM in New Zealand Service Industries, The Service Industries
Journal, 29:6 (2009): 74160.
63. Marchington, M., & Wilkinson, A. High Commitment HRM and Performance, in M. Marchington & A. Wilkinson, Human Resource Management at Work,
7198 (London: CIPD, 2005).
64. Oster, G. Extreme Diversity, Review of International Comparative Management, 12:1 (2011): 1829.
65. Browning, V., Edgar, F., Gray, B., & Garrett, T. Realising Competitive Advantage through HRM in New Zealand Service Industries, The Service Industries
Journal, 29:6 (2009): 74160.
66. Heskett, J. L. Beyond Customer Loyalty, Managing Service Quality, 12:6
(2002): 35557.
67. Schneider, B., & Bowen, D. E. Winning the Service Game (Boston: Harvard
Business School Press, 1995).
68. Gandolfi, F. Human Resource Management: Fundamentals, Concepts, and Perspectives (Kln, Germany: LAP Lambert Academic Publishing, 2010).
69. Redman, T., & Mathews, B. P. Service Quality and Human Resource Management: A Review and Research Agenda, Personnel Review, 27:1 (1998): 5777.
70. Browning, V., Edgar, F., Gray, B., & Garrett, T. Realising Competitive Advantage through HRM in New Zealand Service Industries, The Service Industries
Journal, 29:6 (2009): 74160.
71. Schneider, B., & Bowen, D. E. Winning the Service Game (Boston: Harvard
Business School Press, 1995).
72. Marchington, M., & Wilkinson, A. High Commitment HRM and Performance, in M. Marchington & A. Wilkinson, Human Resource Management at Work,
7198 (London: CIPD, 2005).
73. Browning, V., Edgar, F., Gray, B., & Garrett, T. Realising Competitive Advantage through HRM in New Zealand Service Industries, The Service Industries
Journal, 29:6 (2009): 74160.
74. Gandolfi, F. Human Resource Management: Fundamentals, Concepts, and Perspectives (Kln, Germany: LAP Lambert Academic Publishing, 2010).
75. Marchington, M., & Grugulis, I. Best Practice HRM: Perfect Opportunity or Dangerous Illusion? International Journal of Human Resource Management,
11:6 (2000): 110424.
76. Alcazar, F. M., Fernandez, P.M.R., & Gardey, G. S. Researching on SHRM:
An Analysis of the Debate over the Role Played by Human Resources in Firm Success, Management Revue, 16:2 (2005): 21341.

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77. Boxall, P., & Purcell, J. Strategic Human Resource Management: Where
Have We Come from and Where Should We Be Going? International Journal of
Management Reviews, 2:2 (2000): 183203.
78. Browning, V., Edgar, F., Gray, B., & Garrett, T. Realising Competitive Advantage through HRM in New Zealand Service Industries, The Service Industries
Journal, 29:6 (2009): 74160.
79. Delery, J. E., & Doty, D. H. Modes of Theorizing in Strategic Human Resource Management: Tests of Universalistic, Contingency, and Configurational
Performance Predictions, Academy of Management Journal, 39:4 (1996): 80235.
80. Haynes, P., & Fryer, G. Human Resources, Service Quality and Performance: A Case Study, International Journal of Contemporary Hospitality Management, 12:4 (2000): 24048.
81. Labovitz, G., & Rosansky, V. The Power of Alignment (New York: Wiley and
Sons, 1997).
82. Guest, D. Human Resource ManagementThe Workers Verdict, Human
Resource Management Journal, 9:3 (1999): 525.
83. Price, A. Human Resource Management in a Business Context, 2nd edition,
(London: Thomson Learning, 2004).
84. Edgar, F. Employee-Centred Human Resource Management Practices,
New Zealand Journal of Industrial Relations, 28:3 (2003): 23040.
85. Barney, J. B. Organizational Culture: Can It Be a Source of Sustained Competitive Advantage? Academy of Management Review, 11:3 (1985): 65665.
86. Mueller, F. Human Resources as Strategic Assets: An Evolutionary
Resource-Based Theory, Journal of Management Studies, 33:6 (1996): 75785.
87. Reed, R., & DeFillippi, R. J. Causal Ambiguity, Barriers to Imitation, and
Sustained Competitive Advantage, Academy of Management Review, 15:1 (1990):
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88. Barney, J. B. Organizational Culture: Can It Be a Source of Sustained Competitive Advantage? Academy of Management Review, 11:3 (1985): 65665.
89. McKenzie, K. Organizational Culture: An Investigation into the Link between Organizational Culture, Human Resource Management, High Commitment Management and Firm Performance, Otago Management Graduate Review,
8 (2010): 3950.
90. Carmeli, A., & Tishler, A. The Relationship between Intangible Organizational Elements and Organizational Performance, Strategic Management Journal,
25 (2004): 125778.
91. Chow, I., & Liu, S. The Effect of Aligning Organizational Culture and
Business Strategy with HR Systems on Firm Performance in Chinese Enterprises,
International Journal of Human Resource Management, 20:11 (2009): 2292310.
92. Mahal, P. Organizational Culture and Organizational Climate as a Determinant of Motivation, Journal of Management Research, 8:10 (2009): 3851.
93. Boxall, P., & Purcell, J. Strategic Human Resource Management: Where
Have We Come from and Where Should We Be Going? International Journal of
Management Reviews, 2:2 (2000): 183203.
94. McKenzie, K. Organizational Culture: An Investigation into the Link between Organizational Culture, Human Resource Management, High Commitment Management and Firm Performance, Otago Management Graduate Review,
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95. Ngo, H., & Loi, R. Human Resource Flexibility, Organizational Culture
and Firm Performance: An Investigation of Multinational Firms in Hong Kong,
International Journal of Human Resource Management, 19:9 (2008): 165466.
96. Mahal, P. Organizational Culture and Organizational Climate as a Determinant of Motivation, Journal of Management Research, 8:10 (2009): 3851.
97. Chan, L., Shaffer, M., & Snape, E. In Search of Sustained Competitive
Advantage: The Impact of Organizational Culture, Competitive Strategy and Human Resource Management Practices on Firm Performance, Journal of Human Resource Management, 15:1 (2004): 1735.
98. Barney, J. B. Organizational Culture: Can It Be a Source of Sustained
Competitive Advantage? Academy of Management Review, 11:3 (1985): 65665.
99. Lau, C. M., & Ngo, H. Y. The HR System, Organizational Culture, and
Product Innovation, International Business Review, 13 (2004): 685703.
100. Carmeli, A., & Tishler, A. The Relationship between Intangible Organizational Elements and Organizational Performance, Strategic Management Journal,
25 (2004): 125778.
101. Platonova, E. The Relationship among Human Resource Management, Organizational Culture, and Organizational Performance, Unpublished
doctoral dissertation (Birmingham, AL: University of Alabama, 2005).

Chapter 3

SWOT Analysis and the


Three Strategic Questions
Tom Hinthorne

Analysts use the SWOT analysis to identify the firms strengths (S), weaknesses (W), opportunities (O), and threats (T). Strengths and weaknesses
are associated with the firms internal environment and are to some degree manageable by the firm (e.g., human resources). Opportunities and
threats are associated with the firms external environment and are beyond the control of the firm, although adaptation may be possible. Today,
the SWOT analysis is one of several tools available to business analysts; it
is widely taught in business schools; it continues to offer value-added opportunities to analysts; and it is equally applicable to for-profit and nonprofit firms. However, its analyses tend to be qualitative and difficult to
quantify, which makes rigorous application imprecise.
The purpose of the SWOT analysis is to use the strengths of the firm to
capitalize on opportunities, diminish threats, and reduce weaknesses (e.g.,
fill resource gaps). Jay Barney traces the analysis of the firms strengths
(i.e., resources and capabilities) and weaknesses to the work of Edith Penrose (1959), whose analyses underlie the resource-based view (RBV) of the
firm.1,2 Other writers have traced the linking of strengths and weaknesses
(i.e., SW) and opportunities and threats (i.e., OT) to the work of Kenneth
Andrews (1971).3 The SWOT analysis is typically an analytical platform

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Strategic Management in the 21st Century

for creating strategic plans. Ultimately, the firm seeks to answer three strategic questions: Where is the firm now? Where does it want it to be in 5 to
10 years? How does it plan to get it there?4
In the 1950s, 1960s, and 1970s, many large firms developed central planning operations, and the planning process was relatively formal and systematic. Analysts called this approach the rational design school, and the
SWOT analysis was associated with this school. In ensuing years, as planning environments became more turbulent and unpredictable, senior management delegated more of the planning to its strategic business units and
reduced or eliminated its central planning operations. Increasingly, analysts saw strategy as being crafted through some instinctive experientialbased process emerging out of the weakly coordinated decisions of multiple
organizational members.5,6 Analysts called this approach the emergent process school. Today, depending on the circumstances, both approaches have
merit.
This chapter develops in four parts. First, to make it instructive and
interesting it focuses on the Northrop Grumman Corporation (NGC) and
its primary target market, the U.S. Department of Defense (DoD). Second,
the chapter focuses on the external environment of the firm and the assessment of opportunities and threats facing NGC and the industry. This is
the top downbig picture context for subsequent analyses. Third, the chapter focuses on the internal environment of NGC and the assessment of its
strengths and weaknesses. Last, to show how the SWOT analysis structures the planning process, the chapter considers how NGC might answer
the three strategic questions. The time of the SWOT analysis is late 2010/
early 2011.
NORTHROP GRUMMAN CORPORATION
NGC and its global competitors and suppliers are in the aerospace and
defense industry. They are in the early months of a retrenchment process,
given pending cuts in DoD expenditures. Product extensions into the
commercial and civil markets (i.e., nonmilitary government markets, such
as law enforcement) offer new revenue opportunities. Thus, NGC and its
competitors are perfecting unmanned aerial systems (e.g., NGCs Global
Hawk and Fire Scout drones) and cybersecurity systems (e.g., protecting
computer networks from attacks).
In February 2009, Wes Bush, NGCs president and chief operating officer
(CEO), described NGC as a diversified security company serving the long-term
needs of the DoD and related markets. The DoDs needs include: (1) assure U.S. military dominance, (2) confront irregular challenges such as terrorism, and (3) safeguard populations and critical infrastructures. 7 Bush
said, The United States faces a complex and rapidly changing national

SWOT Analysis and the Three Strategic Questions

57

security environment . . . requires the ability to respond to constantly


evolving threats, terrorist acts, regional conflicts and cyber attacks.8
In January 2010, NGCs board appointed Wes Bush as the president
and CEO of NGC. As of November 2010, NGC had revenues of $35 billion (trailing 12 months) of which about 78 percent were attributable to
defense.9,10 NGC had the fourth-largest market share in the aerospace and
defense industry behind Lockheed-Martin (United States), BAE Systems
(United Kingdom), and Boeing. The largest firms in the industry were conglomerates that tended to follow each others actions (e.g., in unmanned
aerial systems and cybersecurity systems). NGC had 120,000 employees
in 50 states and 25 countries. Its supply chain was global. In December
2010, a prominent advisory service gave NGC an A+ financial rating. Its
primary U.S. competitors had A+ or A++ ratings.
In October 2010, Bush gave further definition to the scope of the
DoDs mandate. The U.S. military had to be able to fight conventionally trained and equipped military adversaries, contend with violent
insurgencies and conduct humanitarian operations (e.g., in Haiti). In
addition, the U.S. military had to be prepared to fight adversaries that
had nuclear and biological weapons, ballistic missiles, and space capabilities. Moreover, there was the threat of cyber-attack and multiple regional instabilities. Bush concluded saying, the global commons now
includes cyber-space, and energy, food and water-rich areas among a
world population that grows every year in numbers, desperation, and
technological savvy.11
In October 2010, Bush reviewed the third-quarter calendar results,
which were good. He said, Third quarter results demonstrate that our
focus on sustainable performance improvement (i.e., NGCs top policy directive) continues to gain traction across the corporation (emphasis added).
Sales were up four percent to $8.7 billion and free cash flow was $817 million (i.e., the cash left after the business has paid all of its cash expenses).
NGC had also repurchased $180 million of its shares, continuing its share
purchase program of nearly $6.8 billion in the last six years. NGC was investing in NGC. Its business units included:
1. Aerospace systems: (e.g., manned and unmanned aircraft, spacecraft,
high-energy laser systems, microelectronics, etc.). Its 2009 revenues
were $10.4 billion.
2. Electronic systems: (e.g., airborne surveillance, aircraft fire control,
precision targeting, electronic warfare, air and missile defense, etc.).
Its 2009 revenues were $7.7 billion.
3. Information systems: (e.g., intelligence processing, decision support
systems, cybersecurity, systems engineering and integration, etc.).
Its 2009 revenues were $8.6 billion.

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Strategic Management in the 21st Century

4. Shipbuilding: (e.g., designs, builds, and refuels nuclear-powered aircraft carriers and submarines for the U.S. navy, etc.). Its 2009 revenues were $6.2 billion.
5. Technical services: (e.g., logistics, infrastructure, sustainment support,
training and simulation services, etc.). Its 2009 revenues were $2.8
billion.12
With the exception of shipbuilding, NGCs four other business units
are involved with other firms and countries in developing the $382 billion
F-35 Joint Strike Fighter program. Lockheed Martin is the contractor; NGC
is a principal subcontractor. The DoD launched the program in the mid1990s. The objective is to develop an affordably stealthy multirole fighter
plane for three target markets: (1) the F-35A for the U.S. air force and its
allies; (2) the F-35B short takeoff, vertical landing, for the U.S. marines and
British Royal Navy; and (3) the F-35C carrier-launched version for the U.S.
navy.13 By January 2010, the consortium had produced 19 F-35s; it was
still testing the planes; and the estimated cost per plane ranged from $95
million to $135 million.14 The program is controversial, but NGC is well
positioned to capitalize on its 20 percent to 25 percent share of the project
revenues in the near future.
NGC is a 40 percent partner in the production of the F/A-18E/F Super
Hornet, the U.S. navys frontline carrier-based strike fighter and the
worlds most advanced multirole strike fighter. Boeing is the contractor,
while NGC is the principal subcontractor. NGC manufactures fuselage
sections and associated subsystems. Delays in the production of the F-35s
would likely be offset by increased production of the Super Hornet. The
F/A-18s have been sold to the air forces of Australia, Canada, Finland,
Kuwait, Malaysia, Spain, and Switzerland.
In June 2010, Loren Thompson, defense analyst and CEO for the Lexington Institute, said NGC seemed well-positioned in terms of its business lines and competencies. For example, in 1999, NGC purchased
Ryan Aeronautical, inventor of the Global Hawk, it continued to develop
the unmanned stealth plane, and in 2009, it had almost 45 percent of the
$3 billion market.15 The Hawk can fly at 60,000 feet for more than 30 hours,
at speeds of almost 340 nautical miles per hour. Equipped with proven
new technology, it can see through most types of weather, day or night,
and identify simulated improvised explosive devices (IEDs).16 In sum, the
international market for unmanned aerial systems is small and growing;
there are potential civil and commercial applications (e.g., agriculture and
energy); and existing firms are already positioned to aggressively exploit
these market opportunities.17
Thompson approved of the recent replacement of CEO Ron Sugar with
the younger, more numbers-driven Wes Bush and NGCs renewed emphasis on capital efficiency over revenue growth. He favored divesting

SWOT Analysis and the Three Strategic Questions

59

under-performing businesses like shipbuilding.18 NGC was weighing


the divestment of its shipbuilding unit (i.e., a sale or spinoff ). The units
operating income (i.e., income before interest and taxes) as a percentage of
the units revenues was a 4.8 percent profit in 2009, a 37.5 percent loss in
2008, and a 9.3 percent profit in 2007.19 In November 2010, NGC e-mailed
its 30,000 shipbuilding employees to say that if it were to spinoff the newly
named Huntington Ingalls Industries shipbuilding division, NGCs
stockholders would own 100 percent of the outstanding shares of the independent, public traded, wholly owned NGC subsidiary. Moreover,
NGCs board had approved the spinoff and appointed retired Admiral
Thomas Fargo, a member of NGCs board, as chairman of the board of the
spinoffshould the spinoff happen.20
This background description of NGC provides the context for a SWOT
analysis of NGC and the aerospace and defense industry. Next, the chapter focuses on the external environment of the firm and the techniques
used to analyze the opportunities and threats facing NGC and its industry and, by extrapolation, other firms and industries. This process begins
with an analysis of societal forces, followed by an analysis of competitive
(industry) forces, an analysis of scenarios, and an analysis of stakeholder
forces.
ANALYSIS OF THE EXTERNAL ENVIRONMENT
OPPORTUNITIES AND THREATS
Opportunities and threats develop from forces in the external environment. These forces have the power to change the direction and economic
viability of the firm and are beyond the control of the firm. However, successful firms align their strategies with these forces. Scanning the external
environment for forces and their effects begins with the opinions of experts and develops from there. The objective is to identify and assess the
forces that are dealmakers or deal breakers. The possible maybes
may be worth watching for the future, but it is important to keep the analysis simple, focused, and relevant.
The Analysis of Societal Forces
For strategic planning purposes, it is important to understand the societal forces that are creating the opportunities and threats facing the firm.
To guide the analysts thinking, most strategy books offer lists of societal
forces (e.g., economic, legal, natural, political, sociocultural, and technological forces). Typically, only a few forces are truly decisive in shaping the
direction of the firm. Here, the discussion focuses on the societal forces affecting NGC. These forces and their future manifestations (i.e., what they
morph into) are likely to play a significant role in shaping the future of

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Strategic Management in the 21st Century

NGC over the next three to five years. Thus, the forces discussed here (i.e.,
societal, competitive, and stakeholder forces) are generally not static.
It is important to remember that an opportunity for one group of stakeholders may be a threat to another. For example, NGCs management may
see terrorist and cyber-attacks on the United States as a business opportunity with a moral imperative to protect the nations interests and the
people of the United States. Alternatively, the general population is likely
to see terrorist and cyber-attacks on the United States as a threat. Thus, in
the following analyses, the reader should interpret the labeling of forces
as opportunities or threats as meaning more threats than opportunities
or more opportunities than threats.
Economic ForcesThreats
At the onset of 2011, economic forces dominated NGCs strategic planning environment. The recession that began in 2007 had unleashed powerful forces that significantly affected many firms and governments in the
United States and Europe, and to lesser degrees, firms and governments
in Asia, Africa, and South America. For most firms, the recession posed
significant threats; for some it was fatal; and for a few, it created opportunities (e.g., merger and acquisition opportunities). Similarly, it brought
some governments (e.g., Greece, Ireland, Portugal, and Spain) to the brink
of potentially disastrous sovereign debt defaults.
In November 2010, the Federal Reserve Banks Open Market Committee reviewed the U.S. economic situation and its plans to manage inflationary and deflationary pressures and keep the federal funds rate
between 0 and 1/4 percent. It noted that the rate of recovery in output
and employment was slow. Household spending was increasing slowly,
but it was limited by high unemployment (9.4%), modest personal income
growth, depressed home values and housing starts, and tight credit. Business spending on equipment was rising, but more slowly than earlier in
the year, although investment in commercial and industrial real estate remained weak. Businesses were hesitant to add employees. Meanwhile, inflationary expectations remained stable. To encourage economic recovery
the committee decided to purchase a further $600 billion of longer-term
treasury securities by the end of June 2011.21
Global leaders gave the Feds decision mixed reviews. Detractors said
the injection of $600 billion would devalue the U.S. dollar, creating a revenue advantage for U.S.-based exporters (i.e., an opportunity) or a revenue disadvantage for U.S.-based importers (i.e., a threat). Others feared
the injection of $600 billion would trigger inflation and speculation-driven
asset bubbles. The minutes of the committees December 2010 meeting
confirmed that it planned to continue its controversial $600 billion bond
purchases.

SWOT Analysis and the Three Strategic Questions

61

In November 2010, President Obamas commission on reducing the


federal budget deficit recommended sweeping spending cuts and various
increases and decreases in taxes.22 At fiscal year-end, September 30, 2010,
the U.S. budget deficit was $1.3 trillion, and the national debt was $13.7
trillion or about 97 percent of gross domestic product. The commission
recommended a $100 billion reduction in the DoDs annual expenditures
over the next five years. However, its recommendations were controversial and nonbinding.
The DoDs estimated budget for fiscal 2010 included $508 billion for defense programs plus $128 billion for the Global War on Terror (GWOT) for
a total of $636 billion.23 (In 2002, the comparable budget was $342 billion.)
Additional appropriations for the GWOT in fiscal 2010 were expected to
increase the actual expenditure to perhaps $700 billion.24
In January 2011, Secretary of Defense Robert Gates was told to reduce
the DoDs expenditures by $78 billion over the next five years.25 In sum,
given the federal budget deficit and debt, DoD expenditures were likely
to plateau or even decrease in the future. However, significant attacks on
the United States (e.g., the 9/11 attacks) might result in renewed growth in
the DoD expenditures despite the deficit and debt. In addition, the United
Kingdom was planning to reduce its defense budget by 20 percent, and
several European countries were analyzing similar reductions.
Military/Terrorist ForcesThreats
In the early days of 2011, U.S. security forces were engaged in two wars
and ongoing terrorist activities. The 9/11 attacks in 2001 were history, and
the president and some congressional representatives were questioning
the need to spend $700 billion a year on national defense. This reticence
posed a significant threat to firms in the aerospace and defense industry.
However, a series of 9/11-magnitude terrorist attacks or the outbreak of
another war in the Middle East or on the Korean peninsula could turn the
threat into an opportunity for NGC and other firms in the industry.
In January 2011, pictures of Chinas J-20 stealth fighters first test flight
appeared on the Internet. Apparently, the development of the J-20 was
more advanced than most analysts had estimated. Within days, Secretary
of Defense Robert Gates met with Chinas president, Hu Jintao and asked
him how the test flight went. From Hus reaction it appeared he had not
been briefed on the test flight, raising questions about the militarys motives and the wisdom of putting President Hu in an embarrassing position. For more than 70 years, Chinas military had been under the control
of the Chinese Communist Party.
Once in service, the J-20s could be based in the interior of China from
which they could patrol Taiwan, the East and South China Seas, and
the Western Pacific, threatening Japan, South Korea, and other Asian

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Strategic Management in the 21st Century

countries.26,27 The J-20 looked similar to the U.S. F-22 Raptor, which is the
only operational stealth fighter in the world. Manufacturing of the F-22
was halted in 2009, but production could be restarted.
Cyber ForcesThreats
In April 2009, Defense Secretary Robert Gates said the United States
is under cyber attack virtually all the time, every day. The Wikileaks
saga tested the cybersecurity of companies such as PayPal, MasterCard,
and Visa. Experts considered the attacks relatively primitive. In contrast,
J. B. Gib Godwin, NGCs vice president, Cyber-Security and Systems Integration, said, Everyday there are an estimated 360 million probes directed at Pentagon computers, looking for vulnerabilities.28
In July 2009, Linda Mills, corporate vice president and president of
NGCs information systems segment provided another example of a cyberattack. That attack involved nearly 170,000 zombie computers in 74 countries linked together . . . it managed to hit virtually every major federal
agency, including the White House.29 She explained how NGCs engineers connected a personal computer loaded with the best commercial
security software to the Internet. Within four hours, they detected the first
ping by a potential hacker. Within a week, a hacker had installed a root
kit to control the computer. Within two weeks, NGCs computer was enslaved and run by a server in Canada that was run by a server in Singapore that was run by a server that could not be traced. Then, NGCs
computer was used to attack a computer in Poland.
On September 6, 2007, in a remote area of eastern Syria, North Korean
workers were constructing a large building that analysts surmised would
house a nuclear facility. Shortly after midnight, when most of the workers had left the site, Israeli F-15 Eagles and F-16 Falcons swept in and
obliterated the building. Initially, Syria said nothing about the attack. Its
Russian-built air-defense system gave no warning of the attack. Israel had
taken control of Syrias computers, so the Syrians saw what the Israelis
wanted them to see, which was status quo. Later Syria and North Korea
expressed outrage at the attack. Syria said Israel destroyed an empty
building. Syria cleaned up the debris and plowed the area. Israeli news
services said nothing about the attack.30
NGC has been engaged in cybersecurity research for 20 years.31 The
need for cybersecurity on NGCs networks led it to develop a high-tech
network defense capability for the management of vulnerabilities, intrusion detection and prevention, incident response, and forensics.32
In July 2010, NGC opened its new Cyber Security Operations Center in
Maryland, a cyber-threat detection and response center to protect NGC
and extend the lessons learned to customers networks. In October 2010,
NGC opened its Fareham cyber range in the United Kingdom. NGC

SWOT Analysis and the Three Strategic Questions

63

linked its U.K. range to its Maryland facility and other cyber ranges. The
ranges simulate large complex computer networks and their responses
to threats.
Political ForcesOpportunities
The presidents and the Congress agendas can have a significant effect on the prosperity of the aerospace and defense industry. The 9/11 attacks in 2001 led to a big increase in DoD expenditures. Today, President
Obamas agenda is more oriented to domestic needs (e.g., improving education and healthcare). In addition, U.S. arms sales to other countries continue to have a significant political dimension and impact on the industry.
Last, as Standard & Poors explains, weapons purchases are not based
on price and performance alone, but also on political considerations.33
For example, the F-35 Joint Strike Fighter program elected to use a Pratt
& Whitney (P&W) engine. General Electric (GE) and its supporters were
promoting a GE engine. The DoD estimated the cost savings of halting the
continuing development of the GE engine at $2.9 billion.34
The industry relies on many lobbyists and political action groups for
access to the DoD. The contract acquisition market is not perfectly competitive. Thus, the DoD may continue to support military contracts for
political reasons, even though the military need has passed. In addition,
the DoD may award new contracts to support a contractor who needs the
business or to preserve competition among the contractors.
Protecting jobs is important to congressional members, and the defense contractors leverage this fact. For example, in November 2010,
NGC had 4,800 employees in San Diego County, California. About 2,300
worked on the development of its Global Hawk. In response to anticipated funding cuts, NGC put advertisements in five area newspapers
explaining the importance of the Hawk and enabling people to use a
Website to communicate directly with their congressional representatives. In addition, in November 2010, NGC was moving its corporate
headquarters from Los Angeles to northern Virginia to be closer to the
DoD (i.e., the Pentagon).
Innovation ForcesOpportunities
To identify societal forces, it makes sense to turn to the experts and start
with their projections. For example, in mid-2009, McKinsey & Company
analyzed The 10 Trends You Have to Watch.35 Although such forecasts
are useful, the trends are likely to affect firms and industries differently.
For example, the McKinsey authors projected a trend they called innovation marching on and noted innovation in fields such as information
technology, biotechnology, nanotechnology, materials science, and clean

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Strategic Management in the 21st Century

energy. In these industries and the aerospace and defense industry, the
saying is innovate or die.
The aerospace and defense industry thrives on innovation, and the
DoD contractors create innovative solutions that sometimes have civil and
commercial applications (e.g., unmanned air systems). Thus, the McKinsey authors claim that innovation will continue seems reasonable; innovation is a source of competitive advantage. However, following the end
of the Cold War, large cutbacks in the DoD expenditures led to a major
exodus of talent from the industry. According to Wes Bush, As a result,
across the industry, we have a population gap in our ranks between the
ages of about 38 to 52 . . . simple rule . . . technology attracts talent.36 In
sum, reductions in DoD technology funding are likely to shift talent to
other industries (i.e., a threat).
Conclusions
In late 2010/early 2011, NGC faced several powerful societal forces.
First, economic forces were a significant threat, and firms in the aerospace
and defense industry were crafting retrenchment strategies (i.e., reducing
costs and assets) and developing recovery strategies.37,38 Second, military/
terrorist forces had not been able to mount a successful attack in several
years, and this fact threatened the industrys funding and preparedness. Third, cyber forces were an increasing threat, and the possibility of a
cyber-war was no longer a Hollywood fantasy. Fourth, political forces,
which usually created opportunities, were focused on reducing the DoDs
funding, clearly a threat to many firms in the industry. Fifth, innovation
forces, which typically created opportunities, were on the verge of declining. The aerospace and defense industry was retrenching. Firms were putting their low-potential projects on hold, and some of the talent that fueled
innovation was looking for opportunities in other industries. An exodus
of talent could be crippling.
Unfortunately, there is no way to quantify the societal forces and
calculate, for example, a scaled assessment of an opportunity or threat
(e.g., 90 = excellent opportunity, low threat; 50 = balanced opportunity
and threat; and 10 = low opportunity, high threat). Although threats
may conceal opportunities, the foregoing analysis suggests the aerospace and defense industry faces a period of declining opportunities
and rising threats.
The next step in developing a SWOT analysis is to evaluate the competitive forces that are shaping the firms industry. Here again, the purpose
of the environmental scanning is to identify and assess the forces that are
truly dealmakers or deal breakers and avoid being mired down in the
analysis of minutia.

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65

The Analysis of Competitive (Industry) Forces


Competitive forces have the power to change the direction and economic viability of the firm. Michael Porter published his classic model of
industry structure analysis in 1980.39,40 The model focuses on five competitive forces arranged in an airport hub-and-spoke layout, that is:
(1) the threat of new entrants (north terminal), (2) the intensity of competitive rivalry (hub), (3) the bargaining power of buyers (east terminal),
(4) the bargaining power of suppliers (west terminal), and (5) the threat
of substitutes (south terminal).
Entry barriers reduce the threat of new entrants (i.e., economies of scale,
expected retaliation, high brand loyalty, etc.). If there are strategic groups
within the industry, mobility barriers within the industry will inhibit or
prevent movement from one strategic group to another. In an industry,
firms within strategic groups follow similar strategies, whereas different
strategic groups within the industry follow different strategies.
In Porters analytical framework, the subject of the analysis (e.g., NGC)
is positioned in the central box, and it is the center of the analysis. Rivalry determinants and the determinants of buyer power, supplier power,
and substitution structure the nature of the industry and give the analysis
depth and breadth. The five forces operate in the external environment
of the firm and have the potential to create opportunities and threats for
firms in the industry. The basic logic of the model argues that the more intense the competitive forces are, the lower will be the long-run return on
investment and vice versa.
Analysts use the model to analyze the structure of industries and to
position firms in their industries with the intention of creating sustainable competitive advantages (i.e., sustainable levels of excellence in free
cash-flow generation). Free cash flow is the preferred measure because
cash pays the bills; cash creates and sustains credit; and cash and credit
secure assets that generate more free cash flow. Therefore, it is important to never run out of cash or credit.41 Analysts typically use free cash
flow in the valuation of assets (e.g., payback, net present value, and internal rate of return criteria). Otherwise, they use some form of asset
valuation (e.g., replacement cost). Sometimes analysts focus on profit
as opposed to free cash flow. However, as the statement of cash flows
clearly shows, profit is only a partial measure of cash flow. It is the first
line on the statement of cash flows, and it excludes significant sources
(uses) of cash.
Analysts want to know how the industry creates value (i.e., free cash
flow) and who captures the value created. They envision the firm competing with its competitors (i.e., the intensity of competitive rivalry). In addition, Porter argues that the firm is also competing with its buyers and

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Strategic Management in the 21st Century

suppliers. Buyers typically want lower prices, higher quality, longer warranties, etc. If the switching costs are favorable, they might buy a competitors products or play one firm against another. The greater the bargaining
power of buyers is, the greater is the buyers share of the value created by
the industry, everything else being equal.
By contrast, suppliers want higher prices, lower quality requirements,
less onerous warranties, etc. The greater the bargaining power of suppliers is, the greater is the suppliers share of the value created by the industry, everything else being equal.
Porter saw substitute products as coming from outside of the firms industry (e.g., beef, pork, and chicken are substitutes). The substitute serves
the same function (e.g., nutrition), yet it is different (e.g., in appearance
and/or chemical composition). Thus, it can place a ceiling on the price
the firm can charge for its product, thus limiting the producers valuecreation possibilities. Last, if the threat of new entrants is high and low
prices are a barrier to entry, it could further limit the producers valuecreation possibilities. An industry with strong buyers and suppliers, economically viable substitutes, and entry-barrier pricing, could be very
unattractive. Unattractive industries often find it difficult to raise capitaldebt or equity.
Analysts use Porters model to understand the structure of an industry and the forces shaping the development of the industry, past and
future. Typically, they want to learn how to position the firm in the industry to create a sustainable competitive advantage. Thus, using Porters model to analyze the aerospace and defense industry might reveal
the following:
Bargaining Power of BuyersHigh to Moderate
The contracting activities of the DoD drive the economic activities
of the aerospace and defense industry contractors. The primary buyer
is the DoD (i.e., the Pentagon), which represents the various military
services. Thus, contracts are usually associated with a military service
(e.g., a navy contract). NGCs other buyers include civil buyers (i.e.,
nongovernment buyers, such as police forces and border patrols), commercial buyers, foreign governments, and scientific institutions (e.g.,
NASA). The DoDs purchases are significantly influenced by economic
forces, military/terrorist forces, and the presidents and the Congress
agendas (i.e., political forces). In June 2010, Loren Thompson, defense
analyst, pointed to trends unfolding within the Pentagon . . . migration of funding out of high-end technology and into people skills . . .
move to in-source tens of thousands of jobs previously contracted out
to industry.42 This migration threatens NGCs ability to retain hightechnology talent.

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67

Intensity of Competitive RivalryHigh and Rising


In the aerospace and defense industry the annual revenues of the largest
25 firms range from $3 billion to $65.7 billion.43 The worlds largest aerospace and defense contractors are Lockheed Martin, BAE Systems (United
Kingdom), Boeing, Northrop Grumman, General Dynamics, and Raytheon. The larger firms have invested heavily in proprietary product technology and building economies of scale and brand identity (e.g., in 2009,
NGC spent $610 million on research and had 6,293 patents). There are also
hundreds if not thousands of smaller firms in the global supply chain.
Competition at all levels of the industry is increasing, putting downward
pressure on profit margins and free cash flows. The DoD clearly favors
competition. Firms will likely reduce their margin requirements to protect revenue generation. Well-positioned firms will purchase firms with
distinctive competencies. Firms without distinctive competencies will exit
the industry.

Bargaining Power of SuppliersModerate


The large firms in the aerospace and defense industry (e.g., NGC)
depend on a global supply chain. Given that the large firms are developing, producing, and marketing relatively similar products and
services, it appears there may often be alternative buyers for suppliers products and services, giving suppliers more bargaining power
than they would have as a sole (captive) supplier. In addition, the industry depends on a continuous infusion of researchits own and
the research of universities and independent research facilities. The
bargaining power of these facilities depends on the quality of their research (i.e., their reputation).

Threat of New EntrantsLow


New entrants add capacity to the industry. New entrants may bring
new, even leap-frog, technology and/or productive capacity. Given the
expected decline in DoD contracting and intensifying competition, significant additions to industry capacity are unlikely. However, industry
leaders and analysts are discussing the likelihood of mergers and acquisitions (e.g., Boeing and NGC) and the possibility that one of the large
firms might exit the industry. They seem to agree that mergers and acquisitions among the largest firms are unlikely because of the associated
antitrust issues, but they are already underway among the second- and
third-tier firms. The administration and the DoD are not in favor of largescale mergers and acquisitions.44

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Strategic Management in the 21st Century

Threat of SubstitutesUnknown
Substitutes serve the same function as the products/services they displace. Research displaces technology, and some of the research may come
from industries presently or historically not engaged in producing products/services for the DoD. The likelihood of displacement largely depends on the switching costs and value-added potential.
In the aerospace and defense industry, the pending cuts in DoD spending set the context for the high and rising intensity of competitive rivalry.
The high-to-moderate bargaining power of buyers, primarily the DoD
and congressional representatives fighting for a share of the DoD contracts and jobs for their home districts, increase the intensity of competitive rivalry. The moderate bargaining power of suppliers is explained by
the industrys global supply chain and its dependency on a continuous
infusion of research. By contrast, the threat of new entrants is low. The
next section explains the use of scenarios for managing a host of complex,
high stakes, and relatively unpredictable forces that shape NGCs and the
industrys strategic plans.
The Analysis of Scenarios
Analysts typically assess the future of a firm by projecting a future
state of the industry (i.e., a single scenario).45 Then, they examine various
cases within the scenario (e.g., most likely, worst-case, and best-case pro
forma financial statements). Sometimes, however, the planning environment is more complex and less predictable, and analysts must examine
multiple independent scenarios with different policy prescriptions (e.g.,
DoD expenditures under a Democratic- versus a Republican-controlled
presidency and/or Senate). Historically, when Republicans controlled
the presidency and/or the Senate, DoD expenditures usually increased.
When the Democrats controlled the presidency and/or the Senate, DoD
expenditures usually decreased.46 In each scenario, analysts examine the
opportunities and threats NGC uses in both planning processes. As Wes
Bush explained:
We face a shifting security environment shaped to a significant extent by unpredictable external events and the political responses
that they motivate. . . . We look for . . . changes in global macroeconomics; the military actions and investments of Americas peer
competitors; patterns of terrorist events; events associated with key
resources such as food and energy; and weather-related disasters or
pandemics. Any of these could be indicators of a new, relevant reality. Understanding these early indicators and being able and willing
to react to them is what turns risk into opportunity and competitive
advantage.47

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69

This powerful quote captures the reality of strategic planning at NGC.


Strategic planning at NGC is driven by a multitude of complex, high
stakes, relatively unpredictable events. NGC scans the external environment for indicators of a new, relevant reality and plans accordingly. The
next step in developing a SWOT analysis is the analysis of stakeholder
forces that are shaping the firms opportunities and threats in its external
environment.
The Analysis of Stakeholder Forces
Stakeholders create opportunities and threats in the external environment of the firm. A stakeholder is a person(s) or organization(s) that
affects or is affected by the actions or inactions of another person(s) or
organization(s). NGC has many stakeholder relationships whose enhancement and maintenance are critical to its success (e.g., stakeholder
relations with the DoD and members of the F-35 Joint Strike Fighter program). More specifically, to accelerate its research and feed its neverending search for talent, NGC announced plans in December 2009 to invest millions to fund graduate fellowships and other research for at least
five years at Carnegie Mellons CyLab, MITs Computer Science and Artificial Intelligence Lab, and Purdues Center for Education and Research in
Information Assurance and Security.48
Edward Freeman initiated the seminal research in stakeholder analysis.
In his 1984 book, his approach to strategic management focused on creating mutually beneficial stakeholder relations (i.e., win/win situations).
He asked:49
1. Who are our stakeholders?
2. How do stakeholders affect each division, business and function, and its
plans?
3. What are our assumptions about critical stakeholders?
4. Have we allocated resources to deal with our stakeholders?
In 1994, Freeman developed the principle of who or what really counts. To
whom (or what) do the managers of the organization have to pay attention?50
This principle moved away from Freemans 1984 proposition and created
the possibility of win/lose situations. Thus, it was not only a question of
who the stakeholders were, but also which stakeholders controlled managements attention, to what degree, and why? In 1997, Mitchell, Agle,
and Wood used Freemans principle of who or what really counts to argue,
Stakeholders with powerful, legitimate, urgent claims gained preferential access to management.51
In 1996, Hinthorne proposed a predatory view of stakeholder relations in an analysis of deregulation in the U.S. airline industry.52 The use

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Strategic Management in the 21st Century

of the predatory/prey analogy suggests a strategic management style oriented to acquiring assets and removing obstacles with little or no regard
for the human element in stakeholder relations. Hinthorne argued that in
complex, high-stakes situations, the leaders of some organizations developed predatory management styles to achieve their organizations goals.
These leaders used power and force relations (e.g. stakeholder coalitions),
and legitimacy to secure their goals. For example, they used institutional
structures of power (i.e., executive, judicial, legislative, and regulatory)
at the federal, state, and local levels to secure organizational goals. They
preferred win-win strategies, but they also had some power to select, exploit, and destroy stakeholdersalso exclude or silence stakeholdersto
secure organizational goals, albeit while giving the appearance of pursuing legitimate goals.
Obviously, stakeholder relations are not always amicable. In stakeholder disputes, there are essentially two options for resolving the
disputescollaboration or litigation. There may be appeal processes (e.g.,
in working with government agencies), and arbitration and mediation are
used. Litigation tends to be the preferred process of dispute resolution in
the United States, and it is costly and time consuming.
If the disputants are sincerely interested in avoiding litigation and resolving their dispute on amicable terms, they may find that collaboration
is the preferred process. However, there is a caveat: the disputants must
share some critically important superordinate goals. Muzafer Sherif (1958)
defined superordinate (i.e., common) goals as goals that are compelling and highly appealing to members of two or more groups in conflict
but which cannot be attained by the resources and energies of the groups
separately. In effect they are goals attained only when groups pull together.53 Sherifs research validated two hypotheses: (1) in conflict situations, groups will tend to cooperate to achieve superordinate goals, and
(2) the more frequently the groups cooperate successfully to secure superordinate goals, the lower the conflict will be.
Collaboration is widely used in stakeholder disputes over natural resources (e.g., forest restoration and the protection of endangered species).
It is typically less costly and more flexible than litigation. It is time consuming but no less so than litigation. Wondolleck and Yaffee studied over
200 collaborative situations, and their book is a good reference.54 Collaboration usually faces significant threats. First, there is competition (e.g.,
egos, turf wars, self-interests, and win/lose and us/them mentalities).
Second, there are conflicting interests (e.g., different core values, objectives, and strategies). Third, there is mistrust. Fourth, there is the compliance with U.S. laws and regulations that create unnecessary project delays
and paperwork. Fifth, there is ineffective management of the collaborative
process (e.g., lack of process skills and resources). Sixth, there are comfort
zones (e.g., fears of change, collaboration, public interaction, lawsuits, and

SWOT Analysis and the Three Strategic Questions

71

taking risks). Seventh, there is the need to secure the input of all likely
stakeholders.55
The SWOT analysis is not just about the analysis of societal forces, competitive forces, and scenarios. It is also about the analysis of stakeholder
forces. Stakeholder forces have the power to change the direction and
economic viability of the firm. Therefore, good stakeholder relations are
important. Collaboration is usually preferable to litigation when the disputants have superordinate goals and can collaborate successfully. However, litigation may be the only option when the disputants do not have
superordinate goals. It may also be necessary to protect the firms assets
(e.g., intellectual property or reputation). Next, the SWOT analysis turns
to an assessment of the firms external environment and its strengths and
weaknesses.
ANALYSIS OF THE INTERNAL ENVIRONMENT
STRENGTHS AND WEAKNESSES
Analysts use the RBV of the firm to assess its strengths and weaknesses.
The RBV enables a firm to identify and develop its internal strengths, so it
can capitalize on external opportunities. It also enables the firm to identify
and reduce its internal weaknesses (e.g., fill resource gaps) and thereby reduce external threats. Much of the information presented here reflects the
work of Jay Barney.56
The Underlying Assumptions
The analysis reflects two assumptions: resource heterogeneity and resource immobility.
1. Resource heterogeneity: A firms resources reflect its evolutionary path
of development, so its collection of resources is path dependent
and unique. As a result, its resources are heterogeneous despite
surface similarities. Heterogeneity could be a strength and a source
of competitive advantage or a weakness and a source of competitive
disadvantage. For example, NGC shares similarities with its competitors. However, it and each of its competitors have traveled different development paths, and their resources are unique.
2. Resource immobility: Some resources are costly or impossible to imitate or acquire. Their supply curves are inelastic (vertical), and a
potential buyers willingness to pay higher prices does not increase
supply. At the extreme, there are no sellers.
In addition, Michael Porter and the RBV see the business as a chain of
cost-incurring and value-creating activities, beginning with some form of

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raw materials and ending with some form of finished product/service.57 At one extreme, the fully integrated firms activities include the
complete value chain (e.g., land + oat seeds Quaker Oats on the grocery shelf ). At the other extreme, the firm may have only one activity (e.g.,
farmers who provide only land). Analysts examine each cost-incurring
and value-creating activity to see how and where the firm creates value to
ensure the configuration of activities is functioning optimally. In addition,
they look for ways of reconfiguring activities to create greater synergies.

The Analysis of Resources and Capabilities


The definition of resources excludes assets readily available in markets.
Resources include financial, human, knowledge, physical, organizational,
reputational, and technological assets. Knowledge ranges from information that is relatively easy to codify and transmit to know-how that is
tacit. Knowledge creation and management are potential sources of competitive advantage, especially if they enhance valuable tacit know-how
or provide information enabling a first-mover advantage.
The firms resources are not static and may be emerging along a predetermined path as the firm follows a specific strategy (e.g., growth, stability,
or retrenchment)58 or simply drifts because the firm does not have an effective strategy. Moreover, the value of the firms resources and competitors resources change over time. Resources are firm-specific assets that to
some degree must meet several criteria. Jay Barney called this the VRIO
Framework with the acronym standing for valuable, rare, inimitable, and
organization.59
1. Resources must be valuable, that is, capable of exploiting opportunities, reducing threats, and creating a sustainable competitive advantage (e.g., a sustainable level of excellence in cash-flow generation).
For a resource to be truly valuable, the firm must be able to associate
the resource with specific value creating opportunities. If a resource
is not unequivocally valuable, then its ability to create value is suspect.
2. Resources must be rare, that is, not readily available in markets.
Moreover, most if not all competitors do not possess them or have
the means to create them, except perhaps at great cost. Resources
that are valuable but not rare cannot produce a sustainable competitive advantage because they are readily available to competitors. At
best, they can produce competitive parity.
3. Resources must be difficult to imitate, otherwise, competitors could
copy them. At the extreme, the more useful, albeit confusing, word
is inimitability. That is, the resource cannot be imitated. Perhaps the

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73

technology is proprietary (e.g., intellectual property) or the technology is physically not available for reverse engineering. Resources
must also have few or no substitutes, that is, other resources cannot
replace them. Causal ambiguity (i.e., ambiguous cause-effect
relationships) may preclude imitation. That is, the observable is
not necessarily the source of competitive advantage. For example,
firms may have socially complex networked resources (e.g., organizational culture, senior management synergies, tacit knowledge,
transformational leadership, etc.).
4. The firm must be able to exploit its resources. Firms combine resources
to create distinctive capabilities that they use to complete specific
activities efficiently and effectively. As firms refine their distinctive capabilities, they develop processes and routinesrepetitively
used codified and tacit practicesto enhance their distinctive capabilities and ensure optimal execution. These are complementary
resources. They enhance the value, rarity, and difficulty of imitating
the firms primary resources.
Resources are typically evaluated in the preceding order of importance
(i.e., how valuable (most important), how rare, how inimitable, and how
exploitable). Thus, as a resources value rises (), rareness (), inimitability (), and exploitability rises (), the more likely it is that the resource is
a major strength, able to form capabilities, exploit opportunities, and diminish threats.
Example: NGC sees its leading capabilities in climate and environment technologies, battle management, cyber-security, defense
electronics, homeland security, information technology and networks, naval shipbuilding, public health, systems integration, and
space and missile defense.60
Example: In October 2010, NGC opened the first commercial cyber
test range in the UK. The cyber range will simulate large infrastructures and global threats and evaluate how these networks, whether
military, civilian or commercial, respond to an attack in order to develop capabilities that will make these networks more secure. The
range is linked to NGCs Cyberspace Solutions Center in Maryland
(United States).61 Conclusion: Keeping in mind that NGC spends
over $600 million a year on research, it appears many of NGCs resources would variously meet the four resource criteria. Moreover,
NGC has combined resources to create capabilities that may produce
sustainable competitive advantages.
Example: In February 2009, Wes Bush explained how NGC developed a portfolio approach to managing roughly 100 different business elements. He said, We fully characterize each of these in terms of

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Strategic Management in the 21st Century

its products, technologies, customers, competitors, competitiveness, financial performance, and balance sheet. We also consider impacts resulting
from the interdependencies of these business elements.62 Conclusion: This
appears to be a best practices approach to managing the business.
NGCs competitors and suppliers would likely have similar analytical tools, so NGCs portfolio analysis, while valuable, is probably not
rare, inimitable, and exploitable.
The Qualification and Quantification
of Resources and Capabilities
The identification and assessment of resources and capabilities are subjective. That is, how valuable, how rare, how inimitable, and how well is
the firm organized to exploit its resources. In the RBV, resources and capabilities must be unequivocally valuable, rare, and costly to imitate. In
addition, the firm must be able to exploit its resources. Many firms do not
have unequivocal resources. Thus, they do not have the strengths to capitalize on opportunities, diminish threats, and reduce weaknesses (i.e., fill
resource gaps).
Every participant in a SWOT analysis has a personal concept of what
the words valuable, rare, inimitable, and exploitable mean in any given
situation. In each persons mind there is an inherent subjective scaling of
the criteria (e.g., valuable, absolutely, or valuable, well maybe). These
personal concepts become more useful when analysts quantified them for
comparative analysis. Here, an analyst might use a 100-point scale (e.g.,
valuable, absolutely100 or valuable, well maybe30). Once the
participants quantify their personal concepts, they can debate the issues
and perhaps reach a useful consensus (e.g., valuable, within a consensus
range of 60 to 80 for the following reasons . . .). Quantification elevates the
analysis of resources and capabilities from a yes/no/maybe level
(e.g., yes it is valuable, no it is not valuable) to a more productive level
that facilitates serious debate and objectivity.
The trap in using the RBV is to identify undifferentiated assets as resources. The human tendency in a competitive managerial environment
is to protect ones turf, objectively if possible and subjectively if necessary.
To correct for this tendency, analysts can debate and quantify the assessment of resources and capabilities and match these strengths to opportunities in the external environment to see if there is a strategic fit. Table 3.1
uses a 100-point scale, with 100 being the best, to assess three of NGCs
capabilities relative to its primary competitors.
The numbers in the table reflect competitive barriers. The higher the
number is, the greater is the barrier. For example, NGC has an A+ financial rating. The assessment indicates this is a very valuable resource (90); it
is very rare (80); it is somewhat costly to imitate (40); and the firm is very

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75

Table 3.1
A Hypothetical Assessment of Three of NGCs Capabilities

How valuable?

NGCs A+
Financial Rating

NGCs UK Cyber
Range Investment

NGCs Portfolio
Analysis Tool

90

100

80

How rare?

80

80

10

How costly to
imitate (inimitability)?

40

100

20

How exploitable by
NGC?

90

90

90

Relative importance

250

370

200

Possible

400

400

400

well positioned to exploit it (90). In sum, the A+ rating is worth 250 points
out of 400 possible points, perhaps indicating NGCs A+ rating gives it at
least competitive parity. The columns compare three hypothetical NGC
capabilities.
A comparison of the four columns indicates the U.K. cyber range has
the greatest potential for creating a sustainable competitive advantage.
Relative to its competitors resources and capabilities, the cyber range is
extremely valuable (100); it is very rare (80); it is extremely costly to imitate (100); and NGC is extremely well positioned to exploit it (90).
Last, NGCs portfolio-analysis tool is very valuable (80); it is not rare
(10); it is not costly to imitate (20), but the firm is very well positioned to
exploit it (90). Notice too, it is a complementary resource that sustains
NGCs business units.
After the firms analysts have assessed its resources and capabilities
qualitatively and quantifiably as relative strengths or weaknesses, the
remaining question is this: how and when will the firm fill its resource
gaps? The purpose of the SWOT analysis is to use the strengths of the firm
to capitalize on opportunities, diminish threats, and reduce weaknesses
(e.g., fill resource gaps), so there should be plan to reduce the firms weaknesses as well as a plan to capitalize on its strengths.
THE SWOT ANALYSISA PLATFORM
FOR STRATEGIC PLANNING
The SWOT analysis is typically an analytical platform for creating strategic plans. To get an overview of the issues, analysts often pose and try
to answer three strategic questions: Where is the firm now? Where does it

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Strategic Management in the 21st Century

want to be in 5 to 10 years? How does it plan to get there? These are challenging questions, particularly for an outside observer. Nevertheless, the
foregoing analysis suggests some answers, bearing in mind that it is late
2010/early 2011, and everything might look very different in 3 years, 5
years, and 10 years.
Where Is the Firm Now?
NGC is well positioned in the aerospace and defense industry (S). Its
annual sales are $35 billion of which 78 percent are attributable to defense,
giving it the third-largest market share in the industry (S/W). NGC has
a 20 percent to 25 percent share of the F-35 Joint Strike Fighter program
revenues (S), and it is a 40 percent partner in the production of the F/A18E/F Super Hornet (S). NGC has almost 45 percent of the unmanned
aerial systems market, which has growth potential (O), but the market is
still relatively small (T).
NGC had an A+ financial rating (S) and a global supply chain (S). Its
third-quarter sales were up four percent to $8.7 billion; its free cash flow
was $817 million (S); and over the last six years it had repurchased nearly
$6.8 billion of its shares (S). NGC may have a sustainable competitive advantage (i.e., a sustainable level of excellence in free cash-flow generation). However, the largest firms in the industry are conglomerates that
tend to follow each others actions in good times and bad (W). Thus, it
is likely that the largest firms have a high degree of competitive parity.
NGCs management is numbers driven (S) and focused on capital efficiency over revenue growth (S), divesting underperforming businesses
(S), and sustainable performance improvement (S). It uses a portfolio approach to manage 100 different business elements. NGC spent over $600
million on research in 2009 (S), and it has 6,293 patents (S).
Where Does It Want to Be in 5 to 10 Years?
NGC is planning to spin off its shipbuilding business (S); so presumably, it does not want to invest in low-margin manufacturing operations.
The remaining business units, aerospace systems, electronic systems, information systems, and technical services, are involved in the F-35 Joint
Strike Fighter program and presumably are businesses that the management wants to expand. Aerospace systems include unmanned aircraft,
and information systems include cybersecurity. NGC is repurchasing
significant quantities of its stock, which raises a question of intentions.
In late 2010, NGC had 291,990,000 shares outstanding; at $60/share, its
market capitalization was $17,519,400,000. Is there a move to take the
company private and avoid the scrutiny of the Securities & Exchange
Commission?

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77

How Does It Plan to Get There?


NGC might have been in a retrenchment mode for several years. It appears to have a strong financial position, and it is well positioned in its
industry. It seems to be more focused on the efficient use of capital as opposed to revenue growth (S), which the investors seem to favor. It will use
its numbers-oriented portfolio analysis to decide what operations to keep
and build and what operations to divest. It looks like NGC has made a
decision to spin off its shipbuilding segment, which is consistent with retrenchment. As it retrenches, it will develop a recovery strategy, building
on the expertise of its four remaining business units. However, NGC faces
several challenges over the 5- to 10-year period, including:
Societal forces: Economic forces (e.g., federal debt and deficit levels), military/terrorist forces (e.g., the probability of a 9/11-scale attack), and their
interdependencies will drive NGCs scenarios. Cyber forces are likely to
become more threatening; political forces will continue to shape scenarios;
and unforeseen forces are likely to emerge. Innovation will continue to
move forward; however, the level of innovation in the aerospace and defense industry is problematic.
Competitive forces: It appears that the aerospace and defense industry
is facing declining market opportunities. As a result, firms in the industry are implementing retrenchment strategies and mulling over recovery strategies. The structure of the industry appears rigid and unlikely
to change significantly in the near future. The bargaining power of the
buyers is likely to remain high to moderate. Political forces may keep
some firms and product/service offerings operating beyond their economic life to maintain competition in an industry sector or for political
reasons (e.g., protecting jobs in a congressional district). The intensity
of rivalry is likely to remain high and rising, precipitating firm closures,
mergers, and acquisitions. The bargaining power of suppliers is likely
to be moderate and global, and the threat of new entrants is likely to
remain low.
Stakeholder forces: The aerospace and defense industry appears to face
stakeholder forces that could affect its strategy choices. Creating win/
win relations is important, and Freemans four questions are worth considering.63 The industry could probably improve its stakeholder relations
through collaboration. However, there are significant barriers to collaboration. Unless the stakeholders can find common ground (i.e., superordinate goals), collaboration simply will not happen. Mutual trust is also
critical. Beyond collaboration, there is litigation, which is costly and lessens the likelihood of successful collaboration in the future but may be necessary to protect the firms assets.
In closing, the SWOT analysis provides a useful tool. However, none of
the components, with the possible exception of the analysis of resources

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and capabilities, is measureable on a commonly understood scale. As a


result, communication remains subjective and imprecise. However, an
opportunity to make a valuable contribution to the research literature
beckons.
NOTES
1. Edith Penrose, 1959. The Theory of the Growth of the Firm. Oxford: Oxford
University Press.
2. Jay B. Barney, 2011. Gaining and Sustaining Competitive Advantage. Upper
Saddle River, NJ: Prentice Hall.
3. Kenneth Andrews, 1971. The Concept of Corporate Strategy. Homewood, IL:
Richard D. Irwin.
4. Thomas Wheelen & David Hunger, 2010. Concepts in Strategic Management
& Business Policy, Achieving Sustainability. (paraphrased from p. 6), Upper Saddle
River, NJ: Prentice Hall.
5. Henry Mintzberg, 1987. Crafting Strategy. Harvard Business Review,
JulyAugust, 6675.
6. Robert M. Grant, 2003. Strategic Planning in a Turbulent Environment: Evidence from the Oil Majors, Strategic Management Journal, 24: 491517.
7. Wes Bush, President and Chief Operating Officer, Northrop Grumman
Corporation, 2009. Wes Bush Addresses the Wharton Aerospace Forum, February 6.
8. Northrop Grumman Corporation, 2010. Securities & Exchange Commission, Form 10-K: 27, February 9.
9. Yahoo, Inc. 2010. Northrop Grumman Corporation, November.
10. Standard & Poors, 2010. Industry Surveys, Aerospace & Defense, February 11.
11. Wes Bush, 2010. Wes Bush Addresses the Center for Strategic and International Studies, October 19.
12. Northrop Grumman Corporation, 2010. 10-K, February 9.
13. Defense Industry Daily, 2010. F-35 Joint Strike Fighter: 20092010, December 15.
14. David Pugliese, 2010. F-35 Purchase Plan Based on a Wing and a Prayer,
Opposition Says, Postmedia News, December 11.
15. Helen Kaiao Chang, 2009. Northrop Grummans Success Formula, San
Diego News Network, May 27.
16. Northrop Grumman Corporation, 2010. Northrop Grummans ASTAMIDS
Proves It Can Detect IEDs from the Air in Near-Real Time, NGC Press Release,
December 6.
17. Bruce Gerding, 2010. Bruce Gerding Addresses Aerospace & Defense Industry Suppliers Conference, May 4.
18. Loren B. Thompson, 2010. Remarks to the BB&T Capital Markets Defense
Teleconference, June 22.
19. Northrop Grumman Corporation, 2009. Form 10-K, March 11, p. 45.
20. Karen Nelson, 2010. Northrop Picks Name, Leader for Company It May
Spin Off, www.sunherald.com, November 24.
21. Federal Reserve Bank, 2010. Open Market Committee, November 3.
22. John D. McKinnon, Corey Boles, & Martin Vaughan, 2010. Deficit Panel
Pushes Cuts, Wall Street Journal, November 11: A1.

SWOT Analysis and the Three Strategic Questions

79

23. Standard & Poors, 2010. Industry SurveysAerospace & Defense, February 11.
24. Loren B. Thompson, 2010. Remarks to the BB&T Capital Markets Defense
Teleconference, June 22.
25. Nathan Hodge & Julian E. Barnes, 2011. Pentagon Faces the Knife. Wall
Street Journal. January 7: A1.
26. Jeremy Page, 2011. Test Flight Signals Jet Has Reached New Stage,
Wall Street Journal, January 12: A10.
27. Jeremy Page & Julian E. Barnes, 2011. Test Flight Upstages Gates, Hu, Wall
Street Journal, January 12: A1.
28. J. B. Gib Godwin, 2009. J. B. Gib Godwin Addresses AFCEA TechNet
Asia-Pacific on Cyber-Security, November.
29. Linda Mills, 2009. Linda Mills Addresses the National Press Club on Cyber
Security, July.
30. Richard A. Clarke & Robert K. Knake, 2010. Cyber War: The Next Threat to
National Security and What to Do About It. New York: HarperCollins Publishers.
31. Reuters, 2009. Northrop Grumman Launches Cyber Defense Team, December 2.
32. Linda Mills, 2009. Linda Mills Addresses the National Press Club on Cyber
Security, July.
33. Standard & Poors, 2010. Industry SurveysAerospace & Defense, February 11.
34. Editorial, 2011. Flying the GE Skies, Wall Street Journal, January 7: A1.
35. Eric Beinhocker, Ian Davis, & Lenn Mendonca, 2009. The 10 Trends You
Have to Watch, Harvard Business Review, July-August, 5560.
36. Wes Bush, 2006. Wes Bush at the Strategic Space and Defense 2006 Conference, October 11.
37. Keith D. Robbins & John A. Pearce II, 1992. Turnaround: Retrenchment and
Recovery. Strategic Management Journal, 13: 287309.
38. John A. Pearce II & Keith D. Robbins, 1994. Retrenchment Remains the
Foundation of Business Turnaround. Strategic Management Journal, 15: 40717.
39. Michael E. Porter, 1980. Competitive Strategy: Techniques for Analyzing Industries and Competitors. Cambridge, MA: Harvard University Press.
40. Michael E. Porter, 2008. The Five Competitive Forces that Shape Strategy,
Harvard Business Review, January, 7993.
41. Tom Hinthorne, 1994. Evaluating Business Practices: Linking Purpose,
Practice and People, Industrial Management, 36(4): 57.
42. Loren B. Thompson, 2010. Remarks to the BB&T Capital Markets Defense
Teleconference, June 22.
43. Standard & Poors, 2010. Industry SurveysAerospace & Defense, February 11.
44. Strategic Discourse, 2010. Comments by Boeings Dennis Muilenburg Indicate Massive Defense Merger, September 12.
45. Michael E. Porter, 1985. Competitive Advantage: Creating and Sustaining Superior Performance, Cambridge, MA: Harvard University Press.
46. Loren B. Thompson, 2010. Remarks to the BB&T Capital Markets Defense
Teleconference, June 22. Thompson was citing the research of Ron Epstein at Merrill Lynch.

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47. Wes Bush, President and Chief Operating Officer, Northrop Grumman Corporation, 2009. Wes Bush Addresses the Wharton Aerospace Forum, February 6.
48. Grant Gross, 2009. Northrop Grumman Launches Cybersecurity Research
Group, IDG News, December 1.
49. Edward R. Freeman, 1984. Strategic Management: A Stakeholder Approach.
Boston: Ballinger.
50. Edward R. Freeman, 1994. The Politics of Stakeholder Theory: Some Future
Directions. Business Ethics Quarterly, 4: 40921.
51. R. K. Mitchell, B.R. Agle, & D. J. Wood, 1997. Toward a Theory of Stakeholder Identification and Salience: Defining the Principle of Who and What Really
Counts, Academy of Management Review, 22(4): 85386: 95.
52. Tom Hinthorne, 1996. Predatory Capitalism, Pragmatism, and Legal Positivism in the Airlines Industry, Strategic Management Journal, 17: 25170.
53. Muzafer Sherif, 1958. Superordinate Goals in the Reduction of Intergroup
Conflict, American Journal of Sociology, 63(4): 34956.
54. J. M. Wondolleck & S. L. Yaffee, 2000. Making Collaboration Work: Lessons
from Innovation in Natural Resource Management. Washington, DC: Island Press.
55. Tom Hinthorne & Patricia Holman, 2009. Wildfire Protection: Conflict in
the Bitterroot National Forest, Case Research Journal, 29(1): 4761, Winter.
56. Jay B. Barney, 2011. Gaining and Sustaining Competitive Advantage. Upper
Saddle River, NJ: Prentice Hall.
57. Michael E. Porter, 1985. Competitive Advantage: Creating and Sustaining Superior Performance, Cambridge, MA: Harvard University Press.
58. Thomas L. Wheelen & David Hunger, 2010. Concepts in Strategic Management and Business Policy: Achieving Sustainability, 12th Edition. Upper Saddle River,
NJ: Prentice Hall.
59. Jay B. Barney, 2011. Gaining and Sustaining Competitive Advantage. Upper
Saddle River, NJ: Prentice Hall.
60. Robert F. Brammer, Vice President and CTO, Northrop Grumman Information Systems, 2010. 2010 MIT Europe Conference, Brussels, Belgium, October 13.
61. Ken Beedle, Northrop Grumman Corporation, 2010. PRNewswire, London, October 22.
62. Wes Bush, President and Chief Operating Officer, Northrop Grumman Corporation, 2009. Wes Bush Addresses the Wharton Aerospace Forum, February 6.
63. Edward R. Freeman, 1984. Strategic Management: A Stakeholder Approach.
Boston: Ballinger.

Part II

The Strategic Environment

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Chapter 4

The Economy, the Government,


and Managerial Decision Making
R. Scott Harris

INTRODUCTION
This chapter originally was titled The Economy and Managerial Decisions. The emphasis and bulk of the discussion would have been
on how managerial decisions are impacted by various free market
phenomena. Many such discussions tend to offer general advice and
warnings centered around various macroeconomic indicatorssuch
as interest rates, inflation, unemployment, etc. They sound erudite but
usually prove to be pretty useless where the rubber hits the road. For
example, the national and even local unemployment rates are of little
help to the personnel managers who are having a difficult time filling
positions with qualified workers. Likewise decisions to resize are in response to many factors that are idiosyncratic to a firms particular products and relevant micromarkets and often are totally independent of
national trends. Sure, there is a correlation: in bad times, more firms will
be downsizing. But the point is that there will be some firmsperhaps
even a sizable minoritythat will have expansion opportunities and
generalized advice based on economy-wide macrotrends will be wrong
for them. Even if the macrovariables seem relevant, the specifics of ones

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circumstances usually are critical in determining how and the extent to


which a business unit should react.
Giving advice that must be applied in specific ways from the distance and comfort of the professorial chair is both presumptuous and
rather arrogant, if not insulting to the knowledge of those who are in the
trenches of business and industry making the hard, bottom-line, day-today choices that will affect the lives and choices of workers, suppliers,
and customers in untold numbers of ways. At first blush, it may seem
that I am merely reiterating the old stereotypical differences between the
ivy tower and practicality that have given rise to such unhelpful truths
as that may work in theory, but it doesnt work in the real world.1
The stereotype is rooted in a misunderstanding of the fundamental differences in types of knowledge that must be employed in making any
decision. Each place, the academy and the workplace, has different but
crucial contributions to make that managers need to recognize.
TYPES OF KNOWLEDGE: A USEFUL TAXONOMY
Nobel Laureate Friedrich von Hayek astutely categorized types of
knowledge as being scientific or of specific time and place.2 The category labels require brief explanation. Scientific knowledge is general
knowledge that has universal application. An easy example would be
the law of gravity and its consequencesdefinitely scientific. Other
examples are less stereotypically scientific, such as the knowledge of
knowing how to type using a QWERTY keyboard, or the knowledge of
double-entry bookkeeping, or knowledge of the relationships between
elasticity of demand and marginal revenue, or knowledge of inventory
models, or knowledge of the psychology of colors, etc. Though emanating from many branches of the traditional classifications of knowledge by subject matter, and ranging from the very general to the highly
refined, all these fall into the category of Hayeks scientific knowledge. They have several important commonalties: they are in and of
themselves nonspecific, but useful in many diverse specific applications. They are the types of knowledge that are commonly taught in
schools. We discuss gravity in physics courses, double-entry accounting in accounting courses, learn to type in typing (or keyboarding)
classes, etc.
There are many useful things that we cannot teach in schools. Those
often fall into Hayeks other type of knowledge category, the knowledge of specific time and place. This is the knowledge that one gains
through intimacy with ones immediate surroundings. Though it
often is the case, immediate need not always be thought of in a physical or spatial sense. Immediacy is more an idea of knowing the specific
things that are important factors to take into account as one applies

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85

the more general scientific knowledge. One may have graduated from
the most prestigious of universities, but the degree will be of little value
if it cannot be usedand its use invariably will require good specific
knowledge of time and place. I still remember as a youth coming home
to tell my dad that I had learned in my foreign language class that Castilian Spanish is spoken with a lisp compared to Mexican Spanish. Dad
was unimpressed. He was concerned that, were I ever to visit a Spanish
speaking country, I would be able to ask someone where the bathroom
is. Much later, I made the acquaintance of a gentleman who was the
president of a multistate supermarket chain. After earning an MBA from
a top-tier school, his first job was stocking shelves in an urban grocery
store. Though the MBA program provided a great depth of scientific
knowledge, it could only be applied after he learned the grocery business literally by starting at the bottom throwing cans on the night shift.
What should be apparent is that both forms of knowledge that were described by Hayek are crucial to good decision making; neither can be
said to be more or less important than the other.
My purpose in bringing this up is to recognize that each manager
must possess both types of knowledge and that across the economy, the
specific knowledge that will be employed is so diverse, specific, and
sometimes multifaceted and complex that what works for one will almost certainly not work (or at least work as well) for another. So, a chapter of cookie-cutter advice would be of little help if indeed we were truly
looking at the impact of macroeconomic variables on specific managerial decisions.
FREE MARKET MACROECONOMICSALL YOU
REALLY NEED TO KNOW IN 30 SECONDS
An often overlooked fact of pure free market behavior only adds fodder to my contention that there would be little of particular use for me
to say in a discussion of markets and management. Markets have an
uncanny and nasty habit of doing things that were not expected or anticipated; it would be the likely case that almost anything I say would
be shallow or simply moot. The whole idea of market risk is a direct
acknowledgement of this. People are innovative, and innovation, by
definition, is outside of the box and hence does not yield predictable
results. Entrepreneurship, the acceleration of technological achievements, and the resulting advances in communication and the spread of
all forms of knowledge create a soup of unknown digestibility. Things
are changing, and what those changes portend make our future both exciting and risky. So, if I were to focus on our economy as a free market,
it would be proper to end this chapter here with a salute and a heartfelt
earnest set of best wishes on your ongoing voyage.

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A CHANGE OF PARADIGM
Fortunately for me, the critical assumption in the foregoing discussion
is false: the economy within which managerial decisions are and will be
made is becoming less and less legitimately characterized as a free market. Recognizing the fact that government is playing an ever-increasing
role in the economy changes the paradigm in significant ways. Unfortunately it is predictable that the expansion of governments activity in the
economy will yield a whole new slew of unintended consequences that
will both increase risk and decrease overall productivity and the wellbeing of our citizens. But it also presents new opportunities for those
savvy enough to identify how the game is fundamentally changing and
act accordingly. Therefore, the bulk of this chapter will be devoted to the
topic of The Economy, the Government, and Managerial Decision Making. Discussion of the ramifications of the addition of the two words,
the government into the title could fill up several books the size of this
one. So, it will fall on me to highlight just some of the implications. That
hopefully will allow me to be general in a meaningful way so that the
reader hopefully will be able to readily apply their own knowledge of
time and place to determine their own best courses of action.

The Myth of Free Market U.S. Capitalism


The first lesson is that we recognize that the U.S. economy is not
and never has been a true free market economy. In his 1963 book, The
Triumph of Conservatism, about the so-called called Progressive Era
at the beginning of the 20th century, historian Gabriel Kolko wrote,
[T]he answer is that the federal government was always involved in the
economy is various crucial ways, and that laissez faire never existed. . . .
This has been known to historians for decades, and need not be belabored.3 This fact may be well known, yet it most decidedly needs to be
belabored as it is conveniently ignored all too often in public discourse.
Whenever any Tom, Dick, or Mary runs for public office, increasingly
there are identified economic issues where something is claimed to be
amiss with our free market economy. Having erected such a straw
man, the inevitable fix proposed by the political wannabes will be
more government oversight, regulation, or outright management of the
offending businesses. So pervasive is the faith that ours is an imperfect
but free market system that it is almost never suggested that the offensive behavior could be the result (intended or not) of government intervention itself in the marketplace. And, in those rare instances when
blame is laid on the governments doorstep, the solution offered is to
change or increase government involvement rather than to examine it
for being the fundamental source of the problem. The continued duplicity, complicity and imperfection of the free market is implicitly

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assumed as an article of faith; the only mistake those who subscribe to


that faith made was that they didnt get the proper amount of government intervention right the first time. Politicians do not get elected on
the mea culpa platform.
Some may point out that even in the best of all worlds, there is a legitimate role for government to play in the economy. In its simplest form,
the government role would be to set the ground rules and be an impartial referee of last resort in the economy, but otherwise let the chips fall
where they may. There would seemingly be a role for the government in
granting and enforcing copyrights and patents. Then there would be a
role in dealing with natural monopolies and the provision of public
goods. All of these are generally accepted as proper roles of government in the economy. My argument is not whether these are proper or
improper, but rather that the government unmistakably is involved in
the economy. That is a fact. Further, it is a fact that the involvement
of the government in the economy has consequences that are often far
from the intent of the involvement. Even the most traditional roles we
have assigned to government are not untainted. For example, many
claim that copyright and patent protection is needed to encourage innovation and growth by protecting intellectual property. Actually the
example of copyright and patents provides several interesting lessons
to which we will turn later. However, now it is sufficient that we understand that government is not a neutral benign, staid, and static arbiter in
the economic affairs of the nation. Rather, it is an alternative stage where
managers must have a presencewhether they like it or not.
Lessons from Microsoft and History
Microsoft Corporation is a place of legends. Harvard dropout Bill
Gates and his cohorts parlayed their passion for computer programming, a lot of hard work, a fortuitous misstep by IBM, and a little luck
into the worlds largest software producer. They made wealth the oldfashioned way: they produced something of value, took it to market,
and the market responded. As Microsoft grew, so did the scrutiny of
their business practices not just from competitors and the press, but
also from government regulators. In 1990, the Federal Trade Commission started an investigation into the relationship between Microsoft and
IBM Corporation.4 Things simmered along for a few years with no huge
push from regulators. The earlier issue ended in a consent decree and
there was a Justice Department denial of a proposed acquisition (Intuit
Corp.), but other than those and similar bumps in the road, the company focused on its core competencies and strove to stay ahead of its
competition in the marketplace. Then, in 1997, the Department of Justice initiated full-blown antitrust proceedings against Microsoft. In 2000,
it was found guilty and the order was issued to break Microsoft into

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two companies. Though the breakup order was reversed on appeal and
eventually things got settled by late 2002, the cost of defending themselves was huge. Further, it never was clear that Microsoft had done
anything wrong other than try to compete in the marketplace by building a better mousetrap (or, in this case, software). Professor Ben Klein
of UCLA carefully analyzed all of the charges and arguments against
Microsoft and was able to demonstrate that virtually all of Microsofts
alleged missteps were perfectly consistent with competitive behavior.5
What is interesting about this Microsoft example is not what went on
in the trial, but rather something else. The Center for Responsive Politics was founded in 1983 by two U.S. senators with the goal of tracking money in politics and [showing] its effect on elections and public
policy.6 The center publishes its information on its OpenSecrets.org
Website. Its information on the political contributions of Microsoft Corporation includes the following:
Prior to 1998, the company and its employees gave virtually nothing in terms of political contributions. But when the Justice Department launched an antitrust investigation into the companys
marketing of its popular Windows software, things changed. The
company opened a Washington lobbying office, founded a political
action committee and soon became one of the most generous political givers in the country.7
Microsofts political contributions in 1990 were a grand total of
$3,800, divided among five candidates, all but one of whom were part
of the Washington state congressional delegation. That grew to a total
of $251,474 for the 1996 election cycle. Then in 1998, the amount jumped
to $1,366,821 and hit $4,628,893 in 2000! Amounts have ranged from
$2 million to over $4 million in each two-year election cycle since 2000.8
In addition, lobbying efforts, which had been limited prior to 1998,
jumped to almost $4 million in 1998 and hovered between $8.5 and
$9.5 million each year from 2003 through 2008. In 2009 and 2010, the lobbying expenditure hovered between $6.7 and $6.9 million (presumably
due to the recession).9
The coincidental occurrence of the Justice Departments antitrust lawsuit and Microsofts decision to enter the political fray is telling. Some
(who choose not to speak for attribution) opine that the Justice Department suit was a wake-up call to the company for not paying proper attention to rendering unto Caesar. Whatever the reason, one thing is
clear: Microsoft discovered that its success depended on both how it
competed in the marketplace as well as how it competed in the political
arena. In contrast to how Microsoft cofounder Bill Gates is managing his
personal fortune, the corporate entity Microsoft is not (and never was)

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89

in business to spend millions on charity or goodwill. Those lobbying efforts are at a very minimum designed to fend off challenges that emanate from politically inspired changes in the ground rules. More likely
would be the situation where Microsoft has discovered that it sometimes
can be easier to beat the competition through political means than it is to
meet them head on in the marketplace.
The art of using government to mold the playing field in ones favor
is nothing new and is quite ubiquitous. A visit to a hearing of a local
government board that is deciding whether or not to grant a liquor license often reveals that those speaking most fervently against approval
are those who have been lined up and orchestrated by someone who already holds a liquor license and would face additional competition if the
new license were approved. In Billings, Montana, each of the two hospitals separately and independently saw fit to petition the city to abandon a block of city street so the hospitals could expand. Each hospital
wished to acquire a separate block (three blocks apart) of the same street
that would primarily adversely impact access to their own emergency
rooms. But at the hearings, each hospital rose in opposition to allowing
the other to acquire the rights to the street because of claimed blockage
of access to their emergency room three blocks away.
Federal regulatory agencies were set up to regulate business activity,
often at the behest of and with the cooperation of the very businesses
they were destined to regulate. For example, the Interstate Commerce
Commission originated because competition had an uncanny way of
destroying the railroads attempts to cartelize the industry, resulting in
pricing and pooling agreements that were highly instable and unpredictable. Although customers found this volatility to be disconcerting,
the railroads were apoplectic. Fortunately, they found sympathizers in
the halls of Congress who not only crafted stability in the form of the Interstate Commerce Commission, but then also have effectively shielded
the industry from the provisions of the Sherman Antitrust Act.10 To be
effective in their charge of regulating the railroads, the commission
needed to have intimate knowledge of the operation of railroadsnot
at the abstract level, but at the nitty-gritty level; the specific time and
place type of knowledge mentioned earlier. Accordingly, they put the
proverbial fox in charge of the henhouse in what turned out to be a magnificent opportunity for the railroads to use the government as a vehicle
to further their own ends. This phenomenon is so well known and often
repeated that it is commonly referred to as the capture theory of regulation, wherein the companies that are subject to regulation capture the
regulatory body to work on their behalf.
In a rare instance of deregulation, the foxes didnt guard the henhouse adequately. The Civil Aeronautics Board (CAB) was dissolved in
the later 1970s and interstate passenger air carriers were cut adrift from

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the agency and its predecessors that had effectively cartelized them
since the 1930s. So effective was the CAB at protecting those whose job
it was to regulate that during the entire time the CAB existed, no new
interstate airlines entered the business in the United States. So, when
Cornell University Professor Alfred Kahn was appointed by President
Carter to head the CAB, a great deal of complacency about how to compete in the marketplace was pervasive in the industry. Those few airlines that had come into existence while the CAB reigned avoided CAB
oversight by restricting their routes to intrastate flights entirely within
California or Texas, the only states large enough and populous enough
to sustain an airline. Kahn was well aware that the unregulated intrastate airlines offered fares at a fraction of the prices that were regulated
by the CAB. The author recalls ads for Pacific Southwest Airlines (PSA)
that offered one-way fares between San Francisco and Los Angeles for
$12.50, whereas fares for the same interstate distance between New York
and Boston were several times the price. Further, the intrastate carriers
were generally reporting profits, whereas the cartelized interstate carriers struggled. Kahns push to abolish the CAB fare structure and ultimately the agency itself thrust the interstate carriers into a completely
new competitive paradigmthe marketplace.
The transition for most airlines was painful. Many, Eastern, Western,
and Pan American, to name a few, did not survive. All found the challenges of upstart newcomers or old intrastate carriers such as Southwest
who now could expand into the interstate market to be formidable. At
least one of the old guard airlines returned to familiar territory where
they maintained a competitive advantage, the halls of the Capitol in
Washington, D.C., where they could engage in aggressive lobbying. This
was important to Dallas-based American Airlines, because it was particularly vulnerable to Southwest who was using nearby Love Field as its
base of operations. Likewise, supporters of the new Dallas/Fort Worth
(DFW) international airport were chagrined that Southwest had successfully sued to stay and compete with them from Love Field, an airport
that DFW had supposedly replaced for commercial flights. The type and
extent of lobbying and by whom will never be truly known, but we do
know that the then majority leader of the U.S. House of Representatives
(and future Speaker of the House) Jim Wright, a congressman from Fort
Worth, Texas, inserted an amendment to the International Air Transportation Act of 1979. The act was passed by both houses of Congress as
amended and was signed into law. The amendment, infamously known
as the Wright Amendment, had virtually nothing to do with international air transportation; its sole purpose was to alter the ground rules
by which Southwest (and Love Field) could compete with the airlines
operating out of DFW. It did so by restricting Southwests normal interstate flights from Love Field to states contiguous to Texas: Oklahoma,

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Arkansas, Louisiana, and New Mexico. It did allow for interstate flights
to other states but only if done on commuter aircraft with a maximum
capacity of 56 passengers. Later amendments to various bills expanded
the allowable states to which nonstop flights could be made. In 2006,
the Congress passed the Wright Amendment Reform Act of 2006 that
would phase out the restrictions by 2014.11
These examples are diverse yet consistent in showing the degree to
which government affects competitive outcomes. I reiterate: It is simply
not enough to do your best at outperforming your competition in the
marketplace (as Microsoft almost found out the hard way); you must always be cognizant of both opportunities and threats that come from the
regulatory and legislative processes. To do so, you must be well versed
in the way governmental regulatory and legislative processes work and
try to stay as far ahead of the competition in that game as possible. It
takes considerable resources. The small businessperson must be willing to log in nights at local government hearings to get to know the
ropes. Managers of larger companies need to have eyes and ears in local,
county, and state halls of government, and often at the federal level.
If nothing else opens your eyes to the importance of having skin in the
game at the governmental level, try this: since 1998 the annual spending
on lobbying at the federal level alone has increased from $1.44 billion
(with a b!) to $3.47 billion in 2010. Those who spend that kind of money
consider it an investment; they wouldnt spend it if they didnt think it
was worth it. And, if you still are not convinced, consider the process
of how many of the recent important laws came to be enacted. Senate
and House staffers are generally young; they do not have the expertise
or the knowledge of time and place necessary to craft the mountains
of legislation that come out of Washington, so they have to rely on others whose presence is strategically orchestrated by lobbyists to be in the
right place and just the right time. I recall a viral YouTube video that was
released at the height of the debate over the health-care bill.12 It showed
a town hall meeting with Senator Arlen Specter and Health and Human
Services Secretary Kathleen Sebelius. In it Senator Specter basically admitted that he might not have time to learn the written details of even
the most important bills that he was going to vote on. That admission
is telling in several ways: If the health-care bill was over 1,000 pages in
length and was so quickly cobbled together that those who voted on it
did not have time to read itlet alone understand its far-reaching implicationswho did we entrust to write and approve of the bill? We are
told that the insurance companies were frozen out of the final bill, but
I wouldnt take either that bet or one that denies that the pharmaceutical companies and the AMA or the American Hospital Association had
significant influence in crafting the final bill. Perhaps that explains why
a record amount of money was spent on lobbying that yearthe year

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following the election of a President who promised to bring transparency to government.


At this point you may be forgiven if you think I am belaboring this
point, but the facts are that the importance of keeping close watch on and
being prepared to influence government decision makers is not something business schools prepare managers for. Sure, we teach courses that
acknowledge that we all must comply with various regulatory and legal
constraints, but usually that environment is presented as static, when we
know that nothing could be further from the truth. Government involvement in the economy is becoming increasingly fluid and those who understand the dynamics of the processes by which regulations and laws
are formed will have a dramatic advantage over those who sit on the
sidelines and react. If business schools really mean what they say about
training tomorrows managers for the challenges they will face, we need
to develop meaningful courses in how governmental actions are formulated, rendered, and administered. A former colleague (who will remain
nameless) took a stab at creating such a course in an MBA program a
few years ago. He took the students to Washington, D.C., and divided
them into teams, each one of which would pass the course only if they
were successful in getting a specific piece of (usually trivial) legislation
of their making introduced and enacted into law with the Presidents
signature. Time was shortonly one semesterbut during that time
the students had to get their bills introduced and manage their passage
through committees and both houses of Congress. There was only one
rule: students were absolutely forbidden to let anyone know that they
were doing it for a class project.
With the major exception of the dismantlement of the CAB in the
1970s and incidental adjustments such as the Wright Amendment Reform Act of 2006, the general trend over the years has been for the influence of government to become increasingly larger factors in managerial
decisions. Until quite recently, most of the action was still practiced at
the microlevel with earmarks and specific lines in legislation inserted
to benefit specific interests either through grants, subsidies, or tilting
the playing field in favor of someone (and against someone else). A few
years ago, that changed.
THE GAME IS CHANGINGNOW
In 2004, economists Harold Cole and Lee Ohanian published an article in the prestigious Journal of Political Economy13 that was lauded by
Nobel Laureate Robert E. Lucas Jr. as exciting and valuable research
that recast our understanding of the Great Depression of the 1930s.14
The exercise was not just academic because understanding the past
hopefully will enable us to avoid making the same mistakes again. A
significant finding of the research was summarized by Professor Cole:

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The fact that the Depression dragged on for years convinced generations of economists and policy-makers that capitalism could not
be trusted to recover from depressions and that significant government intervention was required to achieve good outcomes. Ironically, our work shows that the recovery would have been very
rapid had the government not intervened.15
Fast forward to 2008: As a result of years of arm twisting from Capitol
Hill and various occupants of the White House to make housing affordable, banks and mortgage brokers who caved to the political pressure
found themselves in a bit of a pinch. The house of cards that had underpinned their success to datenamely, a shortsighted faith in continued appreciation of housing valueswas starting to collapse. It started
with the subprime mortgage market. But rather than recognizing this
for what it truly was, namely, a pool of mortgages that constituted about
15 percent of total mortgages where only 20 percent were in serious payment arrears (more than three or four months behind in payments), the
Chicken Littles put this together with a few other bad decisions by
some large companies and sounded the alarm. Three to four percent of
the mortgage market that was concentrated in the highest-risk group
would normally not seem to constitute a crisis worth summoning the
financial equivalent of the horse cavalry, but the call went out for the
entire army, navy, air force, and marines. From a macroeconomic standpoint, this was a mere blip in the economy, but none of that matters if
your company has a lot of wealth tied up in that particular blip. And, if
your company has a lot of political clout and friends in high places, well,
you know what happened.
A few years prior, the seventh-largest company in the United States,
Enron, had imploded and had been allowed to fail. Now, the worry
was that there might be some more failures. Indeed, some did pay the
priceIndymac Bank, Bear Stearns, and Lehman Brothersbut others,
still standing, albeit with their pants down around their ankles, made
the desperate call to be saved from their past missteps. Lets face it: too
many of these strategically placed folks had abandoned good management practices and basic common sense and succumbed to the allure of
questionable accounting practices and flimflam leveraging in their appeasement of pressure from Capitol Hill to make housing affordable and
in their ubiquitous quest to make a quick buck. They had been caught.
And they knew the market would render summary judgment and mete
out uncompromising punishment. They knew that there were longestablished and robust institutions in place to deal with them. Takeovers
of depreciated assets by others occur all the time subsequent to bad decisions or bad luck. Failing that, bankruptcy laws have evolved over decades to handle these situations in an orderly but predicable way that
minimizes the impact on the rest of the economy. There simply was no

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good reason from a macroeconomic point of view at that time for anyone
to panic;16 those who were panicking were trying to save their own skins
and had a vastly inflated view of their importance in the overall scheme
of the economy, and they found friends in the highest places.
Once Treasury Secretary Paulson got on board, President Bush was
not far behind. Both chorused the sky is falling refrain and promised
swift remedies. Now, most of us were on the outside looking in. Those
at the highest levels of government were clearly panicking. Some possibly believed that the crisis was indeed severe and that we were on the
brink. Others, in a cynical power grab went to great lengths to recast
their past complicity in overtly pressuring lenders to issue risky mortgages and tried to pin all of the blame on free markets. The cacophony
from the banks of the Potomac was heard across the country, and folks
rightfully grew uneasy. People reacted rationally by battening down the
hatches and preparing for the rainy day. Large purchase decisions were
delayed, spending was curtailed. Banks and lenders normally would adjust and tighten lending procedures, but the noises from Washington,
D.C., on how the government would react to all of this were ones nobody had heard before. That added even more uncertainty to the mix
and the credit markets rationally decided to put decisions on hold until
they could figure out what was going to happen. That signal was generally misinterpreted as further evidence that the economy was on the
brink, resulting in still more panicand a recession was born. Basically
the recession was caused by policy makers who possess the lethal combination of ignorance regarding the overall and strategically complex
ways that markets work, combined with unflagging egos that they alone
know how to make things right. It helps that in the process they are saving their own hides.
All of the political processes that fell out from the subprime mortgage blip couldnt have been better orchestrated to produce a new phenomenon: bailouts taken to heretofore unimaginable heights. As if it
were some new special technological breakthrough, too big to fail
has now become the standard. Bank and auto company executives invoked it while ignoring their own miscalculations or even misdeeds.
In a supreme gesture of disdain for the pain others were suffering as a
consequence of their errors in judgment, they flew in corporate jets to
Washington, D.C., to claim their indulgences.
As this is being written, the administration is, naturally, playing up
the good news that they can claim for their interventionist actions while
downplaying or ignoring those that didnt work out so well. The emphasis seems to be on when General Motors will pay us back and whether
the government (aka, the taxpayers for publicity purposes) will actually make a profit. The same goes for the banks. So far, there hasnt
been much said about how the taxpayer has fared with Freddie Mac and

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Fannie Mae. From an economic point of view, this is all nice, but it truly
ignores the long-lasting legacy from the bailout precedent. Nobody has
enunciated this legacy better than Neil Barofsky, the man the Obama
administration named to be the special inspector general of the famous
Troubled Asset Relief Program (TARP). On January 27, 2011, Mr. Barofsky was interviewed by Steve Inskeep on National Public Radios (NPR)
Morning Edition. The following is excerpted from that interview:
Inskeep: Lets talk about whether the problem has been fixed,
here. Why have you been saying that more bank bailouts are more or less inevitable?
Mr. Barofsky: Well, its not just me saying it. It was really information that was provided to us by Secretary Geithner
in an interview that we did with him in December
with respect to a recent audit. And the problem is
that the notion of too big to failthese large financial institutions that were just too big to allow them
to go undersince the 2008 bailouts, theyve only
gotten bigger and bigger, more concentrated, larger
in size. And whats really discouraging is that if you
look at how the market treats them, it treats them as
if theyre going to get a government bailout, which destroys market discipline and really puts us in a very dangerous place.
Inskeep: Let me make sure I understand what youre saying.
Youre saying that credit rating agencies and investors, when they look at the risk of investing in a bank,
they say, well, they can do whatever they want because the government will bail them out. Thats what
you think?
Mr. Barofsky: Exactly. And its not just what I think. Recently, just
this past month, S&P, one of the largest of the rating agencies, did something remarkable. They said
that theyre intending to change their rating methodology to make it a permanent assumption that the government will bailout the largest institutions, give those
banks higher ratings. Which means theyre going
to be able to borrow money more cheaply. Theyre
going to be able to access credit and capital and debt
more easily.17
In a later interview on February 18, 2011, with NPRs Chris Arnold, Mr.
Barofsky indicated that the TARP program, which was originally designed

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in part to help between 3 and 4 million people stay in their homes by


avoiding foreclosure, has only reached about 500,000 people and that
many people are being rejected for the wrong reasons . . . [because] the
government didnt put the right incentives in place to really bring the
banks on board.18
Not only is this bailout not meeting its intended purpose, it is also
setting a huge precedent that the market is already adjusting for. On
one hand, it raises the expectations that too big to fail businesses will
be exempt from the discipline of market forces, allowing them to take
bigger risks and act with greater impunity toward their stakeholders.
On the other hand, it portends an increasing substitution of government
regulation for the discipline that would otherwise be meted out by the
market. There are two aspects to regulation that need to be understood:
(1) Regulation by government oversight is a much more expensive proposition than regulation in the marketplace. Taxpayers foot the bill to
(supposedly) keep businesses in line while preventing them from failing; no such burden is borne when the discipline of the markets force a
business into insolvency and failure. (2) Regulators, if they are not captured by industry as discussed earlier, are necessarily outsiders. They
will never be privy to the degree of knowledge of time and place concerning the everyday operations of those they are charged to regulate.
In the vast majority of instances, meaningful decisions are made where
the rubber hits the road and those often are very specialized decisions
made in response to very specialized knowledge of time and place. In
that environment, regulators are pushing the proverbial strings uphill.
Things will slip through the cracks (like several million people whose
mortgages are being foreclosed!). Inefficiencies will occur as businesses
expend resources to get around regulations or avoid their consequences.
And, on the bottom line, taxpayers will pay for it.
The lesson for managers is one of peril, especially those who are not
Washington insiders or who are small potatoes; in other words,
most of us. You will not only experience increased demands for complying with new regulations, and in dealing with regulatory oversight from
people who often will have no clue about the special circumstances you
face in your business environment, you will also have to adjust how you
interface with other businesses, especially those deemed too big to fail.
Doubtless a new equilibrium will be found, but it will be a frustrating
one. Products that before would have been valuable to customers but
marginally profitable for you will become unprofitable as you absorb increased overhead when your costs of regulatory compliance increase. To
become nimbler at responding to the increase in unpredictability associated with heretofore uncharted expansion of government in the economy, long-term decision processes will be abandoned in favor of a less
efficient series of short-term decisions, as the business and regulatory

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environment becomes riskier. In sum, look for managers plates to have


more heaped on them while given fewer resources with which to respond. Doing the groundwork now that will allow for rapid adjustment,
and understanding of the new operating environment and what it portends will allow most astute managers to prepare. In this changing environment, it is imperative that you reassess and understand where the
threats (and any opportunities) are likely to come from and alter your
strength/weakness profile to best prepare. Be realistic and you will improve your chances of staying ahead of the tsunami.
There is one postscript to this section that I truly hope will not come
to pass, yet fear it may. Over the past several years we have seen an increase in the number of high-profile cases of white collar crime. There
always have been snake oil vendors and opportunists in our midst. On
the frontier and in common law, miscreants of this sort were run out on
the rails or otherwise dealt with on a case-by-case basis. As technology
and communication improved, it became practical and cost effective to
codify increasing numbers of acts that would be considered criminal. As
with most things, there is a point of decreasing returns in writing laws
and establishing regulations. We are told that ignorance of the law is no
defense, but with increasing numbers of laws and regulations, it will
be nigh impossible for managers not to sooner or later find themselves
committing some sort of violationoften that they didnt know about.
This creates a new dimension of liability and risk for managers. Since
laws and regulations are always subject to interpretation, overzealous
regulators could advance their careers by casting very wide nets that entangle managers whose activities are fundamentally blameless, but may
be in technical violation. Although such charged managers are entitled
to their day in court, defending oneself is costly in terms of resources,
time, and ultimately reputation. The chilling effect that this will have on
innovation and thinking outside of the safest boxes will only increase as
regulation multiplies.
FOLLOW THE LEADER? NEW RISKS
IN FOLLOWING OLD RULES
Predictable increases in the number and scope of government mandates and regulations will not only increase the uncertainty that managers will face vis--vis their dealing with government, they will also
make it harder to decipher information that is gleaned from the marketplace. As all managers are well aware, they must constantly make decisions based on information they possess. Much of that information will
fall into the knowledge of time and place category and will be very
specific to the particular circumstances the manager faces. In making
decisions, experience can be of great value. Recall that the experience

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of throwing cans on a night shift served well the president of a grocery


chain. So, too, will the experiences of others serve in predicting your
success or failure in a similar venture. But, since no two decisions can
ever be made under absolutely identical circumstances, the trick is to
know what circumstances encountered in the past or by others are relevant to the decision at hand. Although there are some commonalities
everywhere, the experiences of the manager of a rock quarry are likely
to be less helpful in managing a Mexican restaurant than the experiences
of a manager of a delicatessen.
If more regulations are imposed, the chances increase that some of
those regulations will become critical in making certain decisions. So,
managers will not only have to differentiate between potential variation
in specific market conditions in seeking experiences to guide decisions,
they will also have to additionally decide if the regulatory environment
is similar enough to make a past experience useful. The more regulations
there are, the harder it will be to rely on simple and direct experiences to
guide future decisions. Instead, one will have to identify and control for
all relevant differences in circumstances and make suitable adjustments.
Good decision making will become both costlier and riskier.
Two examples show how the regulatory environment can affect managerial decisions in what otherwise would be considered similar businesses. The first takes us back to the days when the CAB regulated
interstate airline fares. The regulated fare prices were set so high that
airline seat capacity far outstripped the demand to fly. As a consequence
the industry average occupancy rate was right around 50 percent of capacity. In an unregulated market, the affected airlines would have cut
fare prices to compete for customers and thereby enticed a greater number of people to fly. But, they couldnt do that. Instead, they tried to lure
customers through other forms of competition that were not regulated.
They increased the amenities associated with flyingmeals, champagne, leg room, the sex appeal of the cabin attendants, etc., with each
airline not only trying to outdo the others in these established ways, but
they also kept trying to find new and innovative ways to compete that
would get around the controlled fare prices. One of the airlines discovered that purchasing high-end hotels at popular destinations to which
they flew could be helpful. Since the CAB did not control hotel rates,
the airlines found they could effectively lower prices on travel packages by discounting hotel prices to customers who flew on their airlines.
The first airlines that did this experienced a boom in sales, so everyone
else in the industry was forced to do the same or lose out to competitors. Even though airlines were not especially adept at running hotels
the differences in business models were not inconsequentialeven with
less-than-perfect management, the hotel programs became a critical part
of the airlines competitive strategies. Along these same lines, some airlines found it profitable to acquire rent-a-car companies.

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As mentioned earlier, there were a few airlines that operated within


the states of California (PSA and Air California) and Texas (Southwest
Airline) that were not subject to the CAB controls (since the U.S. Constitution only allows the federal government the right to regulate interstate
commerce). These intrastate airlines charged fare prices considerably
below those charged by their interstate brethren and were generally
profitable. Although some paid attention to the amenities that the interstate airlines offered, most discovered that they were unnecessary. Air
California, for example, discovered that it could cut recruiting and training costs of its cabin attendants if it picked up stewardesses (yes, they
were all women at that time!) who had been let go by other airlines because they had grown too old, had gotten married, or otherwise lost
their sex appeal. Folks flying Air California from Orange County (before
it was named John Wayne) airport to San Francisco showed much more
interest in the low fares and good service from experienced cabin attendants than with fantasizing. Since none of the intrastate airlines could
fly long hauls (the flights between Los Angeles and San Francisco took
less than an hour), it did not make sense to offer meals in any case.
It is important to understand that both the intra- and interstate airlines were subject to government regulations. Both groups were subject
to the safety requirements of the FAA, and although interstate airlines
were regulated by the CAB, in California the intrastate airlines were
regulated by the state Public Utilities Commission. So sorting out
what was good for one group and not another was not evidently apparent to the upper management of PSA as they noticed the bottom-line
impact of hotels and car-rental businesses on their competitors. Given
those experiences, PSA dove into the hotel and car-rental businessand
promptly lost a ton of money. The psa-history.org Website describes the
situation:
Back in 1967, PSA started the Fly! Drive! Sleep! campaign. The
goal was to fly people, have them get a PSA rent-a-car, and stay in a
PSA hotelsimilar to Uniteds 1987 Allegis plan. So PSA bought
ValCar rent-a-car from Thrifty. However, PSA was still a commuter
airline, and the traffic base wasnt there to support the ideaValCar
was never profitable, and shuttered in September 1971.
The plan was expanded with hotel purchases. The Islandia in
San Diego, San Franciscan in SFO, Queen Mary Hotel at LGB (Long
Beach service started in 1971), and PSA Hollywood Park hotel were
all acquired or built. Again, the hotels lost money and were leased
to Hyatt in 1974 (later divested). PSAs checkbook was used toward other acquisitions, like 4 radio stations, 2 background music
creation companies, and even a 70-foot long catamaran (catering to
J. Floyd Andrews love of fishing). Two jet leasing firms were created to dispose of PSAs excess aircraft. All of the acquisitions took

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their toll, causing a $16.7 million loss in 1975 (even after most were
disposed of ).19
Even in hindsight, the authors of the history attribute at least part
of the losses to the fact that PSA was a commuter airline, and not to
the fact that the rent-a-car and hotel business gave them no competitive
advantage because, unlike the interstate airlines, their fares were not
kept artificially high. Low hotel and car-rental prices for their customers
could only be losers.
This example shows how important it is when looking to others experiences to understand what differences between you and them are
critical when making specific managerial decisions. With increasingly
selective regulation, it will become progressively difficult to know when
to emulate others successes and when not to.
A second example may be more familiar to you. Federal Express and
United Parcel Service (UPS) are both in the package delivery business.
From many customers standpoints, they are direct competitors. Yet,
their business models are built around very different regulatory environments. UPS is subject to operating under the National Labor Relations Act (NLRA), whereas FedEx works under the aegis of the Railway
Labor Act (RLA). This has an impact on the two companies labor relations strategies in quite different ways. It is much easier for labor to
unionize under the NLRA than it is under the RLA and consequently,
UPS has a more costly labor agreement than does FedEx. Both companies are duking it out in Washington, D.C., with FedEx spending about
$9 million a year in lobbying expenses to protect its interests, whereas
UPS is paying about $5 million a year to lobby the government to level
the playing field.20 It is interesting to note that UPSs efforts appear
more designed to bring down FedEx to their level rather than to lift
themselves to the same level as FedEx.
Though both FedEx and UPS deliver packages on your and my streets,
because one started primarily as a truck deliverer and the other as an
air deliverer, they fall under different regulations. So, regardless of how
similar two companies appear to be in product and structure, one cannot assume that they are treated similarly by the government regulatory
agencies. This is yet another instance where appearances can be deceiving and confusing, especially if they dont seem to make sense.
ALL IS NOT AS IT SEEMS
Patents and copyrights are explicitly addressed in the U.S. Constitution: To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to
their respective Writings and Discoveries.21 The flip side of that is that

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patents and copyrights, by their definition, bestow government enforced monopoly rights upon their holders. As we learn in economics
101, monopoly stifles social-wealth production and transfers wealth
to the monopolist from the rest of society. The stated intent of copyrights and patents is to promote wealth production, but in applying
them, we create institutions that work contrary to that intent. The history of congressional debate and enactments of copyright and patent
law clearly shows there was recognition of the double-sided nature of
the laws.22 Despite the recognition that copyrights and patents grant extended monopoly rights to their holders, it may seem curious that there
was an unchecked trend during the 20th century and culminating with
the Copyright Term Extension Act of 1998 for the term of copyrights to
be extended retroactively. Thus a work copyrighted in 1924 that would
have entered the public domain 56 years later in 1980 under the terms of
the original copyright will continue to enjoy protected monopoly status
until January 1, 2020. Clearly the balance envisioned by the framers of
the constitution when they explicitly called for limiting the monopolistic effects of copyrights and patents is tilting in favor of extending monopoly rights. Although it is conceivable that an argument can be made
that such an extension is warranted in modern times to promote the
progress of science and useful arts, no such argument exists for retroactively extending the monopoly power since the affected items subject to
patent and copyright were already produced under the aegis of the old
laws. The only effect the retroactive coverage of these laws could have
is to further extend monopoly power and perpetuate windfall wealth
transfers to those now fortunate enough to have inherited a copyright.
Novelist Cory Doctorow cites a specific descendant of an author (who
will go unnamed here because of his litigious bent) when he blogged,
The professional descendants making millions off a long-dead writer
have become a serious impediment to living, working writersand
readers. If this isnt the greatest proof that extending copyright in scope
and duration screws living creators and impedes the creation of new
works, I dont know what is.23
The discussion of patents and copyrights brings us to an admonition
for managers. Successful business strategies must take into account all
aspects of government involvement in the economy. Government itself
is old technology characterized through the claim of monopoly rights
to use force and violence.24 The rules by which these monopoly rights are
administered are what separate democracies, republics, dictatorships,
and other manifestations of government. So, in our example, copyrights
and patents are enforced by the government through the threat of fines
and/or incarceration for those who violate the rights of the patent or
copyright holders. It is important to note that those whose wealth is
protected by government-issued and enforced patents and copyrights

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do not pay for that protection; that burden befalls the general taxpayer
who also is likely to be the person paying monopoly tribute to the copyright or patent holder.
Though we will shortly turn to issues involving the benefits of lobbying
government for special considerationin this case the retroactive extension of copyrightsthere is another point that pops out of this example. As
I write this, new technologies are being credited with mobilizing citizens
in the Middle East to demand changes in the old technology of government. Just as electronic and information technology render it more difficult for despots to enforce their will on the people, so too will it become
more difficult for any government to enforce laws that can both easily
be circumvented and are judged to be meritless even by those who impute ethical considerations into their decision making. Cheap and widely
available technology and safe-haven Website locations allow people to circumvent royalty or copyright payments almost at will. Although the governments response of imposing astronomical fines on those it catches and
charges may have some deterrent effect, every governor and police official
knows that laws simply cannot be enforced in the face of general civil disobedienceat least not in a society that generally sees itself as civil and
free. Therefore, it would be wise for managers and businesses that seek
special favors and protection from the government to focus their attention
on the pulse of the public mood and be aware of how far people can be
pushed to comply with edicts.
Examples are all around us of how technology is allowing innovative
people to (often legally) circumvent monopolistic practices resulting from
copyrights and patents. College students who feel the pinch of escalating
costs of education have learned that textbooks are often published in both
U.S. and international editions. The two editions are usually identical in
content, but the U.S. edition typically is a hardback text, whereas the international has a soft cover. The quality of paper in the books may or may
not differ. Pictures and diagrams in the international edition may be in
black and white as opposed to color in the U.S. edition, but not always.
The salient difference is the price of the textbookand with it, the price of
the knowledge it contains. Students have discovered that it is worth their
while to learn what book is being used in a course far enough in advance
so they can order it from foreign mail-order sources. This market has become significant enough that students can occasionally find U.S. mailorder suppliers who make international editions available.
On another domestic front, in an effort to make ethical drugs more
cheaply available to medical patients, folks have learned that drugs that
are pretty pricey in the United States are considerably cheaper in other
countries. Bowing to constituent pressure, some politicians are looking
into the possibility of allowing U.S. residents to purchase drugs from foreign retailers.

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The issues of copyright protection afford a case study in thinking


outside of the box. The old-school mentality would be to pass a law
and enforce it, come hell or high water. In contrast, over the past several years, there has evolved another approach to production. The notion
that copyright protection is necessary to foster inventiveness, growth, and
progress is being challenged by events we are all familiar with. The open
source movement in computer programming and technology has refuted
the argument that copyright protection is necessary to spur innovation.
A few years ago a young author named Cory Doctorow (whom I cited
earlier) decided to publish a book he had written. He put the entire book
online and made it generally available through free downloads. He only
asked readers to honor a Creative Commons license for his book. To
use modern lingo, the book went viral and was subsequently published
on real paper. It spent seven weeks on the New York Times bestseller list
even while it remained as a free download. It is interesting to note that
the book, Little Brother, was written for a young adult audience, precisely
the type of person who could hack a Website or pirate the book at will.
But this is also the type of person who would have been on the frontlines
in Egypt.
Predating and independent of Doctorows act of rebellion, David Levine,
a highly respected economist and now John H. Biggs Distinguished Professor of Economics at Washington University in St. Louis started examining the assumptions behind intellectual property rights, especially those
having to do with patents and copyrights. Along with colleague Michele
Boldrin, Levine critically examined the theoretical underpinnings of intellectual property using the lens of history and as much data as they could
gather. Their findings stunned them because the evidence they found ran
counter to the received wisdom regarding the social-incentive effects of
protecting intellectual property. Going back to the dawn of the Industrial
Revolution, they discovered that patents and copyrights have generally
been used to inhibit progress rather than incentivize it. Having started the
investigation with the same predisposition toward patents and copyrights
as the framers of the constitution, Boldrin and Levine had to completely
rewrite significant portions of their book on the subject as the evidence became increasingly clear. Like Cory Doctorow, they published their book,
Against Intellectual Monopoly, online,25 followed by a hardcover version
published by Cambridge University Press. Ironically the hardback version is copyrighted (presumably at the insistence of the publisher rather
than the authors).
The lesson to be learned is that managers must be nimble and become
aware of the practical limits that technology is placing on the extent to
which traditional government power can be exercised on their behalf. As
we shall now see, this does not mean that government involvement in
the economy will likely be waning in the near future. Far from it. What

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it does mean is that managers must be careful not to get on the wrong
side of uncontrollable civil disobedience. An unenforced law is no law
at all. It also means that there will be new opportunities for managers to
exploit new social trends that open daily as a result of technological innovations. Many of those opportunities will involve disenthralling oneself of the old paradigm of relying on government to protect one from
competition.
CONCLUSION
If there is a theme in this chapter, it is that government involvement in
the economy only serves to lessen confidence and the degree of certainty
that one can have about the success of business outcomes. The admonition is that managers have to be on top of things increasingly in order
to avoid pitfalls and missteps. In a competitive market economy, success is achieved by keeping ahead of your competition. Sure, one can be
blindsided by an unforeseen entrepreneur building the proverbial better mousetrap. But the main focus is on providing customers with better products and service than ones competitors. Adding government to
the mix changes the focus of the manager as well as the modus operandi.
The goals associated with maximizing wealth are largely unchanged,
but the methods of doing so may be profoundly changed. Managers face
options: do they concentrate on outperforming their competition in the
marketplace or do they try to outmaneuver them in the halls of government? And, as we have seen, they have to be aware of the risk that the
government will be a fickle master/servant or that the old benefits from
alliances with government will be rendered moot by advances in technology and/or consumer consciousness.
Postscript
In his farewell address to the nation on January 17, 1961, President
Eisenhower foresaw the dangers we are facing. The speech is most famous for its warning about allowing the military-industrial complex
to acquire too much influence in the halls of government. I leave you
with another excerpt from the address, but invite you to read the speech
in its entirety.
. . . Today, the solitary inventor, tinkering in his shop, has been
overshadowed by task forces of scientists in laboratories and testing fields. In the same fashion, the free university, historically the
fountainhead of free ideas and scientific discovery, has experienced a revolution in the conduct of research. Partly because of
the huge costs involved, a government contract becomes virtually
a substitute for intellectual curiosity. For every old blackboard

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there are now hundreds of new electronic computers. The prospect


of domination of the nations scholars by Federal employment,
project allocations, and the power of money is ever presentand is
gravely to be regarded.
Yet, in holding scientific research and discovery in respect, as
we should, we must also be alert to the equal and opposite danger
that public policy could itself become the captive of a scientifictechnological elite.26
NOTES
1. The test of any theory is whether it works in the real world. If a theory
doesnt add to our understanding of how things work, it is simply a bad theory
that either needs fixing or discarding. Ultimately any prediction must be based
on somethingand that something is, by definition, a theory. So, while the old saw
about theories and the real world sounds nice, in reality it is just a red herring.
2. Friedrich von Hayek, The Use of Knowledge in Society, American Economic Review, 35, No. 4. (1945): pp. 51930. American Economic Association. Available at http://www.econlib.org/library/Essays/hykKnw1.html.
Hayek used his knowledge categories to buttress his thesis that central
economic planning and socialism cannot work because it would be impossible
for a central planner to possess the requisite specific knowledge of time and place
to make good decisions. More recently, professors William Meckling (late; of the
University of Rochester) and Michael Jensen (emeritus at Harvard) extended
Hayeks knowledge taxonomy to apply to business leadership and the various
managerial roles within an organization. So, while Hayeks original purpose was
to discuss macroeconomic policy, Jensen and Meckling have taken the same ideas
and applied them to the microeconomic levels of organizational management.
3. Gabriel Kolko, The Triumph of Conservatism: A Reinterpretation of American
History, 19001916 (London: The Free Press of Glencoe, 1963), 4.
4. This and subsequent timeline information were taken from the U.S. v.
Microsoft: Timeline at http://www.wired.com/techbiz/it/news/2002/11/35212
(accessed February 19, 2011).
5. Benjamin Klein, An Economic Analysis of Microsofts Conduct, Antitrust
(Fall 1999): 3847.
6. http://www.opensecrets.org/about/tour.php (accessed February 19,
2011).
7. http://www.opensecrets.org/orgs/summary.php?id=d000000115 (accessed
February 19, 2011).
8. http://www.opensecrets.org/orgs/totals.php?id=d000000115&cycle=
2000 (accessed February 19, 2011).
9. http://www.opensecrets.org/lobby/clientsum.php?year=2010&lname=M
icrosoft+Corp&id= (accessed February 19, 2011).
10. For a complete history and evaluation of the Interstate Commerce Commission, see George W. Hilton, The Consistency of the Interstate Commerce Act,
Journal of Law and Economics, 9 (October 1966): 87113.
11. The actual text of the Wright Amendment used to be posted on the Southwest Airlines Website but has apparently been taken off following Southwests

106

Strategic Management in the 21st Century

current dtente with DFW and American Airlines and the passage of the Wright
Amendment Reform Act of 2006. The full text of the 2006 act is available at http://
www.gpo.gov/fdsys/pkg/BILLS-109s3661enr/pdf/BILLS-109s3661enr.pdf and
a discussion of the original and reform bills is available at http://rsc.jordan.house.
gov/UploadedFiles/LB_092906_suspensions.pdf starting on page 3 (both Websites accessed on February 19, 2011).
12. http://www.youtube.com/watch?v=J-Bpshk5nX0&NR=1&feature=fvwp
(accessed February 19, 2011).
13. Harold L. Cole and Lee E. Ohanion, New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis, Journal of Political
Economy, 112, No. 4 (August 2004): 779816.
14 . http://newsroom.ucla.edu/portal/ucla/FDR-s-Policies-ProlongedDepression-5409.aspx?RelNum=5409 (accessed February 20, 2011).
15. Ibid.
16. Economist Lee Ohanian explains how the fundamentals of the economy
were still robust in a video interview: http://reason.tv/video/show/585.html
(accessed February 20, 2011).
17 . http://www.npr.org/2011/01/27/133264711/Troubled-Asset-ReliefProgram-Update (accessed February 20, 2011). Italics added.
18 . http://www.npr.org/templates/transcript/transcript.php?storyId=
133839730 (accessed February 20, 2011). Quote is reporter Arnold paraphrasing
Mr. Barofskys response. Barofsky later made this direct response: This is a product of poor program design, of poor oversight by the Treasury Department, or
poor execution of compliance. Treasury designed this program and its failings are
its failings.
19. http://www.psa-history.org/articles/hist.php (accessed February 20,
2011).
20. http://washingtonexaminer.com/op-eds/2009/06/ups-vs-fedex-laborlaw-corporate-weapon (accessed February 20, 2011).
21. U.S. CONST. art. I, 8, cl. 8.
22. For a discussion of the history of copyright and patent legislation, debate, and case law, see Tyler T. Ochoa Patent and copyright term extension
and the Constitution : a historical perspective, Journal of the Copyright Society of the U.S.A., 49 (2001): 19125. Also available at http://homepages.law.
asu.edu/dkarjala/opposingcopyrightextension/constitutionality/OchoaJCSTermExtArt.pdf (accessed February 18, 2011).
23. http://www.boingboing.net/author/cory-doctorow-1/ Blog entry 8:21
AM Fri (February 25, 2010) (accessed February 27, 2011).
24. The founding fathers of the United States recognized this when they
attempted to craft a constitution for the government that restrained the scope
and application of force and violence. The Bill of Rights would otherwise be
unnecessary.
25. http://levine.sscnet.ucla.edu/general/intellectual/againstfinal.htm (accessed February 19, 2011).
26. Dwight D. Eisenhower, Farwell Address, January 17, 1961. Audio and
text available at http://www.americanrhetoric.com/speeches/dwightdeisen
howerfarewell.html (accessed February 27, 2011).

Chapter 5

Navigating the Political Environment


Ronald J. Hrebenar

After all, the chief business of the American people is business.


President Calvin Coolidge, January 17, 1925,
in an address to the United States Press Club,
Washington, D.C.
. . . for years I thought what was good for the country was
good for General Motors and vice versa.
Charles E. Wilson at his 1953 congressional
confirmation hearings to become secretary of
defense in the Eisenhower administration
Money is the mothers milk of politics.
Jessie Unruh, speaker of Californias state assembly
quoted in Time magazine, December 14, 1962
On being a politician dealing with lobbyists. . . . If you cant
eat their food, drink their booze, screw their women and still
vote against them, you have no business being up here.
Jessie Unruh, quoted in Lou Cannons
Ronnie and Jesse: A Political Odyssey. Garden
City, NY: Doubleday, 1969, p. 101.

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U.S. business and government have always existed in a symbiotic relationship. Business needs government to provide the services, policies,
contracts, preferments and, yes, the protection it needs to make the profits necessary to survive and prosper. Government (and more clearly, the
politicians and bureaucrats that run the government) need business for
election support in their political campaigns or for post-politics jobs.
They needed each other in the 1800s, the 1900s and now, especially, in
the 21st century. However, it would be true to note that the need for business to be much involved with governments on all levels of U.S. politics
greatly increased beginning around 1900, when government began to be
much more involved with business. Today, every business, no matter how
small, has to deal with governmental regulations and concerns on an almost day-to-day basis. Clearly, the business of the federal government is
business and that the business of Washington, D.C., is lobbying. Washington is filled with lawyers, and many of these lawyers are also lobbyists
lobbyists who mostly work for the world of business.
In addition, one can see this in a brief walk around the famous K
Street in Washington, D.C., where thousands of corporations, trade associations, interest groups, and lobbyists have their offices.1 smaller versions
of K Street exist around many state capitals and some city and county
halls. Lobbying is a growth business in the United States even in these
times of economic doldrums because whether the economy is good or
bad, government and business remain intertwined.
This chapter addresses that essential relationship between business
and government. Unfortunately, many, if not most, businessmen and corporate executives know little or nothing about how to deal with government and the people who make the decisions for the government. An
MBA, although a wonderful degree to have on ones resume for leading a
major corporation in the United States, does not prepare a business leader
for making his or her claims on the city council, state legislature, or the
Congress. Dealing with government from a businessmans perspective
might seem to be very easy, but it isnt. Lobbying, the process of communication between the interest and government, can be very complicated. Its
an art, not a science.2 Well, it seems to be more of an art than a science. It
does have a large number of dos and donts which are so widely agreed
on that they seem to approach the level of laws or theories. Even if lobbying is studied by scholars from political science from colleges of social
and behavioral science, the practice of lobbying is still considered an art.
The nation is filled with an enormously wide range of interests who
have concerns and demands to make at the various levels of the U.S.
government. We do know that the great majority of these interests come
from the world of business. At the state level, business dominates the
debates in the legislatures and in the various offices of the bureaucracy.
Compared to the other interests that may seek to influence public policy,

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109

business is the 300-pound gorilla in state politics. No other interest


comes even close to rival the power of the business lobbies
A PLAN,THATS WHAT WE NEED, A PLAN!
Any organization that feels it needs to play the game of politics in its
states capital or in Washington, D.C., needs to have in mind a set of goals
or objectives. You need to clearly state what you want and why you want
it. Politics is often called the politics of compromise, so you need to also
have in mind your fallback position or compromise position. You should
be aware of the resources you may already have in-house (within the organization) or access to these resources from previous ventures in the world
of politics (if any) and special relationship your organization may have
with politicians or governmental agencies that may be useful. One should
be aware of the potential time frame in which the political goals need to be
achieved. Is this a long-term goal? Or does it have to be done right now?
Often, like purchasing airline tickets, right now can be very expensive.
Some sense of possible costs is also essential to consider. Start with the
costs of failure to your company or association. Some outcomes from governmental decision making can be extremely costlymaybe even fatal
to an interest. Other costs may involve only a minor inconvenience. If it
is the latter case, then a low-cost lobbying campaign may be just fine. But
if it is the former, substantial costs may be completely justified. Finally,
consider what information and data need to be collected and evaluated
that might be useful in the upcoming campaign. OK, now we have the elements of a plan. The next step is implementation.
OUR BUSINESS NEEDS PROFESSIONALSWHERE ARE
THE LOBBYISTS?
Just like a military general in a war, todays business leaders need intelligence and experience in order to deploy the armys resources in such
a way as to maximize the prospects of victory. For a CEO to try to make
his or her case to the government unassisted is like trying to do your own
brain surgery. You can try, but it is not recommended. Think of the lobbying team as your intelligence branch, or G-2 in military slang. Large corporations have their own in-house lobbying team in their public relations
(PR) or government affairs division. The larger the corporation, the more
specialized that team may be: some specialize in state and local lobbying and others may specialize in federal lobbying, and the company, if it
has concerns with the federal government, may have its own office in
Washington, D.C., or lobbying firms it has on retainer.
What do these lobbyists do? There are specialized roles that lobbyists have developed over the decades. One of the most important roles

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is that of watchdoglobbyists who are assigned to specific sites in government watch for potential problems that may emerge that may impact,
negatively or positively, their employer. Not the most exciting job, day in
and day out, but just like a nations spy in a neutral country, the information they find can make the difference between being ready to deal with a
threat or opportunity and being surprised and perhaps, suffering defeat.
Around Congress or a state legislature, these watchdogs attend committee meetings and political party discussions and listen and follow up on
bits of information. It is important that these watchdogs know the vital interests of the company so they can understand when something that may
sound quite disassociated really might be important down the road.
A second and very frequent type of lobbyist role is that of contact man
someone who knows key people in government and other interest groups
and is able to identify who to talk to about a certain type of issue at this particular moment of the public-policy process. From the viewpoint of major
law and lobbying firms, these lobbyists are often called rainmakers because of the big-money clients they are expected to bring into the firm.
Many contact lobbyists are high-level former officials in government
some are former senators and House members, whereas others have
worked in the executive branch offices of the president or governors. The
biggest names in this category can demand and get salaries that run well
over a million dollars a year. Their real value lies in the unique access
they retain to communicate a clients interests and concerns directly to the
people in the government who have the power to accomplish policy objectives. The policy process is filled with veto points and roadblocks that
can affect a policy or a piece of legislation. The policy process is also filled
with many actors who can assist or hinder ones interests in many different waysmany of them hidden behind the scenes and nearly invisible
to even the decision makers in the process. Government at all levels, but
especially at the federal and state levels, has gotten just too complicated
and the people who understand that the best are often the lobbyists who
specialize in the very narrow and complex pieces of the process.
A third role for lobbyists is that of the persuader. Persuaders are the lobbyists we think of when we think of them in the popular mass media
the ones with the thousand-dollar suits and the Gucci shoes. These are
the lobbyists out front in the policy battles. They go from office to office.
They shepherd people from the home districts back to the state capitols
and Congress. They are the ones sitting up in the balcony on the last night
of the session hoping that the bills they support are on the calendar and
will be heard and voted upon before the session is adjourned. They are the
experts on the members of a legislature or Congress and their staff. They
know who your friends and enemies are, who needs campaign funds in
the next election, what arguments and facts will be effective, and who is
persuadable and who isnt.

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Other lobbyists are specialists in certain parts of modern lobbying campaigns. Some specialize in grassroots campaign organization, where the
lobbyist attempts to create pressure on political decision makers by getting people in their districts or home states to make demands on these
decision makers to support certain policies or issues. Others organize coalitions of several or many interest groups or corporations to join together
on a specific issue campaign. This has become a much more common strategy in recent years and affords the advantage of both economies of scale
and specializations of access. Five groups, for example, can contact many
more decision makers in a legislature than just one, but each group will
often have very specialized relationships with specific legislators, which
facilitate access that one group could never achieve.
WHERE CAN OUR COMPANY FIND
SOMEONE TO LOBBY FOR US?
Where does one find an effective lobbyist? Good news, your company
or association may have a good one already working for you. In smaller
trade associations, the executive director will often have the lobbying experience and skills to represent your interests. Larger associations and
corporations will often have one or more governmental liaisons or governmental relations specialists. These should be your first choices unless
there is something out of the ordinary involved in your particular situation. Maybe, for example, this particular fight is sited in a governmental agency or legislative committee that your in-house lobbyist has never
worked before. If that is the case, then you will probably need to seek
out a lobbyist or lobbying firm who has experience in dealing with this
decision-making site. Many of Americas giant corporations and powerful trade associations have lots of in-house lobbying expertise; many have
major lobbying firms or law firms on retainer in Washington, D.C.; and
they still will go out and hire a specialist lobbyist or firm when necessary.
Washington and many of the larger state capitals have small boutique lobbying firms that specialize in one particular issue area, such as energy law,
or even one specific unit of government such as the House Agriculture
Committee. A great advantage offered by these small firms is that a client will be only one of a small number of clients the firm must take care
of. The big firms have dozens of clients and many of them may be paying
much more than what you may want to spend. The big firms are big for a
reason. They have a track record of success, lots of special contacts, many
talented lobbyists, and great expertise in many of the strategies and tactics of a multifaceted lobbying campaign. Some firms or associations like
being the big fish in a small pond and others love playing in the ocean.3
As Bertram Levine, a former lobbyist for Johnson & Johnson and now a
professor of political science at Rutgers University, has said:

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Strategic Management in the 21st Century

There is no official set of criteria for determining what is and what is


not quality lobbying. It follows that there is no authoritative ranking
system for the professionno top to bottom list ranging from the
best to the worst.4
It is important that the corporate or association leader designate someone to be the contact person between you and the lobbyist or lobbying
firm.5 During any lobbying campaign, things may change very quickly
and rapid decisions may often have to be made to take advantage of an
unexpected opportunity or to avoid a potential setback. One decision that
most do not like to think about is the decision to pull the plug on either
a successful or unsuccessful lobbying campaign. Since such campaigns
can cost as much as tens of thousands of dollars a month, it is a waste of
money to keep a campaign running after you have won or lost. On the
other hand, even if you wonthis roundfuture dangers to your goals
may lie in different venues. Some lobbying campaigns have had hundreds
of battles in many different arenas over decades.
LOBBYING FOR YOUR OWN INTERESTS
Lets assume for financial reasons you have decided to lobby for yourself. My strong recommendation is to find an experienced lobbyist who
has knowledge of your lobbying topic and the governmental unit that will
be making the decision. But, maybe your organization is a little strapped
for money in its budget and has a governmental affairs department or an
executive director that can manage the lobbying. Thats fine, many corporations and associations have decided to do just that. You have a wide
range of options open to you to help you achieve your goals, but lets do
some background thinking first. Which institution or institutions of government have the power to achieve or block the policy decision you are
concerned over? Know your target is the first major piece of intelligence
you need. Since most of us are concerned about new laws or ordinances
that impact our businesses, we might assume that our focus should be on
the city council, county commission, state legislature, or even the Congress. Find out where the decision that affects you will be made and then
focus on that institution. You might want to spend a little money up front
to discuss with a lobbyist who has worked with that institution and is
knowledgeable about the norms of behavior and expectations regarding lobbying and the members of the decision-making body. Make no mistake; there
is often a great range of what is considered to be the rules of the game,
even among similar level units in the same state. Urban and rural, religious and secular, Republican or Democratic, and professional and amateureach comes with a different set of informal rules regarding what is

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113

normal and what is outside the norms. So before you do anything, make
sure what you think you should do is acceptable.
As was mentioned previously, it is very important to designate one
person as the lobbying coordinator for your corporation or association.
The reason for this is to avoid multiple messages or lobbying efforts that
may be confusing or worse, counterproductive. The key to good and often
successful lobbying is staying on the message as much as possible and
making sure that all the personnel involved in the message are trained
and coordinated. If legislators hear multiple or conflicting messages, they
start to get worried and often decide to avoid the issue as much as possible since it could be politically dangerous to them. One of the tasks performed by the coordinator is the collection of materials and information
that will be useful in the campaign. This can include information from
your own organization as well as from other similar organizations, as well
as information about the legislators or bureaucrats you wish to lobby. You
will also want to gather information from other organizations that may
be lobbying the body since they may be potential coalition allies that may
work together with you to help achieve your goal. Finally, you will want
to explore what other states or governmental units have done on the same
issue to see if you can strengthen your argument for action or learn what
to fight against or just what to avoid. There is no sense of reinventing the
wheel, if you can avoid it. The next step after the information is gathered is
the packaging of it in forms that can be easily understood and effectively
packaged. The refined information can be distributed in one-page handouts during one-on-one visits, on Websites, in mass media appeals, and
in media interviews.
One extremely important set of rules involves the creation of access
to the decision makers. Usually, the lower the level of government is, the
easier is the access to the decision makers. City council and county commission members are usually pretty easy to approach and to communicate
your interests to them. Up a level and depending on the state, the members of the state houses of representatives and senates may be accessible
in small, rural states or really tough to meet in those states with so-called
professional style bodies, such as California. I recommend the direct approach, dont send e-mails or letters, but try to set up face-to-face meetings. As you already know, e-mails get trashed very easily and the people
you want to talk to may get hundreds of e-mails every day. The key to access to legislators in many cities and states is going to their office, talking
with their secretaries, and setting up a short (and I mean short) meeting.
These people are always busy. Even those who are not very busy, act like
they are and so when asked the question, How much time do you need?
the answer should always be, Five to ten minutes would be fine. Actually, that is all the time you need. I know that your office has collected

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lots of information to support your position, but this is not the time to
dump it on the legislator. You need a printed one-page summary. Yes, boil
your entire argument down to a single page. It should identify the problem, note its seriousness, link it to the legislator by explaining its impact
on his/her district or the state in general, and clearly state the action that
you want done. If you want a bill introduced, indicate you already have
a copy of the proposed bill. If you want an already introduced bill passed
or killed, clearly identify that bill and indicate where it is in the legislative
process. If the legislator is really interested, the meeting may last longer
than a few minutes and he/she may ask you for additional information,
which you can provide at a later time. Play it by ear and always respond
to questions with honesty and in a positive manner. Never threaten! Statements such as if you dont support this, we will get you! are the kiss of
death for your company unless you can carry out the threat. In reality, the
tactic of burning bridges in the political game is rarely an effective path to
follow. Even opponents on the specific bill you are concerned about this
time may be potential allies in future lobbying campaigns or future years.
Dont burn bridges!
After you have finished the meeting, take a few minutes and make some
notes about who you saw and what you discussed. Be sure to write down
if you were asked for additional information or any supporting action. Always follow up on any such requests. Be known as a reliable and responsible participant in the political decision-making process. The notes will
help you remember the meeting and facilitate future meetings and maybe
help you and your organization to decide if you want to get involved in
the campaign finance part of lobbying and maybe even put together a
political action committee (PAC) to provide for even easier access in the
future.
Lets discuss the possible situation where access is not as easy as it may
be at the local government level. Lobbying political decision makers is
always easier if the interest has developed a personal relationship that
facilitates the making of lobbying appointments easier. Over the years,
a number of access-creating activities have been tried and tested. Access creation in the 19th century and the first half of the 20th century usually was male dominated and involved smoke-filled rooms, alcohol, food,
poker, and, sometimes, female companionship. By and large, those days
are gone now. Todays access-creating techniques center on the offer of
campaign support and campaign money and certain types of limited social activities. On the national level, major interest groups are constantly
being asked to buy a table at some reception to honor and support a
particular member of Congress. The implication is if you attend or buy
a table, you will have a much easier time meeting the congressman and
making your case. Major interests also will make campaign contributions
at key moments in a legislative or election cycle that may be even better

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115

at getting attention for your group. At the state level, some states, such
as California, have very stringent laws on how much can be given to a
candidate or even how much can be spent on a reception or other types
of entertainment. The infamous Delay-Abramoff golf trips to Scotland in
the 1990s resulted in many new rules on the federal level that limited the
spending on such access-creating activities. Some states, such as Utah,
have few such laws other than ones that may require the reporting of such
expenditures, although Utah passed a new law in 2010 that prohibited
campaign fund raising during the annual state legislative session from
January to early March. Even the wild west of Utah political fund raising finally got some restrictions. This is an important point to remember:
the rules change all the time and you want to be on the right side of these
rules. You will want to be very clear about what the rules require or prohibit in your state. It is very embarrassing to be featured in the local newspaper as a violator of such laws. One basic informal rule is that specific
lobbying does not happen at such events. If you invite a state legislator to
a football game, performance of a symphony, or a dinner, enjoy the time
together and discuss common general interests, but dont lobby. Formal
lobbying occurs later. Dont worry, the good time you all spent together
will not be forgotten.
DIRECT LOBBYING VERSUS INDIRECT LOBBYING
There are two basic lobbying strategies: direct and indirect lobbying.
The resources of the organization should be contrasted. The following is
a menu of tactics available for selection in a direct-indirect lobbying plan.
The listing of tactics is from the more effective to the less effective tactics.
Direct Lobbying Tactics
1.
2.
3.
4.
5.
6.

Face-to-face personal lobbyist visits to elected officials.


Personal visits to the staff of public officials.
Bringing influential constituents to meet with public officials.
Writing letters to public officials. Personal, individual letters are best.
Phone calls to public officials or their staff.
Sending e-mails to public officials.

Indirect Lobbying Tactics


1.
2.
3.
4.
5.

Grassroots lobbying campaigns.


Mass media advertising.
Public opinion polls.
Mass public opinion molding efforts.
Elite opinion molding efforts.

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Direct face-to-face lobbying is the gold standard of lobbying. Everything else is done to support the basic form. Face-to-face lobbying is considered to be the most effective because it allows the interest to directly
communicate its concerns, needs, and demands directly to those who possess the power to do something politically. The lobbyist and the public official exist in a mutually symbiotic relationship. Each has something the
other desperately needs. The interest seeks governmental assistance and
the public official seeks political support for future elections or political
issue campaigns. The environment for such lobbying discussions is usually the spaces outside the legislative chambers or perhaps the offices of
the legislators. The legislative arena has characteristics that facilitate the
lobbying process. It is complex and chaotic. Out of the thousands of bills
that might be introduced in a legislative session, sometimes fewer than a
hundred are actually passed. There is never enough time to complete the
work on the agendanot even a fraction of the work. The political process tends to be a winner-takes-all gameoften a zero-sum game given
the limited resources available and seemingly endless lists of demands
that request some allocation of resources. Everyone in the process desperately needs information and the most frequent (and most useful) source
of information is the lobbyist. The exchange is simple: the lobbyist helps
out the governmental officials by providing them with information and
the government official reciprocates by helping the interests gain their objectives. There is a cycle to every governmental decision-making site. At
crucial times in those cycles the needs of the officials or the lobbyists may
dominate. For lobbyists in a legislative site the crucial moments are as
the session goes down to its final hours. For legislators, the closer they
are to the next election, the more responsive they are to lobbyists who
possess resources that may help them win the next election. In the old
days, bribery was very important to many legislators; those days are almost completely gone now. The danger of exposure and personal disaster
is too great to risk in todays mass mediadominated society. In todays
political world, the public officials greatest interest is in getting the resources they need to stay in office and lobbyists are crucial to getting those
resources.
The important thing to remember is that lobbyists need public officials
and the public officials need the lobbyists. As was mentioned earlier, the
process is chaotic. Lawmaking could be described as making sausage in
the dark. In one aspect, this is very true. Much of what happens in the process is hidden from public view. Deals are made in closed meetings and
the public events are often largely symbolic. Many casual observers of the
legislative processthink public events, such as committee meetings with
interest-group testimonyare crucial to success or failure of a cause. Occasionally it may be, but much more often, the hearings and testimony
are staged events to justify the decisions that have already been made by

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party, legislative, and interest-group leaders. These decisions are important in the public framing of the legislative decision-making process, but
the real decisions are usually made by interest-group leaders and lobbyists in private meetings off the legislative floors.
The general rules of direct lobbying are pretty simple. Keep it short in
terms of time and the one-page handout with the information you want
to communicate to the official. Be clear and direct. Mention the problem,
why it is important, what is desired, and what the political implication
may be. Provide honest information of either a technical or political nature. Just like location, location, location is the key to a successful business,
the key words for a lobbyist are absolute honesty, honesty, honesty. If an
interest-group leader or lobbyist is seen as offering dishonest or wrong information, his or her days in that profession are at an end.
The transfer of information process is usually preceded by some preliminary meetings with the legislators or bureaucrats staff. This should
not be bypassed because in many venues, the staff controls access to a
wide variety of information and has a great influence on the officials decisions. Many times, the legislators are inundated with issues in a legislative session and they look to their staff or the party caucuses for guidance
on many votes. Thus it is important to learn the ins and outs of the legislative process. There are many veto points in the complex process. There
are many places to bury a proposal and many decision points that have to
be overcome to make something happen. The legislative process is often
a death march of legislation. In short, there are many places a bill can be
altered or left to die.
There will be times when you may be invited to give testimony at a
formal hearing of a legislative, executive, or regulatory body. Such invitations are seldom random; they are usually carefully planned and set up in
consultation with the legislative leaders of the convening body. Often the
hearings are done to justify decisions that are already made or to show the
various organizations involved that they are really playing an important
role in the decision-making process. There are a couple of simple rules for
you if you are asked to make such a presentation: (1) write two presentations, one to insert into the written record and one for the oral presentation; (2) one pagekeep it short; (3) thank everyone for the opportunity to
present before their organization; and (4) make your presentation, give a
summary, make a clear request for specific support, and then close.6
INDIRECT LOBBYING, GRASSROOTS, AND MEDIA
Organizations and businesses often may decide to try more indirect
techniques in order to make their direct lobbying more effective. Indirect
lobbying involves attempts to sway public opinion to be more supportive of the groups lobbying objectives. Businesses often have difficult PR

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problems. And, of course, there are a variety of ways for dealing with
them. Some of them involve efforts to improve the corporate image. Support of various charities or sporting teams is often a good move that casts
a good glow on the corporate identity that can be useful in later lobbying
efforts.
Issue framing or spinning is often initiated prior to a lobbying campaign. Issue framing are efforts to alter public perceptions or attitudes
regarding a specific issue. One can initiate issue framing by submitting
opinion pieces to local newspaperseither the states major newspapers
or even better, the smaller and less-urban papers. Newspapers are often
looking for filler, and you should view it as a great opportunity to communicate your message to the general public.
A much more expensive step in issue framing involves the use of paid
media and professional PR firms. Paid media can be the use of billboards to
bring your issue to the attention of a larger percentage of the general public. If you want to get attention to your cause and a more favorable public
response to your business or organization, you may have to invest in hiring a PR firm. On the other hand, if you have the access to the legislature
or the relevant government agency that controls the fate of your issue, you
probably do not need to spend any money on PR. Remember, this can be a
very expensive tactic. At the expensive end of the category is placing your
companys name on a sports arena or community building. At the bottom
is sponsoring a little league or five-kilometer run. All such efforts get your
name in front of the public in a positive manner. The goal is to create a positive response for your company when you come to make your case.
Real media lobbying is extremely expensive. As is common knowledge
to everyone involved in election campaigns, the decision to use electronic
media greatly multiplies the cost of a campaign. Of course, campaign
media, or in this case, the cause- or issue-related media continuum has
many stops along the way. Radio ads are relatively cheap to run during a
legislative session; television is much more expensive and may be beyond
the budgets of all but the largest corporations or associations. One consideration in the use of paid electronic media in an issue campaign involves
the careful determination of your target audience. Using the radio to target very narrow segments of the population, such as Hispanics or those
listening to conservative talk radio, can be a very inexpensive option. Frequently, your targeted audience will be the political elite who make the
decision that has an impact on your issue. In Washington, D.C., this may
involve ads in the D.C. newspapers or the Capitol Hill political media. The
more expensive approach is to place ads on the D.C. radio or television
stations. During the Clinton administration, the famous Harry and Louise ads that killed the Clinton health-care reforms in 19931994 were basically shown just in the Washington, D.C., media markets. Planned public
rallies in support of your issue can be done on the steps of the capital or

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the city hall, and handouts to watchers or media representatives are often
the cheapest possible form of issue-campaign media.
Recent Supreme Court decisions have freed corporations and groups to
spend unlimited amounts of money during political campaigns in media
advertising on issues.7 The Citizens United v. the Federal Election Commission, decided in 2010, was the landmark court decision that eliminated
legal restrictions on the use of unlimited corporate funds in federal elections. The Supreme Court held that corporations must be afforded the
protection of the freedom of speech provision of the First Amendment
of the U.S. Constitution. The 54 decision, with the five conservative justices in the majority, overturned provisions of the 2002 federal Bipartisan
Campaign Reform Act. The door has been opened for a huge inflow of
corporate (and labor union) money into federal election campaigns and
the disclosure of donors and expenditures in these campaigns by these
organizations has been largely eliminated in any meaningful way. Of
course, it is the huge financial muscle of national-level corporations or
associations that allows them to play this game. But that may be impossible for you. However, on the state and local levels, when public opinion
is in flux, even small media efforts can have a big impact on election campaigns and attitudes toward public-policy issues.
Some companies have found it to be effective to work with think tanks
and research groups as well as local colleges and universities. Sponsoring
research projects that may support your lobbying effort is quite common
as is the sponsoring of seminars to raise the visibility of your issue. Such
think-tank or higher-education activities may also raise your respectability
and legitimacy as a major player in the lobbying game. Most states have
a number of such think tankssome liberal and some conservativethat
often are looking for sponsors to help pay the rent on their quarters.
Grassroots lobbying can be a cheap way to put pressure on governmental decision makers. This approach is a common form of lobbying for
corporations and groups seeking to invoke indirect pressures. Instead of
communicating directly with decision makers, indirect lobbying seeks to
go to the grassroots to outside the beltway to activate different types of
constituents to communicate the groups message to the decision makers.
The process starts with a corporation or group deciding that additional
political pressure on the decision makers may be useful in achieving the
lobbying objective. There is no reason to do grassroots lobbying if the lobbying objective is easy to achieve as it may be in some cases. The next
decision involves a determination of what part of the grassroots the corporation or group may want to activate. There are two general strategies:
shotguns and rifles. The shotgun approach is to mobilize as many constituents as possible to communicate their concerns, demands, or requests.
The shotgun approach can use either a natural or an artificial style of
communication. Take, for example, a natural shotgun campaign that asks

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local level real estate agents to send a message (e-mail, letter, or telephone
call) to their city council members who are considering a new ordinance
restricting the placement of house for sale signs. The campaign would
be natural because each of the messages would be written in a unique,
individualistic way. An artificial shotgun campaign would seek to overwhelm a political office with relatively large numbers of messages. Perhaps most, if not all, of the messages are identical, but it is the numbers
that may have the greatest impact.
The rifle grassroots is a much more focused indirect lobbying campaign. Its goal is to seek out influential or important constituents to communicate personal messages to the decision makers. The most expensive,
and probably the most effective, way to do this is to bring a handful of important constituents to the decision makers office. An example would be
a company, such as a bank, that has a number of branches in a particular
state. In this instance the company would organize trips to the state capital
by bankers with offices in the districts of members of the state legislature
holding seats on a committee deliberating a proposed law that would impact the banks. Less expensive would be a company or association having key members write, call, or e-mail their messages. Even a U.S. senator
or powerful House member pays attention when a letter comes to his office from the president of the biggest bank in his or her district. We know
that governmental officials gets thousands and even millions of messages,
but their office staff always culls out the important ones to place in the
folder on their bosss desk to read.
The very well-organized groups or corporations have a grassroots campaign already set up on their computers and they can activate the campaign in very short time. The less well-financially endowed corporations
and associations can play the same game with a much cheaper and less
well-organized effort. Associations such as the League of Women Voters and Common Cause, that do not have millions of dollars to run such
campaigns, have in the past run effective grassroots campaigns using telephone trees, where 10 people call 10 people each, who then call 10 more
and so forth.
THE LAST SITE OF LOBBYINGTHE COURTS
Finally, we should discuss the site for the final stand of organizations that have played the lobbying game in the legislative and executive
branches and lost at both battlegrounds. The U.S. judicial system and the
courts can be the final site for protecting your interests. Most people do
not think of the courts as a site for political battles, but they clearly can be
and often are. We also know that legislators and bureaucrats often make
decisions that violate existing law and even constitutional law. One good
example would be the aforementioned proposed city ordinance regulating

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lawn signs for realtors. Such a law could easily be a violation of the First
Amendments protection of the freedom of speech, and in this case, commercial speech. Unless you are a huge corporation or powerful national
association, you probably do not have the resources to pursue a case all
the way to the U.S. Supreme Court, but there are ways to play the judicial
lobbying game on the cheap. A corporation or association can file a suit
challenging an ordinance, law, or regulation. That is the costly version of
judicial lobbying because it may cost hundreds of thousands of dollars. A
much less costly form is to file an amicus brief in an already existing case.
This piggybacking on to another case is very common and some cases will
end up with dozens of amicus briefs seeking to add their wisdom and
reputations to a cause. Another recent form of judicial lobbying has been
the financial activity of corporations and groups in elections involving judicial selection and retention. Especially at the state supreme court level,
elections have attracted millions of dollars from interests seeking to influence the judges who may have to vote on issues and interests that impact
the corporations and interests in the state. This lobbying tactic has always
been possible, but has become more often used in recent years as the costs
of even judicial elections has risen in the world of electronic campaigning.
CONCLUSIONS
The key to lobbying on the state or local level is really quite simple. Hire
a good lobbyist who knows your issues and has good access to the decision makers your organization wants to influence. It is also possible to do
your own lobbying. If you do, you may not be able to spend all your time
in the capital city or the decision-making site. Thats all right, but make
sure you are diligent in monitoring the important developments that may
impact your interests. This is especially important during legislative sessions or on the days the legislature at the local level may be meeting. You
should be building up a collection of relevant information of both a political and a technical nature that may be of use in the future lobbying you
will be doing. You will also want to build up a useful set of important contacts that you can go to if necessary. These can include legislators, legislative staffers, officials in the executive branch, relevant agency personnel,
in-the-know media, and significant actors from other organizations that
may share your interests and may join you in future coalitions. One must
always remember that although the official legislative session is the place
where many final decisions affecting success or failure are made, most
of the important work in framing the issue and even drafting proposed
legislation or regulations is done prior to the session or in the legislative
interim. There is much more free time in the interim and thus more opportunity to gain access and present your case. Remember, government is
a 365-days-a-year operation and important planning and decision making

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is occurring nearly every day on a formal or informal basis. You need to be


aware of what is happening and try to influence it when you can.
There is no secret to successful lobbying and it is not so difficult that
educated individuals cannot learn how to do it and be successful in a relatively short period of time. Successful lobbying involves contacts and
trust; technical and political information; having resources and using the
resources in a manner that is politically effective; and having reasonable
political objectives and reasonable plans to achieve them. Lobbying is an
art, not a science and thus there is no ironclad set of laws that must be
followed. Correct lobbying is based on the unique pattern of resources
your group may have and the political environment you have to operate
with and the goals you are seeking to accomplish. There are many choices
to be made and many of them seem to be reasonable. Like many aspects
of real politics, the key to success is political management or the careful
application of power to achieve the desired results. Dont assume all the
important decisions are being made by one governmental entity to the exclusion of other governmental entities. In other words, dont have such a
singular focus on the decision making at one site, such as one chamber of
a legislature, that you miss important events occurring at other sites.
Good lobbying requires flexible decision making. The political environment is very fluidchanging every day because of the impact of previous
decisions, economic changes, or world events. As the political environment changes, your lobbying must also adapt or risk failing. There is nothing worse than having a cause or an objective that has been made obsolete
by changing events. This is why your organization really needs someone
who knows what is happening on any given day.
Finally, allow me to mention one other aspect of successful lobbying:
group unity or at least the appearance of group unity. Your group, at least
in public, must speak with one voice, and hopefully the voice of authority
or expertise on the topic you are lobbying for. A group that appears to be
divided on an issue loses influence very quickly. Even worse, the groups
reputation as a lobbying force will be damaged for a very long time.
Remember, lobbying is a communications process. It is your constitutional right to communicate with government and make your needs and
concerns known to government officials.8 If you have not gotten into the
game, you may want to reconsider your interests and your relationship with
government and how you can take political action to protect your interests.
APPENDIX: SEVERAL THINGS TO REMEMBER
WHEN LOBBYING
1. You are dealing with political decision makers who have a wide
range of ambitions, motivations, and goals. The key to effective lobbying is aligning your interests and goals to the decision makers.

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2. Most government officials want to succeed in their jobs, keep their


jobs, or get even better jobs. Any way you can connect with these
decision makers and help fulfill everyones goals will help you to be
a winner.
3. The reality of politics is compromise. Almost never does anyone get
everything they want in a lobbying exchange. Remember that lobbying success means accomplishing your goals a little bit at a time. Be
prepared to compromise and dont have a short-term time horizon.
Be aware of the changes that can impact your interests, and be flexible.
4. Know the decision-making process. In any legislature, there are lots
of dark spots where legislation can be killed, severely altered, and
even advanced to law status. The same is true in the governmental
bureaucracy. Many different actors can play a critical role that profoundly affects your interests. Think of the decision-making process
like an assembly line with different actions along the line. If one of
these stations breaks down, the chances of the final product reaching
the end of the line are small.
5. A good lobbying process requires lots of time and effect and planning long before the line starts humming. Start as early as you can on
your lobbying campaign in terms of the basic preparations.
6. Lobbying can be hard work. Be prepared. Sometimes it is tedious
and even boring. Sometimes you have wait for long as the decision
makers deal with one issue after another and meet others before they
find time to meet with you and discuss your issue.
7. Be courteous and positiveno matter how you may feel at a given
moment. Remember, you are asking for someone to do something for
you and your organization. No one wants to interact with a grumpy
or bad-tempered individual. It is OK to be committed and maybe
even a bit intense in terms of your commitment to your cause, but
rudeness or excessive aggressiveness is often a negative in the lobbying process. Remember, mutual respect often works very nicely.
NOTES
1. Allan J. Cigler and Burdette A. Loomis, Interest Group Politics. Washington,
DC: Congressional Quarterly Press, 2007, 21432.
2. Bertram J. Levine, The Art of Lobbying: Building Trust and Selling Policy. Washington, DC: Congressional Quarterly Press, 2009.
3. Ronald J. Hrebenar, Interest Group Politics in America. Armonk, NY: M. E.
Sharpe, 1997, chapter 4.
4. Levine, op. cit. p. 34.
5. Clive. S. Thomas. Dealing Effectively with Alaska State Government: Lobbying
the Legislature, the Governors Office and State Agencies. University of Alaska: Corporate Programs.

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6. AARP, You Cant Fight City Hall, quoted in Hrebenar, Interest Group Politics in America, op. cit. pp. 11213.
7. Citizens United v. Federal Election Commission, 558 U.S. 08-205 (2010). Other
recent federal decisions that have significantly impacted the rights of corporations
in federal campaigns; McConnell v. Federal Election Commission, 540 U.S. 93 (2003),
which earlier upheld most of the BICRA, and Federal Election Commission v. Wisconsin Right to Life, Inc., 551 U.S. 449 (2007), which began the process of freeing corporate money to buy ads in federal election campaigns.
8. The First Amendment to the U.S. Constitutions least-known clause is the
one that protects the citizens right to lobbythe right to petition government
for redress of grievances. Of all the clauses in the First Amendment, this one has
been least addressed by the Supreme Court and has the most absolute levels of
protection.

SELECTED BUSINESS LOBBYING BIBLIOGRAPHY


deKieffer, Donald E. 1997. The Citizens Guide to Lobbying Congress. Chicago: Chicago River Press.
Gray, Virginia and Russell L. Hanson. 2008. Politics in the American States: A Comparative Analysis. Washington, DC: Congressional Quarterly Press.
Guyer, Robert L. 2003. Guide to State Legislative Lobbying. Gainesville, FL: Engineering THE LAW.
Hrebenar, Ronald J. 1997. Interest Group Politics in America. Armonk, NY: M. E.
Sharpe.
Hrebenar, Ronald J. and Bryson B. Morgan. 2009. Lobbying in America. Santa Barbara, CA: ABC-CLIO.
Opensecrets.org. The Website of Center for Responsive Politics. This site has a
lot of information on Washington, D.C., lobbying, data on major interest
groups, and lobbyists.
Rosenthal, Alan. 1993. The Third House: Lobbyists and Lobbying in the States. Washington, DC: Congressional Quarterly Press.
Thomas, Clive S. 2011. Dealing Effectively with Alaska State Government: Lobbying
the Legislature, the Governors Office and State Agencies. University of Alaska:
Corporate Programs.
Wittenberg, Ernest and Elisabeth Wittenberg. 1994. How to Win in Washington:
Very Practical Advice about Lobbying the Grassroots and the Media. Cambridge,
MA: Blackwell.

Chapter 6

The Influence of Social Forces


on Firm Strategy
Tracy L. Gonzalez-Padron

The dual economic and social project was born of a simple


fact that remains just as true today: a company cannot succeed
in the long run if it turns its back on the society it is a part of, if
it only looks to its short-term economic gain. Danones founder
understood very quickly that creating economic value and social value are both essential to a companys solidity.
Frank Riboud, CEO Danone1
Forces external to the organizations boundary challenge managers to
adopt business practices while continuing to meet the companys objectives. A firms success depends on understanding the economic, political, technological, and social forces that influence an industry. One of
the most complex and intangible forces that affect business are those of
a social natureembedded in the values and norms of a society. However, as the opening quote illustrates, responding to social forces is instrumental for long-term company success. Social forces are the effects from
changes in demographic patterns, tastes and habits, and concerns for the
environment and health. For example, there are increasing demands for
businesses to take responsibility for negative externalitiessocial costs

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such as pollution, health care, and unemployment that firms do not bear.
Governments are responding through regulations to minimize effects or
through taxation to recover costs.
In a 2006 survey of executives, responses highlight how companies
continue to struggle with tactics for addressing multiple social issues effectively.2 Approaches to address social issues range from reactionary to
strategic. Successful companies view growing social concerns of climate
change, human rights, and corporate responsibility as opportunities for
innovation and growth. Porter and Kramer propose a strategic approach
to address social issues that have a direct impact on the business, either
through a reliable supply chain or competitive product offerings.3 The
authors expand on this theme in a 2011 article that redefines business as
creating shared value with its communities. They stress, The competitiveness of a company and the health of the communities around it are
closely intertwined4 and call for businesses to consider the social and
economic impact on the community when making business decisions.
The significance of this shift is evident with the proliferation of evaluative firm rankings based on corporate social performance (Business Ethics
magazines 100 Best Corporate Citizens), environmental performance
(Newsweeks Americas Greenest Companies), and corporate reputation
(Fortunes Worlds Most Admired Companies).
How best to respond to societal expectations of business in firm strategy? First, managers need to understand the social forces that generate
salient social issues influencing their organizations performance through
environmental scanning. Second, social and environmental issues should
be included in firm strategy through sustainable business practices measured by a triple bottom line. Third, an organizational structure for a strategic approach to sustainability requires top management commitment,
an ethical culture, stakeholder engagement, and functional integration.
The resulting organizational policies and procedures lead to product innovation, customer satisfaction, and a positive reputation that influence
financial performance of the firm.
SOCIAL FORCES INFLUENCING BUSINESS
Traditions, values, and attitudes of a changing population are social
forces that guide employee and consumer behavior. Social issues such
as privacy, obesity, offshore supply, and pharmaceutical product safety
challenge organizations to adapt to changing ground rules that can influence financial and reputation performance. Social and environmental
issues generally fall into three categories: (1) general social issues important to society; (2) value chain social effects from the company operations;
and (3) social dimensions of competitive context that affect competitive
advantage of a company, such as labor, environmental, and regulatory

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influences.5 A company should focus on those social issues that have a direct impact on the business. For example, Danone identifies the following
social issues for their company requiring strategic responses:
Employment downturn: Influences the income of the family, individual identity and social integration, sense of personal achievement,
and employee commitment.
Product safety and health concerns: Influences demands for food safety,
scientifically proven health claims, the quality, and conformity of
products marketed with respect to nutrition.
World food-related health situation (including undernutrition, malnutrition, excess-weight, obesity, and chronic food-related diseases: Influences
voluntary programs to improve products nutritional value, provide
nutrition labeling, and communicate valid health claims to avoid
regulatory demands.
Increasing population effect on food requirements: Influences pressures
on natural resources (soil and water) needed for agricultural production.6
However, not all social problems escalate to an issue requiring managerial attention. Social issues obtain meaning through the interpretation of
the public and other interested parties such as individuals, organizations,
associations, governments, and governmental agencies. Managerial attention heightens when stakeholders capable of influencing governmental
action or company policies define social issues as problematic to society,
often because of a triggering event.7 For example, popular business press
reveals the power of activist groups in escalating a social issue for corporate and regulatory attention. Student activist demonstrations against
Coca Colas worker conditions in Colombia cost the beverage company
millions of dollars in college contracts.8 Health and wellness trends and
concerns of obesity pressured snack and fast food companies such as
Pepsi, McDonalds, and KFC to change their product offering and marketing strategies.9 Timberland established supplier guidelines for leather
supply in response to a Greenpeace guerrilla e-mail attack.10
The challenge for managers is to identify those social trends that warrant company attention and resources. One approach is to understand
how your company affects the environment and quality of life of the community in which it operates. Authors Christopher Meyer and Julia Kirby
developed the ripples of responsibility that outlines firms accountability, remediation competence, and brands credence for a particular social
issue.11 They argue that the trend toward greater corporate accountability for negative effects is inevitable. Companies have the option of acting proactively on their own terms or being coerced by outside forces to

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solve social issues related to their business. Therefore, the level and type
of response to a particular social issue correlates to three characteristics:
(1) the extent that the business is responsible for the social consequence;
(2) whether the organization has expertise for addressing the issue; and
(3) brand-reputation effects from consumer attitudes. Ripples of responsibility reference three concentric circles surrounding the core business of
a firm:
Take Ownership
These are effects that can be directly traced to your operations.

Take Action
These are effects that you contribute to and in relation to which you
have particular problem-solving competence.

Take Interest
These are distant ripple effects, and you have no special competence
to ameliorate them. Channel efforts through other trusted parties.12
Adding complexity for managers is the dynamic nature of social issues
that influence corporate attentiveness and responsiveness. Studies show
that societal expectations follow a path from a period in which an issue
was unthinkable, to a period of increasing awareness and expectations
for action, and then to a period where dealing with the issue becomes ingrained in the normal functioning of the company.13 Shareholder resolutions over time show that some issues, such as human rights and energy,
endure at a consistent level, whereas environmental and diversity issues
follow an interrupted pattern as interests rise and fall.14 Understanding
this social issue cycle can help organizations to identify emerging social issues, respond quickly, and influence legislative or regulatory action.
THE TRIPLE BOTTOM LINE
Competitive companies are managing social forces through a sustainability strategy, including in their bottom line an assessment of
effects on the broader social, economic, and ecological resources of the
community in which they operate, and seeking to lessen the negative effects while continuously improving upon the positive ones. Sustainability is often defined as development that meets the needs of the present

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129

without compromising the ability of future generations to meet their own


needs.15 This definition appeared in the 1987 World Commission on Environment and Development report that also stresses the role of industry
as the main instrument of change that affects the environmental resource
bases of development both positively and negatively and calls for greater
collaborations between the private sector and governments.16
Many companies view social and environmental issues through a triple
bottom line, incorporating economic, environmental, and social dimensions in reporting performance. The triple bottom line furthers a company
focus on value creation by reporting, not just on the economic value that
they add, but also on the environmental and social value that they add
or destroy.17 The economic dimension represents the financial impact of
the organization in contributing to economic viability of the surrounding
community and includes the sales of products and services; profits paid
to investors or reinvested into the firm; and taxes paid. The environmental
dimension centers on the company stewardship of natural resources and
includes reducing waste that fills landfills and pollute waterways, reducing energy use and carbon emissions, and complying with environmental regulations. Finally, the social dimension focuses on the influence the
company has on people and includes encouraging an inclusive approach
to employees, customers and suppliers, respecting the human dignity of
the workforce, and supporting community projects for addressing social
issues.
The real synergy of the triple bottom line occurs when the dimensions
interact, providing firms a competitive advantage by improving quality of
life for employees and suppliers and by offering different products that fill
customer demand. For example, focusing on the economic and social dimensions generates employment, employee commitment, and sales from
marketing campaigns for customers to contribute to solutions of social issues. Meyer and Kirby encourage companies to channel efforts through
other organizations to address general social issues for which they have
no special competence.18 For example, Procter & Gamble partners with
UNICEF to combat the fatal maternal and neonatal tetanus by donating
the cost of one tetanus vaccine for every purchase of specially marked
Pampers diapers and wipes.19 The program also offers employees a threemonth paid sabbatical to volunteer with UNICEF, increasing employee
commitment and retention for the firm while providing valuable knowledge to a nonprofit organization. Danone addresses the social issue of unemployment and subsequent influence on family consumption through
a program jointly managed with an NGO. The company describes the
program:
The Semilla project in Mexico is a different type of approach: it is inspired by the Danones experiences in South Africa with Danimal

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and the Daniladies, and with the Grameen Ladies in Bangladesh,


and entails distributing products door to door to create jobs for local
residents. This is a perfect illustration of the relationship between
economic and social value creation. Adapting to the realities of different countries means taking into account their social concerns and,
for the poorest among them, coming up with new distribution models to do as much as possible to create jobs and combat poverty.20
Likewise, a competitive advantage evolves from a focus on the economic and environmental dimensions that lower costs, protect supplies
of critical raw materials, and generate revenue from innovative product
solutions. Perhaps the most visible economic outcome from environmental management programs is lower operating costs, including savings from greater resource efficiency and lower litigation or regulatory
costs.21 For example, Ecolab, Inc. reports that resource-efficiency efforts
in plant operations save 6,500 gallons water daily, reduce material- and
waste-removal costs by $320,000 annually from product scrap reuse, and
$260,000 annually from better controlling chemical use in production.22
Companies realize that emerging environmental regulations can influence their production operations. An example of a company that anticipated government bans on lead solders used in electronics production is
Hewlett-Packard, which invested in developing a soldering process that
eliminated lead well before the July 2006 European Unions Restriction
of Hazardous Substances Directive regulating the use of lead in electronics products.23 Another outcome of responding to environmental issues
is protecting natural resources critical to production of a product or service. For example, Danone identifies the environmental impact from increased agricultural food production as a major social force. In response,
they implemented strategies to protect water resources by reintroducing clean water as waste, reducing water consumption, and collaborating with organizations that promote the conservation and restoring of
wetlands.24
Revenue from innovative products and services considering the environmental impact on consumers and the community represents another
intersection of economic and environmental dimensions. For example,
when research showed that laundry care was a leading household expense due to water-heating energy costs, P&G developed cold-water specialty detergents, helping the company enter a new market.25 Similarly,
Ecolab Inc. develops new products by assessing how environmental variables affect customer costs associated with water use, energy, and waste
treatment in food-production processes.26 The result of their sustainability product review is a series of cleaning and food-processing products
that appeal to customers for economic reasons (lowering long-term total
costs) while meeting environmental-oriented goals. One such product

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131

developed by Ecolab is waterless lubricant for bottle processing that reduces water use at one large processing plant by 1.5 million gallons annually and results in cleaner and more efficient bottling lines.
Social forces related to the environment affect communities through
employee safety and health, product safety, and supplier integrity. The
toxicity of materials in product manufacturing and use is a major social
environmental issue influencing companies in many industries. Major
chemical exposures, such as at the Three Mile Island nuclear plant and
the Bhopal India chemical spill, highlighted fears of health risks from toxins used in industry. As one article states, It is a rare morning paper or
evening broadcast that does not contain news of acid rain, polluted waters, tank-car derailments, toxic waste dumps, or malfunctions at nuclear
power plants.27 As a result, the United States formulated regulations
relating to the use and disposal of toxic chemicals in the manufacturing
process; these regulations were aimed at improving the health of people
working in polluting industries and of communities neighboring these industries.28 A series of subsequent state regulations improved the health of
workers and citizens substantially. However, companies find that communities are holding them responsible for past environmental practices, as in
the case of a New Jerseys community lawsuit against Ford Motor Company for property damage and personal injuries from hazardous paint
sludge and toxins dumped almost 40 years earlier that continues to contaminate the soil, air, and groundwater.29
Today, global supply chains increase the urgency for companies to address environmental issues that influence employees and customers. Production in emerging countries to reduce costs can result in unsafe working
conditions, environmental pollution, and incentives for using the cheapest and toxic materials. In a 2011 audit of suppliers, Apple found that 137
workers at a Chinese factory had been seriously injured by a toxic chemical used in making the signature slick glass screens of the iPhone.30 Likewise, Mattel discovered unapproved leaded paint in its supply chain,
resulting in a recall of over 2 million toys in 2007.31
Chemical exposures from household, personal care, and food products
may increase health risks such as cancers, developmental disorders, and
obesity. Consumer product sources with potentially dangerous toxins include pesticides, fabrics, foam, plastics, electronics, toys, cleansers, lotions,
and our food. Companies have to redesign products to remove banned
toxins from their production, while consumers are becoming more educated on the dangers of continual exposure to the accepted level of chemicals in daily product use. Therefore, advocates for product safety call on
industry to develop consumer products that replace harsh chemicals with
gentler, natural ingredients. Examples include products such as Clorox
Greenworks and Seventh Generation that clean effectively, while eliminating chemical fumes or residue. Companies may certify their products

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as meeting standards set by the Natural Products Association for foods,


dietary supplements, home-care products, and health/beauty aids. Standards focus on four dimensions: natural ingredients, safety, responsibility,
and sustainability:
Natural ingredients: A product labeled natural should be made up
of only, or at least almost only, natural ingredients and be manufactured with appropriate processes.
Safety: A product labeled natural should avoid any ingredient
that has peer-reviewed, scientific research showing human health or
environmental risk.
Responsibility: A product labeled natural should use no animal testing in its development except where required by law.
Sustainability: A product labeled natural should use biodegradable
ingredients and the most environmentally sensitive packaging.32
The triple bottom line provides companies a framework for responding
to dynamic social forces influencing their business. Successful strategies
require understanding the direct effects of company operations on the environment and communities and emerging trends in societal expectations
of business. Companies that develop capabilities to include societal goals
strategically report improvements in innovative products or services, access to new markets, reliable supply chains, and the shaping of the industrys competitive structure.33
SUSTAINABILITY STRATEGY IMPLEMENTATION
Although sustainability clearly is growing in importance, organizations struggle in how to integrate sustainability into decision making and
new product development. To remain competitive, companies need to
translate societal trends in environment or social issues into specific product offerings, while still meeting customer demands for performance. A
powerful barrier against investing in sustainable products is the lack of
demand for products that have a positive social and/or environmental
impact.34 Studies show that consumers are less likely to purchase sustainable products and services in product categories that value strength or
aggressiveness, especially the cleaning product category.35 Therefore, a
strategic approach to sustainability requires that organizations solve two
problems simultaneously. They must (1) formalize and execute a vision
for customer value creation and (2) recast how they operate to execute
new management structures, methods, executive roles, and processes tailored to sustainability demands.36

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An example of strategic social and environmental sustainability efforts


would be the steps undertaken by Procter & Gamble, a leader in consumer
packaged goods with sales in about 80 countries in 2011. The magnitude
of the effects that P&G has on its customers relates to the scale and scope
of its 50 leading brands in beauty and grooming, health care, snacks and
pet care, fabric care and home care, and baby care and family care. The
P&G 2011 Sustainability Overview titled Commitment to Everyday Life
begins with the following statement:
At P&G, were committed to delivering products and services that
make everyday life better for people around the world. Our opportunity to touch and improve lives comes with a responsibility to do
so in a way that preserves the planet and improves the communities in which we live and work. Were continuing to make progress
in our focus areas of Products, Operations and Social Responsibility,
enabled by our employees and our stakeholders.37
Another company receiving awards for sustainability is Ecolab, Inc.,
the global leader in industrial cleaning and food-safety products and services with $6 billion in global sales.
At Ecolab, making the world a cleaner, safer place is our business. We
are committed to providing our customers with the most effective
and efficient cleaning, food safety and infection control programs
available. Sustainability is inherent in our products and services.
From concentrated, solid formulations to innovative packaging and
dispensing methods, our products are designed to help increase
safety, lower the use of water and energy, and reduce the chemicals
and waste released to the environment. Strengthened by the expertise of our associates and combined with our dedication to social responsibility, these offerings provide value to our customers and the
global economyand help foster a more sustainable world.38
Both of these examples illustrate the importance of considering all aspects of the business in a sustainability strategy, including product offerings, employee engagement, and internal operations. What are the
cornerstone business dimensions for a successful sustainable business
strategy? A three-year assessment of 183 companies by MBA students
from a leading university provides insights into dimensions that are evident in a sustainable business. Each assessment included management interviews and completion of a self-assessment survey of 113 items. Out of
the 183 companies, only 45 (24.2%) feel that their organizations current
efforts in environmentally and socially sustainable business make them

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leaders in their industry, although almost half (92 firms) are making substantial progress in their sustainability efforts. The sample includes companies that are relatively small (49% with less than 500 employees) and
large (51% with over 500 employees, including 41 companies with more
than 3,000 employees). The findings from the project showed little difference in the success factors for a sustainable business strategy due to size.
From the initial survey, four dimensions of a sustainable business emerge
that include top management commitment; an ethical culture; stakeholder
engagement; and functional integration. These form the organizational
structure to support policies and procedures for producing products and
services that provide economic and social value. There are key questions
for management relating to each of these dimensions for assessing organizational opportunities for a sustainable business.
Top Management Commitment
Top management commitment in stressing environmental and social
programs positively influences employees in the organization. Putting
emphasis on areas other than the financial bottom line signals to the organization that these social goals are equally valid, and offers opportunities for creative programs and integrative solutions that work to meet the
triple bottom line. Lack of emphasis, on the other hand, communicates
apathy toward social responsibilities and an unwillingness to devote time
or effort into anything other than maintaining the profit margin of the organization. Industry leaders in creating social and economic value demonstrate their commitment in the following ways:
Top Management Commitment
Does management emphasize environmental and social programs?
Has the company developed a formal policy statement that addresses
environmental practices?
Has the company developed a formal policy statement that addresses
social issues (i.e., human rights, diversity)?
Does the top management provide the resources required to meet
environmental/social goals or objectives?
Does the top management seek periodic audits of environmental/
social activities?
The CEO, senior management, and the board of directors express the
companys position on social and environmental issues through annual reports, letters to shareholders, and corporate mission statements. A formal
policy statement demonstrates a public commitment by an organization

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to take responsibility for their social and environmental imprint. It communicates to members of the organization that environmental and social
efforts are an organizational priority, positively influencing the corporate
culture and encouraging individuals to present solutions. For example,
the CEO of P&G states in a letter in their 2011 Sustainability Overview
report:
The opportunity to make a difference that lasts generationswhether
through our brands and services, our operations, our environmental
sustainability efforts, or our philanthropyis what attracts people
of remarkable character and caliber to P&G. We are committed, together, to improving life every single day. Were proud of the progress we make year after year, and we are inspired by the challenge
to do more. (Robert A. McDonald, Chairman of the Board, President
and Chief Executive Officer)39
Incorporating environmental and social goals into the corporate culture
through the positive communication of top management is essential, but
without monetary and human resources, such communication becomes
irrelevant. Of the top management questions in the survey, this is the one
topic where the majority of all businesses see room for improvement. In
particular, smaller companies view any programs beyond regulations for
social and environmental responsibilities as an expense that would inflate
costs and lose customers. One company states, If youre smart about balancing, then you can really drive most of the way there without incurring
much cost, but if youre not careful you can spend lots of money and not
get any real return out of it. You can be a good corporate citizen but you
wont be around. Thats not sustainable.
Articulating a sustainability strategy entails leadership to develop measures to identify and manage the social and environmental effects of corporate activities in order to gain reputational advantages. For example,
the auditing of these activities by an outside agency can provide corporations with expert measuring techniques and perspectives that benefit from
experience with similar corporations. Top management encouragement
of, and cooperation with, such practices is crucial in order to properly
examine how the company environmental and sustainability efforts are
improving over time. Consequences of not delivering on promises of sustainable business practices can be long lasting. As Meyer and Kirby state,
When the public perceives that a company is producing an externality
that it could take greater responsibility for but isnt, thats when mechanisms of compulsion are brought to bear, from regulation to riots.40 Thus,
top management emphasis on social and environmental issues through
formal policies, resources, and auditing is a critical success factor for implementation of a sustainability strategy.

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Ethical Culture
A strong ethical culture that encourages fair and honest practices is another characteristic of industry leaders in sustainability. The ethical climate of an organization refers to the degree of organizational commitment
to ethical responsibilities of corporate citizenship and defines appropriate
behaviors of its employees and suppliers. Ethics is not often considered in
discussions of corporate social responsibility; yet a culture that promotes
and monitors ethical standards is the founding principle for responsible
companies.41 Companies establish an ethical culture through business ethics programs that guide employees, suppliers, and distributors to understand expected conduct through training and communications, advice
and reporting mechanisms, and monitoring through auditing systems.
The following questions identify key characteristics of industry leaders in
sustainability:
Ethical Culture

Does the organization have a comprehensive code of ethics?


Does a confidential procedure exist to report misconduct?
Is fairness toward employees an integral part of processes?
Do employees follow professional standards?

A comprehensive code of ethics sets the bar for the way in which a corporation handles its relationships with customers, employees, suppliers,
government, and the community. The strength of an ethics code depends
on how much it is encouraged and implemented by the upper management; when executed by all of a companys employees, it can enhance
the reputation of the company, while reducing risks. Larger companies
are more likely to have a formal code of ethics than small and mediumsized enterprises. A lack of a code of ethics puts the company at risk of
employee or supplier actions, resulting in criminal prosecution, product
recalls, toxic waste spills, or harassment claims. Therefore, a formal statement of a code of ethics includes the social and environmental issues that
influence the business.
Businesses globally are creating an infrastructure for reporting wrongdoing through ethics hotlines or ethics officers to comply with legislation
such as the Federal Sentencing Guidelines and Sarbanes-Oxley Act in the
United States and with similar legislation in Europe. Studies have found
five employee responses when exposed to ethical misconduct in the workplace: inaction, confronting the wrongdoer(s), reporting to management,
calling an internal hotline, and external whistleblowing.42 However, many
employees remain silent from fear that speaking up will damage relationships and cause others to view them negatively.43 Employees must feel

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confident that they are free to voice their concerns or report when they
witness misconduct taking place.
A strong indicator of an ethical culture is the employee perception of
fairness in the workplace. An emphasis on fair treatment of workers is necessary to demonstrate responsiveness to social issues relating to human
rights and diversity. Studies show that the ethical leadership of the immediate supervisor demonstrates the degree of concern for others, fairness,
and trustworthiness for employees that contributes to an environment
that values ethical conduct.44 Ethical leadership reduces employee stress
and affects job satisfaction. For example, a worker in a multinational company states: I am thankful that I am at a company that I dont have to go
there (meaning compromise his/her ethics)Im fortunate enough that
I dont have to make those decisions. It is something that the company is
very proud of.45
Along with organizational codes of ethics, employees of ethical companies abide by professional standards for their discipline, whether it is
accounting, finance, marketing, or engineering. Of all the questions relating to ethical culture, this is the only one that is not significantly higher
in larger companies. Companies in highly regulated industries, such as
financial services, governmental contracting, and health care, value compliance with professional standards in order to maintain legitimacy in the
market.
Companies may comply with voluntary standards and codes of conducts to address the legal, ethical, social responsibility, and environmental issues they face. Particularly over the past two decades, a number of
prominent business associations, NGOs, and international government
institutions developed a body of global standards for a responsible business. For example, a global network of business leaders committed to
principled business leadership provides principles for responsible business. The Caux Round Table believes that business has a crucial role in
developing and promoting equitable solutions to key global issues. The
International Organization for Standardization has an environmental
management standard (ISO 1400) and social responsibility standard (ISO
26000), both assisting companies to operate in the environmentally and socially responsible manner that society increasingly demands. The Global
Reporting Initiative provides globally applicable guidelines for reporting
on economic, environmental, and social performance.
Stakeholder Engagement
Sustainable companies recognize salient stakeholder groups, their key
issues, and their potential for helping or harming the business. A widely
accepted and popular definition of a stakeholder is that any group
or individual who can affect or is affected by the achievement of the

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organizations objectives.46 Stakeholders exhibit at least one of these characteristics: (1) the potential to be positively or negatively affected by organizational activities and/or is concerned about the organizations impact
on his or her or others well-being, (2) can withdraw or grant resources
needed for organizational activities, or (3) is valued by the organizational
culture.47 Industry leaders develop expertise in stakeholder engagement
and are able to address their concerns and interests. Key questions companies may ask include the following:
Stakeholder Engagement
In my organization do units engage with external stakeholders (e.g.,
suppliers, customers, local communities) in order to carry out their
projects?
Does the company have an assessment tool to evaluate social and
environmental performance of its key suppliers?
Does the company educate and/or assist its suppliers in meeting
environmental/sustainability goals?
Does the company measure its customers demands for environmentally and socially responsible products (and/or services)?
Stakeholder engagement includes processes for information gathering
about the interests and expectations of stakeholders, information giving to
share activities and performance, and dialogue and consultation. Nearly
half of the respondents indicated that they engaged stakeholders by communicating with them. Tactics varied from engaging in formal dialogue
or surveys to informal engagement (staying in touch with customers, discussing sustainable issues during other communiques, etc.). Although a
company benefits from such communication processes, a collaborative effort with stakeholder groups provides greater opportunities to become
better aligned with their stakeholders and better positioned to become
sustainable enterprises.48
Industries vary in the degree of engagement with specific stakeholder
groupsespecially customers, regulatory agencies, and suppliers. Manufacturers tend to have a greater focus on suppliers than nonmanufacturers. Although consumers and employees receive the largest attention
overall, services and retail are most attentive to these two groups. Highly
regulated industries, such as utilities (e.g., energy and air travel) and industrial manufacturing, have the greatest focus on regulatory groups. One
interesting story from the interviews relates to a multinational corporation working with a regulatory agency. Prior to starting business in Costa
Rica, the company discovered deficient chemical and environmental regulations. Rather than take advantage of a lack of regulatory oversight,

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139

the company immediately collaborated with the government to design


and pass environmental legislation modeled by the most stringent U.S.
guidelines.
Suppliers are important stakeholders for a firm, yet many companies
do not consider the supply chain in social and environmental programs.
Social issues relating to suppliers relate to diversity, the environment,
and labor concerns. The complexity of the global supply chain suggests a
greater likelihood of accepting responsibility for the actions of their suppliers. Firms with a larger percentage of their sales or supply from outside
of the United States should pay particular attention to address employee
concerns. A need to focus on employees is a reflection of the various legal
and regulatory issues with labor in international markets, as well as the
difficulty in managing and controlling supplier labor practices. Industry
leaders in sustainability select and evaluate suppliers based on their social and environmental performance, helping competent vendors become
socially responsive, and helping socially responsive vendors to become
competent. Inclusion of social and environmental issues in vendor selection has far-reaching effects in an industry. Of the companies interviewed,
more than a quarter of respondents require their suppliers to meet government regulations, industry standards, or voluntarily codes for sustainability. Other respondents implement social and environmental programs to
continue to supply a major customer.
Understanding customer demand for products that have a positive social and/or environmental impact is critical for a strategic sustainability
strategy. Consumer expectations regarding health and safety, marketing
and advertising, and product performance influence buying habits. Industry leaders seek customer input for developing solutions that address
social or environmental issues. For example, at Ecolab they survey field
sales staff to understand their customers operations, collect quantitative
and qualitative research on customer satisfaction and perceptions, and encourage customers to meet with management to build mutually beneficial
relationships.49
Functional Integration
When instituting a top-down initiative to institute environmental
awareness and social programs, employee engagement at all levels is imperative for a successful sustainability strategy. Through sharing of information and resources, companies can generate an organizational culture
that encourages innovative approaches to environmental and social issues. However, each function within an organization faces unique social
and environmental challenges. Providing education and training enables
employees to achieve positive results company wide, while sharing experiences encourages crosspollination of ideas throughout the organization.

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A review of five cases of employee engagement finds the following best


practices: (1) inviting all levels of an organization into dialogue and acting on resulting ideas; (2) having a clear and compelling vision that everyone creates and supports; (3) integrating sustainability concerns into
fundamental human resource practices, product design, and corporate facilities; (4) proving consistent messages through peer partners, lunch-time
discussions, newsletters, and community service events; and (5) training
the managers to train others in safe and proper practices.50 The questions
where leaders of sustainability scored the highest reflect these best practices:
Functional Integration
Does the company integrate social and environmentally conscious
practices across product/service lines?
Is staff at all levels educated concerning environmental awareness
and sustainability?
Is the spirit and vision of social responsibility communicated to all
levels in all locations?
Are department managers trained to understand environmental/
sustainability programs and policies in order to achieve the environmental/sustainability goals and issues of their departments?
Does the company provide a method for communication between
departments within the company (e.g. sales/marketing, product
design, purchasing, etc.) regarding sustainability/environmental
issues and practices?
Although you may expect functional integration to be more difficult for
larger companies, results of the sample surveyed show the opposite. Companies with more than 500 employees indicate more emphasis on training, communication, and crosspollination among functions. At least one
organization includes social and environmental activities in job descriptions, with a closed-loop feedback system created by auditors and agencies. They state: as the auditors make findings related to processes or
sustainability, changes and improvements are incorporated and the process repeats itself.
Management research shows that awareness, understanding, and demand from managers and employees are key success factors to implementing a sustainability strategy.51 However, some of the survey respondents
admit that sustainability discussions are primarily in the upper levels of
the company and communication to other levels is too strategic and not
practical enough for the mid-level manager or front-line employee. In one
organization, the management expressed that social and environmental
activities were only the responsibility of a sustainability department and

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therefore only communicated within that group. Company training and


communication initiatives need to consider all levels and locations of the
organization. One company interview includes upper management stressing effective communication of their sustainability strategy, although a
lower manager of the same company is not able to recall communicating
sustainability concepts to their employees. Successful companies invest
in integrating environmental, social, and economic goals across the organization expecting each functional area to understand the effects of their
activities, accept the responsibilities for implementation, and develop policies and practices for achieving these goals.
Policy and Practice
With an organizational structure for social and environmental responsibility, functional areas can implement practices that drive sustainability
performance. Formal policies encourage employees to consider social and
environmental issues in the design, production, and marketing of products
and services. However, sustainability performance only improves with
continuous learning through monitoring the effects practices have on all
stakeholders. Offering products and services that provide social and economic value to consumers requires coordination of policies and practices
among research and development, procurement, production, and marketing departments. At Ecolab Inc., new product innovation involves collaboration with sales, marketing, R&D, and engineering employees through
an assessment of customer needs, product data, sales and financial projections, and sustainability effects.52 For a successful implementation of a
sustainability strategy, companies can assess the extent to which employees incorporate and measure social and environmental issues through the
questions relating to product design, purchasing, marketing/packaging,
operations, and facilities. From results of the 113 items in the initial survey, industry leaders put a significantly greater emphasis on the following policies and practices than those with little or no sustainability efforts:
Product Design
Is there a formal policy to reduce the dependence on nonrenewable
natural resources through design of the products or services?
Is life-cycle thinking made an integral aspect of product design?
Is the product designed to reduce the amount of materials and packaging required?
Does the product design achieve a high recycled content?
Are materials evaluated for upstream and downstream energy and
fuel intensity?

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Purchasing
Does the company have an environmentally preferred purchasing
policy or guidelines?
Does the company provide socially diverse suppliers the opportunity to participate in sourcing opportunities?
Does your organization assess human rights conditions of your firsttier suppliers and suppliers beyond the first tier?
Does purchasing identify and purchase sustainable products (recycled, recyclable, bio based, climate neutral, nontoxic)?
Does the purchasing department promote minimization, reuse, or
recyclability of packaging from suppliers?
Are local products/suppliers given preference in purchasing decisions?
Marketing/Packaging
Has the company developed and implemented environmentally oriented packaging guidelines for customer shipments?
Does the company promote minimization of packaging?
Are incoming and outgoing packaging material reused or recycled?
Are marketing claims periodically evaluated and substantiated to
avoid inaccurate or misleading claims (i.e., green washing)?
Do marketing and sales strategies accurately reflect company sustainability policies?
Does the company educate its customers about sustainability issues?
Operations
Has the company developed a pollution-prevention program for its
operations?
Does the company ensure business and administrative operations
(papers, toners, marketing materials, etc.) comply with sustainable
guidelines?
Does the company dispose of its waste in an environmentally responsible manner?
Has the company developed a system to identify and reduce air
emissions?
Has the company developed a system to identify, reduce, and/or
eliminate hazardous materials?
Does the company require and promote recycling throughout its
operations?

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Are waste-minimization procedures implemented and tracked in all


processes?
Does the company have policies in place to minimize transportation
emissions in employee transportation or product delivery?
Does the company have policies in place to minimize energy use in
the receiving or delivery of its products and/or services?

Facilities
Does the company track the consumption and reduction of energy?
Does the company track the consumption and reduction of water in
its facilities?
Are electrical, mechanical, plumbing, and lighting fixtures chosen for
maximum efficiency?
Are green spaces and native landscaping incorporated at the site as a
means of reducing water usage?
Do the parking facilities accommodate alternative fuel vehicles, carpoolers, and cyclists?
Does the companys new/recent facilities meet a nationally recognized green building standard (LEED, Green Globe, etc.)?
Although not a comprehensive list of policies and practices for implementing a triple bottom line, the chosen activities focus on offering products and services that minimize the impact on the environment, while
increasing the health and safety of consumers, employees, suppliers, and
the community. They represent organizational competences for becoming a market leader by realizing sustainability as an opportunity for innovation to address social and environmental issues.53 Questions relating
to nonrenewable natural resources, energy and water use, recycling, and
waste management address the environmental and economic dimensions
of the triple bottom line by increasing efficiency throughout the value
chain. Additionally, increased revenues result from the focus on developing innovative product solutions through a life-cycle analysis that addresses the overall impact of the product through raw material acquisition,
manufacturing, distribution, use and reuse, and end-of-life management.
Marketing questions relate to customer perceptions of innovative products or packaging that requires the ability to generate real public support
for sustainable offerings and not be considered as greenwashing.54
Likewise, a number of the questions relate to social issues for business.
For example, purchasing and operations departments focus on eliminating hazardous and toxic materials to address social and environmental

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issues of product safety and employee health. Policies for sourcing from
socially responsible suppliers illustrate a commitment to incorporate diversity and human rights into the procurement function. As a whole, the
survey questions provide a starting point for companies struggling to address social and environmental issues that affect its customers, employees,
suppliers, and surrounding communities.
MANAGERIAL IMPLICATIONS
Understanding the social forces influencing firm strategy is both important and complex with increasing demands for companies to take responsibility for social costs. Social forces are dynamic, reflecting shifts in
demographics, lifestyles, attitudes, and social norms. Issues that evolve
from societal trends include social (i.e., human rights and diversity) and
environmental (i.e., energy use and climate change). The triple bottom line
approach views social issues in three dimensions: economic, environmental, and social. The interactions among these three dimensions highlight
emerging social issues, such as job creation, employee welfare, product
safety, supplier integrity, and waste management, which arise from the attention of the press, government, and activist groups. Management must
prioritize attention and resources on the social issues that have the most
impact on their industry.
Companies gain a competitive advantage if able to anticipate and respond to social trends that guide consumer and employee behavior.
Therefore, management of leading firms emphasize their commitment to
addressing social and environmental issues through a formal strategy that
encourages ethical practices in engaging with key stakeholders, including customers, employees, suppliers, regulatory agencies, and the community. Collaborative efforts with customers or the government can result
in innovative product and service solutions to pressing social issues. Integration of the vision for social responsibility to management and employees at all levels aligns business activities to achieve organizational social
and environmental goals. Through implementation of sustainable business practices that consider influences of social forces, the company reduces risks of regulation and litigation, enhances efficiency, and increases
revenues by creating economic and social value for customers.
Why is it so important to attend to social and environmental issues in
business? Because the degree to which a company addresses social trends
in its strategy influences its overall reputation, customer satisfaction,
and innovation, which in turn affects financial performance.55 Although
doing good creates customer satisfaction and a positive reputation, irresponsible actions lower customer satisfaction and overall reputation that
have lingering effects. An unethical practice that exploits or harms another party reduces the customers satisfaction, whether or not the firm

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145

is directly responsible. For example, consider a retailer who prides themselves on animal rights, and a supplier was found to use animals for testing products. High customer ethical expectations of the retailer may result
in higher dissatisfaction.56 Unfortunately, a poor reputation for corporate
social responsibility discredits social and environmental initiatives. Some
firms recognize this in their annual reports; as the tobacco company, Altria
Group, states:
We know that this is an evolving process and continually strive to improve our efforts to earn public trust and strengthen our reputation
through a commitment to responsible marketing, quality assurance,
ethical business practices and by giving back to our communities.57
As shown, social trends relating to health, safety, energy, waste, and
employment influence firm strategy by expecting responsible business
practices throughout the value chain. Negative social and environmental
effects from company activities become targets for activist groups, creating detrimental reputational effects, and impending regulation. Through
constructive dialogue with stakeholders, companies can anticipate and respond to emerging issues to create both economic and social value. Sustainable businesses recognize that strategic responses to social forces are
instrumental for long-term company success.

NOTES
1. Danone. Danone Sustainability Report 2010, Available from: http://www.
danone.com/images/pdf/danone_uk_24mai.pdf.
2. Bonini, Sheila M. J., Lenny T. Mendonca, and Jeremy M. Oppenheim, When
Social Issues Become Strategic, The McKinsey Quarterly, 2006. 2: pp. 1931.
3. Porter, Michael E. and Mark R. Kramer, Strategy and Society: The Link
between Competitive Advantage and Corporate Social Responsibility
Response, Harvard Business Review, 2007. 85(6): pp. 13637.
4. Porter, Michael E. and Mark R. Kramer, Creating Shared Value, Harvard
Business Review, 2011. 89(1/2): pp. 66.
5. Porter and Kramer, Strategy and Society: The Link between Competitive
Advantage and Corporate Social ResponsibilityResponse, Harvard Business
Review, 2007. 85(6): pp. 13637.
6. Danone. Danone Sustainability Report 2010, Available from: http://www.
danone.com/images/pdf/danone_uk_24mai.pdf.
7. Mahon, John F. and Sandra A. Waddock, Strategic Issues Management: An
Integration of Issue Life Cycle Perspectives, Business and Society, 1992. 31(1): p. 19.
8. Foust, Dean, Geri Smith, and Elizabeth Woyke, Killer Coke or Innocent
Abroad? in Business Week. 2006. p. 46.
9. Business: The Blog in the Corporate Machine; Corporate Reputations, in
The Economist. 2006. p. 66.

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Strategic Management in the 21st Century

10. Swartz, Jeff, Timberlands CEO on Standing up to 65,000 Angry Activists,


Harvard Business Review, 2010. 88(9): pp. 39127.
11. Meyer, Christopher and Julia Kirby, Leadership in the Age of Transparency, Harvard Business Review, 2010. 88(4): pp. 3846.
12. Ibid., p. 44.
13. Zyglidopoulos, Stelios C., The Issue Life-Cycle: Implications for Reputation for Social Performance and Organizational Legitimacy, Corporate Reputation
Review, 2003. 6(1): p. 70.
14. Graves, Samuel B., Sandra Waddock, and Kathleen Rehbein, Fad and
Fashion in Shareholder Activism: The Landscape of Shareholder Resolutions,
19881998, Business and Society Review, 2001. 106(4): pp. 293314.
15. World Commission on Environment and Development, Our Common
Future. 1987, Oxford, New York: Oxford University Press.
16. Ibid., Chapter 12: Towards Common Action: Proposals for institutional and
Legal Change.
17. Elkington, John, Cannibals with Forks : The Triple Bottom Line of 21st Century
Business. Published 1997 by Capstone Publishing Limited, Oxford Centre for Innovation, Oxford, UK; Stony Creek, CT: New Society Publishers.
18. Meyer, Christopher and Julia Kirby, Leadership in the Age of Transparency, Harvard Business Review, 2010. 88(4): pp. 3846.
19. Procter & Gamble. Social Responsibility: Pampers Vaccinations, Available
from: http://www.pg.com/en_US/sustainability/social_responsibility/pampers_
vaccinations.shtml.
20. Danone. Danone Sustainability Report 2010, Available from: http://
www.danone.com/images/pdf/danone_uk_24mai.pdf, p. 34.
21. Epstein, Marc J., Making Sustainability Work: Best Practices in Managing and Measuring Corporate Social, Environmental and Economic Impacts, 1st ed.
2008, Sheffield, UK: Greenleaf Pub.; San Francisco: Berrett-Koehler Publishers.
288 pp.
22. Ecolab, Inc. Sustainability Report 2010, Available from: http://www.
ecolab.com/Publications/SustainabilityReport/sustainreport2010_40pp.pdf.
23. Nidumolu, Ram, C. K. Prahalad, and M. R. Rangaswami, Why Sustainability Is Now the Key Driver of Innovation, Harvard Business Review, 2009.
87(9): pp. 5664.
24. Danone. Danone Sustainability Report 2010, Available from: http://
www.danone.com/images/pdf/danone_uk_24mai.pdf, p. 34.
25. Nidumolu, Ram, C. K. Prahalad, and M. R. Rangaswami, Why Sustainability Is Now the Key Driver of Innovation, Harvard Business Review, 2009. 87(9):
pp. 5664.
26. Milliman, John, Tracy L. Gonzalez-Padron, and Jeffrey Ferguson,
Sustainability-Driven Innovation at Ecolab, Inc.: Finding Better Ways to Add
Value and Meet Customer Needs, Environmental Quality Management, 2012. 21(3):
pp. 2133.
27. Erikson, Kai, Toxic Reckoning: Business Faces a New Kind of Fear,
Harvard Business Review, 1990. 68(1): p. 123.
28. Dunagan, Sarah C., et al., Toxics Use Reduction in the Home: Lessons
Learned from Household Exposure Studies, Journal of Cleaner Production, 2011.
19(5): pp. 43844.

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147

29. Stodghill, Ron, Can Ford Clean up after Itself? New York Times. 2007. p. 1.
30. Barboza, David, Workers Poisoned at Chinese Factory Wait for Apple to
Fulfill a Pledge, New York Times. 2011. p. B1.
31. Becker, Monica, Sally Edwards, and Rachel I. Massey, Toxic Chemicals in
Toys and Childrens Products: Limitations of Current Responses and Recommendations for Government and Industry, Environmental Science & Technology, 2010.
44(21): pp. 798691.
32. Natural Products Association. NPA Quality Assurance Programs, October 25, 2011; Available from: www.npainfo.org.
33. Gonzalez-Padron, Tracy L., and Robert W. Nason, Market Responsiveness
to Societal Interests, Journal of Macromarketing, 2009. 29(4): pp. 392405.
34. Wirtenberg, Jeana, Wiliam G. Russell, and David Lipsky, Introduction and
Overview, in The Sustainable Enterprise Fieldbook, Jeana Wirtenberg, Editor. 2009,
New York: Greenleaf Publishing, pp. 224.
35. Luchs, Michael G., et al., The Sustainability Liability: Potential Negative Effects of Ethicality on Product Preference, Journal of Marketing, 2010. 74(5):
pp. 1831.; Sheth, Jagdish, Nirmal Sethia, and Shanthi Srinivas, Mindful Consumption: A Customer-Centric Approach to Sustainability, Journal of the Academy
of Marketing Science, 2011. 39(1): pp. 2139.
36. Lubin, David A. and Daniel C. Esty, The Sustainability Imperative, Harvard Business Review, 2010. 88(5): pp. 4250.
37. Procter & Gamble. 2011 Sustainability Overview Report, Available from:
http://www.pg.com/en_US/sustainability/overview.shtml.
38. Ecolab, Inc. Sustainability Principles; Available from: http://www.eco
lab.com/CompanyProfile/GlobalSustainabilityPrinciples.
39. Procter & Gamble. 2011 Sustainability Overview Report, Available from:
http://www.pg.com/en_US/sustainability/overview.shtml, p.2.
40. Meyer, Christopher and Julia Kirby, Leadership in the Age of Transparency, Harvard Business Review, 2010. 88(4): p. 43.
41. Epstein, Marc J., Making Sustainability Work: Best Practices in Managing and Measuring Corporate Social, Environmental and Economic Impacts, 1st ed.
2008, Sheffield, UK: Greenleaf Pub.; San Francisco: Berrett-Koehler Publishers,
pp. 3637.
42. Kaptein, Muel, From Inaction to External Whistleblowing: The Influence of the Ethical Culture of Organizations on Employee Responses to Observed
Wrongdoing, Journal of Business Ethics, 2011. 98(3): pp. 51330.
43. Milliken, Frances J., Elizabeth W. Morrison, and Patricia F. Hewlin, An Exploratory Study of Employee Silence: Issues That Employees Dont Communicate
Upward and Why, Journal of Management Studies, 2003. 40(6): pp. 145376.
44. Mayer, David, Maribeth Kuenzi, and Rebecca Greenbaum, Examining the
Link between Ethical Leadership and Employee Misconduct: The Mediating Role
of Ethical Climate, Journal of Business Ethics, 2010. 95: pp. 716.
45. Gonzalez-Padron, Tracy, Ecolab Inc.: How a Company Encourages
Ethical Leadership, in Learning from Real World CasesLessons in Leadership,
D. D. Warrick and Jens Mueller, Editors. 2011, Oxford, UK: Rossi Smith Academic
Publishing, pp. 4148.
46. Freeman, R. Edward, Strategic Management: A Stakeholder Approach. 1984,
Englewood Cliffs, NJ: Prentice Hall.

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47. Ferrell, O. C., et al., From Market Orientation to Stakeholder Orientation,


Journal of Public Policy & Marketing, 2010. 29(1): pp. 9396.
48. Sloan, Pamela, Redefining Stakeholder Engagement: From Control to Collaboration, Journal of Corporate Citizenship, 2009(36): p. 35.
49. Milliman, John, Tracy L. Gonzalez-Padron, and Jeffrey Ferguson,
Sustainability-Driven Innovation at Ecolab, Inc.: Finding Better Ways to Add
Value and Meet Customer Needs, Environmental Quality Management, 2012. 21(3):
pp. 2133.
50. Fairfield, Kent D., et al., Employee Engagement for a Sustainable Enterprise, in The Sustainable Enterprise Fieldbook, Jeana Wirtenberg, Wiliam G. Russell,
and David Lipsky, Editors. 2009, New York: Greenleaf Publishing, pp. 14161.
51. Wirtenberg, Jeana, Wiliam G. Russell, and David Lipsky, Introduction and
Overview, in The Sustainable Enterprise Fieldbook, Jeana Wirtenberg, Editor. 2009,
New York: Greenleaf Publishing, p. 17.
52. Milliman, John, Tracy L. Gonzalez-Padron, and Jeffrey Ferguson,
Sustainability-Driven Innovation at Ecolab, Inc.: Finding Better Ways to Add
Value and Meet Customer Needs, Environmental Quality Management, 2012. 21(3):
pp. 2133.
53. Nidumolu, Ram, C. K. Prahalad, and M. R. Rangaswami, Why Sustainability Is Now the Key Driver of Innovation, Harvard Business Review, 2009. 87(9):
pp. 5664.
54. Ibid., p. 60.
55. Brammer, Stephen and Andrew Millington, Corporate Reputation and
Philanthropy: An Empirical Analysis., Journal of Business Ethics, 2005. 61(1): pp. 2944;
Luo, Xueming and C. B. Bhattacharya, Corporate Social Responsibility, Customer Satisfaction, and Market Value., Journal of Marketing, 2006. 70(4): pp. 118;
Mcwilliams, Abagail and Donald S. Siegel, Corporate Social Responsibility: A
Theory of the Firm Perspective, Academy of Management Review, 2001. 26(1): p. 117.
56. Rhea, Steven J. Skinner, and Valerie A. Taylor, Consumers Evaluation of
Unethical Marketing Behaviors: The Role of Customer Commitment, Journal
of Business Ethics, 2005. 62(3): p. 237.
57. Altria Group, Inc. 2004 Annual Report. 2004, Altria Group, Inc.: New
York, p. 8.

Chapter 7

Business-Government Dynamics
in the Global Economy
Drew Martin and Loren M. Stangl

INTRODUCTION
When analyzing foreign market opportunities, a major pitfall is making
incorrect assumptions about a countrys external environment. Managers tend to assess foreign market conditions using a self-reference criterion, thus unconsciously referencing their own values and experiences
when appraising new environments. However, decisions based on selfreference criterion limit a managers ability to accurately assess foreign market conditions. In the United States, business decision makers
tend to follow neoclassical economic assumptions about how businesses
and government affect competitive market conditions. Yet, the roles
businesses and governments play in the marketplace vary by country,
by industry, and over time. Capitalism comes in many shapes and
sizes with no dominant form. This chapter develops a four-cell model
of business-government relations to explain differences that marketers
encounter in foreign environments. The model contributes to research
on varieties of capitalism (VOC) by framing the discussion around foreign entry decision-making criteria. This chapter advocates that managers approach foreign market opportunities with awareness of personal
bias and openness to various business-government configurations.

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Strategy recommendations offer possible solutions for the various economic conditions.
Interdependencies between business organizations, industrial sectors, and economic institutions vary by country and evolve over time.
For firms considering international expansion, competitive advantages
and awareness of industry competitive structure may not be enough for
success. Firms need to understand the underlying mechanisms that define the business-government dynamics within the home and host countries to effectively create successful international strategies.1
The strategy tripod approach considers firm, industry, and institutional perspectives to create a holistic evaluation of foreign market
opportunities. As such, a strategy tripod approach considers the embedded nature of strategic decision making in international business environments.2 Integrating the resource-based view,3 industry-based view,4
and institutional theory5 into a single perspective, the strategy tripod
approach recognizes that a firms embedded environment affects both
domestic and international strategies.6 This chapter advocates an awareness of both home and host country institutional environments as preconditions for firms considering international expansion.
Institutional theory builds upon the recognition that firms operate
within a social framework representing a countrys idiosyncratic economic, social, and political history. A countrys institutional matrix includes formal institutions (e.g., laws and regulations) and informal
institutions (e.g., social norms and shared cultural beliefs). Institutional
theory also recognizes that interacting regulatory, normative, and cultural-cognitive forces support and maintain stable behavior.7 Regulatory forces establish the rules of the game by which firms operate.8
In contrast, social norms and values define proper9 and admired behavior.10 Cultural-cognitive forces relate to preconscious cultural behavior
affecting regulatory and normative conditions.11 DiMaggio and Powell
maintain that institutions exert pressure on both firms and individuals
to conform through coercive, imitative, and normative expectations.12 In
addition, the governments cooperation or involvement directing economic growth and facilitating international trade also develops as part
of the institutional matrix. As a result, expectations regarding appropriate business-government interaction and cooperation vary by country.
Globally, various capitalist configurations exist that display complementary firm-institutional environments.13 Institutional theorists debate
whether isomorphic forces shape homogeneous firm strategies based
on a countrys institutional comparative advantage, or heterogeneous
firm strategies coincide and thrive within any given institutional architecture.14 In either case, institutional theory recognizes that national
environments operate differently and the firms domestic environment
influences firm strategy.

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151

Business relationships with government-directed economic institutions develop through repeated interactions based on historical events
and cultural expectations. Economic institutions both enable and restrict
firm activities.15 According to Boyer, Firms organizational choices are
actually informed and constrained by the overall institutional architecture, not the other way around.16 Hall and Soskice support this proposition by contending, In sum, and in many respects, [firm] strategy
derives from [institutional] structure.17 This line of thinking advances
the notion that institutional expectations become embedded in the firms
organizational activities. For example, China and the United States have
different ideas about the role of business and government. The Chinese
government takes a more obvious and active role in business planning
whereas the U.S. government attempts to follow a laissez faire approach
to business activity involvement, until forced to intercede (e.g., the recent financial crisis).
Does government involvement in trade impede or improve free
trade? The answer to this question depends on how one views the role
of government in the economy. From the U.S. perspective, government
interventions in business activities create market-entry barriers and provide industry subsidies that negatively affect the competitive market.
U.S. business leaders and government policy makers operate under the
assumption that markets should be free and unfettered. Do free markets
actually exist in the neoclassical sense? Neoclassical economists assume
that governments role should be minimal. Businesses should be free
to make revenue-maximization decisions without government intervention. Assuming market information is available to all participants, the
neoclassical market is the most efficient because businesses operate in
their own best interest. How can governments be involved in centralized
planning? Too many variables affect the market conditions. Only individual businesses operating within the market have the ability to move
quickly enough to capitalize on market changes.
Do businesses operate in a purely competitive, global market? The
evidence suggests pure competition died long ago with Adam Smith.
Not surprisingly, American businesses that base their strategies solely
on neoclassical economic theories struggle both internationally and domestically. For example, U.S. leadership in solar-panel manufacturing
has been lost to Chinese companies heavily subsidized by their national
government. Even a $535 million government-backed loan to Solyndra
did not make the solar-panel manufacturer immune from low-cost Chinese imports resulting in the companys bankruptcy.18 Chinas government continues to tilt the playing field by turning a blind eye to working
conditions and currency manipulation. Last year, seven Chinese workers took their own lives because working conditions in their Shenzan
factory included illegally long hours and draconian rules for a daily

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wage of $11.19 These workers spent up to 80 hours of monthly overtime


to meet consumer demands for Apples new iPad.
Concerns about Chinas undervalued currency led some government
policy makers to consider actions to correct the trade imbalance.20 Historically, the U.S. Congress is not comfortable with government involvement in free trade as evidenced by vetoes of previous efforts to fast
track presidential authority to negotiate on international trade issues.21
In recent years, greater support has emerged for government involvement in trade negotiations.
Structural and cultural rationales offer explanations as to why some
nations develop competitive advantages in certain product areas.22 Assuming these differences contribute to trade advantages, these competitive advantages are treated like national security interests. To level the
playing field, the World Trade Organization and regional trading areas
(e.g., North American Free Trade Association and the European Union)
reduce some barriers; however, the road to consensus among member
nations is slow.23 Also, trade zones potentially present barriers for nonmember countries.
The preceding text suggests that the business and government dynamic vary by country. Even businesses not considering foreign markets
need to be concerned about how their domestic market is influenced
by government policies as well as domestic and foreign competitors. To
help in understanding these differences, the following framework offers
a model to explain different market conditions in both industrialized
and developing countries. A four-cell model outlines the different roles
played by businesses and governments in market formation. First, the
discussion reviews the mainstream theories of business and government
relations. Understanding these different forms of capitalism provides
a background about the variety of global perspectives. These perspectives influence the formation of market structures. By understanding
these differences, businesses can better understand the global business
environment and they will be better prepared to succeed in overseas
markets.
FORMS OF CAPITALISMCURRENT AND PAST
A wide and diverse body of literature debates the causes, consequences, and typologies of global capitalism.24 According to Baumol
and his colleagues, no single and pure form of capitalism is likely to
dominate any economy to the exclusion of elements of the other, the mix
of different systems being what is the most important for the countrys
growth.25 A common theme to most research on capitalism varieties
is an exploration of the influences of governance, employment, and/

Business-Government Dynamics in the Global Economy

153

or investment institutions on business activities.26 This chapter explores


capitalisms variations based on business-government dynamics.
Depending on the philosophical foundation, one arrives at very different conclusions about the appropriate level of public sector involvement in business and economic development. National differences stem
from governments role in business-development activities. These differences offer guidance to categorize the different forms of capitalism.
Economic and political science literatures examine the growth of industrialized nations in terms of these relationships. Specifically, the literature focuses on a variety of institutional,27 industrial,28 and organized
labor,29 or, a combination of all three characteristics.30
Lazonick31 and Pitelis32 provide a framework relating to the strength
of business and national governments in industrialized nations market formation. This framework shows four basic capitalism forms. Placement of nations within this model depends on the relative control public
(government) and private (organized groups) have on the market.
Proprietary Capitalism
The movement from a monarchy to a more democratic form of governance supports the transition from mercantilist to free market theory.
A weak governments role assures that markets remain transferable so
participants are not hindered from making transactions. Governments
operating under the proprietary form of capitalism would not be considered a principal beneficiary of policies and laws. Adam Smith is
one of the first to present a weak-state model.33 Under proprietary capitalism, individuals are free to make economic production and consumption decisions. The governments role is limited to performing tasks for
the public good (e.g., national security) and to maintaining an environment that allows for a free-flowing economic system.
Smiths invisible hand assumes that the nation is composed primarily of small, sole-proprietary businesses. Each small business serves a
small percentage of the total market. Government action interferes with
the markets spontaneous order. Since small businesses dominate the
competitive environment, organized societal groups also are assumed
to be weak. No dominant group controls enough resources to influence
the market (monopoly power). Chandler coins the term proprietary to
describe this weak state-weak society capitalism form.34
Theory expansion from classical economics to neoclassical economics is sometimes credited to the Alfred Marshalls work on marginal
analysis.35 The fundamental idea of Marshalls work is that the power
of supply and demand generates market equilibrium. Market-price
equilibrium occurs when the quantity demanded equals the quantity

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supplied at a given price and given time (the point where the market
clears). This school of economics assumes that the market is free of
imperfection.
An important variant stemming from the neoclassical theory is attributed to John Keynes.36 Keynesian economic intervention responds to
high unemployment in England that contradicted the classical assumption of full employment (Says Law). According to Says Law, a wage
rate always exists that makes full employment possible in a capitalistic system.37 Keynes argues that the employment level has no relationship to the cost labor; instead, an increase in aggregate demand serves
as the primary incentive to hire more workers, which directly relates to
the level of investment. Businesses will not hire more people to produce
more products unless a demand for the surplus exists. The investment
decision requires inducements such as: (1) the marginal efficiency of the
capital (e.g., the best return for idle cash); or (2) the risk related to the
loan payoff to finance the production that makes the rate of return acceptable. Through monetary (e.g., prime lending rate) or fiscal policy
(e.g., state procurement policy) manipulation, the government affects
total spending and total employment.
Support for proprietary capitalism comes from the Chicago and public choice schools. Milton Friedman and the Chicago School proponents express concern about any concentration of power. Essentially,
they believe affecting trade for a public good is impossible.38 Unlike the
Keynesian use of demand as an employment-level determinant, Milton
Friedman focuses on the equilibrium of the money market (known as
quantity theory). Equilibrium in the money market is believed to be the
necessary market condition for expenditures on goods, services, and
securities. The public choice school also supports a limited state role.
Public choice proponents are critical of any government intervention. In
the minimal-state model, the states role should be limited to protection
against force, theft, fraud, and enforcement of contracts.39 All other state
actions violate individual rights.
Although the proprietary form is considered the theoretical foundation for United States capitalism, this form has several shortcomings.40
At least three shortcomings associate with neoclassical theory.41 These
shortcomings suggest that the existence of this form of capitalism is
problematic.
First, neoclassical theory assumes preexisting markets where one individual or group has oligopoly or monopoly power. The automobile
and commercial aircraft manufacturing as well as consumer retailing are
examples of oligopolies. General Motors, Boeing, and Walmart complete
against Toyota, Airbus, and Target, respectively. Small businesses trying to enter these competitive environments face insurmountable barriers. For example, Walmarts 9,700 retail stores had fiscal year 2011 sales

Business-Government Dynamics in the Global Economy

155

of $419 billion.42 Even Walmarts suppliers are kept in line by the retails purchasing power. In the mid-1990s, Rubbermaid raised the price
charged for the companys products because a key ingredients price increased by 80 percent. Walmarts solution was to give more shelf space
to lower-priced competitors, forcing Rubbermaid to merge with rival
Newell.43 Clearly, Walmarts size creates economies of scale enabling the
company to sustain a cost leadership position.
Second, Pareto efficiency assumes rationality of buyers and sellers. Retail shopping behavior studies suggest buyer behavior does not support
rationality. According to Point-Of-Purchase Advertising International,
70 percent of retail purchase decisions are made in the store; in-store displays encourage between 1.2 percent and 19.6 percent product lift.44 John
Barghs research on unconscious behavior helps explain this behavior.45
According to Bargh, most brain functions are done unconsciously and
automatically and people are on autopilot for most functions. Rather
than making decisions deliberately or rationally, consumers use their
instincts.46
Third, neoclassical economics assumes state action neutrality toward
all individuals or groups. What is government neutrality? Any governmental subsidy offers one stakeholder group an advantage. Do all
members of society benefit equally from government intervention? The
government-guaranteed loan to solar-panel maker Solyndra created
1,100 jobs and supported the clean-energy development. In this case,
government policy makers felt the loan guarantee served national interests. Solyndras recent bankruptcy filing leaves taxpayers and law
makers with questions about whether or not all stakeholders benefited
equally from the government-guaranteed loan.
Some evidence suggests that industrialized nations are moving even
further away from proprietary capitalism. Examining Western European
and U.S. economic growth from the 1930s to 1960s, Andrew Shonfield
concludes government planning increased regardless of the countrys
historical relationship between business and government.47 Shonfield
suggests centralized planning helps to take some fluctuations out of the
market and allows for wider benefit distribution. The rewards appear
to be even greater in the future as state and business planning methods
improve.
Despite the proprietary models limitations, the governmental trade
policies remain influenced by neoclassical economic assumptions. For
example, negotiations for a free trade agreement between Australia and
China include the recognition the latter is a market economy, a condition for free trade negotiations.48 Arguably, free trade agreements are a
two-edged sword. Ignoring these arrangements put domestic businesses
at a disadvantage when competing against other foreign firms.49 Entering the free trade agreement exposes domestic businesses to foreign

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competition on equal footing. Countries with lower production costs


have price advantages, and domestic production moves overseas to
remain competitive. In this case, not all stakeholders benefit equally
from government action. For example, organized labor unions see jobs
disappear overseas from outsourcing related to free trade agreements.
Managerial Capitalism
In The Visible Hand, Alfred Chandler discusses the transition from
proprietary to managerial capitalism.50 Between the 1840s and
1920s, the economy of the United States transformed from agrarian and
rural to industrial and urban. Modern multiunit business enterprises replaced small, traditional, sole-proprietary businesses. Controlling more
resources enabled the new industrialists to increase productivity and
lower costs. These industry consolidations resulted in greater market
control by large, vertically integrated corporations. Big business arrived
in the United States, seizing control of resources including raw materials, production technology, labor, and ultimately the government. A
managerial capitalism artifact is oligopolistic price fixing, which results
in market inefficiencies.
Organized groups are the principal beneficiaries of managerial capitalism.51 Governmental assistance varies proportionately by the resources
each group controls. Under managerial capitalism, the governments
primarily role is to support these groups as an act of self-preservation.
Satisfying large corporations helps the government to retain the existing structure and size (e.g., funding from tax revenues). Atomized societal members find their roles reduced. Marginalized groups controlling
fewer resources receive far fewer benefits than people belonging to
powerful and well-organized groups. The U.S. Congresss approval of
the 2003 tax bill created $350 billion savings for tax payers. This legislation passed despite less than one-third of the public feeling these tax
cuts were the best way to increase economic growth and increase jobs.52
One estimate found only 22 percent of tax payers with incomes less than
$100,000 would benefit by President Bushs 15 percent maximum dividend tax rate.53 Who benefits the most by low dividend tax rate? Clearly,
big business owners gain the most from such policies.
A pluralist society enables organized groups to exert too much influence on government trade policies. Capitals growing interests eventually control the activities of government, even at the expense of the
long-term interests of society.54 Big capitals development into transnational corporation threatens the existence of the nation-state as well as
labor unions and small capital. Following this line of thinking, growth
trends in large corporations come at the expense of higher unemployment and a decline in small businesses.

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157

Despite the apparent shortcomings of managerial capitalism, this


form best represents the dominant state of U.S. capitalism.55 Managerial capitalism also has proponents; for example, Austrian economist Joseph Schumpeter argued that a production system dominated by big
businesses is superior to one with only small businesses.56 Government
regulation should not be based on the principle that big business must
operate under a system of perfect competition. While Schumpeters
mention of government regulation seems to suggest the need for some
big business limitations, he encourages market development beneficial
to big capital. Another argument is big business represents the lesser of
two evils.57 Capitalism stands with federalism, the separation of powers,
and the antitrust tradition in the deep suspicion of authority.
Cooperative Capitalism
The strong state-strong societal form of capitalism can be characterized by both collectivist and neocorporatist theories. Whereas the former has historical roots in U.S.-state theory, the latter can be traced back
to Europe. The European version has little in common with the U.S. style
of capitalism due to organized labors inclusion in the model. Jeffrey
Harts analysis of capitalism highlights this difference by distinguishing between cooperative governance based on organized labors relative
strength.58
The collectivist theory can be traced back at least to Alexander Hamilton. Hamilton provides recommendations for strong government guidance and protection of domestic industry.59 Hamilton states that the
nation as a whole should support industry development. He warns that
small manufacturers in the United States could never catch up with the
larger and more-advanced manufacturers of Europe unless they are protected and subsidized. Government needs to provide a strong role to
ensure the economic well-being of citizens. Arguably, Englands fall in
manufacturing competitiveness is attributed to government failure to
protect domestic industries from foreign competitors.60
Some distinguishing collective-capitalism features include: (1) the
organizational integration of a number of distinct firms, (2) the longterm integration into the enterprise of personnel below the managerial
level, and (3) the states cooperation in shaping the social environment
to reduce the uncertainty of facing private sector investments.61 During
the 1980s and 1990s, Japans phenomenal economic growth and success
were credited by some authors to collectivist policies where business
and government work closely together for national interests.62 As was
the case historically in the United States and the United Kingdom, the
Japanese state played an important role in protecting the home market.
Government protection allowed business organizations to develop to

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the point where they could attain a comparative advantage in international markets.
Another cooperative form of governance is the neocorporatist system,
where societal interests are represented by formal, compulsory, noncompetitive groups.63 Neocorporatism should be understood in terms
of degrees instead of absolutes. Comparative studies on industrialized
capitalist nations conclude that the United States is the weakest in terms
of its level of neocorporatism.64 Due to legal limitations on industry collusion and cartels as well as the lack of a unified group representing
labor interests at the national level, the United States lacks the foundation to develop a neocorporatist style of capitalism.65
Collective-capitalism critics express concerns about the limitations of
centralized planning and increasing the power of government. Austrian
school proponent Friedrich Hayek argued that a centralized authority
cannot possibly acquire all the dispersed knowledge required for decision making.66 Other arguments against a more formalized relationship
between government and business come from the proponents of proprietary capitalism, such as the Chicago and public Choice schools.67
Also, most big business interests likely will resist a call for more government coordination. For example, interviews with the negotiations
team involved in a joint venture to build commercial aircraft in Japan
and China confirms that big businesses feel better qualified to conduct
their own foreign affairs. Businesses only want government assistance if
it is in their best interest.68 An example of this governmental role can be
seen when U.S. presidents visit Japan to lobby for more-open automobile markets.69 On the other hand, these same businesses try to distance
themselves from U.S. national policies when human rights violations
surface.70
In recent years, some economists have called to formalize the relationship between business and government.71 Increasing government-assisted foreign competition successfully is penetrating the U.S.
market. At the same time, U.S. businesses have difficulties entering foreign markets. Perhaps U.S. businesses are beginning to realize they are
mismatched when competing against nations with more formalized business and governments relationships. Lester Thurow sees the
United States as using an individualistic strategy against countries that
have a more cooperative form of capitalism.72 Robert Reich echoes similar sentiments; he recommends that a more formalized business and
government partnership be supported.73 In the early 1990s, the Clinton administration advocated a more active role for government and
international trade. President Bush tried to continue this trend, but he
had more difficulty getting congressional approval.74 The U.S. government started to assert itself in overseas markets on behalf of U.S.
businesses.

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159

This trend trickled down to the local level as well. Even U.S. state
governments started sending representatives abroad for trade missions.
Starting in the 1980s, many U.S. state governments opened overseas promotion offices in Asia and Europe.75 In particular, Japanese economic
growth led state government policy makers to believe that market opportunities existed and local government was best positioned to help
businesses. Most overseas offices were understaffed and underfunded.
Annual or biannual office budgets make long-term planning difficult.
Some offices became part-time ventures for English-speaking local business people. Other offices closed when state budgets required balancing. No compelling evidence supports the assertion that these state
offices did much to help U.S. businesses enter Japans tightly controlled
market.76 Little evidence suggests alliances between business and government resulted in a stronger position for the U.S. economy. These cooperative efforts appear to serve other purposes, such as offering state
governors a bit of international experience to enhance their political
portfolios in the event of them having aspirations for a role in politics at
the national level.
Authoritarian Capitalism
Although the strong state-weak society form is not found in many
industrialized nations, this model of capitalism has a record of rapid
growth in todays global economy. An authoritarian system provides a
strong centralized government to discipline disorderly and aggressive
societal impulses. Authoritarian capitalism gives the head of government extraordinary powers. Government organizes societal interests
from above, and prohibits the formation of autonomous groupings that
might resist state leadership. Late-developing nation-states with weak
industrial infrastructure are historically excellent candidates for this interventionist form of capitalism.77
Authoritarian capitalism first emerged in the early 1900s and, to varying degrees, continues to shape newly industrialized nations during
times of war. Some early corporatist models were found in Italy and
Germany during the World Wars.78 The primary difference between todays neocorporatist systems and the former corporatist systems is that
the government of the latter used coercive behavior to control societal
elements (labor and capital). To distinguish corporatism from neocorporatism (the latter also is referred as corporatism in the literature), the
former will be called authoritarian capitalism.
Compared to other forms, authoritarian capitalism is relatively new.
The other three forms of capitalism emerged in response to commerce;
however, the authoritarian variation appears to have roots in conflict or unstable political systems. Under an authoritarian system, tight

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resource control is necessary to build a power base. Whatever reason for


authoritarian capitalisms emergence, the market is structured so that the
principal beneficiaries are government lites.
The economic growth in South Korea and Taiwan represent some
variation found within the authoritarian form of capitalism.79 In both
cases, these nations have had high degrees of political autonomy in
postwar economic development; however, differences exist in how
businesses are organized in these countries. In South Korea, large
business conglomerates (chaebol) remain operational, but Taiwans private business groups (guanxiqiye) primarily are composed of smaller
businesses. Arguably, South Koreas chaebol provide evidence of a different type of market structure. Some evidence suggests that government
planning and directing is still prominent in South Korea. For example,
the South Korean government still has the ability to slow the international expansion of domestic firms.80
Although authoritarian control by the state suggests an antidemocratic decision-making structure, some evidence does support this
forms effectiveness. During the early 1990s, a number of Southeast
Asian economies had tremendous economic growth. In particular Indonesia, Thailand, Malaysia, Singapore, and the Philippines seem to fit
within an authoritarian style of capitalism.81 The recent enterprise expansion in China also seems to parallel other recent Asian nation transitions to authoritarian capitalism.
Today, a growing segment of the world is adopting some variant
of an authoritarian mode of capitalism. Newly emerging democracies
and longstanding dictatorships are both trying to rapidly catch up with
industrialized nations. Authoritarian capitalism offers a possible solution to their goal of a more-prosperous national economy. Although industrialized nations unlikely will evolve into this form of capitalism,
business leaders need to understand the authoritarian modes structure
because todays economy is global.
WHEN CAPITALISMS FORMS COLLIDE
The preceding model shows how differences in the competitive environment can be explained by the dynamics of business and government relations. The model emphasizes some important differences in
business-government relations. The model complements previous
VOC discussions. Hall and Soskice classify capitalism as a dichotomy between two modes of organization: liberal market economies
(LME) or coordinated market economies (CME).82 They argue that institutional complementarities cluster countries into identifiable groups
based on either market or strategic coordination modes of governance.
The United States and United Kingdom classify as LMEs, whereas

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161

Germany and the Nordic countries fall under the CME classification. The
current model extends Hall and Soskices model by considering LMEs to
contain both proprietary and managerial forms of capitalism and CMEs
to contain both authoritarian and cooperative capitalism forms.83
Managers with an eye on overseas markets face problems from their
marketing mix, and economic, political, and sociocultural conditions in
the foreign markets. U.S. managers particularly are naive when assessing
the relationship between the government and competitive environment.
In the United States, business and government seem to be obsessed with
the notion that free and unfettered markets exist and that the government
should have a minimalist role in the economy. As a result, these assumptions may be relied upon when assessing the overseas competitive environment. While collecting information about foreign countries, marketing
managers need to take care not to use a neoclassical economic assumption
in their analyses. Reliance on neoclassical market assumptions may result
in incorrect conclusions about opportunities and threats in the external environment. Business opportunities to enter foreign markets depend upon
the interaction between internal and external environmental factors.84
In the United States, the managerial variant has been the dominant
form of capitalism for the last 100 years. As markets have become more
global, the United States seems to respond slowly to different forms of
capitalism. Evidence of serious trouble began surfacing between the
years 1997 and 2000 when trade imbalance more than doubled from
$215 billion (1997) to $482 billion (2000) and imports increased to over
$1.1 trillion.85 The trade imbalances effect has been increasing difficulties for U.S. businesses to compete domestically as well as internationally. To decrease costs, U.S. businesses outsource production. While this
model lowers costs, domestic unemployment has soared to over nine
percent.86 Consumers fearful of losing their jobs have cut back on spending. Declining sales force retailers to downsize further. Arguably, the
U.S. strategy has backfired.
Meanwhile, state-assisted businesses from other nations seem to be
successful when trying to sell goods and services in the United States.
In 2010, the United States had negative goods trading imbalances with
China ($273 billion), South Korea ($10 billion), and Taiwan ($9.8 billion).87 South Korea rose to become the worlds eighth-biggest exporter
of goods in 2010 and a tenth-ranked gross domestic product growth rate
of close to four percent.88 At the same time, Chinas gross domestic product rose by 10.5 percent and forecasts for 2015 predict a 10 to 12 percent annual growth.89 The evidence suggests that the United States may
be mismatched when competing against nations with more formalized
business and government relations.
Understanding nuances of business-government relations are important for reforming a business strategy to compete in domestic and

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foreign markets. The next challenge for U.S. businesses and government is to find the right balance between assisting and interfering
with commerce. Finding this balance is problematic because neoclassical economic thought influences state policies. Global markets dictate
that something needs to be done to improve the effectiveness of U.S.
businesses to enter foreign markets. Proprietary capitalisms influence
makes this proposition more challenging. Each foreign market also offers a different competitive dynamic. Michael Porters study of national
competitive advantages shows evidence of industry clusters in various
industrialized countries.90 Large multinational corporations reach most
markets affecting markets without major domestic competitors. For example, even though New Zealands business base does not include any
companies in the top global 500 firms, a number of these top foreign
firms have a market presence. New Zealands economy is considered
to be one of the least corrupt and transparent, thereby creating an environment where foreign businesses can easily enter and compete with
smaller, local firms.91 Foreign and domestic firms lobby New Zealands
government, suggesting managerial capitalism is not contained by national borders.
The United States is the headquarters for 133 of the top 500 global
businesses, compared to 61 in China.92 On the other hand, another
U.S. trading partner, Mexico, only has three companies in the global
500 list. These large global companies pay taxes, employ people, and
finance political campaigns. These companies also employ professional
lobbyists to try and influence government policies to protect their selfinterests. Goldman Sachs spent $4.6 million lobbying the U.S. federal
government last year to try and influence the overhaul of financial regulations because key reforms will directly affect their bottom line.93
Corporate lobbyists in the Australia, Canada, Japan, European Union,
United Kingdom, and United States sometimes are former elected officials or retired government employees with links to top policymaking
officials. In the United Kingdom, some observers argue a revolving door
exists between parliament and industry.94
While measures such as the government corruption scale developed by Transparency International and domestic influence serve as
proxies for big business and government involvement, the evidence is
startling.95 Managerial capitalism exists in both the United States and
United Kingdom. Between 2005 and 2011, these economies show declines in transparency and big businesses. Such changes suggest more
government involvement, either directly or indirectly in economic planning. Dramatic increases in government spending serve as subsidies for
businesses affected. For example, between 2005 and 2011, the U.S. federal percentage of spending increased from 19.9 percent to an estimated
25.1 percent of the nations gross domestic product.96 At the same time,

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163

U.S. private sector unemployment increased from 5.2 to 9.2 percent.97


The U.S. total of the global 500 businesses shrank five percent from
176 to 133.98
Japans cooperative capitalism also shows some changes. Like the
United Kingdom and United States, the number of global 500 big businesses dropped from 81 to 68.99 Interestingly, the transparency score for
Japans government shows improvement, suggesting less government
involvement and fewer barriers for foreign businesses. These changes
likely reflect ongoing efforts by the Japanese national government to
boost economic growth. Government spending as a percentage of gross
domestic product continues to hover around 37 percent.100
Finally, Chinas business sector has increased considerably since
2005. China now has 61 of the global 500 businesses, an increase from
16 in 2005.101 The Chinese government owns all large financial institutions and the four state-owned banks account for over 50 percent of the
total assets.102 A combination of high corruption, a weak judicial system, and a strong central government control that limits foreign investment makes foreign business investment challenging. Although Chinas
recent economic growth outpaces the industrialized nations, wages for
workers remains low. Businesses from other countries find price-based
competition against Chinese businesses difficult.
Business and government leaders need to recognize free market economies do not exist. The competitive environment includes both domestic
and foreign big businesses. These giants have economies of scale advantages and perhaps institutional arrangements with local governments to
protect their interests. Any action or inaction by government affects the
playing field as well. To be successful in global markets, businesses need
to understand that differences exist and develop strategies taking these
differences into account.
DEVELOPING STRATEGIES FOR FOREIGN MARKETS
Fosters Lager is a global beer brand. Despite being an industry
leader, the firm misread how capitalism works in China. Fosters purchased majority shares of local breweries in Shanghai, Guangdong, and
Tianjin in 1993. While consumer price sensitivity was an issue, Fosters
could have avoided an expensive lesson had executives understood that
the Chinese beer industry was highly fragmented and each town has
at least one brewery.103 Fosters could not develop a national distribution network because the numerous local breweries slowed the development of an intermediary distribution system in China. The company
experienced additional problems working with the Chinese government
because economic growth was more important than protecting foreign
business interests. Four years and $70 million in losses later, Fosters

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Strategic Management in the 21st Century

sold the Guangdon and Tianjin breweries and took a $100 million
write-off.
Borden learned Japans growing preference for premium ice cream did
not equate to market success.104 Bordens market-entry options included
foreign direct investment, joint venture, or licensing. High foreign investment costs and Japans multilevel distribution system influenced
the companys decision to enter into a limited term licensing agreement
with Meiji Milk, Japans leading ice cream maker. Furthermore, market
success would be challenging because Hagen Daz owned 90 percent of
Japans premium ice cream market.105 This licensing agreement served
Meiji better than Borden. As the licensing agreement approached its end,
Meijis Aya premium ice cream line was launched domestically. Borden
had trained a new competitor.
While Internet businesses are not new ideas, companies using technology to deliver products need to recognize that market entry occurs at
the speed of light. Waiting for even a few months to make a market-entry
decision is a costly decision. eBay executives learned that they missed an
opportunity by delaying the companys expansion into Japan. Used consumer goods waiting for garbage pick-up suggests that Japanese people
tend to shy away from used items. Yahoo Japan discovered Japanese
consumers buy collectables just like everyone else. Yahoos four-month
head start allowed the company to capture 95 percent of the market.106
Two years later, eBay abandoned the companys three percent market
share and gave up on Japan.107
Firms operating in dynamic, knowledge-intensive industries need
to develop strategic networks to help improve their success in foreign
markets.108 International business research finds that firms operating in
emerging or transitional institutional environments tend to substitute
strong network relationships for unstable institutions. Small businesses
experience different challenges, particularly when they are isolated geographically from major international markets. In this case, the industry
type affects the expansion rate. Both small and large businesses seem
affected equally when innovation and change are rapid. Network relationships serve as potential market-entry strategies, particularly if the
industrys innovation rate is rapid.109 In one case, a New Zealand computer software firm discovered that time spent raising capital for international expansion resulted in losing their competitive advantage.110
The preceding examples highlight challenges businesses face competing globally. While Fosters holds a strong, global position in the beer
industry, the firms resources did not overcome competitive and governmental differences experienced in China. The Chinese beer industry
is fragmented, thus making market growth challenging. Chinas strong
government created additional challenges because centralized planning emphasizes economic growth and the countrys legal system lags

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165

economic growth. The lack of legal transparency creates challenges for


foreign companies attempting foreign direct investment options.
Borden found oligopoly-level competition in Japans ice cream market. Japanese businesses have an institutional tradition of business
linkages called keiretsu. These linkages include overlapping boards of directors involving related businesses, a practice considered collusive and
illegal in the United States.111 The larger keiretsu arrangements evolved
from preWorld War II zaibatsu (Mitsubishi, Mitsui, Sumimoto, and Yasuda). These business organizations have existed since the 1920s and
include close relationships with government officials. Retiring, highranking government officials are hired as executives by these keiretsu organizations, creating a partnership between business and government.
In this case, Japans tradition of close business and government relationships made Bordens foreign market success difficult.
eBay just dropped the ball. A lack of Japanese domestic competition
and a global advantage over Yahoo may have made eBay executives
complacent. Technology-related firms need to recognize that market opportunities open and close at the speed of light. While eBay is a market leader and the Japanese market was wide open for opportunity,
eBay executives failed to see a growth opportunity. When the company
did launch in Japan, little effort was made to change their operations
to adapt to Japanese consumers.112 Yahoos executives recognized their
market entry as an opportunity to brand the company as Japanese and
product adaptations were made. Either eBays executives felt the brand
name would encourage Yahoo customers to change loyalty, or they just
wanted to test the market without spending too much money. Regardless of their intent, the results were not good.
Finally, small firms suffer from a lack of resources to enter foreign
markets, or to compete once they arrive. Creating strategic networks
help these firms move quickly and compete effectively. The New
Zealand software company provides an example of what happens in
a fast-changing business climate if capital cannot be raised quickly. In
this case, technological innovation moved faster than the firms ability to raise capital and the product was no longer competitive. Finding
the right company for these alliances is critical. As the market moves
quickly, good partners become scarcer over time.113 Without these partners, the chances of success for small firms are slim. Bigger businesses
will develop similar products, and competing in foreign countries without insider help is expensive and difficult.
To develop an effective market-entry strategy, a firm needs to consider the embedded nature of both domestic and foreign markets. This
chapter identified differences in governments cooperation or involvement directing economic growth and facilitating international trade.
Recognizing that differences exist helps to prevent making incorrect

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assumptions about the target market. Firms need to assess their own
capabilities, the industrys competitive nature, and the host countrys
institutional environment.

NOTES
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In addition to Marshall, other founders credited with the development of the


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www.economywatch.com/world_economy/china/?page=full.
90. Porter, The Competitive Advantage of Nations, 1990.
91. Transparency International (2009), Global Corruption Report 2009. http://
www.transparency.org.
92. Global 500, 2011 Rankings. CNN Money. http://money.cnn.com/
magazines/fortune/global500/2011/countries/US.html.
93. Puzzanghere, Jim. Wall Street; Goldman Boosts D.C. Lobby Force; Departing From Its Under-the-Radar Style, the Investing Giant Is Putting More
Money and Muscle into Its Capitol Presence. Los Angeles Times ( July 5, 2011): B1.
94. Whitehall, Polly C. New MPs links to Lobbyists Worries Anti-Spin
Group. The Guardian, July 3, 2010, 6.
95. Transparency Internationals scale ranges from 0 to 10. To make the scales
axis similar, the government transparency score is divided by 10 to represent a
percentage of transparency. Sources: Transparency International (2011), Global Corruption Report 2005 and Global Corruption Report 2011. http://www.transparency.org.
96. Historical Tables: Budget of the U.S. Government (2011), p. 27. http://www.
gpoaccess.gov/usbudget/fy11/pdf/hist.pdf.
97. United States Department of Labor, Bureau of Labor Statistics (2011).
Labor Force Statistics for Nonagriculture, Private Wage and Salary Workers.
http://www.bls.gov/webapps/legacy/cpsatab14.htm.
98. CNN Money. http://money.cnn.com/magazines/fortune/global500/
2011/countries/US.html.
99. Ibid.
100. Heritage Foundation. (2011), 2011 Index of Economic Freedom. http://www.
heritage.org/index/country/Japan#government-spending.
101. CNN Money. http://money.cnn.com/magazines/fortune/global500/
2011/countries/US.html.
102. Heritage Foundation (2011). 2011 Index of Economic Freedom, http://
www.heritage.org/Index/Country/China.
103. Tanzer, Andrew Over a Barrel. Forbes 162, December 14, 1998,
156159.
104. The Japan Ice Cream Association reports a growing preference for ice
cream from 47 percent in 1997 to 88 percent in 2008. See: Japan Ice Cream Association, Ice Cream Hakusho 2008, May 9, 2009. http://www.icecream.or.jp/data/
pdf/hakusho2009.pdf; Japanese Ice Cream Association. Ice Cream Hakusho
1999. http://www.icecream.or.jp/data/pdf/hakusho1999.pdf.

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105. Taiga Uranaka. Ice Cream Companies Turning to High-end Treats, Japan
Times, June 19, 2003.
106. Belson, Ken, Rob Hof, and Ben Elgin. How Yahoo! Japan Beat eBay at Its
Own Game, Business Week, 3735 ( June 4, 2001): 58.
107. Lane, Greg. Failed Businesses in Japan, Japaninc 73 (September/
October, 2007): 68. http://www.japaninc.com/mgz_sep-oct_2007_issue_failedbusinesses.
108. Pittaway, Luke, Maxine Robertson, Kamal Munir, David Denyer, and
Andy Neely (2004). Networking and Innovation: A Systematic Review of the
Evidence. International Journal of Management Reviews 5/6, no. 34 (2004):
137168; Eisenhardt, Kathleen M., and Claudi Bird Schoonhoven (1996). Resource-Based View of Strategic Alliance Formation: Strategic and Social Effects in
Entrepreneurial Firms. Organization Science 7, no. 2 (1996): 136150.
109. Laanti, Riku, Mika Gabrielsson, and Peter Gabrielsson. The Globalization Strategies of Business-to-business Born Global Firms in the Wireless Technology Industry. Industrial Marketing Management 36 (2007): 11041117.
110. Chetty, Sylvie K. and Loren M. Stangl. Internationalization and Innovation in a Networking Relationship Context. European Journal of Marketing 44,
no. 1112 (2010): 17251743.
111. Sheard, Paul. 1997. Keiretsu, Competition, and Market Access. In Global
Competition Policy, eds. Edward M. Graham and J. David Richardson (Washington,
DC: Institute for International Economics): 501546. http://www.piie.com/publi
cations/chapters_preview/56/16ie1664.pdf.
112. Lane, Greg. Failed Businesses in Japan, 2007, 68. http://www.
japaninc.com/mgz_sep-oct_2007_issue_failed-businesses.
113. Chetty and Stangl. Internationalization and Innovation in a Networking
Relationship Context, 2010.

Part III

Approaches to Strategic
Management

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Chapter 8

Serendipity as a Strategic Advantage?


Nancy K. Napier and
Quan Hoang Vuong

Who, over the age of 20, hasnt experienced a serendipitous event: unexpected information that yields some unintended but potential value later
on? Sitting next to a stranger on a plane who becomes a business partner?
Stumbling onto an article in a journal or newspaper that helps tackle a
nagging problem? Creating a new drug by accident?
Serendipity, defined as the ability to recognize and leverage or create
value from unexpected information, appears in all parts of life,1 and especially in professional fields, including science and technology,2 politics
and economics,3 education administration,4 library and information science,5 career choice and development,6 and entrepreneurship and management.7 Interestingly, although scientists have moved from reluctant to
open acknowledgement that serendipity is behind many an invention or
discovery, few business scholars or managers have systematically studied
or applied serendipity in any direct fashion. The topic, though, may be
gaining more visibility and attention: a new book on luck, for example,
looks at how individuals and organizations have turned good or bad luck
into something of value (return on luck).8
Thus, in this chapter, we seek to understand serendipity in a business context, examine what it could mean for management and strategy,
and how it could be used in business. We divided the chapter into three

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sections. First, we examine the concept of serendipity and its importance


and then review literature about it, in terms of definitions, conditions that
encourage or hinder serendipity at different levels (the level of the individual, the level of an organization, and external conditions), and the process of serendipity. Next, we propose a tentative framework that seeks to
incorporate the literature and existing models, and which draws upon discussions with executives who have begun to track and analyze how they
might use serendipity in their ongoing management practices. Finally, we
close with suggestions for how to develop the notion of serendipity as a
competitive advantage, both in practice and in research.
SERENDIPITYWHY WORRY ABOUT IT?
In the early 1950s, two eminent medical researchersDrs. Lewis Thomas
from New York University and Aaron Kellner from Cornell University
separately noticed an unusual anomaly in their research labs: the ears of
rabbits flopped when the animals received injections of the enzyme papain.9 Each researcher considered the phenomenon to be abnormal and
dramatic, but for each of them at the time, not worth spending much energy on. They were both pursuing other research and this unexpected
event did not peak their interests (or fit into their budgets) enough to follow up. The same phenomenon consistently occurred on subsequent occasions whenever they injected papain; again both researchers noticed it,
but they did not pursue it.
But some years later, in 1955, when Lewis was showing the phenomenon to a group of medical students, he finally decided to follow up on
why the rabbits ears flopped. At that time, he was able (more interest,
time, and money) to pursue what had caused the odd result. When he
at last studied what was happening, the pursuit resulted in research that
was revolutionary, more significant than the research he had been pursuing when he initially noticed the floppy ears. The floppy-eared-rabbit
research eventually led to a Nobel award. In contrast, the other researcher,
Professor Kellner, never pursued the floppy-ears anomaly, as it did not fit
into his research interest. Barber and Fox10 described what happened as
serendipity gained (Thomass decision to look into the phenomenon)
and serendipity lost (Kellners decision not to pursue it). The example
offered a striking illustration of the potential benefit of investigating some
unexpected information or discovery, as Thomas (finally) did.11
More famous examples abound of unexpected scientific discoveries
that have become lifesaving or revenue-generating products (e.g., penicillin, Velcro). Interestingly, and perhaps because the results are easier to
measure, scientists have unabashedly accepted the value of looking for the
unexpected or anomaly that may be more interesting than the expected
findings.12 In contrast, whereas most management scholars generally

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177

ignore, at best, or scoff, at worst, the notion of serendipity as an ability to


cultivate and use to organizational advantage, some management literature has begun to examine the concept. For instance, Brown13 argues that
it could play a role in entrepreneurs actions. Dew14 draws upon Sarasvathy15 to argue that surprises are usually relegated to error terms in
formal models. Instead . . . they may be the source of opportunity for value
creation, but only if someone seizes upon them in an instrumental fashion
and imaginatively combines them with . . . inputs to create new possibilities (italics added). Interestingly, when questioned, many managers will
say it happens all the time, but are reluctant to admit basing major decisions or directions upon serendipity.
Yet, some business strategic moves may depend more on serendipity than
managers or scholars have acknowledged in the past. Meyer and Skak16
studied the decisions of small- and medium-sized enterprises that were considering and/or moving into Eastern Europe. The networks that managers
had developed sometimes offered unanticipated opportunities by providing complementary resources, knowledge, or contacts. Given that the networks were outside of the firms control, an important aspect was that the
managers were open and ready to consider and then take advantage of the
unexpected opportunities that arose. In particular, Meyer and Skak17 found
that for small firms, such elements of chance could affect a firms growth
path and direction because of the networks, contacts, and opportunities that
the managers could pursue as a result of those serendipitous events. When
the small firms responded quickly, they could in some ways leverage such
unexpected information better and faster than competitors.
Finally, Collins and Hansen,18 in describing the idea of return on luck,
note that eventsgood and badhappen in any organization. The ability
to take advantage of them, to execute an action that generates good value,
has benefited some firms in major ways.19,20
As the management literature increasingly begins to open to the possibility that serendipity may have value in business, perhaps the way Taleb21
and others have discussed it in relation to scientists could be applied to
management: successful scientists search for something they know but
generally find something unexpected.22
WHAT DO WE KNOW ABOUT SERENDIPITY?
Serendipity as a concept has been around for hundreds of years. Serendipity as a studied concept is rather recent. In this section, we review
some of what has been examined and studied about several aspects of
or affecting serendipity. First, we review definitions, characteristics and
types of serendipity. Next, we look at the contextual factors influencing it, particularly at the organizational, individual, and external/environmental levels. Third, we examine literature that offers insight into how

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serendipity happens, or the process that seems to occur once unexpected


information appears. Finally, we review literature on the types of actions
resulting from leverage serendipity.
Most discussions on definitions of serendipity start with some version of the story reported by Walpole (1754). Hundreds of years ago, a
king named Giaffer educated his three sons to a level that nearly satisfied
him, but felt they needed a bit more seasoning before assuming the duties of the throne. He sent them into the countryside of what was then
called Serendip, later Ceylon, now Sri Lanka. In the course of their walks,
they noticed and made observations about information they had not
sought or expected, ranging from grass eaten and not, spit wads on one
side of the road, bees and flies, and footprints. When they arrived at one
town, a farmer asked if they had seen his lost camel.
Is the camel blind in its right eye? Is it missing a tooth on the left side
of its mouth? Is it lame in one leg? And is it carrying honey and sugar?
The astounded farmer at once accused the three princes of stealing his
camel and demanded that the emperor punish them. But the wise emperor asked first to hear the princes story.
We noticed along the way that the grass on the left side of the road
had been eaten, while the right side was still covered with fresh grass (so
we assume the camel is blind in one eye). We saw wads of grass that had
dropped onto the ground, through a hole where a tooth should be in the
camels mouth. Bees like honey and flies like sugar, which the camel was
carrying in packs on either side of its back and, as it swayed, must have
left drops in the road. And finally, we noticed three footprints and a drag
where a fourth would be, suggesting the camel was lame in one back leg.
The princes notoriety came from their ability to notice unexpected information that they were not searching for and, later, turn it into something of value. At the time, their curiosity caused them to notice, but
lacking context, they did not connect the various pieces of information.
Once they had a context for understanding the unexpected information
and a problem (the lost camel), they were able to connect the pieces of a
puzzle and offer and explain how they knew about the camel.
Definitions
The Walpole story is useful, but often not useful enough for people who
have tried to define serendipity over the years. In the management literature that has tackled the concept, typical characteristics that emerge include:
Unsought, unexpected, unintentional, unanticipated event or information,23
Out of the ordinary, surprising, anomalous, inconsistent with existing thought, findings or theory,24 and

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An alertness or capability to notice what others do not, to recognize,


to consider, and to connect previously disparate or discreet pieces of
information25 to solve a problem or find an opportunity.
Unsought, Unexpected . . . Anomalous and Inconsistent with Existing Thought
The definitions range from being quite broadunsought discoveries,
unexpected events, or informationto being more specific and narrower
in the nature of the event or information. In particular, the literature makes
it clear that the unexpected information should be an anomalous, incongruous, or inconsistent discovery or finding, at odds with existing theory
or ways of thinking.26 Scientists, especially, appear to conscientiously seek
the inconsistent or anomalous information or event because that forces review of existing theory and can, perhaps, lead to new directions with possible major payoffs.27
In some cases, an individual may be searching for a new idea, problem,
solution, or opportunity. In combinatorial chemistry, for instance, which
often yields new drugs, the notion of a blind search is part of the process,28 with serendipity mistakes just a likely stage in the experiment.
Going down a blind alley in search of some answer but finding another
one, then, is almost built into the research process itself.
Dew29 describes serendipity as the intersection of three domains or
elements: search, knowledge/preparation, and chance. He claims that an
individual needs to be looking for something, such as a solution to a problem or an opportunity. She needs to approach the search with existing
knowledge and preparation so that she will be able to recognize an event
or information. In addition, the unexpected event or information has to
emerge by chance. Thus, according to Dew,30 serendipity occurs only
when all three elements are present and overlap (a search, prior knowledge, and chance event).
Yet, if we return to the three princes of Serendip story (or to the
floppy-eared-rabbit story, for that matter), perhaps the search can come
after the information appears. In their case, it seems that two of Dews31
three conditions existed on the part of the princesprior knowledge and
preparation and the chance occurrence of unexpected information (e.g.,
the grass eaten on one side of the road, the footprints, and rut in the sand).
The princesand often scientistswere not looking for something, but
rather were able to solve a problem once they were presented with it, not
because they were seeking information to solve it.

An Alertness or Capability
Finally, a group of researchers note that the ability to notice or be
aware of unexpected information is critical. De Rond32 talks of scientific

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discovery as beginning with the awareness of anomaly and unsought


factors. Van Andel33 defines serendipity as the experience of observing
an unanticipated, anomalous, and strategic piece of data, which then allows for developing new theories or expanding existing ones.
Other definitions focus on the capacity or ability to see and leverage unsought information or discovery. In other words, serendipity is not just the
unexpected information or event but rather the ability to recognize and do
something with it. Specifically, it is an individuals or organizations ability to recognize and capitalize upon an unexpected event or information
and turn it into something that adds value for the organizationor, in the
case of scientists, the research community.34
Characteristics and Types
For scholars, scientists, and practicing managers, serendipity can
appear in several types, depending partly upon whether there is a
search intent and whether the unexpected information solves some
problem or opens the door to new problems/opportunities. In particular, several researchers use a 2 by 2 matrix to clarify these options. Essentially, they break serendipity into two categories: (1) whether there is
explicit intent to find something or a search exists to solve a problem or
find an opportunity,35 and (2) whether unexpected information solves
an existing problem or reveals solutions to unknown problems or opportunities.36 (Note: A situation where there is an intent and a solution
to the problem at hand is a traditional problem-solving (A to B) situation, not serendipity.) Thus, this generates three types of serendipity, illustrated in Figure 8.1.
Type I
First, the most common type of serendipity is when an individual seeks
a solution to problem A and it does not come from expected sources, but
rather from an unexpected event or piece of information, (B). For instance,
when researchers sought an explanation for obesity, initial assumptions
were that physiological or economic reasons were base causes; individuals had genetic tendencies toward obesity or they purchased cheaper food,
which tended to be higher in fat content. In fact, two researchers studying data from a small town in Massachusetts found another unexpected
explanation, from a completely different direction. Put simply, they found
that your friends can affect your health. People who are overweight
tend to associate with others who are overweight, as do smokers with
other smokers. Christakis and Fowler37 argue that social networks and
friendships may influence health, which was a completely unexpected explanation or solution to the initial problem of obesity.

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181

Figure 8.1
Types of Serendipity

Note. Modified from M. De Rond, 2005, The Structure of Serendipity, Cambridge Judge Business School Working Paper.

Type II
Type II serendipity happens when an individual searches for a solution
to problem A, but rather than finding a solution to A, uncovers something
unexpected and unsought (B). Well-known examples of Type II serendipity include the floppy-eared rabbits we mentioned previously, as well as
penicillin and Post-It notes. Fleming was not looking for penicillin, but
accidently discovered a mold in his lab that of course had many implications and uses. For Post-It notes, a 3M researcher was trying to create a
glue that would stick well and instead, accidentally discovered one that
did not stick so well, but then uncovered many uses for the newly discovered product.
Type III
The story of the three princes of Serendip reflects a final and, as some
might say, the truest form of serendipity. This occurs when a chance or

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unexpected event or piece of information appears, and an individual then


begins to think about what it might mean, and along the way, solves a
problem or discovers a new opportunity he or she had not intended or
thought of previously. In this case, no intent or overt searching happens,
but to gain the benefits of the unexpected event, the individual must still
have knowledge and a prepared mind to notice and then realize its potential value. The legend of the apple falling on Newtons headcombined with his knowledge of scienceled to his serendipitous discovery
of gravitys properties. Likewise, the also now famous story of the invention of Velcro: a man who found insistently sticky burrs on his dog was led
to wonder whether there might be anything of value that could be made
from such an unexpected bit of information.
In Type III serendipity, some scholars insist that there must also be a
metaphorical leap to uncover a possible value or use in the information
or event. In Newtons case, a falling apple came to represent gravitys pull
on any object; the burrs on the dog could be extrapolated to some sort
of material that holds tight.
CONTEXT FOR SERENDIPITY
It is not just the merit of the discovery that counts per se but
also the context in which it emerges.38
If a tree falls in the forest and no one hears it, does it make a sound? If
an unexpected and unsought event happens and no one notices, did it really happen? Context is critical for serendipity. In the floppy-eared-rabbit
example, one scientist did not and one (finally) did pursue an unexpected
observation, yielding major research implications for the one who did.
The key is that both researchers noticed the unusual event. Thus, for unexpected information to be of any potential value, it has to be noticed.
The scholarly literature suggests that two factors influence the possibility of unexpected information being noticed and leveraged. Those factors
exist at two levels: the organization and the individual. Most literature
relating to organizational context refers to how culture can enhance (or
hinder) the chances of serendipity occurring. At the individual level, the
literature discusses characteristics and traits that individuals need to have
or acquire to take advantage of serendipity. We briefly review each of the
context factors further on.
Enhancing Organizational Serendipity
By far, the most important aspect at the organizational level for enhancing the chance that serendipity will be leveraged is organizational culture.39 At least four elements of culture emerge often as being important
for increasing and facilitating serendipity.40

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183

First, the notion of finding ways to help dissimilar individuals interact with one another is critical, especially when they come from different disciplines.41 As the book The Power of Pull suggests, if knowledge is
dispersed,42 it is harder to find desired information with a formal search;
rather, it is more likely that individuals will discover something useful
through a chance encounter. That requires infrastructureboth physical
but also culturalto encourage those encounters. Cunha et al.43 talk of the
need for free flow of information through different types of social networks, such as when smokers meet outside a building. (One must wonder,
as smoking disappears, what interesting ideas and social networks have
also disappeared). When people come from diverse units and hierarchical levels, the opportunities for exploring the periphery of some field
or discipline can grow, and that unexpected information and chance for
exchange is high.
Following closely along with the importance of diverse groups that
interact is the need for trust, willingness to share knowledge, and social capital within an organization.44 In a culture that allows risk taking,
withholding of blame, and openness to a range of ideas, the likelihood
is greater that serendipitous events will be noticed and considered. Only
then can they be leveraged or used to an advantage. If a culture thwarts
open discussion or some amount of directionless activity,45 the chance
for gaining value from serendipity disappears.
Third, in addition to encouraging opportunities for cross-discipline exchanges and trust to happen, the literature suggests that an organizational
culture needs to tolerate a degree of autonomy for experiments,46 controlled sloppiness,47 and minimal structure.48 When some amount of inefficiency, dissent, and failure are allowed to occur, unintentional events
may happen, which may in turn generate ideas, opportunities, or solutions to problems.
Fourth, for members of an organization to actively look for serendipity
in their fields, it has to be perceived as relevant and important for that organization.49 The value of noticing unexpected information needs to be built
into the institutional routine, and then, when some information has been
recognized, it needs to be leveraged and implemented. As that cycle occurs
and individuals see the results, the notion of serendipity gains credibility
and legitimacy. That allows the organization to focus on hiring or developing people with a serendipity disposition, with diverse search styles
(looking for unexpected events), peripheral vision, and weirdness.50
Obstructing Organizational Serendipity
The factors within organizations that encourage serendipity can, of
course, hinder its likelihood if they are lacking.51 Without openness and
trust, the chance of self-censorship increases and individuals will be less

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alert to unexpected information. If power comes into play in deciding


who owns a great idea, or if vested interests dominate within an organization, ideas or observations could be interrupted or quashed somewhere in the organizational hierarchy, making it improbable that ideas
and the opportunity to leverage unexpected information will emerge in
the future. If the organization does not value or allow a certain amount of
experimenting or sloppiness, a discovery may be recast as one that was rational, leading to potential loss of other discoveries in the future. Finally,
if the right people do not support the process and notion of serendipitous
events having possible value, they certainly will go unnoticed.
ABILITIES NEEDED TO BE ABLE TO RECOGNIZE AND TAKE
ADVANTAGE OF SERENDIPITY
Chance is an event, serendipity is a capability.52
In the science of serendipity, luck can be caught, corralled, coached,
and created.53 For organizational leaders to leverage unexpected information, the capability of doing so must exist. This is the arena where education, training, and building of skills are most likely and most promising.
Scientists training students routinely discuss the importance of looking
for unexpected findings, following paths that peak curiosity and may (or
may not) have potential payoff.54 In this section, we discuss the broad categories of skills that individuals need so they may develop the ability to
notice and take advantage of unsought information or events. The skills
fall roughly into three broad groupings: general characteristics, those relating to openness and curiosity, and those relating to preparedness and
alertness, including stage of development. Finally, we close the section
with a review of the types of obstacles that can thwart the capability of
serendipity.
General Characteristics
The literature suggests that individuals who possess several fundamental characteristics are more likely to be able to see and pursue serendipitous events. Four broad groups of characteristics or skills come through:
(1) motivation to work hard and perform well; (2) a social network used
effectively; (3) willingness to take risks; and (4) a good grip on reality in
terms of what is possible or not in the marketplace.
First, regardless of the literature disciplinewhether education, career development, or businessthe research focuses on characteristics
that start with the most basic, including intelligence and competence, a
strong work ethic, persistence, diligence, and motivation to succeed.55
Next, the literature suggests that individuals who more often benefit from

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185

serendipity have strong and diverse social networks,56 which matches


with the need for a culture that encourages cross-discipline interactions.
Third, a willingness to take risks and pursue untested ideas is critical for
creative ventures of any sort, and particularly with regard to unexpected
events or information.57
Finally, and again critical for any endeavor where evaluation of unexpected events is necessary, it is an ability to assess realities. In examining differences between alert and nonalert people who noticed events in
the marketplace, Gaglio and Katz58 supported Kirzners59 alertness principle in their findings that shrewd and wise assessment of the realities
helped to encourage flashes of insights, which in turn led to identification
of market opportunities. Such a grip on reality60 enhances the likelihood
that an individual will notice (by being alert) and be able to assess the information or event for its possible value.
Openness and Curiosity
As we reported in the commonly told story about the three princes of
Serendip, one of their foremost qualities was simple curiosity and the ability to notice.61 They were open to what they found out later were clues to a
lost camel, which they had no knowledge of at the time they made their observations along the way. They simply noticed because they were curious.62
Such openness to unsought events and information has been noted in
career development, even to the point where Williams et al.63 suggest that
women are more open to serendipity in their careers than men. In addition, Van Andel64 includes openness and curiosity as critical factors in
people who find serendipity. Often the curiosity is coupled with a willingness to look for the surprise or the anomaly in a situation.65 Such counterfactual thinking becomes useful later in assessment of the information
or event as well.
Preparedness and Alertness
Was there ever a more trite saying than the often repeated comment
attributed to Louis Pasteur: chance favors the prepared mind66? Yet, if
this holds, then training, reading, and experience could help foster serendipity. And indeed, one of the most frequently mentioned characteristics
needed for taking advantage of serendipity is the notion of being ready
and prepared.67 Kirzner68 defined alertness as being able to notice an event
without searching for it and in the process identifying opportunities that
had been overlooked. Cunha et al.69 note that serendipity thrives on alertness and as a result depends upon mindfulness.70 The opposite, an unprepared mind, discards the unusual observation and hence loses the chance
for leverage.71

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But simply being alert or prepared may not be enough. In a study of


corporate executives and new venture managers, Busenitz72 found that
inexperienced founders of firms were intense and alert in their search
for informationunexpected and otherwisebut that they were less focused in how they searched, and sometimes let curiosity take them further afield (and wasted time) more than the experienced managers did.
In other words, they were open, but perhaps not prepared or alert in the
right manner.
Closely tied to being prepared and alert is, for some individuals, the
stage of their own development, whether that is in careers, knowledge
base, or personal lives.73 For instance, Betsworth and Hansen74 found that
factors both personal and professional influenced the degree to which, and
direction that, serendipitous events played in the lives of college graduates. Gaglio and Katz,75 as we mentioned previously, found that experience (i.e., later stage of career or profession) factors into the ability of new
venture founders to notice and take advantage of serendipity.
Finally, the two medical researchers who noticed the floppy ears in rabbits (Lewis and Kellner) were well-established scientists, with solid reputations, and thus at stages of their careers where they could, if they desired,
be more able or willing to take risks by following a path that could have
led to nothing. Of course, Lewis did not pursue the anomaly until several
factors contributed to his being ready to look at the question. He pursued
the floppy-ears question only later, when he had more resources (rabbits
to test), when he was frustrated with his other research (which had hit a
snag, so he was looking for new areas to pursue), and when he was, as he
put it bluntly, showing off a bit to his students. At that point, Thomas
realized he should be doing a more systematic comparison of injected and
noninjected rabbits.76 Thus, his stage of career and stage of research projects influenced his readiness to look into the rabbit ears.
Obstacles
As we noted at the start of this section, sometimes serendipity lost
wins the day. Several obstacles can impede serendipity. In fact, one could
wonder how it ever occurs! The obstacles range from a culture (discussed
earlier) that neither encourages nor celebrates the ability to notice and take
advantage of unexpected information, to individual inability or unwillingness to be open, courageous, and timely about what events or information
might be of value. Barber and Foxs77 comparison of the medical researchers identified distraction (with other projects) and lack of resources (not
enough rabbits to test) as obstacles to Lewis and Kellner pursuing the unusual observation when they both first noticed it.
But perhaps even more important and more devious are the preconceptions, expectations, and convictions that those researchers held, as do

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others, when they encountered an unexpected or unsought finding.78 Essentially, once expectations and assumptions are set, it becomes hard to
see something differently. In the rabbit ears cases, each scientist had a research focus in an area unrelated to cartilage (which is finally where Lewis
realized the impact of the enzyme). One focused on proteins, the other on
muscles, and as a result, when the out-of-the-norm observation occurred,
and did not fit within their frameworks of how to evaluate it, they could
not explain it (and refrained from pursuing it any further). Thus, a very
large obstacle, which ties back to the willingness to be open, is preconceived notions of the meaning of some observation.
HOW DOES SERENDIPITY HAPPEN?
How does the act of serendipity occur? What happens when individualsor organizationsleverage serendipitous information or events? Is
there a process or framework to help us understand it, follow it, shape it,
or learn it?
In this section, we review three frameworks from the business management literature (although one comes from information technology) that
suggest stages or steps in a process of understanding and using serendipitous events or information. Although 5060 years ago it was not common,
the science disciplines today, as we have suggested earlier, more readily
acknowledge that serendipity is a normal part of operations. In contrast,
Cunha et al.79 note that even now, few management scholars explicitly research serendipity in organizations.
The frameworks have in common the notions of some sort of precipitating conditions or situation, whether at the level of the individual,80 the organization,81 or the external environmental level.82 They also comprise the
need for an individual to notice an unusual event or anomaly, to recognize
there might be some possible value, and to connect seemingly disparate ideas
or data (also known as connecting the dots), which some scholars refer
to as bisociation.83 This stage refers to the ability to identify matching
pairs of events that are meaningful, and which may be, but are not necessarily, causally related.84 Finally, the frameworks generally include some
type of evaluation and resulting action that emerges from the process.85
We describe the three frameworks in more depth further on.
Looking for A but Finding B
Mendoca et al.86 and Cunha et al.87 focus on what we might call Type
II serendipity, where an individual searches for a solution to problem A,
but in the process, discovers something quite unexpected, a solution for
a completely different problem B. The framework has four major variables: (1) precipitating conditions, or those that will encourage or hinder

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likelihood of serendipity occurring; (2) the process of searching for a solution to problem A, including how organizational members go about the
search, and how open and focused they are; (3) bisociation, or the ability
to connect information, improvise, or make do with what is available to
solve problems; and (4) reaching an unexpected solution for a different
problem, including how open the organization and individuals are to ambiguity and imperfection.
Stages
Two other frameworks88 are stage models that focus more on the acts
of noticing or recognizing an unsought or unexpected event or information. Consultants Lawley and Tompkins89 propose a very straightforward framework that argues for the importance of preparation (E minus
1), before some unexpected event (E), and the steps that follow (called
E + 1, E + 2, and so on): recognition, choosing an action, and understanding its consequences. These steps may be iterative and happen repeatedly
over time before the final evaluation and assessment of the outcome is
clear.
A second stage model comes from Gaglio and Katz.90 They focus especially on the impact of unexpected events in terms of their likelihood to
lead to moderate or innovative opportunities. They offer a series of steps
that an individual would experience, where several types of evaluation
occur. First, an individual determines whether an event is normal and expected, or unusual and unexpected. For the normal event, typically the
individual and organization will continue with its status quo plans and
operations, and the event then will very likely yield small or imitative
new opportunities, if any. If the event is unexpected, then a first assessment determines whether to ignore, discount, or pursue it. If the organization chooses to ignore or discount the event, then the outcome is similar
to what occurs with a normal, expected event: following the status quo.
If an unusual event that is noticed and then assessed, subsequent stages
include trying to understand what it means for the industry, society, or
market, and then trying to explain it and put into the organizations context. This happens through what Gaglio and Katz91 call counterfactural
thinking and mental simulation, or trying to sense whether the event
is analogous to something already experienced. From that analysis may
come a big breakthrough that would lead to innovative or quite different
opportunities.
For all three frameworks, the final outcome or action likewise tends to
be something that is unexpected or unsought.92 Those could be, for example, finding a solution to a different problem, discovering a new solution
to an existing problem, or identifying a new opportunity (that ultimately
will save or make money).

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189

DEVELOPING A TENTATIVE FRAMEWORK FOR SERENDIPITY


Our tentative framework for the serendipity process incorporates
many ideas from existing models and adds a few twists. Some of the
twists emerged from attempts to apply serendipity as a competitive
advantage within a sample business firm. Recently the former CEO of a
manufacturing firm, Randy Hales, raised the question in his senior management group of whether the organization could develop serendipity
as a capability and leverage it to their competitive advantage. The firm,
Mity-Lite, based in Salt Lake City, Utah, produces high-quality office
furniturechairs and tablesfor use worldwide. The initial reaction by
the top executives was, not surprisingly, skepticism. Yet the executive
suggested that the managers experiment (curiosity and openness!), spend
30 minutes every two weeks to identify unexpected information, how
they noticed and evaluated it, and then decide what, if any, actions they
might take to leverage it. That very small experiment, in addition to existing research and literature, helped us shape a tentative framework, presented further on. We begin with a definition and its elements and follow
with the framework itself.
Definition
The definition of serendipity that we use is the ability to recognize and
evaluate unexpected information and generate unintended value from it. Four
aspects in the definition are critical to dissect: (1) the ability; (2) to recognize and evaluate; (3) unexpected information; and (4) generate unintended value.
Ability
First, serendipity as a capability more closely mirrors others definitions
that it is an alertness or capability to notice what others do not.93 It is not
a happy accident or an unanticipated discovery. Those are data points,
events, or pieces of information that exist, whether or not they are noticed.
But data points, facts, or information on their own are worthless without
the action or ability to leverage them. Thus, our definition of serendipity
supports others in its focus more on the action taken as a result of observing
or uncovering information, rather than simply on the discovery or event
or piece of information itself.
Recognize and Evaluate
The ability to recognize and evaluate comprises several pieces. First, recognizing includes two critical acts: noticing and connecting information.

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The three princes of Serendip observed or noticed bees circling droplets of


honey, grass that had been eaten on one side of the road, and three hoof
prints and one groove in the sand. Those bits of information, noticed and
filed away then, became important only later, within a context of the problem of a lost camel. In a sense, the bits of information were clues that
they did not realize were clues. Only within that context of a problem
did the princes connect the disparate pieces of unexpected information,
and put those clues together.
After noticing or observing comes evaluation of information. The ability to evaluate encompasses both flash evaluation and more systematic
evaluation in pursuit of creating value. Flash evaluation starts with a gut
feel that moves toward fuller alertness, which in turn can go to a more
systematic evaluation that confirms the initial gut feel. The reliance on
informationwhether from internal (personal or organizational) or external (environmental) sourcesmay vary, however, and we discuss that in
more depth further on.
Unexpected Information
Serendipity assumes the appearance of some type of information that is
unanticipated, unexpected, unplanned, or unsought.94 In a sense, it is the
reverse of what happens during the insight experience. Insight occurs typically after a conscious search for (and then sometimes and unconscious
mulling of ) information to learn or a problem to solve. During the time we
wrestle with the problem, or try to learn a new concept, we must assertively put forth effort and work, absorb information and sort it, before the
insight occurs. Thus, in the case of encouraging insight or aha moments,
we assertively pursue information.
Serendipity, on the other hand, begins more passively. It does not necessarily presume any work or attempt to solve a problem, other than noticing and having a prepared mind. It can include a search (Type I serendipity
that we discussed earlier in this chapter), but it does not require it (Types II
and III). Rather, it contains the notion of unexpected information appearing,
even when there is no immediate problem to solve. Information could be
data, an event, or an observation or clue. Again, to refer to the three princes,
they came across unsought, unexpected, and unplanned information or
clues. They made note, but did nothing with the information until they encountered a contextproblemwhich allowed them to connect disparate
clues or pieces of information into something of (unintended) value.
Unintended Value
Finally, the serendipitous experience includes the element of creating unintended value, which refers to the potential outcome of a problem

Serendipity as a Strategic Advantage?

191

solution, new opportunity, idea, or other direction that was unintended.


In other words, serendipity implies the lack of intension to solve a particular problem or find a particular opportunity. Rather it suggests the ability
to take unexpected information and create value that, before the information appeared, would not have happened.
Tentative Framework
The tentative framework (Figure 8.2) offers a process that individuals
appear to follow as they apply the ability to recognize, evaluate, and create value from unexpected information. The model has many steps, but
we have clustered them into four broad stages, with subparts in some.
The four stages include: (1) setting the stage or conditions that will increase the likelihood that unexpected information will be noticed (A, B, C,
and G); (2) noticing unexpected information and beginning to connect it
to other information (D); (3) evaluating the informationflash evaluation
and, sometimes, more systematic evaluationin terms of whether it could
create unintended value (E); and (4) taking action upon the information to
generate that value (F).

Figure 8.2
Tentative Framework of Serendipity Process

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Setting the Stage (A, B, C, and . . . G)


The model suggests that conditions at three levels may enhance the
likelihood of unexpected information being noticed. First, the characteristics or conditions of an individual (A) that will make her more or less
likely to notice anomalous information (e.g., openness, confidence, curiosity, alertness) are ones that many scholars have covered.95 Organizational
culture (B), including an openness to new ideas, a cross-discipline mix of
people, and an allowance for sloppiness, are similarly ones that research
has addressed.96
Finally, external conditions (C) have been less widely considered and
yet could well be more important for different types of settings or industries.97 In the case of the Mity-Lite executives, once they agreed to try and
track unexpected information and analyze how they could deal with it,
the openness in their culture and willingness to notice unexpected information was critical for them to generate potential future value. As they
became assertively alert to unexpected information, they began to see or
find information that they may have dismissed or not noticed before they
began their tracking exercise.
For example, in one case, the executives were launching a new product and had market analysis in preparation. In the process, they uncovered unexpected information that suggested their pricing methodology
was inaccurate. Because they had been alerted to the notion of unexpected
information and were looking for ways to recognize and leverage whatever they might find, they did notice unexpected information about their
pricing methodology, and evaluated and acted upon it. In the discussion
about their experience, they claimed that because they had been alerted to
the notion of unexpected information, they were more receptive to noticing and otherwise might have missed it without those conditions being
favorable to noticing.
Interestingly, even when information is seen to be of no value, the
simple act of noticing and recognizing possibilities may in turn enhance
the openness for setting the stage for future noticing (G). Thus, the act of
noticing and considering and then doing a flash evaluation may heighten
awareness and increase alertness for more unexpected information later.
Noticing and Connecting Unexpected Information (D)
The process of noticing or being alert to unexpected information98 and
then beginning to connect or bisociate99 unexpected bits of information
is one of the most critical steps in the serendipity process and framework.
Gaglio and Katz100 call this the Whats going on? step, which involves
noticing an unusual piece of information and then beginning to wonder
(and follow through) what it might mean. Critical in this phase, of course,
is the willingness to pursue the anomaly.101

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193

The Mity-Lite executive team offered several examples of unexpected


information that they connected that led to new directions, some more
strategic than others. One example involved a former employee who had
left the firm to gain expertise in a very different area than his previous
job. He joined another organization and realized he missed working at
the manufacturing firm; so he contacted the head of operations saying
that he would like to return to the firm, and was willing to go back to his
former job. Simultaneously, the operations executive had been considering the question of how to help the firm develop and move into the very
expertise arena that the former employee had developed while he was
away from the firm. The executive had decided that he had no option but
to develop an internal candidate since finding an external candidate was
deemed likely to be too difficult and costly. Then, boom! Unexpected information (the former employee with the desired expertise) calls. His reemergence thus solved a problem from an unexpected direction (Type I
serendipity).
EvaluatingFlash and Systematic (E)
The evaluation stages comprise both flash evaluation and more systematic evaluation.
Flash Evaluation. Initially, and coupled with the early connecting of
information bits is a flash evaluation, in which an individual does a quick,
almost gut feel assessment of the unusual information. The manufacturing executives refer to this as using their experienced eyes to assess
quickly some unexpected information. That initial gut feel then may lead
the individual to become more alert to whether there are ways to connect
the observed information to other already known information, both internal and external.
More Systematic Evaluation. A more systematic evaluation would include analytical assessment that leads toward a clearer confirmation of
the informations possible value. That process of assessing unexpected information for potential value is affected by factors such as risk tolerance,
level of uncertainty surrounding the information and evaluation, timing,
and finding additional information that will help confirm or dispute the
initial unexpected information. Depending upon how evaluators/decision makers take those factors into account when assessing unexpected
information may lead to better or worse outcomes.
The systematic evaluation part of the model has three critical elements:
(1) the distance between perceived or anticipated opportunity from the unexpected information and the reliability of the evaluation of the unexpected
information (in the middle), (2) the general evaluation process from gut
feel to a firmer belief about the evaluation, and (3) the factors that may
influence the process of evaluation. Those elements also determine the

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extent to which the information used in making decisions is weighted internally or externally.
The result of evaluation could take on at least three outcomes or decisions of whether to pursue an opportunity. First, when the unexpected information is evaluated in the context of both internal and external factors,
when the evaluator/decision makers are not swayed too strongly by
any of those sources, the evaluation is balanced and the outcome may
well be an opportunity that the decision maker leverages when competitors do not.
In the second situation, the decision maker notices unexpected information but mostly because others point it out and suggest that there is a
way to leverage it. The decision maker then essentially follows the herd
to try and take advantage of the unusual information, resulting in what
might be called a herd outcome. In this case, there is no competitive advantage to the organization because a herd of organizations is trying to
leverage the information.
Finally, internal decision makers may be pressured from sources, such
as government policy makers (e.g., Vietnams Ministry of Finance or the
U.S. Treasury during the financial crisis) to act. In this case, the organization may act on unexpected information without thoroughly considering
external factors or repercussions. During the 2008 financial crisis, for example, large U.S. banks were forced to take sell toxic assets to the U.S. government, which affected their leverage ratios; most ultimately and quickly
repaid the money. Unexpected information, evaluated for them, and the
outcome was not necessarily in their favor. This do it my way approach
is less common but does exist.
Creating Unintended Value ( F )
The ability to recognize and evaluate unexpected information is not
valuable in itself. To be a competitive advantage, the assessment must
yield value and action: the unintended value is thus a critical part of the
process. Whether it results in solving an existing or not-yet-tackled problem, finding an opportunity, or generating new ideas for future use, the
use of serendipity (as an ability) must be that individuals and the organization as a whole can leverage it to create value. The manufacturing
firm executives, for example, realized that by responding to a request for
just one sample product, they ended up with an unexpected customer
that could become major part of the firms business. Since the orders (and
revenue) were not anticipated in the current fiscal year plan, the firm has
decided to incur premium labor (overtime) to fill the demand, with the expectation later of increasing the price point for the products. Unexpected
information/request created an initial problem (finding a way to fill orders), but ultimately became an opportunity.

Serendipity as a Strategic Advantage?

195

WHAT NEXT?
The reaction of managers to the idea of watching for serendipity has
been mixedmost say they understand the concept immediately, once
they move beyond initial skepticism or even outright laughter (how can
you use something so unpredictable?). Others say, of course, it happens
all the time. Some have embraced the idea of actively being open to serendipity and looking for ways to use it. As we mentioned, one firms senior executives who began to track unexpected information and notice
how, if at all, it could take advantage of it, found at least six cases of serendipity gained during their first two months of looking for it. As they
described the incidents, it became clear that they experienced what they
referred to as different types (i.e., people and process based), but they also
experienced all three forms of serendipity: Type I (looking for a solution to
A but finding a solution from an unexpected source); Type II (looking for a
solution to problem A but discovering something completely unexpected
that, in turn, led to an opportunity and solution to an, as yet, unidentified
problem); and Type III (finding something unexpected and unsought that
later turned into an idea for an improved product). Although the executives did not categorize the events as being different types of serendipity, they recognized the value of noticing and being aware of unexpected
information, whereas they had not before their CEO presented the idea to
them. As they have begun to calculate the economic impact, their skepticism about the rather fuzzy notion has dissipated.
This small example of the application and use of serendipity, or the
ability to notice, evaluate, and create value from unexpected information,
is a first step for both managers and scholars to learn more about it. As organizations seek new ways to improve performance, and as the existing
techniques (e.g., lean manufacturing) become widespread, firms will look
for avenues that are less tapped and more difficult to execute well, such
as using creativity and innovation, insight, and serendipity. Being an early
tester, if not an early adapter, may help some of them move into the lead.
NOTES
1. Van Andel, Pek. 1992. Serendipity; Expect also the Unexpected, Creativity
and Innovation Management 1(1): 2032.
2. Barber, B. and Renee C. Fox. 1958. The Case of the Floppy-Eared Rabbits:
An Instance of Serendipity Gained and Serendipity Lost, American Journal of Sociology 64(2): 128136; Custers, Ruud and Henk Aarts. 2010. The Unconscious Will:
How the Pursuit of Goals Operates Outside of Conscious Awareness, Science 329,
July 2: 4750; Peterson, Gail B. 2004. A Day of Great Illumination: B. F. Skinners
Discovery of Shaping, Journal of Experimental Analysis of Behavior 82(3): 317328;
Roberts, Royston M. 1998. Serendipity: Accidental Discoveries in Science. New York:
John Wiley & Sons.

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3. Taleb, Nassim N. 2007. The Black Swan. The Impact of the Highly Impossible.
New York: Random House; Kirzner, I. 1979. Perception, Opportunity, and Profit. Chicago: University of Chicago Press.
4. Delcourt, Marcia A. B. 2003. Five Ingredients for Success: Two Case Studies of Advocacy at the State Level, Gifted Child Quarterly 47(1): 2647.
5. Foster, Allen and Nigel Ford. 2003. Serendipity and Information Seeking:
An Empirical Study, Journal of Documentation 59(3): 321340; LeClerc, Amanda.
2010. Seeking Serendipity: The Inspiration Hunt of a Creative Professional, Faculty of Information Quarterly 2(3) May/June: 18; Nutefall, Jennifer E. and Phyllis
Mentzell Ryder. 2010. The Serendipitous Research Process, Journal of Academic
Librarianship 36(3): 228234.
6. Betsworth, Deborah G. and Jo-Ida C. Hansen. 1996. The Categorization
of Serendipitous Career Development Events, Journal of Career Assessment 4(1):
9198; Diaz de Chumaceiro, Cora L. 2004. Serendipity and Pseudoserendipity
in Career Paths of Successful Women: Orchestra Conductors, Creativity Research
Journal 16(2 and 3): 345356.
7. Brown, Stephen. 2005. Science, Serendipity, and Contemporary Marketing Condition, European Journal of Marketing 39(11/12): 12291234; Dew, Nicholas. 2009. Serendipity in Entrepreneurship, Organizational Studies 30: 735; Pina
e Cunha, Miguel, Stewart R. Clegg, and Sandro Mendoca. 2010. On Serendipity and Organizing, European Management Journal 28: 319330; Svensson, Goran
and Greg Wood. 2005. The Serendipity of Leadership Effectiveness in Management and Business Practices, Management Decision 43(7/8): 10011009; Van
Andel, 1992.
8. Collins, Jim and Morten T. Hansen. 2011. Great by Choice: Uncertainty, Chaos,
and LuckWhy Some Thrive Despite Them All. New York: HarperBusiness.
9. Barber and Fox, 1958.
10. Barber and Fox, 1958.
11. Van Andel, 1992.
12. Hauser, Stephen L. 2008. Translational Research for a New Administration: What Sort of Change to Believe In? American Neurological Association 64(4):
A5A6.
13. Brown, 2005.
14. Dew, 2009.
15. Sarasvathy, Saras D. 2007. Effectuation: Elements of Entrepreneurial Expertise.
Cheltenham: Routledge.
16. Meyer, Klaus and Ane Skak. 2002. Networks, Serendipity and SME Entry
into Eastern Europe, European Management Journal 20(2): 179188.
17. Ibid.
18. Collins and Hansen, 2011.
19. Graebner, Melissa, E. 2004. Momentum and Serendipity: How Acquired
Leaders Create Value in the Integration of Technology Firms, Strategic Management Journal 25: 752.
20. Nonaka, Ikujiro. 1991. The Knowledge Creating Company, Harvard Business Review 69(6): 94.
21. Taleb, 2007.
22. Hauser, 2008.
23. Cunha et al., 2010.

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197

24. Brown, 2005; Van Andel, Pek and Daniele Bourcier. 2002. Serendipity and
Abduction in Proofs, Presumptions, and Emerging Laws, Studies in Fuzziness and
Soft Computing 94:273286.
25. De Rond, M. 2005. The Structure of Serendipity, Cambridge Judge Business School Working Paper; Gaglio, C. M. and J. A. Katz. 2001. The Psychological Basis of Opportunity Identification: Entrepreneurial Alertness, Small Business
Economics 16(2): 95111; Hafner, Katie. 2010. Think the Answers Clear? Look
Again. New York Times, August 31: D1, 4; Kirzner, 1979.
26. Brown, 2005; De Rond, 2005.
27. Barber and Fox, 1958.
28. Garcia, Pio. 2009. Discovery by Serendipity: A New Context for an Old
Riddle, Foundations of Chemistry 11: 3342.
29. Dew, 2009.
30. Dew, 2009.
31. Dew, 2009.
32. De Rond, 2005.
33. Van Andel and Bourcier, 2002.
34. Cunha et al., 2010; De Rond, 2005; Gaglio and Katz, 2001; Hafner, 2010;
Kaish, S. and B. Gilad. 1991. Characteristics of Opportunities Search of Entrepreneurs versus Executives: Sources, Interests, General Alertness, Journal of Business
Venturing 6(1): 4661; Kirzner, 1979.
35. Foster and Ford, 2003.
36. Cunha et al., 2010; De Rond, 2005; Roberts, 1998.
37. Christakis, Nicholas and James Fowler. 2009. Connected: The Surprising
Power of Social Networks and How They Shape Our Lives. New York: Little, Brown.
38. Cunha et al., 2010: 325.
39. Cunha et al., 2010: 319330; De Rond, 2005; Mendoca, Sandro, Miguel Pina
e Cunha, and Stewart R. Clegg. 2008. Unsought Innovation: Serendipity in Organizations. Paper presented at the Entrepreneurship and InnovationOrganizations,
Institutions, Systems and Regions Conference, Copenhagen, CBS, June 1720.
40. De Rond, 2005.
41. Hauser, 2008.
42. Hagel et al., 2010.
43. Cunha et al., 2010: 324.
44. Cunha et al., 2010; Mendoca et al., 2008.
45. Ferguson, as cited in De Rond, 2005: 21.
46. Dew, 2009: 735.
47. De Rond, 2005; Mendoca et al., 2008.
48. Mendoca et al., 2008.
49. Cunha et al., 2010: 327.
50. Danzico, Liz. 2010. The Design of Serendipity Is Not by Chance, Interactions, September + October: 1618; Mendoca et al., 2008.
51. Cunha et al., 2010: 326.
52. De Rond, 2005: 18.
53. Brown, 2005.
54. Roberts, 1998.
55. Cunha et al., 2010; Delcourt, 2003; Diaz de Chumaceiro, 2004; Williams,
Elizabeth Nutt, Elvie Soeprapto, Kathy Like, Pegah Touradji, Shirley Hess, and

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Clara E. Hill. 1998. Perceptions of Serendipity: Career Paths of Prominent Academic Women in Counseling Psychology, Journal of Counseling Psychology 45(4):
379389.
56. Betsworth and Hansen, 1996; Dew, 2009; Hagel et al., 2010; McCay-Peet,
Lori and Elaine G. Toms. 2010. The Process of Serendipity in Knowledge Work,
Association for Computing Machinery, Information Interaction in Context Symposium, August; Mendoca et al., 2008.
57. Diaz de Chumaceiro, 2004.
58. Gaglio and Katz, 2001.
59. Kirzner, 1979.
60. Gaglio and Katz, 2001: 97.
61. Smawley, R. B. 1965. Serendipity: Finding the Unsought, Journal of Educational Research 59(5): 177178.
62. Roberts, 1998.
63. Williams et al., 1998.
64. Van Andel, Pek. 1994. Anatomy of the Unsought Finding. Serendipity: Origin, History, Domains, Traditions, Appearances, Patterns and Programmability,
British Journal for the Philosophy of Science 45(2): 631648.
65. Dew, 2009; Gaglio and Katz, 2001.
66. Brown, 2005: 1232.
67. Brown, 2005; Carter, Bernie. 2006. One Expertise among ManyWorking
Appreciatively to Make Miracles Instead of Finding Problems: Using Appreciative Inquiry as a Way of Reframing Research, Journal of Research in Nursing 11(1),
4863; Cunha et al., 2010; Dew, 2009; Diaz de Chumaceiro, 2004; Garcia, 2009; Miyazaki, K. 1999. Building Technology Competencies in Japanese Firms. Research
Technology Management 42(5): 3945; Williams et al., 1998.
68. Kirzner, 1979.
69. Cunha et al., 2010: 323.
70. Mendoca et al., 2008.
71. Merton, Robert K. and Elinor Barber. 2004. The Travels and Adventures of Serendipity: A Study in Sociological Semantics and the Sociology of Science. Princeton, NJ:
Princeton University Press.
72. Busenitz, L. W., 1996. Research on Entrepreneurial Alertness, Journal of
Small Business Management 34(4), 3544.
73. Barber and Fox, 1958; Betsworth and Hansen, 1996; Williams et al., 1998.
74. Betsworth and Hansen, 1996.
75. Gaglio and Katz, 2001.
76. Barber and Fox, 1958.
77. Barber and Fox, 1958.
78. Barber and Fox, 1958: 131.
79. Cunha et al., 2010.
80. Mendoca et al., 2008; Lawley, James and Penny Tompkins. 2008. Maximising Serendipity: The Art of Recognizing and Fostering PotentialA Systematic Approach to Change, The Clean Collection, June, http://www.cleanlanguage.
co.uk/articles/articles/224/1/Maximising-Serendipity/Page1.html.
81. Mendoca et al., 2008.
82. Gaglio and Katz, 2001.
83. Cunha et al., 2010; De Rond, 2005; Mendoca et al., 2008.

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199

84. Van Andel and Bourcier, 2002; De Rond, 2005: 3.


85. Gaglio and Katz, 2001; Lawley and Tompkins, 2008.
86. Mendoca et al., 2008.
87. Cunha et al., 2010.
88. Gaglio and Katz, 2001; Lawley and Tompkins, 2008.
89. Lawley and Tompkins, 2008.
90. Gaglio and Katz, 2001.
91. Gaglio and Katz, 2001.
92. Krumboltz, John D. 1998. Serendipity Is Not Serendipitous, Journal of
Counseling Psychology 45(4): 390392.
93. De Rond, 2005; Gaglio and Katz, 2001; Kirzner, 1979.
94. Barber and Fox, 1958; Brown, 2005; Van Andel and Bourcier, 2002.
95. Dew, 2009; Diaz, 2004; Gaglio and Katz, 2001; Kirzner, 1979.
96. Cunha et al., 2010; Danzico, 2010; De Rond, 2005; Hauser, 2008; Mendoca
et al., 2008.
97. Gaglio and Katz, 2001.
98. Brown, 2005; Carter, 2006; Cunha et al., 2010, Merton and Barber, 2004.
99. Mendoca et al., 2008.
100. Gaglio and Katz, 2001.
101. Barber and Fox, 1958.

Chapter 9

The Role of Supply Chain


Management in Corporate Strategy
James S. Keebler

WHAT IS SUPPLY CHAIN MANAGEMENT?


In a Harvard Business Review article published in 1958, Jay Forrester introduced a theory of management that recognized the integrated, interdependent nature of organizational relationships in distribution channels.1
He pointed out that system dynamics can influence the activities of various business functions and their impact on production and distribution
performance. Forrester stated that there will come general recognition
of the advantage enjoyed by the pioneering management who have been
the first to improve their understanding of the interrelationships between separate company functions and between the company and its
markets, its industry, and the national economy (p. 52). Thus, the foundation was laid for key strategic management issues and the dynamics
of factors associated with what we today call supply chain management
(SCM).
In the early 1980s, management attention to the functions of materials
management, production, transportation, and warehousing was driven by
two significant conditions: opportunities for cost reduction provided by
deregulation of transportation, and the oppressively high cost of capital
to fund inventories (the prime rate was 20% in 1980). Until the concept of

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total quality management (TQM) was understood and commonly imbedded in the 1990s, a total systems approach to multiple-company materials,
information, and cash flows could not be realized. The commonly used
terms of operations management and logistics management began to give
way to SCM as a newer, broader perspective for corporate management.
The term SCM became a hot topic in the business press and the academic
literature by the year 2000. Specific drivers of top management interest in
SCM included global sourcing, international markets, growing emphasis
on timeand qualitybased competition, and a need for stronger, more
flexible relationships with key customers and suppliers to mitigate environmental uncertainties. An increasing number of firms began outsourcing
noncore activities to improve their return on assets, to give them control,
through effective relationships, without the burden of ownership.
In 2001, the Journal of Business Logistics published an article Defining
Supply Chain Management.2 This contribution summarized the existing
definitions and supporting constructs of SCM into a framework that produced a robust conceptual model and a unified definition of SCM. Supply chains were defined as the companies involved in the upstream and
downstream flows of products, services, finances, and information from
initial supplier to ultimate customer. A supply chain orientation (SCO) is
the recognition by an organization of the systemic, strategic implications
of the activities involved in managing the various flows in a supply chain
to satisfy an ultimate customer of that supply chain. This SCO is necessary
regardless of the organizations position within the supply chain. SCM is
simply the implementation of the SCO, defined as the systemic, strategic coordination of the traditional business functions within a particular
company and across businesses within the supply chain, for the purposes
of improving the long-term performance of the individual companies and
the supply chain as a whole (p. 18).
THE INPUT/OUTPUT MODEL
OF THE FIRM, EXPANDED
A simple model of the single firm would require an estimation of its outputs so that the firm can establish the capacities necessary and the inputs
required to produce and provide the contemplated outputs. The firm must
also add some value in the conversion or transformation process to justify the price paid by its customers, which includes their profit. Figure 9.1
portrays this input/output process.
The fundamental element of a supply chain, then, is the single firm,
which both buys from a supplier and sells to a customer. The focal firms
buying activity establishes a linkage to the suppliers selling activity and
the focal firms selling activity links to the customers buying activity.
Thus, the linkages formed by a single firm in a supply chain include at

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Figure 9.1
Basic Model of the Firm

least two other firms. To achieve the proper balance in both supply and
demand, or inputs and outputs, each firm in the supply chain must, at a
minimum, coordinate the activities of its internal functions and those of
the triad it has established. An SCO requires a new unit of analysismultiple firms in the supply chain, to effectively implement SCM (as is illustrated in Figure 9.2).
Each firm must manage the supply side of its operations, including forecasting, aggregate demand planning, master scheduling, material requirements planning, the bill of materials, production planning,

Figure 9.2
Basic Model of Supply Chain

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203

purchasing, supplier relationship management, production scheduling,


production, and distribution. Each firm must also manage the demand
side of its operations, including marketing, development of new products
and services, sales, customer service, and customer relationship management. Both supply side and demand side functions must be coordinated
to achieve effectiveness and efficiency. Consequently, SCM has two major
roles: supply management and demand management. The physical function of a supply chain (supply management) is to convert raw materials
into goods, and transport them from one point in the supply chain to the
next point and ultimately to the consumer, managing the dimensions of
time, cost, quality, and compliance. A market-mediation function (demand
management) is to insure that the variety of goods and services reaching
the marketplace matches what customers want to buy, how, when, and
where they want to acquire them.
KEY FUNCTIONAL ROLES IN SCM
Marketing is the key function for a firm because it answers the following questions: who are, or who should be, our customers; what do they
want or need; how, when, and where do they want to acquire those products and services; and why would they want to buy them from us. The
firm then has to target whatever market segments they would chose to
serve and effectively position their goods and services to create demand
for them. The marketing concept is a business philosophy that guides
the firm toward customer satisfaction at a profit. It relies on a focus on
the customer, and in a supply chain context, on the customers customer.
Profitability can be achieved only by coordinating all marketing activities
with the other internal business functions. Marketing is the expectation
setter, the promise maker. Other functions are the promise keepers. All
functions must be invested in each others success. All should have a market orientation, which is generating, sharing, and responding to market
information. The management of the entire firm depends on the marketing concept and a market orientation to unify a firms focus, to define the
roles of each function, to promote interfunctional coordination, to direct
the reengineering of the organizational system, to facilitate interfirm relationships, and to improve business performance.
Sales has traditionally focused on prospecting for, qualifying, approaching, and presenting to new customers, overcoming objections, getting orders, and following-up to insure customer satisfaction. Salespeople
are often tasked with objectives to meet short-term forecasts and budget
projections, resulting in oscillations in supply chain flows not necessarily
supported by actual demand. The sales role is changing to implement and
facilitate cooperative behaviors with customers and internal functions. As
a relationship manager with key customers, salespeople are adopting the

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roles of customer advocate and consultant. This requires gaining expertise in their firms internal processes, systems, and capabilities, as well
as those of the customer. The goal for sales is to help the customer better manage and market the customers business, earning their trust and
loyalty through information sharing, joint planning and decision making,
and focus on the customers success.
Customer service can be a function or department, a set of orderprocessing activities, a strategy, and a business philosophy. In many
firms today, the quality of service experienced by the customer is both
an order qualifier and an order winner. It can be a source of competitive
advantage. Customer service is a set of performance outcomes that deliver customer value. Since not all customers are equal, criteria must be
established to segment customers so that the best service can be delivered to the most valued customers. By identifying unprofitable customers based on cost to serve, their behaviors can be managed to achieve a
profitable relationship, or they can be eliminated, freeing up scarce resources to apply to profitable customers. Since customers buy benefits
and satisfaction, increasing their perceived benefits and/or decreasing
the customers cost will enhance their value of the relationship with the
firm. Increasingly important is the quality of the customer-perceived interface, which includes product and service availability and convenience,
as well as responsiveness and reliability. A goal for every firm is to make
it easy for their customers to do business with them, to be accessible, responsive, flexible, and reliable.
Research and development (R&D), often referred to as new products
development, is a critical strategic function of the firm. Inputs include
people, information, ideas, equipment, facilities, funds, and time. Outputs include proposals, research, testing, patents, process technologies,
publications, cost reductions, product improvements, and new products.
These new products might include breakthrough products; its new for
us products; new, improved or next-generation products; line-extension
products; or repackaged, repositioned, or recycled products. The consequences of R&D include survival, risk abatement, capital avoidance,
faster time to market, increased market share, and revenue and profit improvements. Traditionally, R&D has developed and controlled intellectual
properties, sold services to internal clients, interfaced with government, explored new markets, integrated TQM in all functions and processes, and managed the timing of new product introductions. The cost
at the new product design stage is usually less than 10 percent of the total
development costs, but the decisions made in the design stage affect between 60 and 80 percent of the total development costs. The new product
development process from idea generation to commercialization must be
coordinated internally with marketing, engineering, manufacturing, purchasing, and logistics to insure that the decisions at the design stage are

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205

compatible with current systems and technologies, both internal to the


firm and with customers and suppliers.
Production is a function that creates significant added value. It might
involve manufacturing, assembly, creating assortments, or merchandising,
depending on the product and the firms position in the supply chain. The
production plan and schedule directs the what, when, where of production. In the last 100 years, U.S. production has evolved from craft production to mass production, to lean production to supply chain production.
Craft production occurred in the pre-industrial age. Highly skilled workers using simple and flexible tools made exactly what the customer asked
for, one item at a time, and accommodated a high amount of variability in
raw materials. It was slow, but it was tailored to unique customer requirements. Mass production occurred in the early 20th century to reduce the
time and costs of production. It produced standardized products using
inflexible machines and semiskilled labor, processing big batches of work
at one time, preproducing large inventories in anticipation of demand. Inventories were also used as buffers between machines, which could not
handle variability in inputs or stop processing; therefore, defects were
handled at the end of the production process. Lean production started to
take hold in the United States in the 1970s to provide flexibility for constantly changing markets. It used multiskilled workers and highly flexible
machines and emphasized quality at the source. Defects were caught up
front or eliminated entirely by improved supplier processes, facilitating
just-in-time production and constant replenishment based on demand.
Supply chain production involves dispersed or tiered production, where
each tier provides subassemblies to downstream customers, the final tier
completing all assemblies in the end product. Utilizing postponement,
or delayed differentiation, at the final assembly point, some customization can be included in the final product to tailor the product to unique
customer requirements, providing make-to-order capability. This is illustrated in Figure 9.3.
Purchasing has traditionally had a tactical emphasis on cost reductions, shorter lead times, quality improvements, and supply management. The supply chain role for purchasing includes establishing and
managing long-term supplier relationships, creating access to product
and process technologies, and supplier investments through these more
strategic relationships. Purchasing now also coordinates with suppliers
the demand management function of the firm by involving suppliers in
more strategic, joint planning and decision making, value creation, and
engineering activities. Now decisions can be made about which firm does
a particular kind of work, where this firm should be placed in the supply
chain, and how costs and benefits will be shared. Outsourcing of noncore
activities to contract manufacturers and third parties can also be planned
and managed, better understanding the make or buy decision with

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Figure 9.3
Supply Chain Production

the realization that control does not require ownership. Assets will move
to the firms with the lower cost of capital. Collaborative supply chain
relationships that are mutual, equal, and perhaps exclusive, are being
established.
Logistics is a critical supply chain function focused on planning for and
managing the stocks and flows of goods and related information. Major
elements include network design, transportation, warehousing, inventory
management, order processing, and regulatory compliance. A key decision for any firm is to set the targeted levels of service to be provided and
the targeted levels of cost to be incurred by its logistics capabilities for
various product/customer segments. Plant and warehouse missions, locations, and capacities are established to service the market demands within
acceptable cycle times and costs. Transportation-mode choices are made
based on product characteristics, product-demand rates, lead times, and
cost. Management of inventory investments in raw materials, work in process, finished goods, and returns has benefitted from the integration of information systems up the supply chain from point-of-sale captured data.
Firms are working together to replace inventory with information through
more precise scheduling of upstream flows to meet actual demand. Outsourcing of logistics operations requires close coordination with thirdparty logistics providers and has become a primary cause of increased
asset productivity.

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STRATEGY ISSUES IN SCM


There are basically three levels of strategy for most firmscorporate
strategy, business unit strategy, and product-market segment strategy. As
is illustrated in Figure 9.4, the primary corporate strategy is to grow the
business, through market penetration, market development, new product/service development, and acquisition or merger. These are the only
ways a business can grow.
Sometimes an overly ambitious growth strategy destabilizes the organization when it finds itself doing too much, too quickly, necessitating a
change in corporate strategy to stabilize the firm by ceasing the growth
and reclaiming control, consolidating its gains as it catches up with itself.
Periodically, management recognizes that it has attempted to grow the
firm in ways inconsistent with its capability or present desire, and elects
then to pursue a corporate strategy of retrenchment, abandoning unsuccessful lines of business or markets. Each of these three corporate strategiesto grow, stabilize, or retrenchhas very different ripple impacts on
its supply chain.
Larger firms establish various strategic business units (SBUs) under a
corporate umbrella. Each of these SBUs serves a unique set of products, a
homogeneous set of markets, has a limited number of related technologies

Figure 9.4
Only Four Ways to Grow

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Strategic Management in the 21st Century

with other SBUs, and is responsible for its own profitability. There are basically three kinds of business unit strategieslow cost, differentiated,
or focused. Low-cost producers and low-cost providers compete on their
ability to be more efficient than existing competitors, and create this barrier to market entry by potential competitors. This works well for standardized products and commodities where consumers cannot discern a
distinctive, superior advantage across competitive choices they have. The
differentiated strategy is used by firms who compete on the ability to offer
something special and unique with their product or service, allowing them
the opportunity to avoid competing solely on cost. Highly branded items,
trademarked and patented items, and innovative products and services
can be successfully marketed as differentiated items. A focused strategy is
used by business units that zero in on a specific product-market segment,
and is a niche strategy, seeking to dominate, based on a combination of
differentiation and cost leadership, a particular market segment. Gerber
Baby Food is an example of a focused business unit strategy. Recently, the
traditional labels of low cost, differentiated, and focused strategies have
been replaced in the literature by the terms operational excellence, product leadership, and customer intimate strategies, respectively, as the new
and improved terminology.
Product-market segment strategies, found as subsets to the business
unit strategies, tend to follow the description of the product life cycles.
The four product-market segment strategies are build, hold, harvest, and
divest. The build strategy drives and accompanies the introduction and
growth period of new product and service introduction. The hold strategy
accompanies the maturity stage of the product life cycle, when firms create line extensions and proliferate stock keeping units (SKUs) associated
with the product category. The hold strategy might also include actions
to repackage or reposition the product. The harvest strategy accompanies the late maturity stage of the product life cycle, with a decision to
reduce promotional support and maximize profits while sales volume is
still significant. The divest strategy recognizes that the decline stage of the
product life cycle has been realized, promoting thoughtful decisions on
discontinuing the product at its end of life, or to sell it off while it still has
some value.
The focus and consistency of strategy is important. Picking a specific
SBU strategy and sticking with it precludes confusion with internal functions and trading partners. Unfortunately, many multiple-SBU corporations rely on centralized logistics functions whose capabilities and culture
are asked to support conflicting strategies, such as low cost and differentiated, simultaneously. Not much research has been conducted on strategy
conflicts between the sourcing side of the firm and the fulfillment side of
the firm, for example, having a low-cost purchasing strategy and a differentiated fulfillment strategy. Since customers select suppliers based on a

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209

predominant strategy consistent with their own strategy, it is likely that


the consumer or last reseller in the supply chain is best positioned to set
the guiding strategy for the supply chain.
Culture plays a critical role in strategy. Cultural norms, core values,
and guiding principles must support the chosen strategy. Recognition
and reward systems are important in supporting behaviors consistent
with the chosen strategy. For example, a recognition and rewards system that does not encourage functional interdependence and collaboration will not support a product leadership or customer intimate strategy.
The strategic goals and culture of the organization must be aligned to
achieve success.
INTERFUNCTIONAL COORDINATION IS ESSENTIAL
Interfunctional coordination can be defined as the cooperation of the
various internal business functions to achieve the overall goals of the firm
and insure its responsiveness to environmental changes. To achieve an
acceptable degree of interaction and collaboration among the specialized functions of the firm, Mintzberg proposed six basic coordinating
functions:3
1. Mutual adjustment: the process of informal communication in which
people interact with one another to coordinate.
2. Direct supervision: one person coordinates by giving orders to
others.
3. Standardization of work processes: direct specification of the content
of the work, and the procedures to be followed in order to tightly
control different people.
4. Standardization of outputs: specification of what is to be done (i.e.,
the results of the coordination) so that interfaces between jobs are
predetermined.
5. Standardization of skills: loose coordination of people through education on a common body of knowledge and a set of skills that are
subsequently applied to work.
6. Standardization of norms: coordination of people through a common set of beliefs.
To these three different dimensions of coordination: (1) cooperative
arrangements (mutual adjustment), (2) management controls (direct
supervision), and (3) standardization (standardization of work processes, outputs, skills, and norms), other authors would add the additional dimensions of (4) functional expertise and (5) organizational
structure.4

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Interaction and collaboration positively influence a firms performance


as they establish cooperative arrangements and share resources across
functions. Management controls can be best achieved when the integrating managers elicit, receive, and strongly consider cross-functional team
members inputs to the decision-making process, which they coordinate.
Planning systems and performance control systems are used to standardize outputs, since they predetermine the intended outcomes. Training and
education become significant activities in the standardization of skills.
Standardization of norms relies on the marketing concept and an SCO,
along with the existing culture of the organization. A unified policy, and
an aligned recognition and reward system, governing the activities of supply chain participants, which instills a spirit or philosophy of collaboration
in the culture becomes the most important factor for success of interfunctional coordination. Although cross-functional coordination is a must, the
need for in-depth functional expertise should not be ignored. Decisions
made solely in functional silo structures must be avoided. An ideal organizational structure for coordination within a firm must support an internally integrated process for the seamless flows of information, products,
services, and finances. The firms planning and decision making should
be organized around key processes, such as planning, sourcing, production, and fulfillment.
INTERFIRM COLLABORATION ON NONCORE
COMPETENCY FUNCTIONS (OUTSOURCING)
For every supply chain, there are basic functions that have to be done
no matter which firm does them. These supply chain functions include:
design, make, brand, price, promote, buy, sell, stock, display, deliver, finance, and manage risk and the relationship with the ultimate customer.
Who should perform these functions in any particular supply chain? An
important point is that no one company has to manage all these functions. In the early 1900s, Ford Motor Company attempted to perform all
the supply chain functions for the purpose of keeping control of all operations. Ford owned the mines that produced the ore that moved on
Ford Motor Company ships to Ford steel mills, where Ford steel was
used to make Ford automobiles that were sold through Ford dealerships.
The huge costs of capital for such vertical integration caused the company to rethink how to balance the need to control operations with the
need to manage risk. Today, Ford prefers to integrate based on information sharing, not on asset ownership. Companies are constantly evaluating the questions, What should we do ourselves, and What should we
allow someone else to do for us? If the company cannot do something
cheaper than someone else, they must ask themselves if the function is a
core competency. A core competency is something the firm does well that

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211

gives them a competitive advantage in the marketplace. Not everything


done well, however, is a core competency. For example, being really good
at running the company cafeteria does not give the firm a competitive
advantage, and is, therefore, not a core competency. A core competency
is something rare, valuable, hard to imitate, and not substitutable. Even
though a function might be cheaper to outsource, if it is a core competency, it should not be outsourced.
What is core? This varies for each company in the supply chain. The
point is that noncore functions can be shifted to other firms in the supply chain. SCM, then, becomes a great alternative to vertical integration.
An example of a firm that recognized its core competency is an American
company, who is the number two manufacturer in the world of a particular
type of electronics product, yet doesnt make any products. Kodak realized
its core competencies were in R&D, estimating demand, and managing the
product life cycle of its products. Over a five-year period, it outsourced
its production function to five manufacturing subcontractors, its delivery
function to three global third-party logistics providers, and its financing
function to an outside banking consortium. The results were a significant
reduction in per-unit manufacturing costs, significant reduction in its logistics costs, and a substantial savings in financing inventories and operations.
Interfirm collaboration is based on several antecedents: cooperative
norms, information sharing, trust, respect, mutuality, conflict-resolution
mechanisms, reward sharing, and an interdependence that sustains and
enhances the relationship. Consequences include risk reduction, benefits
from shared managerial, physical, technological, and financial resources,
and improved supply chain competitive advantage. Establishing and
maintaining effective supply chain relationships can itself become a core
competency. This will become apparent as more and more virtual organizations develop.
STAGES OF SUPPLY CHAIN MANAGEMENT
Not all supply chains are equal. Not all companies in a supply chain are
equal. Thinking strategically, a supply chain executive might ask: At what
level of competence, or what stage of supply chain maturation, are we?
What level or stage should we aspire to achieve? Firms do have a strategic
choice, but they must first understand where they are, and then understand
what they must do to transition to a more desirable stage. Figure 9.5 portrays a seven-stage model of SCM based upon the increased degree of complexity a firm manages and the degree of integration it has achieved with
trading partners. The first three of these stages are within the capability of
a single firm, where autonomy and independence are preferred. The fourth
stage, partner driven, begins to require collaboration, integration, and interdependence, which dramatically increase with the last three stages.

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Figure 9.5
Supply Chain Stages

Stage 1: Unmanaged, or Managed by Others


In this stage, functions and firms operate independently. They often
lack planning and control activities. Unless they are subcontractors for
and are managed by others, these firms often have inefficient and costly
operations. The overriding strategy is survival. Management is blind to
opportunities and threats. Obviously, firms in this stage are competitively
and financially vulnerable.
Stage 2: A Low-Cost Production
Firms in this stage are likely to produce commodity-like consumer
products or specialized industrial products; some predictability of demand allows the focus to be on manufacturing excellence. Productiondriven synchronization of buying and selling activities prevails. Innovation and customer service are subordinate to standardization and cost
control. Logistics activities, inventory management, warehousing and
transportation, are suboptimized. Supplier relationships are constantly
changing.

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213

Stage 3: Project/Initiative Driven


A series of projects drive incremental internal improvements. Management is primarily results, not process, driven. Alignment and focus are
concentrated on achieving short-term goals. An alphabet soup of initiatives may exist simultaneously, such as EDI, TQM, ECR, VMI, MRP, DRP,
and ERP. While planning and control systems do exist, the focus is on tactical goals and not on strategic opportunities. Limited coordination with
trading partners is found in this stage.
Stage 4: Partner Driven
This stage involves an investment in and responsiveness to meeting
key customer, supplier, or third-party logistics requirements. Management sees growth from innovation, services, and speed, in response to customer or supplier requirements. Internal cooperation and a shared focus
are driven by the external trading partner. Planning is tied to long-term
trading partner needs. Close ties are found with a few key trading partners.
Stage 5: Balanced Internally
Management sees the potential strategic benefits from SCM, and is
now focused on market-driven, not production-driven, synchronization.
Internal physical and informational flows are integrated. With adequate
planning and control systems, significant internal coordination considers
the total system of inputs, processes, and outputs. A just-in-time and a
make-to-order philosophy is possible due to effective coordination with
key immediate customers and suppliers. This stage would be highly desirable for most organizations.
Stage 6: Extended Integration
Management now has a strategic and systemic orientation that drives
integration from the customers customer to the suppliers supplier. The
whole organization is actively collaborating with outside trading partners. There is extensive asset and resource sharing between firms. Trust
and reciprocity exists with trading partners. Relational, technological,
and economic embeddedness provide competitive advantage. More control exists with less ownership. Asset ownership will shift to the firms
with the lowest cost of capital. This stage manifests a true SCO in that it
is a multifirm system. Multifirm governance structures are established.
Stage 7: Real-Time Connectivity
This stage is mainly aspirational, although the enabling technologies
exist today. It is characterized by real-time informational connectivity

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Strategic Management in the 21st Century

Figure 9.6
Characteristics and Strategies of Supply Chain Stages

and pipeline visibility for all members of this supply chain. A high level
of postponement and customization exists. The focus is on innovation,
speed, and flexibility. Enterprise boundaries are blurred. Shared control
and success is achieved through connectivity, shared knowledge, and
forged capabilities. Both market-driving and market-creation opportunities abound. The supply chain strategies just described are summarized
in Figure 9.6.
EIGHT THINGS FIRMS DO THAT DISTINGUISH THEM IN SCM
Firms that aspire to improve their performance through SCM will need
to actively focus on these eight initiatives:
1.
2.
3.
4.

Manage customer behaviors,


Manage product/service offerings,
Manage demand, not just the forecast,
Manage supply chain flows,

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5.
6.
7.
8.

215

Replace assets with information and relationships,


Outsource noncore activities (buy versus make),
Revamp planning and control systems, and
Align recognition and reward systems.

Customers are not all equal. While most firms know who their biggest
customers are, they often dont know which customers generate the most
profit. They also dont know which ones are unprofitable. Consequently,
they can manage customer relationships poorly. The list of active customers should be evaluated annually and segmented based on criteria
that differentiate their value to the firm. The segment of highest-value
customers should receive the best service. For example, their order lead
times could be shorter, their targeted fill rates could be higher, and their
deliveries could be made faster than other customer segments. Unfortunately, traditional accounting systems, which rely on period or product
costing and cost center allocations, do not provide specific cost information to make evaluations on customer profitability. Activity-based costing (ABC) is needed to be able to associate the cost to serve with the
value of service given each customer. ABC involves looking at customer
behaviors and the costs associated with serving them. By influencing the
customer on what, how much, when, and how they order products and
services, the firm can turn unprofitable or marginal customers into profitable ones.
Products and service offerings are not all equal. Just as with customers, the cost to produce and the cost to provide should be evaluated annually using ABC. Most companies will find that a small percentage of
its offerings contribute a large share of its profits. Which offerings are unprofitable? Eliminating those or changing the way they are provided to
customers to make them profitable will increase overall profitability. As
product life cycles and consumer adoption rates dictate strategy changes
from build, to hold, to harvest, and to divest, it is important to constantly
manage the portfolio of offerings. Most companies learn that by doing less
they can earn more, and free up resources to apply to new and more profitable revenue generators.
Forecasting is necessary for most firms, especially those preproducing the independent demand item, or finished good, before orders are received. But forecasting is inexact, and it requires a large investment in
buffer inventories. Some firms invest heavily in the forecasting process
and the measurement of forecast error, which compares actual demand
to forecasted demand. Estimating customer demand to make operating decisions that attempt to balance supply and demand rarely results
in zero stock outs and zero safety stocks. However, firms use four methods to attempt to balance supply and demand: (1) change lead times,
(2) increase or reduce pricing, (3) build inventory levels, and (4) create

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Strategic Management in the 21st Century

production flexibility. If customer demand exceeds current supply, the


firm might be able to increase the lead time on that item. The customer can
decide to wait, to substitute for something in stock, or search elsewhere.
If customer demand is significantly less than current inventory levels for
that item, the firm can announce a temporary price reduction, moving future demand forward. It could also announce a temporary price increase,
postponing current demand. Building inventory levels, including safety
stock, to smooth the effects of both demand and lead-time variability, is a
traditional, but expensive method to manage demand and supply imbalances, given production-capacity constraints. Finally, production flexibility, a principle of lean manufacturing, is seen as a solution to demand and
supply imbalances. These four methods of managing demand can be used
in combination, depending on the level of the firms interest in utilization
of production capacities, safety stock costs, the cost of stock outs, and customer goodwill and loyalty. Managing actual demand is always more important than managing the forecast.
There are numerous flows in the supply chain. These include flows
of products, services, cash, and information. Products flow from suppliers through manufacturers, through distributors, through retailers, to
final consumers. The flows are triggered by an order from the customer
(demand) and flow upstream, or by a previous forecast and flow downstream. These flow in cycles. A retailer will collect product sales information at the point of sale, or use a reorder point inventory management
system, to create orders to send to the distributor. This takes time. The
transmission time is very fast if it is electronic, but the time between orders can be days or weeks. The distributor then reviews the orders received, approves them, and assigns them to a shipping location, where
the orders are picked, packed, and scheduled to be shipped. This could
take hours or days. When the carrier arrives, the order is loaded and transported to the retailer, who receives it into inventory stock or into its retail
space. This also takes hours or days. Then the process repeats itself between the distributor and manufacturer, and then again between the manufacturer and its suppliers. When the elapsed times from order to receipt
up the tiers of the supply chain are totaled, the overall cycle time is weeks
or months. This creates significant, perhaps unnecessary, investments in
inventories to cover the lead times and lead-time variability, and also results in out-of-stock and lost sales opportunities. The entire supply chain
flow cycles should be mapped. Process mapping and process reengineering are important tools to reduce cycle times. Sharing information across
the supply chain, especially about point of sale, inventory levels, and production schedules, can aid in compressing cycle times significantly, reducing overall cost, and increasing sales and profits.
Assets are expensive. Information is relatively cheap. Significant cost
reduction and service improvements can be produced by substituting

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217

information for asset investments. The cost of ownership of inventory,


plants, equipment, and storage facilities is significant, and to some degree,
avoidable. The solution is to use increasingly available and inexpensive
information and integrated information technology to reduce investments
in expensive assets. Relationships are becoming more important in SCM.
Creating and managing relationships with key customers, suppliers, and
third-party providers is the very nature of strategic and systemic management of supply chain activities. Governance structures, built through joint
planning and decision making and supported by joint investments and
shared rewards, are needed for sustainability. Collaboration, connectivity, and integration are essential to improved supply chain performance.
Outsourcing noncore activities is an essential characteristic of SCM.
Deciding what is noncore and selecting reliable suppliers to jointly plan
the objectives, standards, costs, and shared rewards of successfully outsourced functions is a huge and risky task. It requires committing to
a strategic, interdependent relationship. Micro Compact Car AG (MCC),
a wholly owned subsidiary of Daimler-Benz, engaged 18 key suppliers in
the design and production of the smart car. MCC retains the relationship
with the end customer, controls the flow of information, and is able, with
little investment, relying on its reliable suppliers, to assemble a customized car in less than five hours, maintaining a two-week lead time from
customer order to delivery. This supply chain is based on the proposition
of outsourcing noncore activities, and is far superior in performance to
any U.S. automotive supply chain. Every firm should examine what functions it could successfully outsource and the implications outsourcing has
on its operational and financial performance.
Revamping the planning and control systems to provide alignment and
focus throughout the organization will produce significant improvements.
It is amazing how little attention the planning function receives in many
firms, yet the planning function creates the future of the organization.
The last Council of Supply Chain Management Professionals (CSCMP)
study on measurement provided the following 10 findings, based on the
responses from 355 firms, regarding the overall administration of supply
chain measurement:5
1. One-quarter of measures captured were considered not accurate;
2. One-fifth of measures captured were not interpreted similarly within
the firm;
3. One-third of measures captured were not interpreted similarly
between firms;
4. One-fifth of measures captured were not readily understandable to
guide actions;
5. Two-fifths of measures captured were not comprehensive;
6. One-fifth of measures captured were not considered cost effective;

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7. One-quarter of measures captured were not compatible internally;


8. One-third of measures captured were not compatible between
firms;
9. One-quarter of measures captured were not compatible with cash
flow measures; and
10. One-quarter of measures captured encouraged counterproductive
behaviors.
Additionally, the study found there was too much emphasis on efficiency measurement (utilization and productivity) and not enough on
effectiveness (performance). Just as every process has a customer, who
judges its performance, and should have an owner, who is responsible for its performance, so, too, do measures have customers and owners. Every measure needs an owner, to care about meeting the needs and
expectations of the measures customer, and to initiate appropriate improvements in the activities measured. Any measure lacking either an owner or
a customer should be abandoned. Standardized performance reporting
should be regularly challenged for need and usefulness, and eliminated
where possible. The challenge is not to create more measures, but rather to
measure fewer, actionable activities, where customers and owners of the
measures can work together to plan the objectives, set the standards for
performance, evaluate results, and make improvements. Good administration will eliminate nonproductive measurement activities.
Recognition and reward systems can either motivate or demotivate
employees. They should be fair, meaningful, and tied to performance.
They can also encourage either appropriate or dysfunctional behaviors.
For example, incentivizing customers and rewarding salespeople and for
the end-of-quarter, end-of-year sale push that causes spiked workloads
and excessive costs in distribution is a practice that is counterproductive.
Salespeople, and customers, anticipate the incentives to hold off orders
until the end of the period, creating a permanent, unnecessary oscillation
in sales that is not directly tied to demand. Experience tells us that people do what gets rewarded. Functional activities should not be rewarded.
Instead, cross-functional teams could be rewarded based on the performance of the overall process they manage. Organizations must design and
use recognition and reward systems to create alignment and focus on organizational goal and objectives.

NOTES
1. Forester, Jay. W. (1958), Industrial Dynamics: A Major Breakthrough for
Decision Makers, Harvard Business Review, Vol. 38 (July/August), pp. 3766.
2. Mentzer, John T., William DeWitt, James S. Keebler, Soonhong Min, Nancy
W. Nix, Carlo D. Smith, and Zach G. Zacharia (2001), Defining Supply Chain
Management, Journal of Business Logistics, Vol. 22, No. 2, pp. 125.

The Role of Supply Chain Management in Corporate Strategy

219

3. Mintzberg, Henry (1996), Reading 6.2: The Structuring of Organizations.


In H. Mintzberg and J. B. Quinn (Eds.), The Strategic Process: Concepts, Context, Cases
(3rd Edition), Upper Saddle River, NJ: Prentice Hall.
4. Mentzer, John T. (2004), Fundamentals of Supply Chain Management, Twelve
Drivers of Competitive Advantage, Thousand Oaks, CA: Sage Publications.
5 . Keebler, James S., Karl B. Manrodt, David A. Durtsche, and
D. Michael Ledyard (2000), Keeping Score: Measuring the Value of Logistics in the
Supply Chain, Oak Brook, IL: Council of Supply Chain Management Professionals.

Chapter 10

Employee Engagement and


Strategic Management: A Case
Study from Palestine
Yara Asad and
Andrew R. Thomas

Employee engagement as a strategic management tool is the focus of this


chapter. In addition to some discussion about the importance employee
engagement plays in achieving the strategic goals of the organization
through the creation of a healthy working environment, where everyone can be influential and active in fulfilling bigger objectiveswe will
discuss a Palestinian firm that recently implemented this approach and
succeeded.
This case might fly in the face of recent reports that consistently detail how employees are increasingly disengaged from their jobs. For example, a report by Towers Perrin HR Services titled Winning Strategies
for a Global Workforce stated that only 14 percent of global workers are
highly engaged in their jobs and that managers are mostly at fault for the
lack of more significant employee engagement.1
We recognize that this level of dissatisfaction may very well be due to
the current economic downturn, when companies of all sizes and shapes

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221

shed employees in huge numbers after the onset of the global financial
and economic crises of late 2008 and early 2009. The employees who remained were often faced with longer hours, more responsibilities, and reduced levels of compensation.
The concept of employee engagement is far more prevalent on the applied side than in the academic literature. The business press and consulting firms have been widely reporting the move across industries that
encourage managers to engage their employees beyond the most basic levels of their employment. The belief is simple: more engaged employees are
happier, and this translates into greater organizational productivity and a
stronger corporate culture. Although this intuitively sounds good, there is
not a lot of empirical research to back this up. Nevertheless, as numerous
studies consistently report, there is very little doubt that employees around
the world are more dissatisfied than satisfied with their current jobs.
Employee engagement has emerged in the past decade as a viable
strategy for dealing with the unavoidable change and upheaval companies face. The Gallup Organizations Q12 survey has become the foundation for seemingly any firm trying to find out the degree of engagement,
or lack thereof, that its employees possess.2 Gallup identified a strong link
between levels of employee engagement, leadership effectiveness, and organizational success. An extensive multiyear study involving more than
100,000 employees, in 2,500 functions, and 12 industries revealed a number of specific workplace conditions that provide a direct link to organizational and employee success. Gallup has labeled these factors the Q12.
When present at high levels, these factors are the hallmark of an environment where employees can develop and grow. From this research, Gallup
identified the concept of the engaged workforce. Not surprising, organizations reporting high performance levels also had high levels of employee engagement.
The 12 questions Gallup asks are:
Do I know what is expected of me at work?
Do I have the materials and equipment I need to do my work
right?
At work, do I have the opportunity to do what I do best every day?
In the last seven days, have I received recognition or praise for good
work?
Does my supervisor, or someone at work, seem to care about me as
a person?
Is there someone at work who encourages my development?
At work, do my opinions seem to count?

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Does the mission/purpose of my organization make me feel like my


work is important?
Are my coworkers committed to doing quality work?
Do I have a close friend at work?
In the last six months, have I talked with someone about my progress?
At work, have I had opportunities to learn and grow?
What is an engaged worker? According to Gallup, engaged workers
are really the top or best in class performers in the organization. They
are the employees who contribute, perform, and take a keen interest in
doing their best. The impact highly engaged workers can have on an organization is dramatic. Gallup found the following results in organizations
with high levels of employee engagement versus those organizations that
reported low levels of engagement:

50 percent higher levels of employee retention,


Levels of customer loyalty 56 percent higher than average,
Reported 38 percent above the average productivity ratings, and
Returned 27 percent higher profitability than organizations where
employees were not highly engaged.3

When employees join an organization, theyre usually enthusiastic,


committed, and ready to be advocates for their new employer. Simply put,
theyre likely to be highly engaged. But often, that first year on the job
is their best. Gallups research reveals that the longer an employee stays
with a company, the less engaged he or she becomes. Yet, although the
idea of getting employees to be more engaged is a sound one, the implementation of the notion oftentimes comes up short, as the companys culture is simply not ready.
Evan Smith, vice president and general manager of Hypertherm, a New
Hampshirebased designer and manufacturer of advanced metal cutting
products, has spoken about how his company keeps employees engaged.
Hypertherm is consistently selected as one of the best companies in America to work for. Founded in 1968 in a two-car garage, the company has
its roots in building long-term relationships with its 1,000 associates.
Although 32 percent of the firm is employee owned through an ESOP,
and profit sharing annually averages 10 to 15 percent, Mr. Smith attributes
the strong level of highly engaged employees to a culture that goes beyond compensation. Throughout its four-plus decades, the company has
never had a layoff. Although peaks and troughs have inevitably occurred,

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Hypertherm has consciously pursued the strategy of reorienting its existing associates to new opportunities. In the spring of 2009, when the company, like so many others, was experiencing a massive slowdownalmost
50 percent from the peak just a year beforeHypertherm ramped up its
R&D spending and dedicated substantially more resources to workforce
development. In short, Hypertherm has aligned employee engagement
with its longstanding corporate culture.4
THE TRADITION OF COMMUNITY ORGANIZING
IN PALESTINE
Like all other peoples and the places where they live, Palestine is
unique. One component that tends to set Palestine apart is the level of
community organizing that lies at the core of the culture. The countrys
chronic political instability that regularly shapes fundamental institutions such as education and human rights, has compelled the Palestinian
people to most often turn to the grassroots to solve problems. Unlike in
the West, where functioning central governments work to ensure stability and the public good, there has been no such centralized governmental
presence throughout most of Palestines history. Long ago, Palestinians
realized that to meet the basic needs of life and beyond, they would depend on their ability to locally organize communities. As Palestine has
moved inexorably toward nationhood, the long-missing central government has finally begun to emerge. Dynamic national leaders and, more
importantly, national institutions are starting to take hold. Still, community organizing remains at the center of any policy decision and its
implementation.
According to the Marin Institute, one leading think tank that focuses
on grassroots movements, Community organizing is a long-term approach where the people affected by an issue are supported in identifying
problems and taking action to achieve solutions. The organizer challenges
those he or she works with to change the way things areit is a means
of achieving social change through collective action by changing the balance of power. The tactics and strategies employed by the organizer are
similar to the processes of leadership including timing the issue, deliberate planning, getting the attention of the populace, framing the issue
in terms of the desired solution, and shaping the terms of the decisionmaking process.5
Community organizing brings voices to add collective power and
strengthens an issue. It is a key part of an overall strategy to make changes
in a community that are widely felt, and that reflects the wishes of the
people. This requires the organizer to not only listen and be responsive to
the community, but also to help community residents develop the skills
necessary to address their own issues in a sustainable manner. At the heart

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of community organizing are inclusion, ownership, relationship building,


and leadership development. Community organizing looks at collective
solutionslarge numbers of people who engage in solutions that impact
even more people. These people usually live in the same neighborhood,
town, or block.
Community organizing begins here, with the need to address the local
need, through developing the local industry and enhancing the skills of
the workforce in order to create firms that are capable of competing locally, growing larger, and entering new markets. In order to grow an industry and develop the capacity of its employees, massive investments
are needed. The question remains whether the national economy of Palestine, or the government, which relies on foreign aid to cover its public
needs and expenses, will be able to properly fund economic development.
Community organizing in Palestine has always been at the forefront of
political, economic, and social change. As a centralized government has
taken root as a result of the Oslo agreement with the Israelis in 1996, the
Palestinian economy became one of the major areas of focus for many
community organizers.

ENVIRONMENTAL FACTORS
To better understand the context of community organizing within Palestine, it is necessary to briefly explore environmental factors (economic,
political, and social) of the area.
Economic Factors
The Palestinian economy has witnessed many ups and downs, mainly
due to the general political situation. GDP growth averaged over 10 percent per year between 1994 and 1999, but slumped following the outbreak
of violence in 2000, with the Palestinian economy experiencing one of the
worst recessions in modern history. However, GDP has always rebounded
when given the chance, increasing by 8.5 percent in 2003 and 6 percent in
2005, reaching the same level as in 1999.6
The GDP recorded an increase by about 9 percent during the three
quarters of 2010 compared with the same period of 2009. The growth was
concentrated in economic activities with the largest share of GDP in agriculture and fishing, construction, wholesale and retail trade, transport,
storage and communications, services, and public administration. The
construction activity recorded the highest growth rate during that period,
by about 36 percent GDP per capita for the Palestinian Territories. This increased by 5 percent during the third quarter of 2010 compared with the
same quarter of 2009.7

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There was a 3 percent increase in the total number of workers during


the first three quarters of 2010, compared with same period of 2009. This
was due primarily to an increase in the number of workers in the construction industry and services sector in the Palestinian Territories. The
unemployment rate during the first three quarters of 2010 reached about
24 percent compared with 25 percent during the same period in 2009. The
unemployment rate declined in the West Bank from 17.7 to 17.3 percent
and in the Gaza Strip from 38.4 to 37.9 percent. Still, the rate of unemployment is woefully high and a great strain on the Palestinian people.8
Regarding trade movement in Palestine (the total exports and imports),
there was an increase during 2010 in revenues of the value-added tax related to trade exchange with Israel. In 2010, exports increased by 8 percent
compared with 2009, and imports increased by 6 percent compared with
2009.9
Prices consumer prices had increased from January to November 2010
by 3.58 percent compared with the same period in 2009 and that resulted
in the decline of the purchasing power.10
The year 2010 had witnessed additional government reforms in tax collection in line with the reform and development plan that the government
has been implementing since 2007. Local revenues (tax and nontax) accounted for about 38 percent of total revenues and that covered part of
current expenditures, thus reducing dependence on foreign support to
cover the budget.
Government revenues had increased by 17.3 percent during the first
three quarters of 2010 compared with the same period in 2009, whereas
government expenditures declined by 2.7 percent. In addition, the deficit
in the general budget declined by 22.5 percent during the first three quarters of 2010 compared with the same period in 2009.
The industrial sector had witnessed a decline by 6 percent during the
first three quarters of 2010 compared with the same period in 2009. The
total number of workers in the industrial sector had increased by 2 percent during the first three quarters of 2010 compared with the same period of 2009 (increase by 2.3% in the West Bank and a decrease by 2.4%
in the Gaza Strip). Industrial activity constitutes about 13 percent of total GDP.11
Political Factors
Due to the political situation in Palestine, local companies face severe
export restrictions, not only from the international markets where Palestinian products are viewed as being below standard, but also from Israeli
restrictions on borders, which are aimed at weakening the overall Palestinian economy by enforcing harsh restrictions and regulations on the
export of Palestinian goods. In addition, many Arab countries include

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Palestinian products within the list of Israeli products that all Arab countries boycott.
The combined area of the West Bank and Gaza is smallonly 6,020
square kilometers. However, Palestine suffers from various political obstacles caused by Israeli restrictions, including a separation wall, which
is frequently closed, and the difficulty of movement for goods and people
within the West Bank and the Gaza Strip.12 The total population of the
Palestinian Territories at mid-2010 was about 4.05 million, 2.51 million
in the West Bank and 1.54 million in Gaza Strip. One out of every fifth
of participants in the labor force is unemployed in the first quarter of
2010. Most of the population of Palestine is young, with about 57 percent
below the age of 20. Declining fertility rates, however, will reduce the relative size of the youngest section of the population, those under 20 years
of age.13

Social Factors
The Palestinian National Authority was formed after the Gaza-Jericho
Agreement, signed in Cairo on May 4, 1994, which created a Palestinian
nation that would be governed by the Palestinian National Authority,
with restrictions over borders and control of resources.
The Palestinian market is dependent on foreign products. Negative
perceptions about the quality of locally manufactured products, accompanied by a lack of awareness about product improvements, led to the weak
positioning of local products within the local market.
As a result of this perception there was a call for the improvement of
quality and standards of the local production through a monitoring of the
manufacturing processes and compliance with international standards. In
response, the Palestinian Authority used its legal system to address these
issues. Furthermore, and in a call for supporting the local products, the
Palestinian Ministry of National Economy initiated a campaign in January, 2010, promoting local products; this was in addition to the boycotting
of all Israeli products that are manufactured in settlements established on
the Palestinian Territories. This campaign had been adopted to a high degree by all the government departments and by the public as well. The
launch of this campaign came in response to the Israeli restrictions imposed on Palestinians.14

BIRZEIT PHARMACEUTICAL COMPANY (BPC)


BPC, established in 1974, is Palestines leading manufacturer of generic
medicines, with a working capital of $150,000. Today, its working capital

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227

is $50 million. BPCs market is not limited to the Palestinian Territories;


the company has a well-established presence in different export markets,
mainly, Algeria and East Europe. It continuously invests in its quality, and
is able to compete within the national and international market; by the
year 2006, BPC was able to establish its first international manufacturing
company located in Algeria. BPC seeks continuous development, and is
currently in the process of finalizing a new building constructed according to FDA standards, with the goal of producing an oncology product. As
of 2010, BPC is the exclusive local Palestinian company that manufactures
oncology products.
Factors contributing to the success of BPC include obtaining the latest
quality standards certificates such as CGMP (current good manufacturing practices) and the ISO certification for quality systems. In addition, its
strong financial position, highly educated and well-trained staff members
distributed among the different departments, and a management team
with long years of experience and high credibility provide a solid footing
for the company.
BPC is one of the major companies that focus on communal and economic development in Palestine. The company invested the capital necessary to establish a financial stock market brokerage company (Lotus
Financial Investment Co.), a microfinance bank (Al Rafah Microfinance),
an insurance company (Al Takafol Islamic Insurance Co.), a real estate
company (Abraj), and several venture capital investments.
BPCs Mission
BPC realizes that the significance of the Palestinian pharmaceutical industry extends far beyond the size of its revenues, and therefore has a vision to be the backbone of the health-care security system in Palestine and
the region, through the manufacture of superior-quality products. BPCs
efforts and role in supporting the Palestinian community have been diversified; the company views its investment in establishing new companies
that can provide work opportunities to the people of Palestine, and that
can affect the growth of the national economy, as a communal role.
Since 2005, BPC has shifted its social responsibility vision from the traditional one that focused on supporting health institutes, promoting education by granting scholarships, sponsoring researchers, and supporting
cultural events and athletics, into a more directed vision focusing on serving the needs of the community by addressing communal problems that
were not touched by the government.
BPC was one of the leading companies initiating unique and innovative
corporate social responsibility (CSR) projects, with set focus and a strategic vision, directed through a well-studied plan that focused on spreading

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awareness about the company, its status, products, investments, growth,


and quality. In less than five years the company succeeded in building
a solid image within the local market, resulting in increased awareness
among Palestinians, numerous requests to visit its facilities, and demand
for BPCs products.
Employees
BPC employs 300 people, within its main location in Palestine. However, due to the companys 35 years of growth, BPC decided to enlarge
its premises and to bring all employees together under one roof instead
of having three branches in one city. This was not welcomed by employees and resulted in dissatisfaction and operational difficulties. As a result,
it was difficult to get the companys teams working together, serving the
bigger goal of supporting the companys success and mission.

The BPC Employee-Engagement Strategy


One of us (Yara Asad) was initially approached by BPC to implement a
corporate responsibility project, which would serve in building the public
image of the company. Once Yara started designing the project, she quickly
realized that in order to build an external image, BPC also needed to focus
on building its image internally by motivating its employees, getting them
to work in teams, and aim toward the bigger goals of the company.
To begin with, she studied the status of BPCs employee culture. Multiple focus group sessions were held across the organization with employees at every level. Further, several one-on-one interviews were conducted,
and as a result, she designed a project intended to address the issue.
Since more than 40 percent of the employees reside in rural villages
around Ramallah city, we chose the villages that would include groups of
more than six people within each village, thereby end up with 10 groups.
The goal was to enhance the skills and qualifications of group members by
providing around 100 employees with various training sessions, including sessions on the process of working in teams, cooperating and communicating while away from work, communication skills and networking,
team building, leadership, proposal writing and budgeting, and time
management. The details of the project and its goals were explained to all
the teams as follows:
The Company normally spends more than 50,000 dollars annually
on communal development projects, and therefore, instead of having BPC PR management design and set the projects of which the

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229

company would serve its social responsibility, BPC envisioned acquiring and covering its role in social responsibility by engaging its
employees. The company will qualify its personnel, then will request
teams to elect a leader, distribute roles of each team member. Team
members should meet regularly. Each member should have a role in
this project, and after training sessions, the groups should each go to
their villages and work on an official proposal to be submitted to a
managerial committee, consisting of eight people: three from the top
management, three employees that did not participate in the project,
and two external people who are not from within the company. The
proposals should present a developmental project that groups from
each village would like to implement. This should describe the project, its budget, the reason this project is beneficial, and who would
benefit from it, of course including the fact of how this project would
address the image building of the Company.
A competitive process followed, through which the company awarded
$20,000 to the priority project and $10,000 to the second- and third-place
finishers. The remaining $20,000 was then distributed among the rest of
the seven teams to serve as a motivator and to show gratitude to the people who participated.
The project was implemented over six months, during which all teams
were competing, motivated, and challenged. The company realized that
by implementing this project, it was enhancing the skills and qualifications of its employees. The next step was to encourage employees to work
on developing their home villages, to design and implement development
projects that would be announced in their communities, and which would
make them proud of their accomplishments. The goal was to unite teams
instead of letting them remain distracted by the companys reorganization
and to use the new initiatives to promote the companys name throughout
the country.
One hundred employees participated in this project, and the rest of
the 200 were given the chance to participate in voting for the projects.
All employees got the chance to participate in implementing the winning project by attending events and activities in the field and by having
each group supervise and implement its own project within its respective
village.
After the implementation phase a survey was distributed to the two
sets of employees. The first set was for the employees who participated in
the project, and the second set targeted the employees who didnt participate. The results reflected on the motivation of the employees, their loyalty and commitment to the company, and the successful achievement of
the projects goals.

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In addition, awareness about BPC within the community was growing, resulting in a wide coverage for the image of the company all around
the country. Market share rose from 18 percent within the local market to
21 percent, mainly due to having consumers request BPCs products by
name from their doctors and from the OTC medicines as well.
As a result of the project, employee motivation and productivity were
enriched. The employees who participated in the project became more
active, more involved in team work, and worked as moderators among
those who found it difficult to fit within the newly formed teams in the
company. Those who didnt form groups in the first session requested the
company to re-implement the same project the following year, thereby allowing new groups to be formed; this encouraged the CEO of the company to announce the sponsorship of the same project for three years. This
allowed all employees to participate and be motivated.
As a result of the team-work enhancement, the employees were sharing
their thoughts more openly with management, and were more open about
their needs; as a result, employees formed a company-sponsored football
team as a way for them to promote and build the companys name. The
management of BPC, after realizing and acknowledging the effect of the
project on its culture, people, and market share, further invested in enhancing its employee engagement by promoting various activities, and
enhancing the role of effective monthly meetings for all the members of
the company. These meetings encouraged brainstorming and listening
sessions, and proved a means through which top management was able
to initiate what are known as knowledge management (KM) channels
among employees. Finally, the BPC management initiated the establishment of an internal blog that both the employees and the management
could use to secure an open communication channel.

LESSONS LEARNED
An employee-engagement approach can help companies to deal with
the challenges not only of a business that is running in a regular global environment, but also during a crisis, such as the recent recession, because
by establishing trust, the management can unlock more of the knowledge
and commitment of individual employees. As Paul Drechsler, CEO of
Wates Group, said, a leaders focus on engagement is even more important during difficult times to motivate, engage and ultimately retain your
people. Engagement can enable organizations to retain their employees
support while taking and implementing difficult decisions. Indeed, unlike
the experience in previous recessions, many companies have in the past
year worked closely and collaboratively with staff to mitigate the effects
of scarce credit and collapsing markets on the workforce.

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231

Moreover, despite the effects of the current economic climate, there


is an increasing number of young graduates and who have grown up
experiencing only good economic conditions. Despite the present recessionary conditions, these young graduates will not be likely to put up
with working lives where they are expected to hang their brains and individuality at the door, or buckle down under a command-and-control
management style. A less-deferential population is less and less willing
to subsume their individuality in any area of their lives. Life is no longer
about orders and top-down decisions for the generations that grew up in
a world of globalization, openness, creativity, and individual appreciation and spirituality. Therefore, expectations need to be met by the new
graduates, who are fresh, enthusiastic, optimistic, and looking forward
to work and personal development. In order to get the best out of these
graduates, managers need to understand the needs of the new workforce,
and to provide them with at least some of those needs in order to absorb
more of the talents that can help make the market grow and the economy
boom again. As the saying goes, People join organizations but they leave
because of managers.
NOTES
1. John Michael Farrell and Angela Hoon, Whats Your Companys Risk
Culture, Business Week, May 12, 2009, p. 27.
2. The Gallup Organization introduced the notion of employee engagement
in two bestselling books: First, Break All The Rules: What the Worlds Greatest Managers Do Differently (Simon & Schuster, 1999) and Follow This Path: How the Worlds
Greatest Organizations Drive Growth by Unleashing Human Potential (Warner Books,
2002).
3. Ibid.
4. Interview with authors, July 13, 2011.
5. Marin Institute Website, http://www.marininstitute.org.
6. Hassouneh, Muhammad and Abu Libdeh, Hasan. Palestine Investment Conference. Retrieved March 26, 2010, from Presentation Notes Online Website, http://www.scribd.com/doc/25577574/Palestine-Investment-ConferenceBethlehem-28.
7. Palestinian Central Bureau of Statistics: The Performance of the Palestinian Economy during the year 2010. Retrieved January 22, 2010, from http://
www.pcbs.gov.ps/portals/_pcbs/PressRelease/PalEconomic_2010_E.pdf.
8. Ibid.
9. Ibid.
10. Ibid.
11. Ibid.
12. Hassouneh, Muhammad and Abu Libdeh, Hasan. Palestine Investment
Conference. Retrieved March 26, 2010, from Presentation Notes Online Website, http://www.scribd.com/doc/25577574/Palestine-Investment-ConferenceBethlehem-28.

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13. Shehadeh, Loay. Palestinian Central Bureau of Statistic: Fertility Is Declining While Unemployment Is on the Rise. 2009. Retrieved April 1, 2010, from
http://english.pnn.ps/index.php?option=com_content&task=view&id=6102.
14. Karama. Palestinian Minister of Economy: Karama Website Kick Off to
Support Palestinian Products. 2010. Retrieved March 18, 2010, from http://www.
aknews.com/en/aknews/2/119982/.

Chapter 11

The Soft Stuff Is the Hard Stuff:


How Relationships and
Communications Can Drive the
Execution of Business Strategy
Linda Clark-Santos and
Nancy K. Napier

In this chapter, we take a somewhat contrarian approach and explore the


value of soft skillsspecifically, building strong relationships and communicating effectivelyin driving the effective execution of strategy. We
divided the chapter into five parts. First, we describe what happens with
relationships and with communication that might contribute to the failure to execute business strategy. Next, we discuss why relationship and
communication problems happenincluding the power of organizational
culture, competition among peers, the rise of cynicism, the isolation of
executives, and the impact of organizational design. The third section focuses on what happens as a result of these problems. The fourth section
covers the now what?that is, recommendations for different groups on
how to contribute to better execution of business strategy, including actions for leaders and individual contributors in large organizations and
in start-ups, and for students and professors who teach them. Finally, we

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close the chapter describing the potential benefits of implementing the


recommendations.
In working on the chapter, we decided to use as a main content base the
30-year business experience and expertise of one of the authors. Although
she (Linda) has extensive academic experience (as a faculty member and
dean), she has spent much of her career in strategic human resource management of several organizations, ranging from Ore-Ida (division of HJ
Heinz) in Idaho, to H-E-B Grocery Company in Texas, to Washington Mutual and Starbucks in Washington State. Thus, many of the examples and
knowledge come from doing not just teaching.
WHAT MIGHT CAUSE A BUSINESS STRATEGY TO FAIL?
Executives typically spend considerable time, effort, and resources
in the development of a robust business strategy. However, some firms
struggle to translate their strategic intent into crisp execution. Typically,
the core business depends on technical expertise to deploy the strategy.
The strategic intent of large, publicly held companies is the responsibility of the executive group in consultation with the board of directors. In
smaller, more entrepreneurial start-ups, the purpose and strategic intent
come from a leadership group generally headed by the founder. Whether
the organization is large and well established or is new and fresh, it is critical that those working in the organizations understand the marketplace
opportunity the leaders are trying to seize. Once leaders effectively communicate the strategy, individuals and work groups should be able to see
how their work contributes to the success of the company.
Though often overlooked, two factors affect the successful execution
of business strategy: (1) strong working relationships across the organization, and (2) effective communication about the strategy. We discuss each
below.
Relationships
Generally, most companies define working relationships vertically
that is, managers and their direct reports. In large organizations, the reporting relationships may be matrixedwhich means that reporting
relationships are based on multiple intersecting dimensions such as functions, geography, or product. In other words, one person may report to
more than one boss depending upon where the individual resides and the
nature of his/her work. These intersecting relationships add complexity
that can create confusion and thus impede execution.
In smaller, entrepreneurial companies, the roles and reporting relationships may be fluidevolving and changing as the company continues to
define itself and its niche. In such a setting, individuals and managers may

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also find that their roles and responsibilities evolve. Those close to the
founder and his/her top leaders may find themselves in situations that
require them to demonstrate leadership or to take on duties not reflected
in their original titles or jobs and perhaps beyond their current capability.
The ambiguity and fluidity of roles and responsibilities can hinder crisp
execution and damage relationshipsparticularly among newly hired talent and those who have longer tenure.
Communication
Another reason many organizations stumble in executing their strategy may lie in diluted or confused communication. Though the communication is still generally top-down, in a matrixed organization, messages
may flow from more than one sourcewith reinterpretations stemming
from the various legitimate, but possibly conflicting, vantage points. In
large companies, with many layers of management and several business
units, the communication of the strategy can be diluted or reinterpreted as
it penetrates the organization. Communication flow of strategy is generally top-down with each layer of management editing or interpreting the
message along the way. As a result, the final message might be contorted
or confusedrather like a photo reproduced repeatedly from an increasingly fuzzy photo rather than the clear original.
In smaller, more entrepreneurial organizations, the founder and his/
her colleagues may communicate informally and haphazardly as the strategy takes shape. In the haste to refine and revise their approach as the opportunity and their offering become more clearly defined, they are likely
to send messages on the fly rather than craft clear, definitive communication. Furthermore, the sense of urgency and resulting breakneck pace
that is common in such organizations may compound the confusion and
further overshadow important strategic messages.
The Bottom Line
The result in both larger and smaller organizations may be the same: ineffective communication about the strategic direction of the firm coupled
with weak or convoluted relationships can impede the successful execution of the firms strategy.

WHY DO RELATIONSHIP AND COMMUNICATION


PROBLEMS HAPPEN?
In this section, we cover six reasons why communication and organizational relationship problems can occur, illustrating the challenge that

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leaders face in successfully integrating all the elements that make for effective strategy execution.
The Power of Organizational Culture: Leaders
Create Culture and Culture Trumps Strategy
Culture is generally defined as a set of norms that guide behavior within
an organization. A more informal definition of culture is what and how
things get done. Corporate culture develops over time through a variety
of practices and rituals. According to William Schneider of the Corporate
Development Group, the behaviors and practices of leaders shape the culture of their organizations.1 These include a variety of human resources
practices as well as how the organizations members make decisions, deal
with conflict, and foster innovation. In addition, the physical environment
itself shapes culture.
Many practices come into play in shaping cultureincluding hiring,
rewards and compensation, advancement, and employee development.
The ways in which these practices emerge and operate within organizations say much about what the culture is and what types of behaviors and
actions leaders value.
Hiring decisionsthat is, who is invited to join the organization and in
what capacitysignal where the organization is headed and what is likely
to be important in the future. The way that new hires are assimilated also
indicates how mindful the leaders are about the culture and values of the
organization and how committed they are to the success of each individual. Specific considerations include the following: Are people selected for
their values fit or is technical expertise all that matters? Who participates
in the hiring process? And how are new hires assimilatedis it sink or
swim or is there a formal onboarding process designed to bring people
up to speed and to ensure their success?
Other signals about what the organization values come from how it
rewards and recognizes achievement. Examples include the following:
Are titles used to recognize and reward achievement of business goals?
Is recognition done publicly or privately? Are monetary rewards used to
encourage certain kinds of behavior? And finally, who makes the most
money and who is promoted will send powerful messages about what it
takes to succeed. In particular, employees will notice who succeeds and
moves up and who fails and moves out. They will then draw conclusions
about what it takes to thrive and prosper in the organization.
Employee-development programs are another indicator of culture. The
types of training and development the organization invests in as well as
the process it uses signal what the organization leaders consider valuable
and how important learning is to the future success of individuals and
the firm. The degree to which programs are formal and structured versus

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informal and unstructured gives clues to the culture. Another indicator is


whether employees may sign themselves up or must be sponsored by an
executive. Even more telling is whether topics and programs are selected
and designed to serve the business strategy and company objectives or offered as a perk, catering to employee interests, rather than to organizational strategic needs. Finally, do the programs actually prepare people for
advancement and help them contribute to the firms strategic direction?
Other factors that shape culture include:
Who participates in making decisions and how are decisions communicated?
Do the leaders encourage feedback?
Do the leaders avoid conflict?
Is innovation valuedor seen as a threat to the status quo?
Is the physical work environment open and informalor structured
and hierarchical?
All of these leadership behaviors and practices implicitly tell others in
the organization what is important and how they should behave. These
behaviors will trump explicit statements regarding strategy, vision,
mission, and values. Whether leaders like it or not and whether they are
aware of it or not, their behavior sends strong messages and sets the tone
for the entire organization.
As Nilofer Merchant, author of The New How, writes in her blog, After
working on strategy for 20 years, I can say this: culture will trump strategy,
every time. The best strategic idea means nothing in isolation. If the strategy conflicts with how a group of people already believe, behave or make
decisions it will fail. Conversely, a culturally robust team can turn a so-so
strategy into a winner. The how matters in how we get performance.2
All-Stars and A Players: Competition Undermines
Cooperation
A second factor that impedes the crisp execution of strategy is internal
competition. Many executive groups include people who are best-in-class
functional experts or general managers who possess sufficient political
savvy to advance. These A players may act like a group of baseball allstars relying on their individual technical expertise but lacking real teamwork. In an organization with such an all-star culture, A players rise to
the top and peers may compete with each other more than they cooperate. At the top of the organization, the competition becomes even more
fiercewith higher stakes, bigger egos, and fewer players. Such a competitive attitude at the top sets the tone for peer relationships deeper in

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the organization. In fact, lateral peer relationships can be among the most
challenging to cultivate. Generally, there is no great incentive to develop
peer relationships since peers have no formal power over each other. They
do not decide on promotions, recognition, or compensation for each other.
Even in organizations that use 360-degree feedback tools as part of their
feedback loops, there is little one can do to openly influence the career
trajectory of a peer. Often, they are rivals in the quest to succeed their
boss or to win another coveted role. Indeed, some leaders may in fact encourage peer competition. As one chief executive officer put it, I like it
when people are competing for promotion . . . it keeps their heads in the
game. A consequence of such competition is that peers may believe that
anothers success will come at their own expense, so there is little reason
to help that peer succeed. Rather, there is often more reason to undermine
a peers success.
Furthermore, the A players at the top may show little appreciation for
the B players deeper in the organization. Some management experts, however, suggest that B players may be the glue that holds organizations together during difficult times.3 These valuable and steady B players may
become disenfranchised over time, though, if the all-stars operate in their
own self-interest rather than the good of the organization and if that behavior is rewarded and recognized.
Executive Turnover Breeds Cynicism
As the tenure of executives has declined4 and turnover has once again
spiked, many organizations have suffered jolting changes in direction
and strategy. For example, in 2011, the (former) CEO of Hewlett-Packard
(HP), Leo Apotheker, announced the sale or spin-off of HPs PC division
as a major shift in business strategy. Within months, Apotheker was out
and a new CEO, Meg Whitman, reversed the decision. We can only imagine the turbulence and the resulting tug of war these decisions must have
wrought inside the organization.
So common was turnover and change in strategic direction at the top in
another large organization that the middle managers, in a dark and notso-private joke, called themselves the We-Besas in We be here when
you are gone. In another organization, one of us watched five CEOs come
and go in a two-year period, each with his own take on what the organization needed for success. The managers and employees became increasingly disenchanted and disengaged as the door at the top revolved. This
kind of cynicism undermined teamwork and commitment, evidenced by
the exodus of many talented people and the eventual consolidation with
another company.
Some organizations, however, have made stability and constancy of
purpose critical for success. Apple, over several years, has consistently

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communicated its direction and executed its strategy. Even people outside
the firm can articulate Apples primary business strategyto develop
cool, well-designed products that customers do not think to ask for but
must have once they see them. Further, most fans of U.S. business know
how CEO Steve Jobs introduced new productsin his signature black
mock turtleneck and jeans standing on a stage with the product in his
hand. The image conveys clarity and no confusion whatsoever. The fact
that these messages and images (will) live on after Jobss death is indicative of their sustained power and compelling impact.
Executives Become Insulated and Isolated
A fourth factor that often leads to business-strategy failure is that executives become isolated and as a result lose touch with their organizations.
As business organizations increasingly become the result of mergers, consolidations, and acquisitions over organic growth,5 it becomes increasingly
difficult for executives to really know what is going on deep in their organizations. Not only is it lonely at the top, but executives can also become
increasingly insulated. Some, like the now infamous CEOs of Lehman
Brothers or AIG, may isolate themselves on purpose, but generally it is
simply more difficult to stay in touch as an organization grows. Too many
layers and too many players not only dilute the messages going out from
the senior leadership, but can also filter and distort feedback coming in.
When one of us joined a large publicly held company as a senior vice
president (SVP), she experienced firsthand how many layers in an organization can dramatically slow down the work flow. Still new to the organization and just getting to know her team, she received a work assignment
that required some specialized computer skills. She inquired and learned
that a member of her staff had such skills. She approached the individual
whose workstation was just a few steps away and asked for help. The
staff member replied that the SVP would need to check with the staff
members supervisor first. And so off the SVP went to the supervisor. She
quickly learned that the individual she first approached reported to someone, who reported to someone, who reported to someone, who reported
to someone, who reported to someone (sigh) who reported to the SVP. In
a team of nine, there were seven layers of management. What should have
been a 10-minute conversation turned into an hour. An illuminating hour,
to be sure, especially since the SVP would later be charged with streamlining the organization and reducing unnecessary layers. She knew a good
place to start.
In addition to the primarily top-down flow of communication, many
large organizations have little or no two-way communicationno listening posts to identify the concerns and questions of the workforce and
mid-level managers. If leaders make an effort to understand the concerns

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of middle managers and individual contributors, they not only create cohesion deeper in the organization but they also become better equipped to
remove barriers to progress. Absent two-way communication with appropriate feedback loops, their leadership is hollowleadership by exhortation rather than by example, inspiration, or vision.
Moreover, executives may think that more communication is better
communication, not realizing that multiple messages and channels can
actually reduce effectiveness. In one large organization (60,000 employees with five business units), a new head of internal communication conducted an audit to determine how many communication vehicles existed.
His study revealed that over 270 formal communication publications
both print and electronicwere developed and delivered regularly. The
cost and confusion of so many messages actually diminished understanding of the business strategy and limited real traction and results.
Isolated Executives Communicate Poorly about the
Direction of the Business
In many cases, opportunities for mid-level managers to hear firsthand
from the executive team about the strategic direction of the business are
limited. Instead, many large organizations invest heavy resources in an
annual leadership conference to bring hundredseven thousandsof
managers together. In such settings, executives often miss the opportunity
to explain and refresh the business strategy in person, opting instead for
a series of speeches. These speeches can range from a straight-from-theheart but off-the-cuff monologue to a tightly rehearsed but passionless
speech designed to inform but not to inspire. In one painful example at a
large meeting following a business downturn, a CEO took questions from
the audience after his speech. One brave individual asked about the logic
of layoffs when executive compensation was on the rise. The CEO chuckled and said that yes, it was true that he was highly paid and that he had
every intention of continuing to be so. As the audience gasped, he then
called for the next question.
In other cases, firms may choose a more entertaining format. Keynote
speakers might be television comedians or other performers. At one such
conference, one of us was asked to host a breakout session. She chose to
introduce the firms new leadership competency model that would serve
as the foundation for performance reviews and leadership-development
programs. As the agenda firmed up, she was dismayed to learn that one
session offered concurrentlyand thus competing with herswas a simulation of a television game show, complete with prizes and the celebrity
host.
Though designed and delivered with good intentions, such events
can fail to truly engage the hearts and minds of the audience in the

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business. Strategy therefore remains in the hands and the heads of a few at
the top.
In smaller, entrepreneurial organizations, the founders and executives
may thrive on the chaos and adrenaline of the start-up and value those
who can tolerate the same. However, the pace that these entrepreneurs
enjoy and the ambiguity they tolerate may take its toll on others. Some
employees may be reluctant to seek clarity or wish for greater stability
lest they be seen as malcontents not well suited to an uncertain start-up
environment. As a result, the entrepreneur may not realize that people are
confused or concerned about the direction of the firm.
Many other questions about communication about strategy include:

What channels are used?


How frequently are such messages sent?
Whose voice is used?
How complicated or simple are the messages?
How relevant are the messages?
Are there any feedback loops that invite clarification?

Organization Design Impedes Lateral Relationship Building


In addition to the top-down flow of communication in both formal and
informal channels, the organizational design may impede the development
of strong lateral relationships. Typically, meetings focus on the vertical organizationmanagers and their direct reports. The opportunities to meet
and get to know peersthose at the same level across the organization
are rare.
As we mentioned earlier, some enlightened organizations try to create
esprit de corps among their managers by hosting large leadership conferences. However, as we also previously noted, these events may focus more
on style than substance. Further, the schedule can be rigidly structured
with huge plenary sessions coupled with concurrent breakout sessions
that follow. Generally, these breakouts are either designed to entertain
or are structured to serve a vertical sliceagain managers and their direct reports. In either case, there is little opportunity for networking and
cross-functional or cross-unit relationship building. So, the vertical design
of the organization definesand restrictsrelationships. Consequently
mid-level managers find it difficult to gain a broader, more strategic view
of the organization and how their work combines with others for the success of the firm.
Moreover, management retreats that are designed to build teamwork
and esprit de corps are limited to functional teams with a leader and his/
her direct report team. Although there may be value in such events to

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build internal teamwork, they generally focus inward on the needs of the
group rather than on the broader strategy. If guest executives are asked
to attend to address broader organizational issues, their vantage point is
that of the executives rather than peers of the target audience. Once again,
there is limited opportunity to develop peer relationships and to learn
more broadly about the organization from the perspective of peers.
Conversely, in an unprecedented move, an innovative executive in
one large publicly traded company sponsored a customized leadershipdevelopment program that was designed and delivered to a horizontal
slice of the organization. In the program, one segment was focused on
identifying common problems and brainstorming solutions. Each individual was asked to bring a recurring problem and brief the larger group. As
the problems were identified and the discussion ensued, participants discovered that others had solved the very problems that they had found so
perplexing. One rather quiet participant raised his hand and commented,
You know, I just realized that for most of our problems, the answer is in
the room. An inspiring silence fell over the group as people began to nod
and smile. That evening over dinner, much of the discussion focused on
the fact that though the participants had much in common and in some
cases had worked in the same company for many years, they had never
had a chance to really get to know each other and explore what they had
in common and how they might help each other.
With a matrixed organizational design, the design itself can present challenges. In such a design, an individual might have two or more
bosses. In such situations, the competition for attention from those bosses
may cause great confusion and stress. Having to juggle priorities, meeting schedules, and performance expectations from more than one boss can
breed despair and undermine teamwork. Again, competition is likely to
eclipse cooperation when rival loyalties and competing priorities abound.
Interestingly, although matrixed designs might sound effective, working inside such a design is extremely complex. In his book, Designing Matrix Organizations That Actually Work,6 Jay Galbraith, a recognized expert
in organizational design, describes companies that may have as many as
six matrixed dimensions around which they are organized. Then, he suggests that perhaps the number of dimensions that could be used within
an organization is unlimited. However, many who live the matrixed life
might disagree, as the complex web of relationships in such organizations
cannot help but cloud messages, strain interactions, confound loyalties,
and confuse priorities.
In smaller, entrepreneurial organizations, the organizational design
may be flatwith the founder and a few trusted lieutenants running
the show. As the organization grows and new talent is hired, the relationships and responsibilities may evolve in the minds of those at the top but
can be quite obscure to those just joining. In one such organization, one of

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the trusted lieutenants was expected to train new hires but was given no
formal charge to do so. A new hire, selected for considerable expertise and
talent, then resented the guidance of the lieutenant. There was no formal
reporting relationship and the leaders had not made clear that the new
hire should look to the lieutenant for direction, support, and training. Not
wanting to disappoint the founder, the lieutenant struggled for months
to make the situation work. By the time expectations were clarified to get
everyone back on track, the new hires relationships within the firm had
deteriorated beyond repair and he left the organization.
In sum, talented people can struggle in an organization where roles and
expectations are not clear and where relationships are not strong. If the organizational chart has so many arrows and dots that it starts to look like
a Ferris wheel, rest assured that there is sufficient role confusion. Such organizations may waste resources and lose needed talentand results are
likely to suffer.
SO WHAT HAPPENS AS A RESULT?
The challenges and problems stemming from weak relationships and
poor communication can ultimately undermine the success of an organization. The biggest impact is that people will simply disengage or completely withdraw. Specifically, outcomes may include lack of engagement,
short-term focus, silos, lower confidence, and higher confusion and frayed
relationships.
The cynicism resulting from frequent changes in leadership and/or
strategy results in shallow commitments that reduce the level of engagement. Though they may stay, the disenfranchised mid-level managers and
B players in large firms are less likely to go the extra mile for the good
of the organization. Furthermore, highly talented people who have opportunities elsewhere may leave altogether. In other words, those who
stay may disengage and others will simply leave for a better opportunity.
In smaller, more entrepreneurial firms, the lack of clear communication
about the future direction and strategic intent of the business can cause
talented people to curb their enthusiasm and question their commitment.
When engagement suffers, business results suffer as well.7
To survive the turbulence of constant change of leadership or direction,
many employees may concentrate on the short term with no regard for the
future. This short-term focus robs the organization of the staying power
that will sustain the organization during tough times and propel them
forward during better times. Decisions become slow and progress abates
as people hunker down into a survival mode and simply wait for the
next wave of change to hit. In large organizations, poor communication
and relationships can lead to the emergence of silos. When that happens,
peers across the organization refrain from working together and sharing

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information. In one such situation, one business unit was working hard to
launch a new product line that would compete directly and succeed at the
expense of another unit within the same firm. Ultimately both initiatives
failed after wasting resources and straining relationshipsin some cases
beyond repair. Though silos are less likely in smaller but growing organizations, the informal nature of relationships and evolution of responsibilities can ultimately create dysfunction as the firm matures. Because
they value the energetic and informal start-up environment and eschew
anything that seems too corporate, many entrepreneurs resist creating a
more formal structure as the firm matures. As a result, their success may
stall as the need for greater clarity and direction emerges.
Another result from poor communication and relationships is that confidence dissipates and confusion abounds. Employees may lack a clear understanding of strategy and may be confused about their role in execution.
Too many messages and too few with real information about the strategy
erode understanding and hinder execution. Employees are likely to lose
confidence in their leadership, which compounds the lack of commitment.
Finally, relationships fray and focus turns inward. Competing loyalties
and priorities place individuals in no-win situations where they simply
cannot please everyone. As a result, they may pursue their own selfinterest rather than working for the greater good. The causes of the downfall of great civilizations are often internal strife coupled with external
threat.8 Just like great civilizations, great companies can fail as well.
SO WHAT CAN YOU DO?
Given the plethora of what can cause business-strategy execution to
go off track, it is amazing organizations ever do it right. So what actions
can improve the chances of successful execution of business strategy?
In the closing section, we offer suggestions directly to different groups
executives, middle managers, and individual contributors of both large
and small organizations, as well as for students and professors who teach
them. Students need to remember that they will likely one day be those
executives and managers at small or large firms. So even though the day
seems far away, they should keep in mind there are some actions they
could take in the future.
Actions for Executives in Large Organizations
Set the Tone
First, recognize that what you do and say sets the tone for the rest of
the organization. Remind yourself that culture trumps strategy, and your
actions shape the culture. Make a conscious effort to serve as a role model

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for teamwork and call attention to its importance. Evaluate the teamwork
of your executive group and communicate your expectation that they
function together for the greater good of the organization. Tell them that,
as executives, they should put on the big company hat rather than their
small, functional hat. Hold yourself accountable for creating broadbased understanding of the business strategy. Constantly ask yourself
what you can do to get everyone moving together into the future. Finally,
reward and recognize those who are strong team players.
Streamline and Audit Communication
Focus on a few essential messages about strategy and direction; repeat
and reinforce those messages often. Use the communication channels and
vehicles that are most appropriate and compelling for your organization.
Learn to use technology to add a personal touch to your broad, strategic
messages and use those messages in inspiring ways to get results. Help
people understand their contribution to the success of the enterprise. Recognize when you are altering your course and communicate accordingly.
Avoid assuming that everyone will get it if you change direction. Take
special care to take your leadership team and your workforce with you as
you chart the course into the future.
Use Listening Posts
Third, establish some listening posts to enhance two-way communication. Avoid relying entirely on your direct reports to tell you what is
going on deeper in the organization. Use all-employee surveys to put your
finger on the pulse of your organization. Use the results to make it easier
for people to execute and drive the business. Conduct focus groups of
high performers to learn what prevents them from doing their jobs well.
Attend the focus groups yourself to hear firsthand what people are thinking, and ask a recorder to document the results. Invite horizontal slices
(peers from a variety of functional areas and geographies) to lunch or coffee and take the opportunity to discuss your business strategy and answer
questions. Again, ask someone to record what you learn and then work to
address issues you identify. And make sure that the actions you take do
not feel punitive or reflect badly on those who had the courage to speak
up about their concerns.
Create Social Capital and Look Widely for Solutions
Cultivate broad-based solutions to vexing problems by offering crossfunctional action learning development programs to high performers across the organization. Action learning programs9 bring together

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high-performing peers from various areas of the business to solve real


business problems under the sponsorship of a key executive. These high
performers have an opportunity to develop skills and insights needed by
the business and to advance their understanding of the business while
they develop strong, enduring peer relationships. When they have completed their action learning experience, equip them with messages that create deeper, broader understanding of strategy and deploy them across the
organization. Use them as a cadre of cross-functional peers who can look
beyond their areas of purview for holistic solutions to difficult challenges.
Develop Simple Organizational Design
Simplify the organization to eliminate unnecessary confusion and conflict. If you have a matrixed organization, your top management team
must provide integrated direction and model integrative behavior.10
Develop clear charters for lateral and vertical units. Create integrating
mechanismssuch as councils (again with clear charters)that foster collaboration as needed to ensure the right amount of coordination for critical tasks. Figure out how you are going to deal with internal conflicts and
how you want your leaders to escalate matters that need resolution. Clarify roles by calling on all managers to eliminate ambiguity and make sure
who is accountable for which core processes that might be shared by two
or more managerswho gets 51 votes and when? Ask your managers to
target their communication and coordinate where needed to avoid confusion. Recognize that working in a matrix is difficult, so limit the number
of dimensions to those that are absolutely essential. Do whatever you can
to keep things simple. In addition, monitor the number of layers in your
organization and resist the temptation to add layers as you grow. If too
many layers are impeding your progress and limiting your success, determine what kind organizational design principle will best serve your
businesscustomer focus, product line, geographic, front office-back office, for example.11
Develop and Use Peer Relationships
Even senior managers can benefit from peer relationships. Unfortunately, such peers are not likely to reside within your organization. As
a result, you may want to look outside not only your firm but also your
industry to cultivate new and creative solutions. Seek out others from
diverse sectors but from organizations with similar philosophies about
performance. An example is a six-year-long group called the Gang.12
This group of seven includes organizations ranging from dance to software and advertising, law enforcement to football, theater to health information. Senior leaders meet to compare problems and lessons, and have

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discovered over the years that they have more in common (despite their
divergent industries) than not. As one of the leaders has said, once best
practices in your industry are documented, they become normal practices.
Going outside your field is where you get new ideas.
Actions for Entrepreneurs in Start-ups
Entrepreneurs face different facets of the challenges relating to communication, relationships, and design. We suggest those of you starting new
organizations to focus on five key actions.
Be Clear about What You Are Doing
First, think through the business opportunity you are striving to seize
and articulate your offering. Develop a few crisp messages to communicate your strategy and repeat them often. If your strategy and offering are
still in flux, admit it but work hard to clarify and refine your thinking. Engage trusted sources to help you define the opportunity you see and how
you plan to seize it. Realize that much of your talent lies in your vision,
but your success may be defined by your ability to communicate.
Refresh Your Communication as Your Strategy Evolves
If you are fully engaged in your new start-up, you will know what is
happening sooner and faster than most others, including employees. So
you avoid assuming that others see what you see. Instead, display your
thinking to foster understanding and generate clarity. Make a conscious
effort to refine and revise your messages as you grow. Develop your own
leaders voice13 to help you send the right messages the right way. Collect
and capture anecdotes that help tell your story and that of your firm.
Reward the Soft Skills
Recognize and reward those who have the soft skills of building relationships and communicating effectivelyparticularly if those are attributes you dont possess. Seek out those who have the skills of persuasion,
collaboration, and conflict resolution, and make sure they have a place
and a voice on your leadership team.
Have Clear Roles and Responsibilities for All
As your organization evolves, clarify roles and responsibilities of your
lieutenants. Review their responsibilities periodically to make sure you
have not given them informal responsibility without formal authority.

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Recognize that the high level of ambiguity that you, at the top of the organization, find thrilling may be debilitating to those on your team. Cultivate appropriate listening posts to keep in touch with the needs and
concerns of your growing organization and to ensure that valued members of your team are fully engaged.
Consciously Align Your Culture with Your Business
As your organization grows, give thought to what kind of design will
best serve your business strategy.14 Resist the urge to let things grow haphazardly until the point at which things stop working and results suffer.
And pay attention to reporting relationships to make sure they are clear
and that you can hold people accountable in appropriate ways.
In addition, decide what kind of culture you want to create. Consider
what kind of workplace environment is best suited to your business and
your workforce and then act accordingly. Remind yourself that culture
trumps strategy, and that your actions shape the culture. Be aware that the
culture will be created whether you intend it or not and that your actions
will be its most powerful influence.15
Choose Wisely and Assimilate New Talent Fully
As you need new talent, select carefullynot only for technical expertise but also for cultural fit. Involve key members of your current team
in the hiring process to make sure they have a voice. As you welcome
new members to your organization, assimilate them thoughtfully and
thoroughly. Avoid the temptation to let the new hire sink or swim. Communicate expectations clearly and often. Recognize that the onboarding
experience of new hires will likely determine to determine how long they
will stay and how successful he/she is likely to be.16
Actions for Mid-Level Managers, Lieutenants, or Individuals
Separate from top managers at large and start-up companies are the
managers deeper in an organization who execute strategy. They too face
unusual challenges on the soft stuff, and we offer several suggestions.
Understand Strategy
First, make it your business to understand the strategy thoroughly.
Make an effort to understand how your work contributes to the success of
the business. If you are a manager, explain how the work of your unit fits
into the big picture and help people feel that they are part of something
larger than themselves.

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249

Adjust When You Need To


Partly because you may not develop the strategy, you need to learn
how to understand and read it, especially as changes in direction or strategy are in the works. As you recognize it, you will need to adjust accordingly. Resist the temptation to hunker down and protect the status quo.
Have the courage and the wisdom to embrace the change and become an
advocate. Inform yourself about the reasons for the change and understand the implications for your work. If you cannot truly commit and remain engaged, consider whether you should pursue a different position
elsewhere. Recognize that remaining but resisting could stall your career.
Develop and Nurture Peer Relationships
Rather than seeing them as competitors, find and cultivate your peers
in other areas of the business. Assist others when you can and develop
a reputation as a strong team player. Know when to lead and when to
follow. Support others in their efforts to strengthen lateral relationships.
Reach out beyond your area to develop relationships and understand the
big picture. Seek and seize opportunities to work with peers across the organization. Ask how you can help others to succeed and how together you
can contribute to the success of the organization.
In addition to those within your organization, find a professional
buddy outside your organizationsomeone you can trust and use as a
sounding board. Cultivate your ability to consider work challenges from a
different vantage point by seeking the perspectives of those outside your
immediate area. Expand your thinking by growing your professional network and learning from others who are quite different from you.
Develop the Soft Skill of Great Communication
Finally, in addition to embracing change, understanding the strategy,
and building strong relationships both inside and outside your organization, make it a priority to develop strong communication skills. Helping
others understand how your work fits with theirs and contributing to the
success of the firm is a critical leadership skill. Develop your ability to ask
penetrating questions that get to the heart of the matter.
The best leaders and managers know the value of questions and use
them for at least four different reasons: to learn, to build relationships and
teams, to solve problems, and to find or anticipate problems. The best also
know how to ask questions; so you too should recognize the difference
between questions that challenge (and therefore may intimidate) and
questions that genuinely ask for more information to enhance your understanding. And then, of course, take care to listen to the answers others

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Strategic Management in the 21st Century

provide. While someone else is speaking, resist the temptation to mentally


rehearse your next remark.
Actions for Students and for Professors
As we mentioned at the beginning of this section, whether students believe it or not now, they will likely become one of the managers that we
talked about previously, whether in a large or small firm, perhaps even
the one at the top. In that role, students can either support the successful
execution of their organizations business strategy, or be obstacles to it. We
hope they choose to help their organizations succeed.
Actions for Students
So what can students do while they are still at universities to enhance
their abilities to succeed later? We offer several suggestions. First, instead
of dreading group and team projects, welcome the chance to be part of
a team that has a goal. Take advantage of opportunities to work with a
team, sort out how to achieve a goal, and build strong peer relationships.
Recognize that such opportunities are relatively free of riskthat is, failure will not mean job lossbut the skills you will acquire will be a boon
for youand the organization you joinin the future.
Second, cultivate your own communication skillsparticularly asking
good questions and listening actively. Ask for feedback from your team
members on how well you communicate and ask for tips from those you
think are good communicators. Watch and learn from those who do well
what you have not yet mastered.
Also, learn how to bring out the best in others. Recognize that even difficult people and stressful situations offer you great opportunities to learn
and grow. Working with otherseven those you dislikeis a requirement
of work life; the stronger your interpersonal skills are, the more successful
you are likely to be. Develop people skills to balance your technical skills,
and realize that both are essential in the workplace of the 21st century.
Finally, grasp the opportunity to gain experience from internships
within organizations in ways you might not have fully tapped to date.
Watch how people in the organization build relationships in both formal
and informal ways. Ask questions about what kind of skills are needed to
be hired and then to succeed in the firm.
Actions for Professors
Students are not in the learning process alone, as we know. Professors
also have an opportunity and a responsibility to help students cultivate
these skills. We offer a few suggestions. First, create assignments that

The Soft Stuff Is the Hard Stuff

251

indeed provide true conditions for students to lead and to work as a team.
Recognize that too often assignments allow for social loafing, rather than
encourage and force engagement by all. Consider allowing a team to sanction members (even to the point of firing a member). Add peer assessment at the close of a project to provide useful feedback to the students. If
possible, offer the chance for multiple projects with the same team so that
members can rotate the leader responsibility. Encourage students to learn
to lead and be a team player. Cultivate and reward interpersonal skills as
well as technical expertise to help students gain these critical abilities that
executives value.
Second, acknowledge that students need to learn how to bring out the
best in otherseven then they are not in charge and are not required to
do so. Call on students to find ways to integrate their ideas with the good
ideas from other team membersrather than trying to prevail. Learning
to cooperaterather than competeis, again, a skill that senior executives look for but often do not find in potential employees. Help students
learn to draw others out, instead of passively waiting for others to engage.
As students practice working with peers, encourage them to consciously notice and consider the lessons they gain from the experiences,
build on them, and adapt the lessons to new endeavors. Cultivate the ability to reflect, which also helps to build the valuable characteristic (alas) of
seeing the bigger picture. By stepping back to reflect, students are also
learning to step back and see a broader situation, which in turn can also
help instill the understanding of the benefits of cooperation across silos or
different functional areas. Though these soft skills are hard to learn, hard
to develop, and hard to use, your classroom offers generally safe conditions for students to practice them.17
BENEFITS OF IMPLEMENTING THE SOFT STUFF
If executives, entrepreneurs, managers, individual contributors, and
those preparing for (and helping to prepare others for) these roles were to
cultivate effective communication and relationship building, the so-called
soft stuff, a number of good outcomes can emerge.
First, execution might be faster, better, and simpler if the purpose and
strategic direction of an organization is clear up, down, and across the organization. Leaders could get better results if they understand the business strategy and how their teams contribute to its successful execution.
Furthermore, as business conditions change, organizations could be more
nimble in refreshing their strategy and moving ahead without losing
traction.
Second, executivesboth in large organizations and small start-ups
would be better informed, be closer to the action, and be more accountable. Their willingness and ability to both lead and listen would set an

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Strategic Management in the 21st Century

example for the rest of the organization, keep them in touch with reality,
and help them to move their businesses ahead.
Third, employee engagement could remain high despite turbulence in
the marketplace. With confidence that their leaders are making and communicating sound decisions, people are more likely to stay the course and
focus on how to make the organization succeed. A more engaged workforce performs better and gets better results.18 Relationships create stickiness, which increases the likelihood that talented people will stay with
the organization. This applies for the future employees who are now at
universities as well as those already in the employment market. Given
the pace of the business environment, globalization, and the benefits (and
dangers) of remote connectedness through social media and the Internet,
many leaders know that the soft stuff of relationships and communication
will be even more important in the future.
Finally, organizations would be positioned for leadership continuity.
A work environment that fosters engagement and develops social capital while getting business results is likely to be more attractive to the next
generation of leadership talent, who is likely to be less hierarchical than
the current generation of leadership.
THE SOFT STUFF IS INDEED THE HARD STUFF
The workplace of the 21st century is a demanding and complex environment. As organizations globalize, industries grow, companies consolidate, and competition intensifies, success is likely to become increasingly
elusive. Though there is no substitute for technical competence and expertise, the true winners of the future may be those who can overcome differences, cultivate agreement, and move with others into the future. That,
then, is both the challenge and the opportunity. The future is yours.
NOTES
Many thanks to Bianca Jochimsen for her outstanding assistance with this
chapter.
1. Schneider, William E. 1994. The Reengineering Alternative: A Plan for Making Your Current Culture Work. New York: McGraw-Hill/Irwin.
2. Merchant, Nilofer. 2011. Culture Trumps Strategy, Every Time. Harvard
Business Review Blog Network, March 22. http://blogs.hbr.org/cs/2011/03/cul
ture_trumps_strategy_every.html.
3. DeLong Thomas J. and Vijayaraghavan, Vineeta. 2003. Lets Hear It for
B Players, Harvard Business Review 81(6): 96102.
4. ChiefExecutive.net. 2011. 13 Percent CEO Turnover, Highest Rate in Six
Years, ChiefExecutive.net, September 8.
5. The Investment Blogger. 2011. 2011 Mid-Year Mergers and Acquisitions
Update (Part 1), The Investment Blog, July 6.

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253

6. Galbraith, Jay R. 2009. Designing Matrix Organizations That Actually Work:


How IBM, Procter & Gamble and Others Design for Success. San Francisco: Jossey
Bass.
7. Kowske, Brenda J., Herman, Anne E. and Wiley, Jack W. 2010. Exploring
Leadership and Managerial Effectiveness. Kenexa Research Institute WorkTrends
Report.
8. Ferguson, Niall. 2011. Americas Oh Sh*t! Moment, Newsweek, November 7 and 14.
9. Dotlich, David L. and Noel, James L. 1998. Action Learning: How the Worlds
Top Companies Are Re-Creating Their Leaders and Themselves. San Francisco: Jossey
Bass.
10. Galbraith, Jay R. 2009. Designing Matrix Organizations That Actually Work:
How IBM, Procter & Gamble and Others Design for Success. San Francisco: Jossey
Bass.
11. Galbraith, Jay R., Downey, Diane and Kates, Amy. 2002. Designing Dynamic
Organizations: A Hands-On Guide for Leaders at All Levels. New York: AMACOM.
12. Napier, Nancy K., Raney, Gary, Freeman, Ron, Petersen, Chris, Cooper,
Jamie, Kemper, Don, Balkins, Jim, Fee, Charlie, Hofflund, Mark, McIntyre, Trey,
Schert, John Michael, and Lokken, Bob. 2011. Gang Rules: Creativity in Unexpected Places, People and Strategy 34(3): 2833.
13. Crossland, Ron and Clarke, Boyd. 2002. The Leaders Voice: How Your Communication Can Inspire Action and Get Results! New York: SelectBooks.
14. Galbraith, Jay R., Downey, Diane, and Kates, Amy. 2002. Designing Dynamic Organizations: A Hands-On Guide for Leaders at All Levels. New York:
AMACOM.
15. Schneider, William E. 1994. The Reengineering Alternative: A Plan for Making Your Current Culture Work. New York: McGraw-Hill/Irwin.
16. Herman, Anne E. 2009. Onboarding New Employees: An Opportunity to Build
Long-Term Productivity and Retention. Wayne, PA: Kenexa Research Institute.
17. Colvin, Geoff. 2008. Talent Is Overrated: What Really Separates World-Class
Performers from Everybody Else. New York: Portfolio.
18. Kowske, Brenda J., Herman, Anne E., and Wiley, Jack W. 2010. Exploring
Leadership and Managerial Effectiveness. Kenexa Research Institute WorkTrends
Report.

Chapter 12

The New Reality for Business


Institutions: Societal Strategy
Robert Moussetis

An increasingly complex nonbusiness environment has created a greater


need for business institutions to expand their strategic thinking and integrate nonbusiness strategies into their formal strategic planning.1 Although social strategies are evident among the great majority of firms,
it is rather a reactive posture versus a proactive and systematic strategy.2
Generally, firms react to nonmarket issues and rarely have a clear and
methodical strategy to engage the nonmarket environment. Nevertheless,
ethical responsibility and legitimacy3 are critical ingredients of the modern business firm4 that not only require management but also strategizing.
Clearly, the business institutions must generate a satisfactory economic
performance in an environment of high ethical integrity5 and outstanding
compliance practices.6
The great management philosopher, Peter Drucker, has suggested the
enhanced societal nature of modern business institutions.7 He indicated
the distinct possibility that in the new pluralistic society the challenges
of an organization will greatly be based on power, and thus, highlighting a shift from resources, entrepreneurship, and technological innovation to a new pragmatism dictating success for the business firm.8 He
indicated that institutions have become carriers of social purpose,

The New Reality for Business Institutions: Societal Strategy

255

social values, social effectiveness. Therefore, they have become politicized,9 signifying the changing nature of the business institution from
a profit-making center to a social instrument with a broad impact on
society.10 Consequently, business institutions carry a considerable responsibility not only to shareholders11 but also to an extensive number
of stakeholders.12 Inevitably, such responsibility invites the question of
planning, strategy, managerial capability, and effectiveness. In contrast,
there is also the suggestion that business is not to be concerned with any
type of societal activities. It was Milton Friedman who suggested that
businesses have no place in society by saying:
Few trends could so thoroughly undermine the very foundations
of our free society as the acceptance by corporate officials of social
responsibility other than to make as much money for their stockholders as possible. . . . Can self-selected private individuals decide
what the social interest is?13
However, such an approach has led companies to short-term thinking,
maximization of profits, and stockholder satisfaction. Although corporate ethical investment is increasingly concerned with the social responsibilities, it is only a small indication of firms departing from the
profit-only position.14 The transformation of the business institution
from a purely profit-making societal tool to an institution that provides
societal services to its employees (health care, retirement benefits, flexible schedules, etc.) surely has affected the stockholders earnings. However, it is unlikely that business institutions will function without them.
Businesses are not profit-making centers, but cost effective centers.15
Furthermore, the globalization of the economies creates novel challenges
for corporate managers16 that fall outside the boundaries of established
competitive thinking.17 The business institutions need to take a note of
the changing nature of the competition since nonmarket factors (regulations, corporate philanthropy, environment, etc.) might dictate success
or failure.
This essay will argue that the complexity of societal activity requires
an aggregate approach where the exploration of multiple variables (i.e.,
environment, stakeholder power, performance, strategic behavior, managerial capability) cannot take place independently but holistically. A
conceptual map (Figure 12.1) will provide the domain of the major variables and a contextual discussion will attempt to create the common denominator to facilitate empirical research. Moreover, it will argue that
optimal performance is an outcome of the alignment between external
intensity (i.e., external stakeholder power, environmental turbulence)
and internal intensity (i.e., strategic behavior, managerial capability for
political work).

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Strategic Management in the 21st Century

Figure 12.1
Transitional Model

DESCRIPTION OF THE MODEL


The conceptual model was created to provide the practicing manager
with the major variables that a manager would need to consider in developing a societal posture that contributes to the financial success of
the firm. Each country presents cultural and political dynamics that are
unique; hence, the need for a national posture in each country. In addition, the model was created to facilitate the broader perspective of a potential empirical investigation, to recognize all dimensions critical to the
exploratory domain from a multidisciplinary approach, and to facilitate
the selection of a research domain(s) while controlling for exogenous
variables. Furthermore, it forces a manager to take a multidisciplinary
approach by looking at the problem through different scientific optics,
such as the cognitive-logical, psycho-sociological, and political perspectives. The sociopolitical environment defines both the market and nonmarket dynamics. Rule makers will incorporate environmental signals
into their decision-making process. Such decisions are subject not only
to the general external sociopolitical environment but also to the prevailing national culture and stakeholders. Rule makers establish the canons of the game; hence, the managers receive their information from
stakeholders, rule makers, and the firms internal structure before they
render a choice of strategic posture. However, the stakeholders are influenced by the societal strategy performance; therefore, the managerial

The New Reality for Business Institutions: Societal Strategy

257

strategic-posture choice is prompting societal performance as well.


In order to put the conceptual model in context, we must explore the
basic elements of societal strategy as they relate to societal elements.
ENVIRONMENT AND SOCIETAL STRATEGY
Scholars have explored the gravity of the environment as a determinant of strategy and some have specifically affirmed the societal context
of the modern firm (see Table 12.1). Clearly the nonmarket environment
(social and political) affects the business activities,18 pressing the business institution to recognize the strategic implications of the nonmarket
activities. Although emerging societal trends induce overall corporate
revisions, it is the changes in the social and political environment that
trigger corresponding social and political strategies by the business
institution.
Although it is postulated that the environment influences strategy, its
degree, scope, and extent vary in organizational theory (see Table 12.2).
Distinctly, the departure from Webers theories19 of treating the firm as a
closed system triggered research that explored the degree to which a
firm depended to the environment.
The environment-organization relationship postulated by the various
organizational theories led to the suggestion that firms ought to integrate exogenous political pressures into the comprehensive strategy of
the firm. Thus, it is evident that the political pressure exerted on the
business firm required the field of strategic management to integrate
social policy20 and societal strategy21 into the overall corporate strategy
and/or strategic posture of the firm. Considering the various environmental conditions (i.e., heavily regulated old industries versus new and
novel industries with minimal regulations), it is argued that firms need
to investigate the development of an analytical framework to facilitate
societal (i.e., political and social) responses by the business firm.22 There
Table 12.1
Environment, Strategy, and Societal Context of the Business Firm
Issue

Selected Authors

Environment as
determinant of
strategy

Ansoff, 1965; Thompson and Strickland, 1993; Aguilar,


1967; Hofer and Schendel, 1978; Hofer and Schendel,
1979; Steiner, 1969; Steiner, 1979; Lawrence and Lorsch,
1969; Grand and King, 1982; Burns and Stalker 1961

Societal context
of the modern
business firm

Scott, 1992; Starling, 1988; Wood, 1990; Ryan, Swanson


and Buchholz, 1987; Buchholz, 1995; Steiner and
Steiner, 1994; Baron, 1995; Carroll, 1996; Marcus, 1996

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Strategic Management in the 21st Century

Table 12.2
Perspectives on the Environment-Organization Relationship
Theory

Basic Perspectives-Propositions-Modifications

Selected Authors Who Have


Written and/or Researched on
This Topic

Open
systems

Rate of change of organizational systems must correspond to the environmental


change

Ashby, 1956; Emery and Trist,


1960 and 1965; Trist, 1981

Resource
dependence

Strategic choices to adapt


organizations to environmental pressures and uncertainties; thus, to reduce resource
dependence

Pfeffer and Salancik, 1978;


Ulrich and Barney, 1984

Institutional

Organizations obtain legitimacy from their institutional


(political) environment

Jepperson, 1991; Meyer and


Rowan, 1977; Scott, 1987;
Dimaggio and Powell, 1991

Transaction
cost

Organizations seek to
economize transaction
costs in exchanges with the
environment

Williamson, 1981

Stakeholder

Stakeholders seeking influence and/or power


constitute the (political)
environment.

Freeman, 1984; Wood, 1991

Contingency

Optimal performance is the


result of appropriate alignment between the environmental (political) turbulence
and managerial behavior and
capability

Ansoff, 1979; Ansoff and


McDonnell, 1990; Child, 1972;
Lawrence and Lorsch, 1967;
Mintzeberg, 1973; Ginsberg
and Venkatraman, 1985; Fiegenbaum, et. al., 1996

Organizational
ecology

Environmental (political)
pressure allows only fit organizational forms to survive

Aldrich and Pfeffer 1976; Hannan and Freeman, 1989

are different environmental conditions existing for each business firm,


requiring distinct competencies to facilitate a competitive optimization
of regulations and public policy.23 Hence, the development of a measurement of external intensity of the social and political environment offers
management a mechanism to assess information to facilitate appropriate responses. The suggestion to adjust organizational systems changes
to match the rate of environmental change may have led scholars to coin

The New Reality for Business Institutions: Societal Strategy

259

Table 12.3
Environmental-Turbulence Descriptions

Level of
turbulence

Stable
Repetitive

Static
Slow
Change

Dynamic
Changes Fast
but Predictable

Discontinuous
but Changes
Are Foreseen

Unpredictable
Unanticipated

Note: Modified from Igor H. Ansoff and E. McDonnell, Implanting Strategic Management (New York: Prentice Hall,
1990).

the term environmental turbulence24 as a measurement of the environmental change.


ENVIRONMENTAL TURBULENCE
The research typology has depicted environments primarily as stable, uncertain, complex, static, dynamic, discontinuous, and turbulent25
and the variability is known as environmental turbulence. Furthermore,
strategy is often determined as a result of environmental turbulence.26
We have summarized the levels of environmental turbulence based on
the literature descriptions and typology of environmental conditions in
Table 12.3.
Environmental turbulence was defined as the rate of change of the
environment27 and degree of complexity.28 However, there is a lack of
distinction in the literature of whether environmental-turbulence measurements are for business strategies and/or corporate strategies. Some
environmental-turbulence measurement tools are future oriented,29
whereas others are past oriented,30 and a third group maintains no clear
distinction.31 Typically, strategic management is associated with future
developments and issues that may impact the firm,32 whereas competitive management33 is primarily involved with present- and near-future
(depending on the industry) strategy. Therefore, a distinction is required
when using instruments that measure environmental turbulence. Finally, several theoretical and empirical postulations have suggested that
performance is optimized when organizations undertake a careful diagnosis of the environment to assess the levels of turbulence and then decide to respond with the appropriate mode of strategic behavior.34
STAKEHOLDER POWER
The nonmarket environment has an impact on managerial decisions;
thus, unraveling the complexities and power exerted by diverse stakeholders has led management into an uncharted managerial landscape

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Strategic Management in the 21st Century

that requires a holistic conceptualization (at a meta-level) before generating an appropriate strategic approach. It is argued that the strategic behavior and strategic choices displayed by top management are an
outcome of stakeholder power and environmental pressure; therefore,
political strategy rests on managements capability to demonstrate effectively an understanding of stakeholder power. Society through stakeholders grants legitimacy to the business firm. Legitimacy and survival
of an organization depend on the relationship of management with social
and political stakeholders;35 thus, legitimacy grants social and political
leverage for a firm when interacting with social and political institutions
(i.e., government, NGOs, community-consumer groups, etc.). Therefore,
effective and systematic stakeholder management enters the routine
managerial domain. Moreover, legitimacy becomes a source of power.36
The power of various interest groups, through a sociopolitical bargaining process, will determine the firms success in achieving the preferred
sociopolitical strategy.37 The success of strategic programs depends on
the managerial response to stakeholder demands and the relative power
of stakeholders for changes in current actions taken by the firm.38 The
relationships between the business institutions, governments, and society generate a corresponding system of stakeholders to whom managers
are directly responsible. It is postulated that managerial effectiveness
is largely based on the ability to recognize stakeholders, and formulate
and implement thoughtful, cohesive strategies.39 Stakeholders are entities who are likely to be influenced by societal pressures as they relate to
corporations, corporate decrees, or have a distinct contractual relationship with the corporation; therefore, they have a stake in the corporation.40 Managers may be motivated by corporate self-interest, legal or
public pressure, or a legitimate desire to benefit the lives of stakeholders.41 Others have suggested that only those who are directly affected by
the actions of the firm can be considered as stakeholders of the corporation.42 If a stakeholder has either power or legitimacy, stakeholder
management is crucial to the firm.43 Stakeholder management is a strategic tool44 and since government is the primary stakeholder in the regulatory and legislative process,45 success in the market place will largely
depend on success in the social and political arena first.46
STRATEGIC BEHAVIOR AND STRATEGIC CHOICES
Strategic behavior leads to different levels of performance.47 However, what type of strategic behavior produces optimal performance?
The typology developed by Miles and Snow48 provided a foundation for
other scholars of organizational behavior interested in the relationships
between strategy, structure, and process. Validity and reliability have

The New Reality for Business Institutions: Societal Strategy

261

Table 12.4
Managerial Approach to Change
Level of
turbulence
Managerial
capability for
societal response

Evades
changes

Conforms
to changes

Pursues
familiar
changes

Pursues
new
alternatives

Searches
for novel
changes

also been affirmed as usable to explore organizations and their strategies.49 This typology is also consistent with theoretical and empirical
studies over the last two decades.50
Porters51 typology focuses on concentrated industries52 and represents an excellent tool for an existing industry (therefore addressing the
primary premise of low cost, differentiation), but offers neither guidance
for industries in highly entrepreneurial, creative, and innovative settings,
which are still in a pre-infancy stage, nor strategic direction for political
strategy. Table 12.4 summarizes the types of strategic sociopolitical responses employed by an array of researchers and practicing managers.
The suggestion is that organizations employ a different organizational response (endogenously driven behavior) depending on the environmental
(exogenously driven process) conditions (contingency), which facilitates
the goal of this exploratory research to associate environmental turbulence and strategic behavior orientation to performance.
Several authors also have suggested that the aggressiveness of strategic managerial behavior for societal response must match the intensity
of the changes in the societal environment.53
Strategic choices are an outcome of stakeholder power and environmental pressures.54 Strategic choices are manifested into goals; however,
scholars have long argued the intricacies and interplay of the firms
goals.55 Although there is a cost associated with failure to manage the
political agenda of the firm, the most important is the loss of choicemaking discretion.56 Managers who are involved in developing strategic
choices of social goal strategies must realize the opportunities and constraints presented by the political process and legal structures.57 Moreover, strategic choices are an outcome of a strategic posture, which is
developed through assessment of the environment and stakeholder aggressiveness.58 Once the firm has engaged in environmental analysis,
management must make strategic choices about how to best adapt or
respond to the results of the environmental scanning. The result of environmental scanning and strategic diagnosis59 provides the business institution with an array of strategic choices.60

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Strategic Management in the 21st Century

MANAGERIAL CAPABILITY FOR


SOCIAL AND POLITICAL RESPONSE
Although researchers have affirmed the need for corporate sociopolitical strategy, there is minimal research on the development of the managerial capability for such work. Managers need to understand diverse
ideologies, acquire skills in coalition building, bargaining in the sociopolitical domain, stakeholder power, etc.61 Moreover, firms must develop
managerial skills for political response62 and define their social and political marketplace with the same intensity as they define their competitive market place. Managers are responsible for the formulation and
implementation of strategies regarding corporate sociopolitical activities that produce public-policy outcomes that are favorable to the firms
economic success.63
Management should possess capabilities for rethinking traditional
beliefs and understanding the political process and skills in political behavior. Moreover, management should develop a political infrastructure
capable of recognizing the political market domain of the firm, which
will facilitate the necessary sociopolitical networking and relations critical to the profit-making activities.64 The formulation and implementation of social goals65 will allow management to increase its capabilities
and claim success in the sociopolitical arena before stakeholders66 exert
social pressure and/or laws and regulations are implemented to address
relevant issues.
SOCIETAL PERFORMANCE
Management is interested to see how the corporate political activity will be justified in the operational context of strategic management.
Therefore, they must establish a correlation between societal activities
and performance. There is some evidence that companies that perform
in a socially responsible way are as profitable.67 Although top managers
have a perceived value of corporate political strategy, there is very little
evidence to support the view that corporate political performance improves economic performance. There are some studies that suggested a
correlation between corporate political activity and performance.68
WHY SOCIETAL STRATEGY?
It is evident that the business institutions will face a competitive
arena in which a considerable number of nonmarket activities69 (politics, social responsibility) will seriously affect economic performance.
Nevertheless, it is possible to incorporate both sides by accepting that
stockholder profit maximization is obtained through a broader strategy,

The New Reality for Business Institutions: Societal Strategy

263

which goes beyond competitive strategy to include societal strategy.


Although there are strong indicators suggesting that business and societal benefits do not mix well, the business institution has no choice but
to expand its scope to include a greater strategic angle that will accommodate both economic and noneconomic objectives.
The strategic landscape for the modern business firm has changed.
The arsenal of weapons needed to combat the competitive realities is beyond the scope of functional management. Increasingly, corporate social
responsibility (CSR) contributes to shaping the contents of management
education.70 The competitive environment has been extended into rather
uncharted territories for most firms. For example, Microsoft, a highly
entrepreneurial and successful company, encountered a battle that falls
out of the technological and competitive boundaries, that is, the societal
challenge (legal justification of market aggressiveness). Market dominance had created a different theater of war for Microsoft. Regardless of
the opinions surrounding the legal position of Microsoft, it was evident
that the political posture of Microsoft failed to foresee the societal implications of market dominance. Nonetheless, corporate managers are not
trained to assume such roles. Firms will ultimately rely on hired guns
to fight the societal battles of the firm. However, managers are responsible for both market and nonmarket strategies and nonmarket analysis
should be integrated with the analysis of market forces.71 In speculating about the anticipated explosion of the biotech industry, we can only
hypothesize the societal ramifications72 and issues arising from biotech
products (i.e., wealthy individuals cloning themselves for parts, sex selection, etc.). Consequently, the modern business firm must vigorously
consider the societal environment73 and strategize proactively.
This is not an issue only concerning large firms but also the small
firm.74 For example, in most suburban areas of a large city, pizza
restaurants will often support little league sports. The question then
arises whether they can afford not to participate in such social responsibility activities because a competitor may assume such a role. Therefore, whether it is a deliberate strategy for the restaurant owner or
a reaction to the surrounding environment, it is clear that this type
of strategy is not concerned with profitability, product innovation,
or quality of service, but is about creating an image favorable to the
stakeholders of the establishment often at a considerable cost.75 Furthermore, the same restaurant owner might want to keep an eye on
the political scene of her/his community, where issues like zoning,
transportation, etc., may have a critical impact on her/his business.
Therefore, even the small businessperson must deliberately explore the
wider societal ramifications impacting her/his business.
The modern firms objectives will need to be supplemented with
noneconomic objectives and that the firm transformed from a purely

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Figure 12.2
Socioeconomic and Political Environment

economic institution to a socioeconomic institution of society.76 It is evident that the modern business institution is faced with a broader scope
of strategic challenges. Such strategic challenges are not new and for
years firms have employed instruments to counter such issues (public
affairs, government affairs, lobbyists, planned giving, etc.). For the most
part, these activities became part of a business only upon discovering,
for example, a public issue demanding a response by the respective business (reactive). Therefore, the societal strategic posture of the firm has
generally been reactive, as opposed to proactive. The mounting pressure
from such nonmarket activities begs the question for a reconfiguration
of the strategic approach of the modern firm. Societal strategy77 must
become an integral part of the corporate strategy to facilitate the firms
societal role effectively and efficiently. It is also critical to establish the
long-term societal implications of the firms competitive strategy. Competitive strategy employs mechanisms that explore near-future opportunities with near-future performance, although the societal implications
of such strategy lie into the far future. According to Peter Drucker, in
the years to come, the most needed and the most effectiveindeed perhaps the only truly effectiveapproach to social responsibility will be
the determination of social needs before departing into the creation of
financial gains. The interaction between the socio and political environment is illustrated in Figure 12.2.

The New Reality for Business Institutions: Societal Strategy

265

Therefore, societal strategy is the nonbusiness strategic activities


involved with the social responsibility and the legitimacy of the firm.
Social responsibility is granted with the task of maintaining an ethical
behavior and conduct business in a socially responsible manner. The legitimacy strategy attempts to maintain and/or create rules that are favorable to the firm.78
ELEMENTS OF SOCIETAL STRATEGY
If we divide the overall strategy of the business firm into two major
categories, market and nonmarket strategies, societal strategy is the
nonmarket strategy. Distinctly, business firms must not only function in
an environment of outstanding ethical practices (social responsibility)
but also must maintain effective management of the rules of the game
(legitimacy). The social responsibility strategies and legitimacy strategies79 constitute the societal strategy of the firm. Both elements are not
ingredients of the profit-making activities; however, modern firms cannot function without them.
When attempting to define business legitimacy, we encounter a diversity of opinions. Is legitimacy the institutionalization of an organization, the rightful control of power, the relationship of members and
nonmembers, the institutions extent of authority, the institutions acceptance by stakeholders, or simply how the business is being accepted?
Since this is a rather evasive concept, we would accept all of them and
proceed with a more critical question. What does it mean for a business
organization? Hence, the critical element for the business firm would be
the utility of legitimacy and therefore legitimacy strategy. Moreover, the
understanding of legitimacy strategy permits a holistic approach to the
concept of business legitimacy. Legitimacy strategy refers to the nonvoluntary activities presented to the firm by the political environment.
When the political structure accepts corporate activities, then such activities are attributed as legitimate. Therefore, firms must engage in a
process that will generate acceptable behavior by the elected officials.
The representation of business firms with offices of government affairs
in Washington is an indicator of the deliberate strategy80 of the business firm to influence legislators in the creation of favorable rules. Firms
routinely donate funds81 to representatives of both parties. Such activity
aims almost exclusively to generate favorable rules to the business firm.
Success is measured by the legislation of rules that will enhance competitive advantage for the firm.
In contrast, we propose the voluntary constraints on the firm to label
them as social responsibility strategies. For example, when a pizza restaurant supports the little league games and a large firm maintains a
planned giving division, it is evident that business entities, regardless of their size, voluntarily contribute to the community and society.

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Strategic Management in the 21st Century

Although motives may be different, such voluntary activities involve


practices that go over and above the legal requirements of the firm, normally attributed as ethical practices or socially responsible behavior.
Hence, we define social responsibility strategy as the strategy that pursues voluntary activities aiming to contribute to society and enhance the
image of the corporation.
Ethicists will argue that business firms could provide societal contributions without any motivating factors other than the satisfaction
of the recipients. However, when considering the firms responsibilities to shareholders and/or general financial constraints, I would argue
strongly against such an assertion. For example, firms never provide
anonymous donations (how would they explain it to stockholders). Regardless the firms size, ethical considerations and social contributions
not only aim to provide societally, but also to enhance the firms image
in aspiration of generating a better market performance. Moreover, the
term planned giving82 or strategic philanthropy83 is indicative of the
strategic considerations by the firm, including the small business owner.
It is also fair to suggest that we have examples of business contributions
that follow an emotional path rather than a logical path of planned giving activities.
Under those broad definitions, we are incorporating areas such as
corporate political strategy, social responsiveness, ethical strategies,
environmental strategies, lobbying, grassroots, public affairs strategy,
government affairs strategy, stakeholder strategy, coalition-building
strategies, testimony strategies, political entrepreneurship, communication and public advocacy, and judicial strategies.
On a microlevel, some subelements of societal strategy are:
1. Social audit strategies: A diagnosis of the firms social responsibility
and social causes it chooses to support, and the development of the
modalities to support such causes and socially responsible behavior.
2. Code of ethics strategies: Voluntary constraints that the firm chooses
to undertake to respect the internal and external environment of the
firm.
3. Socially responsible investment funds: Investments by the firm in
socially acceptable funds. Usually, socially responsible investment
means not investing in questionable funds associated with industries or companies that may violate standards for the environment,
human rights, product safety, and so forth.
4. Corporate philanthropy: Charitable contributions, donation of
resources, or involvement with local, national, and international
causes.
5. Enlightened self-interest strategies: Efforts by the firm to create a
favorable, ethical image.

The New Reality for Business Institutions: Societal Strategy

267

We often find these strategies under the label of ethical strategies. Ethical
strategies are intended to enhance competitiveness, preserve legitimacy,
deter white-collar crime, and to promote trust.84
LEGITIMACY STRATEGIES
Sociopolitical legitimacy entails authority,85 approval, or conformity
to the legal rules86 as devised by the respective authorities.
Firm legitimacy is a small part of management often better understood by its absence. An organization lacking legitimacy renders itself incapable of pursuing its goals effectively. Basic firm legitimacy
refers to the right to exist and make a profit, while following the rule
of law; however, legitimacy is earned as a result of organizational values and norms that are acceptable to society.87 The global volatility and
interdependence of economies have created a novel legitimacy landscape for the corporations today. Increased global competitiveness
coupled with unemployment, income inequality, labor, environment,
and human rights have brought corporate legitimacy to the forefront of
our society. A new societal sentiment is rising against the corporation.88
Recently, the increased inequality and uncertainty introduced by the
global financial crisis, particularly in the West, also established loss
of faith in the capitalist system to deliver organizational legitimacy
through its:
1. Public relations strategies: Involve communication with the media,
investors, brokerage houses, financial institutions, image building,
employee communications, etc., with sole purpose of maintaining
and improving the company position (e.g., the recent public reassurances by Ford and Firestone about their products).89
2. Government-business relationship strategies: Involve monitoring
the local, state, national, and international regulatory and legislative
bodies, assessing the impact of rules, and taking appropriate action
to create favorable rules (i.e., lobbying).90
3. Regulatory strategies: These are strategies designed to protect rights,
handicap competitors, and/or gain favorable advantage (i.e., preventing a company from bringing their generic product into the
market).91
4. Political and legal strategies: These are the strategies the firm pursues to influence the rules of the game and enhance its financial performance.92
Therefore, nonmarket strategy has become as important as, if not more
than, the market strategy. Recent examples of this nonmarket strategy
would be the steps undertaken by Firestonethe tire manufacturerand

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Strategic Management in the 21st Century

Ford: they maneuvered their ethical and political posture to diffuse financial impact.

WHO PERFORMS THE SOCIETAL STRATEGY?


Managerial Capability for Societal Response
Managers are responsible for the formulation and implementation of
societal strategies that produce public-policy outcomes that are favorable to the firms economic success.
Society did not have any great expectations from corporate management until the 1940s and management functioned without any interference from society. However, the accommodation period ended and
corporate management entered the socialization period, when it began
to be influenced by society. The gap between the organizations performance and societys expectations increased. It was apparent that in the
sociopolitical environment of the firm, the management needed to devise different responses for different levels of turbulence.
Presently, firms need to develop societal-response capabilities for
productive societal response and management should possess capabilities of rethinking traditional beliefs and understanding the political process and skills in political behavior. Moreover, management
should develop a political infrastructure capable of recognizing the societal market domain of the firm, which will facilitate necessary social
networking and relations critical to the profit-making activities. Management is responsible for the social responsibility strategies and for
legitimacy strategies.93
Managerial requirements for ethical capabilities are difficult to assess
since there is no universal agreement on all moral issues. Considering
the responsibility of the management to the firm and its stakeholders,
ethical capability is inevitably guided by self-interest. However, we
must point out that self-interest and moral concerns are not the same.94
Management should employ tools that allow the firm to prioritize issues
based on their urgency95 and thus provide the manager with a classification mechanism to identify issues and their potential impact and to
proceed with formulating and implementing strategies. Considering the
diversity of issues, managers should have the option of considering the
views of experts but retain the ultimate responsibility for the course of
action.
In contrast, management can claim success in the political arena only
before issues become laws and regulations. Managerial capability involves formulating and implementing social goals with a clear understanding of both the legislative process and the power of stakeholders.
Managers must not only understand the legal and/or regulatory structure

The New Reality for Business Institutions: Societal Strategy

269

but also the political process, which will help them provide a contributing social strategy to the overall corporate strategy. Since the nonmarket
issues are critical to the performance of the firm, managers are responsible for developing, formulating, and implementing societal strategies that accommodate the design of favorable policy and/or image to
the firm.
CONCLUSION
The transformation of the business institute into a sociopolitical and
economic institution indicates the emerging need for the development
of a proactive posture to manage the nonmarket environment effectively. Accelerated globalization and technological development present
modern firms with novel issues that require solutions that are very different from current competitive practices. Human rights, environment,
technology, and employment conditions are only a few issuescoupled
with the capability for instant media exposure around the worldthat
dictate that the firms should have in place a well-devised strategy to
counter potential issues, while preferably preventing them from becoming issues.
In summary, we propose that societal strategy involves the voluntary and nonvoluntary activities of the firm with the aim of enhancing
the business (functional-competitive) strategy. By accepting the notion
of a broader strategic angle for the business institution to include societal components, business practitioners and academicians recognize,
at the very least, the impact of societal [nonmarket] affairs on the competitive [market] activities. Such an approach will facilitate the development of a corporate need to study and manage nonmarket strategies
systematically. Business schools and researchers will develop additional
tools to assist business practitioners. Practicing managers will develop a
higher degree of cognizance of the potential impact, or the lack of it, of
nonmarket strategies.
NOTES
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91. Baron, David P. 1993. Business and Its Environment. Englewood Cliffs, NJ:
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New York: Prentice Hall.

Chapter 13

Strategy and EntrepreneurshipA


Discussion of Strategic Entrepreneurs
Franco Gandolfi

INTRODUCTION
The term entrepreneur is, in many ways, one of the most excessively used
and misunderstood modern-day business concepts. Entrepreneur is
often used to refer to individuals who own their businesses. These people may have launched a business endeavor from scratch, purchased an
existing entity, or inherited a business operation. It must be understood,
however, that an entrepreneurially minded person is much more than a
mere owner and/or operator of a business endeavor. So, what exactly is
an entrepreneur?
The term entrepreneur has its origin in the French word entreprendre,
which literally translates into undertaking. Over the years, the term has
taken on a variety of meanings. On the one extreme, an entrepreneur is a person who is exceptionally talented and skilled and who is seen as a pioneer of
revolutionary change, possessing characteristics found only in a small fraction of society. On the other extreme, an entrepreneur is simply a person who
pursues a business-type endeavor. In such a capacity, it is probable that he or
she is working for himself or herself. Unsurprisingly, many definitions of an
entrepreneur have emerged. Some of the definitions are as follows:1

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A person who organizes, manages, and assumes the risks of a business or enterprise;
A person who possesses a new enterprise, venture, or idea and is
accountable for the inherent risks of the outcome;
A person who organizes, operates, and assumes the risk for a business venture;
An owner or manager of a business enterprise who, by taking risks
and initiative, attempts to make profits; and
An individual with a vision who orchestrates the time, talent, money,
and resources of other people to make the vision real.2
The last definition of an entrepreneur is interesting from a number of
viewpoints: First, there is no reference to the assumption of risk in that the
entrepreneur has passed the risk element onto investors. Second, there
is no reference to a new venture; an entrepreneur can orchestrate a vision
of existing businesses into a more efficient and effective organization of
business entities. Third, there is no reference to profitability in that some of
the greatest, manifested visions have been in the world of not-for-profit
endeavors. Fourth, there is no reference to the operation of a business, since
many forms of businesses, including licensing and franchising, have
emerged to enable others to operate businesses. Last, the reference to vision suggests that the actual vision may not be owned by the entrepreneur;
he or she may have borrowed or even stolen somebody elses vision.

THE ENTREPRENEUR AND THE NOTION OF VISION


Consistent with this definition, an entrepreneur is alleged to have the
innate ability to conceive, conceptualize, and cast a vision. History books
are filled with examples of visionary entrepreneurial leaders. Some notable ones are the following:
Thomas Edison: His vision was to provide relief from human drudgery and the elevation of the human spirit through science;
Henry Ford: His vision was to bring mobility to the masses, specifically to bring the cost of a car down to where the worker who built it
could afford to buy it;
Sam Walton: His vision was for people to save money so they could
live better;
Bill Gates: His vision was to see a personal computer on every
desk and in every home; then to empower people through great
software;

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Steve Jobs: His vision was to have an Apple computer on every desk
(not realized yet) and for people to have an Apple device in every
hand (currently being realized);
Richard Branson: He has several visions, from being able to provide
affordable records for everyone to affordable travel to destinations in
outer space (not realized yet); and
Walt Disney: He also had multiple visions; one of them was to create
the happiest place on earth.3
The one characteristic that all these visionary entrepreneurial leaders
had or have in common was or is the aspect of a distinctive vision. These
leaders envisioned things that did not yet exist and created and transformed the visions into reality. Of course, although there is high probability that these distinguished leaders experienced many great obstacles
and challenges, they nonetheless mastered the ability to orchestrate other
peoples resources in order to breathe life into their visions.
SOME HISTORY OF ECONOMIC THEORIES
UNDERLYING ENTREPRENEURSHIP
At its most basic, the notion of economic theory is concerned with two
major societal questions. First, how does a society utilize scarce resources
to create and build wealth? Second, how does that society distribute the
created wealth among its members? Wealth creation and wealth distribution present fundamental and, at times, even controversial questions
pertaining to the development and progress of any society. It has long
been established that entrepreneurship, human creativity, and the innovation of scientific ideas are major mechanisms and catalysts for the creation and distribution of societal wealth. The notion of entrepreneurship
is not new. In fact, some authors have reported that entrepreneurship has
been around for quite some time and, as a direct result, a number of different schools of thought have emerged, including the classical capitalist
economic theory, the neoclassical theory, and the Schumpeterian school of
thought.
Classical Capitalist Economic Theory
Back in 1776, Adam Smith, a Scottish social philosopher and economist, described a capitalist as an owner-manager who organized, synthesized, and combined resources into an industrial enterprise. It was
during this time that the French term entrepreneur was introduced
in order to identify the owner-manager, or entrepreneur, of an industrial
enterprise.4

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Neoclassical Theory
The classical capitalist economic theory espoused the view that selfinterest, also referred to as the invisible hand, would guide participating individuals toward entrepreneurial behavior. However, by the end of
the 19th century, economic theorists argued that the market comprised
many buyers and sellers who interacted in a way that ensures that supply
equals demand. The market was seen at equilibrium (i.e., balanced) and,
thus, perfect. This would be achieved, it was argued, by fluctuations in
prices and supply levels. Therefore, it was posited that wealth would be
created and distributed due to the nature of the perfect market. Within this
school of thought, there is little place for the traditional manager-owner,
the entrepreneur. The neoclassical theory is widely regarded and taught
as the mainstream view of economics. Also, within this framework, a perfect market is defined as having (1) many buyers and sellers, with neither group wielding a decisive influence on the market prices, (2) prices
set by the markets themselves, (3) products and services that are equivalent in substance but differ in price, and (4) buyers and sellers that have
access to complete knowledge of the market and the transactions that
occur.5
Schumpeterian Vision
In the early 20th century, Austrian economist and political scientist Joseph Schumpeter rejected neoclassical economic thinking. He took a decisive pro-entrepreneurship stance and argued that innovation capability
was the key driving force for new goods and services. Schumpeter posited that the market was chaotic rather than perfect due to entrepreneurs
continually providing the markets with creative ideas and innovative
solutions. In fact, the concept of creative destruction rescinds the neoclassical theorists notion of a perfect market. New ideas, products, and
services create a dynamic market mechanism, producing demand that
leads to perpetual wealth creation and wealth distribution.6
Evolving Views of Entrepreneurship
Simply put, an entrepreneur is an individual involved in an entrepreneurial activity. As pointed out, a multitude of definitions on the notions
of entrepreneur and entrepreneurship have emerged. Various professionals view these elements through the lenses of their respective disciplines.
For instance, the economist views the entrepreneur as a factor of production, alongside land, labor, and capital. The sociologist asserts that certain
cultures promote or impede the developing forces of entrepreneurship. In
India, for example, the Gujaratis and Sindhis are known for their sense of

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entrepreneurship. To a psychologist, an entrepreneur is a person driven


by certain intrinsic forces, such as the need to attain something, to experiment, to accomplish, or perhaps to escape the authority of others. To a
businessman, an entrepreneur may be a threat or an aggressive competitor, whereas to another businessman the same entrepreneur may be an
ally, a source of supply, a customer, or someone who creates wealth for
others, as well as someone who finds better ways to utilize resources, reduce waste, and generate jobs that others are glad to assume.7
Various influential contributors have understood entrepreneurs in different lights over time. Some of the more notable views on entrepreneurs
include the following:
Richard Cantillon (1725): An entrepreneur is a person who pays a certain
price for a product to resell it at an uncertain price, thereby making
decisions about obtaining and using the resources although consequently admitting the risk of enterprise.
J. B. Say (1803): An entrepreneur is an economic agent who unites all
means of productionland, labor, and capitalin order to produce
a product. By selling the product in the market he pays rent of land,
wages to laborers, and interest on capital. The difference is his profit.
He shifts economic resources out of an area of lower and into an area
of higher productivity and greater yield.
Joseph Schumpeter (1934): Entrepreneurs are innovators who use a process of challenging the status quo of existing products and services
and setting up new ones.
David McClelland (1961): An entrepreneur is a person with a high need
for achievement. He is energetic and a moderate-high risk taker.
Peter Drucker (1964): An entrepreneur continually seeks change,
responds to it, and exploits opportunities. Innovation is a specific
tool enabling the effective entrepreneur to convert a source into a
resource.
Peter Kilby (1971): Emphasizes the role of the imitatorentrepreneur
who does not innovate per se but imitates technologies innovated
by others.
Albert Shapero (1975): Entrepreneurs take initiative, accept the risk of
failure, and have an internal locus of control.
Gifford Pinchot (1983): Introduced the concept of the intrapreneur as an
entrepreneur within an already established organizational entity.
Although many definitions and understandings of entrepreneurship
exist, all stress four basic aspects of being an entrepreneur regardless of
the field. First, entrepreneurship inherently involves the creation process.
Something new is created, possessing value both to the entrepreneur and

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to the audience for which it is designed and developed. Such an audience may be the market of buyers for business innovation, the hospitals
administration for a new admissions procedure, prospective students for
a new college program, or the constituency for a new service provided
by a not-for-profit organization. Second, entrepreneurship requires the
full devotion of the necessary time and effort. Only those going through
the entrepreneurial process appreciate the significant amount of time
and effort it takes to create something new and to make it operational.
Third, assuming risks is yet another aspect of entrepreneurship. Depending upon the field of effort of the entrepreneur, these risks take a variety
of forms, but usually center around financial, psychological, and social
areas. The fourth and final part of the definition involves the rewards of
being an entrepreneur. The most important of these rewards include independence and personal satisfaction. Money is viewed less as a reward and more an indicator of the degree of success for profit-seeking
entrepreneurs.

TYPES OF ENTREPRENEURS: A CATEGORIZATION


Unsurprisingly, a number of different types of entrepreneurs have been
identified over the years.8 Some of them include:
1. Nascent entrepreneur (i.e., an individual considering pursuing entrepreneurship);
2. Novice entrepreneur (i.e., an individual moving into entrepreneurship for the first time);
3. Serial entrepreneur (i.e., an individual has launched several entrepreneurial endeavors in a sequential fashion);
4. Lifestyle entrepreneur (i.e., an individual who, valuing passion before profit when launching a business, combines personal interests
and talent with the ability to earn a living long term);
5. Habitual entrepreneur (i.e., an individual has launched or is currently launching several entrepreneurial endeavors in a parallel
fashion); and
6. Entrepreneurial manager (i.e., an individual has the characteristics
of an entrepreneur but is in an employment relationship with an
employer; also called an intrapreneur).
Although the distinction of the types of entrepreneurs has at least some
academic value, the more significant issue is the question of what exactly
constitutes a successful entrepreneur. To state it differently, what are some
key characteristics, attributes, attitudes, and behaviors that successful entrepreneurs have shown to possess and display?

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CHARACTERISTICS OF SUCCESSFUL ENTREPRENEURS


Stevensons Six Dimensions
Howard Stevenson studied successful entrepreneurs in both start-up
and established business situations and developed a preliminary description of entrepreneurial behaviors based on six critical dimensions of
business practice.9 At one end of each dimension, there is the individual
entrepreneur who feels confident enough to be able to seize an opportunity irrespective of the resource requirement. At the other end of the dimension, there is the individual manager who attempts to employ and
fully utilize the disposable resources as efficiently as possible. Table 13.1
depicts the six dimensions and their extremes graphically.
Stevensons work highlights six personal traits that successful entrepreneurs possess: tolerance for ambiguity, the ability to create an illusion of
stability, risk management, attention to detail, endurance, and a long-term
perspective. Stevenson remarked that entrepreneurs have the tendency to
identify opportunities, harness and pull together the required resources,
execute and implement an action plan, and harvest the rewards in a timely
and flexible way.
The Mind of an EntrepreneurTimmonss Work
Jeffrey Timmons studied the mind of various successful entrepreneurial individuals and found that entrepreneurs share a common set of

Table 13.1
Six Dimensions of Entrepreneurship
Key Business
Dimension

Entrepreneur

Traditional Manager

Strategic orientation

Opportunity driven

Resource driven

Commitment to
opportunity

Quick and short

Long and slow

Commitment to
resources

Minimal with many


stages

Complete in a single
stage

Concept of control

Use or rent

Own or employ

Management
structure

Networks with
little hierarchy

Formalized hierarchy

Compensation and
rewards

Value-based and
team-based

Individual and
hierarchical

Source: Adapted from H. Stevenson, A Perspective on Entrepreneurship, in The Entrepreneurial Venture, eds.
W. Sahlman et al., 2nd ed., pp. 722 (Cambridge, MA: Harvard Business School Press, 1983).

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attitudes and behaviors.10 Accordingly, Timmons posits that successful


entrepreneurs:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Work very hard;


Are driven by a deep sense of commitment and perseverance;
Have an optimistic outlook;
Strive for integrity;
Have a competitive desire to excel and win;
Are dissatisfied with the status quo;
Seek opportunities and improvements constantly;
Use failure as a tool for learning, development, and growth;
Shun perfection in favor of effectiveness; and
Hold a strong belief that they can personally make a difference.

Moreover, Timmons suggested that successful entrepreneurially


minded individuals possessed solid general management skills and business know-how and were found to be endowed with creative and innovative capabilities.
In a similar vein, the Entrepreneurship Forum of New England suggests the following six qualities of a successful entrepreneur:11
Dreamer: Imagines how something can be better and different.
Innovator: Demonstrates how the idea applied outperforms current
practice.
Passionate: Expresses so the idea creates energy and resonance with others.
Risk taker: Pursues a dream without all the resources lined up at the
start and distributes the risk.
Dogged committer: Stays with executing the innovation and to make it
work.
Continuous learner: Explores constantly and evolves to do best practice.
Characteristics of EntrepreneursBygraves Work
William Bygrave studied the characteristics of entrepreneurs and presented a list of 10 salient characteristics in the form of 10 Ds that were
found in successful entrepreneurial individuals.12 These key characteristics and their description are depicted in Table 13.2.
Having reviewed some of the key characteristics of successful entrepreneurs, what does the actual process of entrepreneurship entail?
THE PROCESS OF ENTREPRENEURSHIP
A number of scholars have conceptualized, analyzed, and formalized
the process of entrepreneurship. The process of entrepreneurship, at its

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Table 13.2
Key Characteristics of Successful Entrepreneurs
Characteristics

Description

Decisiveness

Entrepreneurs make decisions swiftly and decisively.

Dedication

Entrepreneurs are completely dedicated and work


tirelessly.

Destiny

Entrepreneurs wish to be in charge of their own destiny.

Details

Entrepreneurs are obsessed with the critical details.

Determination

Entrepreneurs implement entrepreneurial


ventures with great determination and commitment.

Devotion

Entrepreneurs are deeply devoted and


absolutely love what they do.

Distribute

Entrepreneurs distribute ownership with key employees.

Doer

Entrepreneurs act upon their decisions resolutely.

Dollars

Entrepreneurs view the bottom line as the measure of success


rather than as a motivational driving force.

Dream

Entrepreneurs are visionaries and possess the ability and drive


to materialize their own dreams.

Source: Adapted from W. Bygrave, The Portable MBA in Entrepreneurship, 2nd ed. (Hoboken, NJ: Wiley, 1997).

most basic, is a three-stage process comprising opportunity discovery,


venture creation, and exploitation.13 Accordingly, this three-phase process
comprises the following distinct stages:
The innovation phase: It is in this phase that the entrepreneur conceives, generates, and selects ideas for new products and services.
The implementation phase: This process is generally triggered by a
decision to pursue an idea and encompasses the acquisition of viable
resources, including, among others, capital, labor, and technology.
The growth phase: It is in this phase that the new entrepreneurial
venture first shows signs of progress, growth, and commercial success. As such, the entrepreneur needs to secure new resources, especially managerial capacity, in order to support and sustain the viable
growth of the entrepreneurial initiative.
Of course, each phase is affected by a variety of external factors, such
as personal characteristics of the entrepreneur, the environment, and the
characteristics of the actual innovation.14

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At the heart of an entrepreneurial process is an opportunity. The recognition and assessment of opportunities is critical to the viability and
success of entrepreneurial endeavors. A good business opportunity rests
on an underlying demand for the product or service. Such products and
services should possess value-adding properties that generate profits
(for-profit endeavors) or create self-sufficiency (not-for-profit endeavors).
Next, resources need to be harnessed and utilized judiciously. More specifically, in the early stages of an entrepreneurial activity, the entrepreneur
needs to minimize and tightly control all resources; in later stages he or she
will seek to maximize and own the resources. The understanding and appointment of team members is crucial for success since the team requires
persistence, tolerance, ambiguity, creativity, leadership, communication,
and adaptability. Ultimately, the tool that integrates these three elements
togetheropportunity, resources, and teamis the business plan.15

INFLUENCING THE ENTREPRENEURIAL


ENGAGEMENTA MOTIVATIONAL ASPECT
Why do people take personal, financial, and social risks pertaining to
entrepreneurial activities? It has been reported that individuals decide to
pursue elements of entrepreneurship for a number of reasons. One distinction that has been made in the literature is the aspect of positive or pull
factors versus negative or push factors of entrepreneurship.16 Examples
of so-called pull strategies include the need for achievement, a desire to
be independent, and social-development possibilities. In contrast, push
factors may include dissatisfaction with the present professional and/or
financial situation, family pressures, involuntary exit from employment,
and the risk of unemployment. Within the context of global entrepreneurship, the distinction between opportunity-based and necessity-driven entrepreneurship is of great significance.17
Although there are a variety of discussions contrasting opportunitydriven versus necessity-driven entrepreneurship, there appears to be some
agreement that necessity entrepreneurs are driven mainly by push motivations, although pull factors predominate for opportunity-based entrepreneurs.18 Opportunity entrepreneurship reflects many start-up ventures
seeking to take advantage of arising business opportunities, whereas necessity entrepreneurship exists due to a lack of better professional choices.
Opportunity entrepreneurs frequently pursue business opportunities for
personal interest and while still employed.19 Individuals pursuing entrepreneurial activities out of necessity may see these opportunities as their
best current choice, although not necessarily the preferred occupation.
Still, a necessity-based activity may evolve into an attractive alternative
over time.20

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Empirical research shows that the distinction between opportunitybased and necessity-driven entrepreneurship is an important one in both
theoretical and practical terms. First, it has been reported that opportunity and necessity entrepreneurs differ in terms of level of education, socioeconomic characteristics, and age.21 Second, a start-up situation has
consequences in the way the operation is managed as well as for its ensuing business performance. For instance, individuals who launch their
own businesses due to financial incentives tend to behave differently from
individuals who desire to create an entrepreneurial venture in order to
pursue work-life choices.22 Necessity-driven entrepreneurs tend to be less
satisfied than their opportunity-motivated peers. At the micro level, the
outcomes have revealed aspects of inferior performance on the part of necessity entrepreneurs, whereas at the macro level, opportunity and necessity entrepreneurs have shown to have a different impact on job creation
and economic growth.23 Third, the study of the interplay between business activity and entrepreneurial cycles has shown that opportunity entrepreneurship leads the business cycle by two years, although necessity
entrepreneurship leads the business cycle by only one year.24 Last, it has
been observed that the determinants of nascent opportunity and necessity entrepreneurship differ, yielding important consequences for policy
makers. Measures to stimulate necessity-driven entrepreneurship do not
necessarily benefit opportunity-driven entrepreneurship, and vice versa.25

ENTREPRENEURSHIP VERSUS INTRAPRENEURSHIP


In many ways, the successful entrepreneur embodies the popular vision and manifestation of business success in todays world. The entrepreneurially savvy individual starts a new venture from scratch, secures the
required resources, and builds it into a sustainable business venture. Of
course, this takes a tremendous amount of vision, innovation, and dedication. It has been well documented in both the literature and popular press
that the process of entrepreneurship is ridden with peril and tangible risk.
Sadly, many entrepreneurial start-ups end up in commercial demise. Unsurprisingly, not everyone aspires to become an entrepreneur. Moreover,
although there are probably tens of millions of potential entrepreneurs in
the United States alone, most people simply are not in a position to pursue
their entrepreneurial dreams and ideas for a variety of reasons, including
financial constraints, family concerns, and others.26
The values and aspirations of the ambitious entrepreneur are not confined to new start-ups. The goals and rewards of the entrepreneurially
minded person are in fact realizable within the confines of existing organizations. The intrapreneur, also known as the internal entrepreneur or
corporate entrepreneur, has become increasingly recognized for his or her

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capacity to act as a catalyst to build and add value to the organizations


overall performance and success.27
The term intrapreneur first appeared in a research paper by U.S. management consultants and authors Gifford and Elisabeth Pinchot in 1978
and entered into the American Heritage Dictionary in 1992. An intrapreneur
has been defined as:
A person within a large corporation who takes direct responsibility
for turning an idea into a profitable finished product through assertive risk-taking and innovation.28
The advent, definition, and conceptualization of the concept of intrapreneurship were products of commercial developments of the late 20th
century. This era was dominated by large corporations bloated with extraneous employees, heavy on hierarchy and hierarchical layers, burdened by slow communication systems, and stifled by a rigid interface
between the organizations and their many stakeholders. Indeed, it was in
the late 20th century and the early days of the 21st century, where revolutions in technology and communication unfolded, which in turn have affected markets and entire societies. As a direct consequence, organizations
have become fluid, actions instantaneous, and change discontinuous and
unrelenting.
In the midst of all these unveiling changes, firms rely heavily on their
ongoing innovative capabilities for vitality and success. Clearly, it is now
widely understood that information is ubiquitous, ideas are pervasive,
and most resources are readily available. This combination, presenting
both challenges and opportunities for firms and employees, may in fact
constitute the beginning of a new age of entrepreneurship: the rise of the
intrapreneur.
Intrapreneurship mobilizes individuals within organizations to put
their passion, creativity, innovative capacity, and talents into play in order
to maximize their creative potential and achievements. Firms are forced to
foster an environment where an intrapreneurial mindset among employees can develop and thrive. It has been reported that such attempts yield
increased levels of employee motivation, engagement, and retention, as
well as heightened innovation ultimately leading to the development of
a competitive edge. Although there are legitimate concerns for both employers and employees, including the fear of unrelenting change and the
risk of losing valuable resources, yet in this day and age, developing and
empowering intrapreneurially minded people is critical to the ongoing
success, relevance, and triumph of any organization.
So, how can a culture of intrapreneurship within firms be attained?
First and foremost, the intrapreneur does not need an assigned intrapreneurial role by the firm. The intrapreneur needs to empower himself or

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herself to create his or her own enriched role for the betterment and
sake of the organization. Second, intrapreneurship can be found in any organization; for-profit and not-for-profit, small and large, local and global,
mainstream and niche, private and public, as well as in all industries and
government-owned agencies. Third, intrapreneurship is not confined to
the development of new processes, products, and services. Intrapreneurial behavior on the part of an employee permeates all organizational facets
and includes improving efficiencies, developing new markets, and taking
existing products and services to new heights.
Examples of Intrapreneurial Activities
A number of firms have reaped deep admiration, fame, and prominence for cultivating internal intrapreneurial cultures that promote individual and organization innovation. A well-cited example of the power of
intrapreneurial innovation is the well-known Skunk Works group at Lockheed Martin. This group, originally named after a reference in a cartoon,
was first assembled in 1943 in order to build the P-80 fighter jet. The project was secretive and internally protected since it was to become part of
the United States war efforts.29
At 3M, formerly known as the Minnesota Mining and Manufacturing
Company, employees are allowed to spend up to 15 percent of their working time on projects for the advancement of the firm. Based on the initial
success of this practice, 3M has since introduced a $3 million in-house intrapreneurial program to fund projects that may not necessarily attract
funding through ordinary channels. These so-called Genesis grants
offer up to $85,000 to selected innovators to carry forward their projects.30
A number of technology firms have a strong culture of innovation and
in-house development. Prominent examples include Hewlett-Packard
(HP), Microsoft, Intel, Oracle, and Google. The last-named has been recognized frequently for permitting its employees to spend up to 20 percent of
their time pursuing in-house innovation and intrapreneurial activities.31
A classic example of intrapreneurially minded individuals and their
subsequent successes is found in the ascent of John Warnock and Charles
Geschke, formerly employees at Xerox. Frustrated with the rigidity of the
Xerox culture and disenchanted with the lack of support for their innovative ideas, Warnock and Geschke both resigned from Xerox as employees
and launched Adobe Systems, which is now an S&P 500 firm with revenues close to $4 billion.32
STRATEGIC ENTREPRENEURSHIP
The 21st-century business landscape has been characterized by revolutionary, unpredictable change, increased levels of risk, fluid firm and

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industry boundaries, new managerial mindsets, and innovative business


models. In fact, this new atmosphere can be described in terms of four distinct driving forces: change, complexity, chaos, and contradiction.33 The
ability to navigate through this challenging environment has become a
focal point of scholars in the disciplines of economics, strategic management, and entrepreneurship. Strategic entrepreneurship is a relatively
new term that has arisen in the business literature representing the intersection of strategy and entrepreneurship. To date, the exact nature of
strategic entrepreneurship has remained somewhat elusive and abstract.34
Strategic entrepreneurship has been discussed mainly within the
realm of corporate entrepreneurship. Strategic entrepreneurship refers
to a broader array of entrepreneurial phenomena. Although they may or
may not result in new business entities being added to the firm, they all
involve organizationally consequential innovative activities that are adopted in the pursuit of sustainable competitive advantages. It has been reported that strategic entrepreneurship involves opportunity-seeking (i.e.,
entrepreneurship) and advantage-seeking (i.e., strategic management)
behaviors simultaneously.35 These innovations are the foci of strategic entrepreneurship initiatives and represent the means through which opportunity is created and exploited. As such, innovation can occur anywhere
and indeed everywhere within the firm.
An emphasis on an opportunity-driven mindset enables management
to obtain a competitively advantageous position for the firm. Such innovations may constitute fundamental changes from the organizations past
strategies, products, services, markets, structures, capabilities, or business models, or, alternatively, the innovations may represent fundamental
bases that differentiate the firm from its industry competition. Thus, there
are two salient aspects that ought to be considered when a firm showcases
strategic entrepreneurship. They are:
1. To what degree is the firm transforming itself relative to where it was
in the past?
2. To what degree is the firm transforming itself relative to industry
benchmarks and standards?36
As noted previously, some organizations are known to exhibit very
high levels of innovation consistently; they are known as entrepreneurially minded firms whose operations are deeply rooted in entrepreneurial
corporate cultures. However, innovation is not confined to the culture but
may be embedded in the actual industry in which the firm operates. For instance, technology-based and fashion-related industries have a tendency
to demonstrate continuous entrepreneurial behaviors. Therefore, innovation per se may not prove to be the basis on which firms are differentiated
from their industry rivals. Rather, it may be the products, services, and

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processes that result from innovation that determine how well they are
differentiated from the industry rivals.
Literature shows that strategic entrepreneurship can take on five distinct
forms, namely, strategic renewal, sustained regeneration, domain redefinition, organizational rejuvenation, and business model reconstruction.37
In strategic renewal, the organization redefines its relationships with its
competitors by altering its competitive strategies and practices. As such,
new strategies constitute strategic renewal when they represent a fundamental repositioning of the organization within its competitive landscape.
Strategic renewal has also been labeled strategic innovation or value
innovation.
Second, sustained regeneration refers to an entrepreneurial practice
whereby the organization introduces new products and services or enters new markets on a regular basis. Within this strategic framework, the
firm is in constant pursuit of entrepreneurial opportunities. Sustained regeneration serves as a basis for pursing competitive advantages where
short product-life cycles, rapidly changing technological standards, and
segmenting product categories and market arenas are common practice.
Sustained regeneration cannot be represented by a one-off event but exists when a corporation demonstrates a pattern of recurrent new product
innovations and market entries. Therefore, firms that pursue sustained regeneration practices enjoy a reputation of innovation powerhouses.
Third, domain redefinition refers to an entrepreneurial strategy whereby
the organization creates a new product-market arena that others have
not yet recognized or explored. Within this framework, firms move into
unchartered waters or blue oceans.38 Technically speaking, these pioneering elements are product-market arenas in which new categories are
represented. Domain redefinition can lead to the redefinition of boundaries of existing industries or provide a landscape for the emergence of new
industries. There is an underlying expectation that first-mover status will
provide a basis for sustainable competitive advantage for the firm.
Fourth, organizational rejuvenation refers to an entrepreneurial strategy where the organization purports to improve or sustain its competitive position by modifying existing internal processes, capabilities, or
structures.39 Within this framework, the emphasis of the innovation is
to focus on a set of core attributes linked with the firms internal operations. As such, the main effort is to create a powerful organizational vehicle through with the firms strategy can be implemented. Organizational
rejuvenation has the capacity for the firm to attain a sustainable competitive advantage without changing its business strategy, product offerings,
or served markets. In fact, there are times when organizational rejuvenation entails a fundamental redesign of the entire firm, such as a business
process reengineering (BPR) endeavor, which purports to reconfigure an
organizations value-chain elements. Organizational rejuvenation can also

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involve single innovations that have deep implications for the organizational entity, such as a strategic restructuring effort, or multiple smaller
innovations that collectively contribute to increased levels of effectiveness
or efficiency at strategy implementation. However, in true organizational
rejuvenation, the innovative endeavors cannot simply imitate initiatives
that are commonplace to the industry but must, at least temporarily, differentiate themselves from existing industry practices.
Fifth, business model reconstruction refers to an entrepreneurial strategy
where the organization recalibrates its business model to improve operational efficiencies. Popular activities within the business model reconstruction model include strategic elements, such as outsourcing, which
rely upon external contractors for activities previously provided internally, and vertical integration, which combines supplier or distributor
functions within the ownership or control of the firm.
STRATEGIC ENTREPRENEURSHIP
CONCEPTUAL FRAMEWORKS
Simply put, strategic entrepreneurship can be considered as the intersection of two distinct bodies of literature: strategy and entrepreneurship.
This entity comprises the integration of both concepts and constitutes a
combination of exploration and exploitation aspects. More specifically, strategic entrepreneurship, defined as exploration for future sources
of competitive advantage, combined with exploitation of current sources of
competitive advantage, has been proposed as a way for decision makers
to manage uncertainty.40
A number of conceptual frameworks have appeared in the business
literature. The foundational conceptual framework of strategic entrepreneurship, which was published in 2001, comprised six key domains.41 It
has been posited that activity in these six areas can be jointly classified as
entrepreneurial and strategic. These domains are as follows:
1.
2.
3.
4.

Innovation (i.e., creating and implementing ideas);


Networks (i.e., providing access to resources);
Internationalization (i.e., adapting swiftly and expanding);
Organizational learning (i.e., transferring knowledge and developing resources);
5. Growth (i.e., stimulating success and change); and
6. Top management teams and governance (i.e., selection and implementation of strategies).
Management scholars originally commented that there was an overly
strong emphasis on strategy, overlooking the themes central to entrepreneurship. As a consequence, a revised framework emerged a few years

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Strategic Management in the 21st Century

later, which included external networks and alliances, resources and organizational learning, and innovation and internationalization.42 Although
the models have similarities, the latter framework with its emphasis on
resources, competencies, and capabilities has a strengthened view on both
strategy and entrepreneurship. In 2003, the original authors of the 2001
framework introduced a modified framework having revised the dimensions pertinent to entrepreneurship. They included the aspects of entrepreneurial mindset, entrepreneurial leadership, entrepreneurial culture,
the strategic management of resources, and the application of creativity to
develop innovations. The full integration of these dimensions is believed
to result in wealth creation.43 It has been reported that the modified model
reflects a substantial change in the direction of the literature. Thus, there
are four key dimensions that are commonly associated with the notion of
strategic entrepreneurship:
1. An entrepreneurial mindset consisting of insight, alertness, and flexibility to use appropriate resources;
2. Entrepreneurial culture and leadership where innovation and creativity are fostered;
3. The strategic management of resources which includes human, social, and financial capital; and
4. The application of creativity to foster both incremental and radical
innovation.
Later in the first decade of this new millennium, it was underscored that
strategic entrepreneurship should strike a balance between opportunityseeking (i.e., exploration) and advantage-seeking (i.e., exploitation) behaviors, thereby highlighting the importance of and need for continuous
innovation.44 Additional models and frameworks have since been established and published. However, the strategic entrepreneurship emphasis has to some extent remained theoretical with little guidance and
practical support.
INTEGRATING ENTREPRENEURSHIP WITH STRATEGY
Reviewing the bodies of literature of entrepreneurship and strategic
management suggests strongly that both disciplines are concerned with
firm performance. Although entrepreneurship promotes the pursuit of
sustainable competitive advantages by means of market, process, and
product innovations, it is strategic management that presents the tools for
firms to establish and exploit sustainable competitive advantages within a
confined environmental context.
In order to integrate entrepreneurship with strategy, it is important to
discuss the concepts of dominant logic and dynamic dominant logic. The

Strategy and EntrepreneurshipA Discussion of Strategic Entrepreneurs

293

former, dominant logic, refers to the way in which executives understand


and conceptualize a business operation and make critical decisions regarding the allocation of resources. Dominant logic has been defined as
the lens through which managers see emerging opportunities and options
for the firm.45 Put differently, dominant logic relates to the main means
and methods that a firm utilizes in order to pursue profitsthat is, how
a firm has succeeded or continues to succeed in its operations. Interestingly, although the dominant logic of a firm attempts to capture prevailing mindsets, it also filters and interprets information obtained from the
environment, which, ultimately, guides the strategies, systems, processes,
and displayed behaviors within an organizational entity. As such, managers have been found to consider only information that is perceived to be
relevant to the entitys dominant logic.
The latter concept, a dynamic dominant logic, is an extension of the original concept of dominant logic whereby entrepreneurship acts as the basis
on which the firm is to be conceptualized and resources are to be allocated.46 As a dynamic dominant logic, entrepreneurship has the capacity
to promote strategic agility, flexibility, creativity, and continuous improvement throughout the organization.47
It has been posited that entrepreneurship is more than a preselected
course of action; it is certainly more than a managerial mindset. Entrepreneurship has the ability to provide a theme or direction for a firms entire
business operation. Strategically speaking, entrepreneurship must be an
integral part of an organizations business strategy. Although strategy determines the direction of a firm, it is the integration of entrepreneurship
into strategy at the organization level that has the capacity to greatly enhance the strategic possibilities of the firm.48
Finally, the purposeful integration of entrepreneurship into strategy
has two key aspects: entrepreneurial strategy and a strategy for entrepreneurship. Entrepreneurial strategy encompasses discussions and issues
regarding the application of creativity and entrepreneurial thinking to the
development of a core strategy for an organization. Strategy for entrepreneurship, in contrast, is concerned with the need to develop a strategy
to guide entrepreneurial activities taking place within the organization.49
This, however, is based upon the understanding that firms that embrace
entrepreneurship outperform firms that fail to focus on entrepreneurship
in the long run.50

ENTREPRENEURSHIP EXTENDS ITS INFLUENCE


THE RISE OF THE SOCIAL ENTREPRENEUR
The notion of social entrepreneurship is an emerging academic discipline challenged by competing and conflicting definitions, conceptual

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Strategic Management in the 21st Century

frameworks, and limited empirical evidence. It is clear that the process


of entrepreneurship can be applied to the creation of economic as well as
social goals. Indeed, the late Peter Drucker suggested that the entrepreneur always looks for change, responds to change elements, and exploits
change as opportunities.51 This is regardless of whether the opportunity
has commercial or social motivations. Traditionally, the focus of institutional entrepreneurship has been on for-profit entities, whereas the term
social entrepreneurship has been used to describe activities with social
purposes. However, in recent years, social entrepreneurs increasingly
have been seen as individuals pursuing entrepreneurial (i.e., for-profit)
activities with embedded social purposes.
Over the past decade, the discussion on social entrepreneurship, especially in the popular media and in the business press, has focused on
the successes of high-profile business entrepreneurs. In 2006, for instance,
Bill Drayton, founder of Ashoka, a not-for-profit organization dedicated
to promoting and supporting social entrepreneurs, publicly proclaimed
that social entrepreneurship has the capacity to spark a worldwide productivity miracle. Draytons ideas have since enticed influential business
individuals including eBay founder Jeff Skoll, who launched the Skoll
Foundation with its focus on promoting social entrepreneurship.
So what exactly motivates social entrepreneurs? The Skoll Foundation
describes these social entrepreneurs as individuals who are motivated by
altruism and a profound desire to promote the development and growth
of equitable civil societies who pioneer innovative, effective, and sustainable approaches to meet the needs of the marginalized, the disadvantaged,
and the disenfranchised. As such, social entrepreneurs are the wellspring
of a better future.52
The response from the academic community on the emergence of this
new phenomenon has been less enthusiastic. Although scholars have
examined and conceptualized social entrepreneurship, the field has remained immature and lacks depth, richness, and prescription.53
How can a social entrepreneur be defined? A social entrepreneur is
an individual, group, network, organization, or alliance of organizations
that seeks sustainable, large-scale change through pattern-breaking ideas
in what or how governments, nonprofits, and businesses do to address
significant social problems.54 More pragmatically, a social entrepreneur is
an individual who recognizes a social problem and uses entrepreneurial
principles to create a business venture in order to generate social change.
Although a traditional business entrepreneur typically measures the success of his or her efforts in terms of profitability and return on investment
(ROI), the social entrepreneur is interested in furthering social and environmental goals.
A debate over the exact definition of social entrepreneurship persists,
reinforcing the need for a more constrained definition.55 It appears that

Strategy and EntrepreneurshipA Discussion of Strategic Entrepreneurs

295

the current literature lacks empirical evidence of the successes, scalability,


and sustainability of social improvements. It has even been reported that
the proliferation of new social entrepreneurial activities may actually create competition and inefficiencies in an already highly fragmented social
sector.56
Social entrepreneurship has been studied and analyzed from three distinct approaches. The first approach views not-for-profit organizational
entities as social entrepreneurships. The second approach, in contrast, focuses on how social entrepreneurship can be successful through profit
mechanisms, and a third approach emphasizes and focuses on the socialchange aspects of social entrepreneurship.57 Unambiguously, the latter
view is comparable with a Schumpeterian perspective in that entrepreneurs are essentially agents of change.
Social EntrepreneursPast and Present
Interestingly, although the formal study of social entrepreneurship is
relatively new, it must be clear that the notion of the social entrepreneur
has existed throughout human history. Indeed, socially minded, entrepreneurially driven individuals whose tireless work typifies the concept of
social entrepreneurship have literally changed the world. Some of them
include the following:
Vinoba BhaveFounder of Indias land-gift movement;
Akhtar Hameed KhanPakistani founder of the grassroots movement
for rural communities (i.e., Comilla model) and the low-cost sanitation program for squatter settlements (i.e., Orangi pilot project);
Maria MontessoriItalian founder and developer of the Montessori
approach to early childhood education;
Florence NightingaleEnglish founder of the first nursing school and
creator of modern-day nursing practices;
Robert OwenWelsh founder of the worldwide cooperative movement; and
Friedrich Wilhelm RaiffeisenGerman principal founder of the credit
union and cooperative bank sectors now forming a major segment of
the European banking system.
The endeavors of some (if not all) of these individuals have brought
about deep societal impact and lasting change on a global scale. Equally
important, the list of contemporary social entrepreneurs shows a rich diversity of individuals who have aspired and continue to tackle societys
most pressing problems using creative and innovative entrepreneurial
solutions.

296

Strategic Management in the 21st Century

The following snapshot is a small, incomplete overview:


Ibrahim AbouleishEgyptian founder of SEKEM, a biodynamic agricultural firm, alternative medicine, and educational center based in
Cairo.
Ela BhattIndian founder of SEWA (self-employed womens association) and SEWA Bank.
Bill DraytonAmerican founder of Shoka, Youth Venture, and Get
America Working!
Marian Wright EdelmanAmerican founder and president of the
Childrens Defense Fund (CDF) and strong advocate for disadvantaged American children.
Jamie OliverEnglish TV chef who campaigns to improve childrens
diet at schools. He also trains young people to become chefs. He
founded a social enterprise, Fifteen, which employs newly trained
youngsters.
Muhammad YunusBangladeshi founder of the Grameen Bank and
inventor of the microcredit, which earned him the 2006 Nobel Peace
Prize.
Willie SmitsIndonesian founder of the Borneo Orangutan Survival
Foundation and founder and chairperson of the Masarang Foundation.
There are various debates over who does and who does not count as
a social entrepreneur. For instance, some have advocated restricting the
term to founders of organizations that rely upon earned income generated
directly from paying customers. This is in contrast to others who have extended this by including incomes earned by contracting with public authorities, and yet others include receiving grants and donations as part of
the social entrepreneurship model. Most fundamentally, discussions continue regarding the delineation between business entrepreneurship, with
its focus on wealth creation and economic development, and social entrepreneurship with its emphasis on generating social capital and making
the world a better place.58
CONCLUDING THOUGHTS
This chapter has established that strategic entrepreneurship is the
utilization and stimulation of entrepreneurial activity in order to attain
strategically defined goals, including but not limited to differentiation, diversification, integration, and the pursuit of sustainable competitive advantages. Entrepreneurial activities present significant potential to achieve
such ambitious goals and are thus deemed effective tools for the strategically minded executive. The research has also established that strategic

Strategy and EntrepreneurshipA Discussion of Strategic Entrepreneurs

297

entrepreneurship is comparable with the notions of corporate entrepreneurship at the strategic and corporate levels and intrapreneurship at the
more tactical, operational, and individual levels. Like entrepreneurship
in a broad sense, strategic entrepreneurship is a business phenomenon
that has antecedents and outcomes at various levels of analysis. This field
of management will benefit from further conceptual and empirical study.
Finally, at the individual level, strategic entrepreneurial activities entail the systematic pursuits and exploitation of opportunities that align
with a persons existing knowledge and available resources, even where
the creation of wealth may not be the final goal. On a more corporate, regional, or national level, strategic entrepreneurship embodies the design
and development of a framework that fosters entrepreneurial endeavors
by individuals, agencies, and firms pursuing organizational, regional,
and national goals. These goals are not confined to financial development
and economic growth; they also include the sustainable use of natural resources, as well as the pursuit of improved levels of individuals wellbeing and overall quality of life.
NOTES
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Index

Abouleish, Ibrahim, 296


Abraj Real Estate firm, 227
Activity-based costing (ABC), 215
Adobe Systems, 288
Against Intellectual Monopoly (Boldrin
and Levine), 103
The Age of Discontinuity (Drucker), 7
Aggregate demand planning function, 202
Agle, B., 69
Air California, 99
Al Rafah Microfinance company,
227
Al Takafol Islamic Insurance Co., 227
American Hospital Association, 91
American Medical Association, 91
Americas Greenest Companies
(Newsweek), 126
Andrews, Kenneth, 8, 18, 55
Ansoff, Igor: Corporate Strategy, 7, 9;
gap analysis, 9
Antisthenes, 6
Apotheker, Leo, 238
Apple, Inc., 131, 23839
Arnold, Chris, 9596
The Art of War (Sun Tzu), 4
Ashoka not-for-profit organization,
294

Australia: corporate lobbying in, 162;


free trade negotiations, 155
Authoritarian capitalism, 15960
Balanced internally stage, in SCM,
213
Balanced scorecard, 21
Barber, B., 176, 186
Barnard, Chester, 6
Barney, J. B., 19
Barney, Jay, 19, 55
Barofsky, Neil, 9596
Baumol, William J., 152
Bear Stearns, 93
Benchmarking, 30
Best practices: of business management, 74; documentation of, 247;
of employee management, 4446,
140; of entrepreneurship, 288
Betsworth, Deborah G., 186
Bhatt, Ela, 296
Bhave, Vinoba, 295
Bhopal India chemical spill, 131
Bipartisan Campaign Reform Act
(2002), 119
Birzeit Pharmaceutical Company (BPC; in Palestine): background, 22627; corporate social

302
responsibility projects, 22728;
employee-engagement strategy,
22830; factors in success of, 227;
profile of employees, 228. See also
Employee engagement, as strategic
management tool; Palestine community organizing case study
Boeing Corporation, 154
Boldrin, Michelle, 103
Borneo Orangutan Survival Foundation, 296
Boston Consulting Group, 31
Boyer, Robert, 151
BPC. See Birzeit Pharmaceutical
Company
Brandenburger, A. M., 3637
Branson, Richard, 278
British Royal Navy, 58
Brown, Stephen, 177
Busenitz, L. W., 186
Bush, George W., 94, 156, 158
Bush, Wes, 5859, 68
Business Ethics magazine, 126
Business firms: basic model (illustration), 202; as closed systems
(Weber), 257; customer service
function in, 204; distinguishing
SCM activities, 21418; environment, strategy, societal context of,
257; forecasting function in, 215;
input/output model of, 2012;
interfirm outsourcing collaborations, 21011; logistic function in,
206; marketing function in, 203;
production function in, 205; purchasing function in, 2056;
research and development function in, 2045; resource-based view
of, 19, 3746, 7172; sales function
in, 2034; social forces influences
on strategies of, 12545
Business-government dynamics, in
the global economy, 14966; collision of forms of capitalism, 16063;
cooperative capitalism, 15759;
foreign market development strategies, 16366; institutional theory
and, 150; managerial capitalism,

Index
15657; proprietary capitalism,
15356; varieties of capitalism
research, 149
Business-government symbiosis (in
the U.S.), 108
Business process reengineering
(BPR), 30, 32
Business strategy failures. See Failures of business strategy, reasons
for
Bygrave, William, 283
Camillus, J. C., 20
Canada: corporate lobbying in, 162
Cantillon, Richard, 280
Capitalism: classical economic theory,
278; collisions of different forms
of, 16063; forms of, 149, 15260;
myth of free market capitalism, 86;
neoclassical economic theory, 279;
reasons for understanding types
of, 152
Caux Round Table, 137
Center for Education and Research in
Information Assurance and Security (Purdue), 69
Center for Responsive Politics, 88
CGMP. See Current good manufacturing practices
Champy, James, 11
Chandler, Alfred, 7, 8, 153, 156
Chaos theory, 13
Chicago school of economics, 154
Childrens Defense Fund (CDF),
296
China: beer industries in, 16364;
free trade negotiations, 155; global
businesses in, 163; ideas about
business and government, 151; J-20
steal fighter development, 6162;
undervalued currency concerns,
152; U.S. negative goods trading
imbalances with, 161; working
conditions issues, 15152
Christakis, Nicholas, 180
Christensen, Clayton, 3334
Citizens United v. Federal Election Commission (2010), 119

Index
Civil Aeronautics Board (CAB),
8990, 98
Clausewitz, Carl von, 5
Clorox Greenworks, 131
Coca Cola, 127
Cole, Harold, 9293
Collaboration: advantages of promoting, 46; in stakeholder dispute resolution, 7071
Collective-capitalism, 158
Collectivist theory, 157
Collins, Jim, 177
Command-and-control management,
231
Commitment to Everyday Life
(Proctor & Gamble), 133
Communication: actions for students,
professors, 25051; entrepreneurial
challenges, 247; free market macroeconomics and, 85; intrapreneurship challenges, 288; in lobbying,
108, 11920; mid-level management challenges, 24950; mutual
adjustment factors, 209; as Pfeffers
fourth dimension, 4546; planning
session role, 20; public relations
strategies, 267; reasons for failures of, 23443; role in ethical culture establishment, 136; scenario
planning role, 17; socially responsible strategies, 266; strengthening strategies, 24546; subjectivity,
impreciseness of, 78; technological developments, 5, 97; top-down
communications, 135, 235, 23940,
241
Community-consumer groups, 260
Community organizing tradition, in
Palestine, 22324
Competing for the Future (Hamel and
Prahalad), 11
Competition strategies, 34
Competitive advantage: RBV view
of, 4042
Competitive exclusion principle, 34
Competitive (industry) forces analysis (in SWOT analysis), 6568;
bargaining power of buyers, 66;

303
bargaining power of suppliers, 67;
intensity of competitive rivalry, 67;
threats of new entrants, 67; threats
of substitutes, 68
Competitive Strategy (Drucker), 7
Competitive Strategy: Techniques for
Analyzing Industries and Competitors: With a New Introduction
(Porter), 20, 31
Complementary concept, 3637
Computer Science and Artificial
Intelligence Lab (MIT), 69
Congress (U.S.): aerospace industry concerns, 63; buying a table
support of, 114; copyright, patent
concerns, 101; International Air
Transportation Act of, 90; Interstate
Commerce Commission formation, 89; job protection concerns,
63; lobbyist interactions with, 110;
national defense concerns, 61, 63,
66, 68; Wright Amendment Reform
Act of, 91
Constitution (U.S.): copyright and
patent issues, 100103; First
Amendment rights, 119, 122; interstate commerce regulation rights,
99; legislative violations of,
12021
Coolidge, Calvin, 107
Cooperative capitalism, 15759
Coordinated market economies
(CMEs), 16061
Copyright and patent issues, 100103
Copyright Term Extension Act (1998),
101
Corporate culture: developmental
practices, rituals, 236; employee
engagement relation to, 221, 223;
entrepreneurial contributions, 289;
imitation, duplication difficulties, 4748; methods of improving,
139; organizational serendipity
enhancement role, 18283; positive influences on, 135; powers of,
23637; role of, 4749; valuation of
stakeholders in, 138
Corporate lobbying, 162

304
Corporate rights (Supreme Court
decision), 119
Corporate social responsibility (CSR),
32, 22728, 263. See also Birzeit
Pharmaceutical Company
Corporate Strategy: An Analytical
Approach to Business Policy for
Growth and Expansion (Arcoff ), 7, 9
Cost reduction strategies, 21617
Council of Supply Chain Management Professionals (CSCMP),
21718
Crafting Strategy (Mintzberg), 1011
Creative destruction concept (Schumpeter), 279
Cultural-cognitive forces, 150
Cunha, Miguel, 183, 185
Current good manufacturing practices (CGMP), 227
Customer service function, in firms,
204
Cyber forces/threats (SWOT analysis), 6263
Cybersecurity issues, 62
Cyberspace Solutions Center (of
NGC), 73
CyLab (Carnegie Mellon), 69
Daimler-Benz Corporation, 217
Danone Corporation: actions taken
on social issues, 12930; environmental impact studies, 130;
Ribouds leadership of, 125; social
issues identified by, 127
De Geus, A. P., 17
Delayering, 30, 32
De Rond, M., 17980
Designing Matrix Organizations That
Actually Work (Galbraith), 242
Detachment fallacy (of strategic planning), 15, 33
Dew, Nicholas, 177, 179
Difficult-to-imitate systems, processes, 31
DiMaggio, Paul J., 150
Direct face-to-face lobbying, 11517
Disney, Walt, 278
Disruptive technologies, 3334

Index
Doctorow, Cory, 101, 103
Downes, 37
Downsizing of employees, 30
Drayton, Bill, 294, 296
Drechsler, Paul, 230
Drucker, Peter: The Age of Discontinuity, 7; background information,
280; on entrepreneurs, 281, 294; on
the knowledge society, 12; The
Practice of Management, 8; on social
responsibility, 264; on the societal
nature of modern business, 25455
Eastern Airlines, 90
eBay, 16465
Ecolab, Inc., 13031, 133, 139, 141
Edelman, Marian Wright, 296
Edison, Thomas, 277
Efficiency improvement strategies, 32
Emergent process school (of analysis), 56
Employee downsizing, 30
Employee engagement, as strategic
management tool, 22031; community organizing background,
22324; economic factors, 22425;
emergence of, 221; engaged
worker (definition), 222; political factors, 22526; social factors,
226. See also Birzeit Pharmaceutical
Company; Palestine community
organizing case study
Employee-engagement strategy (of
BPC), 22830
Employment issues: employee downsizing, 30, 127
Engaged worker (definition), 222
Entrepreneurial managers, 281
Entrepreneurial organizations, 235,
241, 24243
Entrepreneurs: actions in start-ups,
24748; Bygraves work on characteristics of, 283; chaotic environments of, 241; characteristics of
success, 284; examples of, 27778;
motivation aspects of engagement
of, 28586; Schumpeterian vision
of, 279; serendipity and, 177; social

Index
entrepreneurs, 29396; soft stuff
implementation benefits, 251;
Stevensons six dimensions of, 282;
10 Ds of, 283; Timmons work
on minds of, 28283; types of, 281,
285; word derivation, 276, 278. See
also Intrapreneurs
Entrepreneurship, 86, 27697; dominant logic and, 29293; Druckers
comments on, 254; dynamic dominant logic and, 29293; evolving
views of, 27981; and free market macroeconomics, 85; in India,
27980; influence on social entrepreneurs, 29396; integration with
strategy, 29293; opportunitybased vs. necessity-based, 28586;
political entrepreneurship, 266,
270; processes of, 28385; pull vs.
push factors, 285; serendipity and,
175; strategic entrepreneurship,
28892; underlying economic theories of, 27881; vs. intrapreneurship, 28688
Entrepreneurship Forum of New
England, 283
Environmental management standard (ISO 1400), 137
Environments (business-related):
Danon impact studies, 130; environmental sustainability, 13437;
environmental turbulence, 259;
environment-organization relationship, 258; governmental role,
153; lobbying environments, 116;
navigation of political environment, 10723; Palestinian case
study, 22426; regulatory environments, 100; related social forces,
13133, 157; World Commission on
Environment and Development,
129. See also External environmental analysis (in SWOT analysis);
Internal environmental analysis
(SWOT analysis); Societal strategy
Ethical culture influence on social/
environmental sustainability,
13637

305
European Union (EU), 130; corporate
lobbying in, 162
Extended integration stage, in SCM,
213
External environmental analysis (in
SWOT analysis): competitive
(industry) forces, 6568; scenarios,
6869; societal forces, 5964; stakeholder forces, 6971
Failures of business strategy, reasons
for, 23435; actions for entrepreneurial start-ups, 24748; benefits
of soft stuff implementation,
25152; communication, relationship failures, 23443; entrepreneurs, actions for, 247; executives,
reversal strategies, 24447; midlevel managers, reversal strategies,
24850; professors, reversal strategies, 25051; students, reversal
strategies, 250
Fallacies of strategic planning, 15, 33
Fannie Mae, 95
Fargo, Admiral Thomas, 59
Federal Express (FedEx), 100
Federal Reserve Bank, 60
Federal Sentencing Guidelines (U.S.),
136
Federal Trade Commission (FTC), 87
Field of Dreams (movie), 12
The Fifth Discipline (Senge), 7, 11, 12
Firms. See Business firms
First Amendment (U.S. Constitution),
119, 122
Five forces model (of Porter), 1516,
3436
Floppy-eared rabbit research, 176,
179, 181, 186
Fly! Drive! Sleep! (PSA campaign),
99
Ford, Henry, 277
Ford Motor Company, 131
Forecasting function, 202
Formalization fallacy (of strategic
planning), 15, 33
Forrester, Jay, 200
Fortune magazine, 126

306
Fowler, James, 180
Fox, Renee C., 176, 186
Freddie Mac, 9495
Freeman, E. B., 69
Free market macroeconomics:
explained, 85; myth of U.S. free
market capitalism, 8687
Friedman, Milton, 154, 255
Gaglio, C. M., 185, 186
Galbraith, Jay, 242
Gallup Organization Q12 survey,
22122
Gap analysis (of Ansoff), 9
Gates, Bill, 8789, 277
Gates, Robert, 61
Gause, Georgy, 34, 22
Geithner, Timothy, 95
General Motors, 6, 94, 107, 154
General planning, strategic planning
vs., 1819
Genesis grants, for intrapreneurs, 288
Geschke, Charles, 288
Get America Working!, 296
Ghoshal, S., 20
Global economy, 133, 14966
Global food-related health situations,
127
Global War on Terror (GWOT), 61
Godwin, J.B. Gib, 62
Goldman Sachs, 162
Google, 288
Goold, M., 20
Government mandates, increases of,
9798
Grassroots lobbying campaigns, 115,
11720
Great Depression (U.S., 1930s), 9293
Greenpeace, 127
Habitual entrepreneurs, 281
Hall, Peter A., 151, 160
Hamel, Gary, 11
Hamilton, Alexander, 157
Hammer, Michael, 11
Hansen, Jo-Ida C., 177, 186
Harvard Business Review article (1958),
200

Index
Harvard Business School (HBS), 8,
3031
Hax, Arnoldo, 14, 18
Hayek, Friedrich von, 8485
Health-related concerns and issues,
127
H-E-B Grocery Company, 234
Henry, H. W., 19
Heracleous, 15, 16
Hewlett-Packard, 130, 238, 288
Hinthorne, Tom, 6970
How Competitive Forces Shape
Strategy (Porter), 9
Hu Jintao, 61
Human resources: cost vs. value
equation, 4244; implementation
of activities, practices, 4647; RBV
view of, 4042
Human resources management
(HRM): historical background,
44; SHRM best practices, 4446.
See also Strategic human resources
management
Huntington Inglass Industries, 59
Hypertherm, 22223
IBM Corporation, 88
Icarus Paradox (Miller), 33
Improvised explosive devices (IEDs),
58
India, entrepreneurship in, 279
Indirect lobbying, 11520
Industrial organization (IO) economics, 34
Industrial Revolution, 6
IndyMac Bank, 93
Information Rules: A Strategic Guide to
the Network Economy (Shapiro and
Varian), 12
Innovation forces/opportunities
(SWOT analysis), 6364
The Innovators Dilemma (Christensen), 33
Input/output model of the firm,
2012
Inskeep, Steve, 95
Institutional theory, 150
Intel, 288

Index
Intellectual Capital (Stewart), 12
Interfirm collaborations on outsourcing, 21011, 217
Internal environmental analysis
(SWOT analysis): qualification,
quantification of resources and
capabilities, 7475; resources and
capabilities, 7274; underlying
assumptions, 7172
International Organization for Standardization, 137
Internet: impact on business strategy, 12
Interstate Commerce Commission, 89
Intrapreneurs: capabilities of,
28687; defined, 280, 287; examples
of activities of, 288; Genesis grants
given to, 288; self-empowerment
of, 28788
Inventory investment management,
in firms, 206
iPhone, 131
Israeli-Palestine Oslo agreement
(1996), 224
Japan: cooperative capitalism in, 163;
corporate capitalism in, 163; economic growth, success in, 15758;
ice cream market competition, 165;
multilevel distribution system in,
164
Jobs, Steve, 239, 278
Journal of Business Logistics article
(2001), 201
Journal of Political Economy, 9293
J-20 stealth fighter program (China),
6162
Just-in-time, 30
Kahn, Alfred, 90
Kaplan, Robert S., 21
Katz, J. A., 185, 186
Kellner, Aaron, 176, 186
Keynes, John, 154
Keynesian economics, 154
KFC, 127
Khan, Akhtar Hameed, 295
Kilby, Peter, 280

307
Kirby, Julia, 127, 129, 135
Kirzner, I., 185
Klein, Ben, 88
Knowledge, types of, 8485
Knowledge management (KM) channels, 230
Kolko, Gabriel, 86
Korean peninsula, 61; nuclear facility
construction, 62
Kramer, Mark R., 126
Lazonick, William, 153
Leadership in Administration: A Sociological View (Selznick), 8
Learned, E. P., 8
Lehman Brothers, 93
Levine, Bernard, 11112
Levine, David, 103
Lexington Institute, 58
Liberal market economies (LMEs),
16061
Liedtka, J. M., 16
Lifestyle entrepreneurs, 281
Lobbying/lobbyists: by airlines,
9091; benefits of, 102; corporate lobbying, 162; correct lobbying factors, 122; in the courts,
12021; direct vs. indirect, 11517;
by FedEx and UPS, 100; good lobbying components, 122; grassroots
lobbying campaigns, 115, 11720;
as a growth business, 108; by
health-care industry, 9192; locating lobbyists, 10912; Microsoft
expenditures, 8889; personal
efforts at, 11215; points to remember, 12223; role of, 10911
Logistic function, in firms, 206
Lorange, P., 20
Lotus Financial Investment, Co., 227
Low-cost production stage, in SCM,
212
Lucas, Robert E., 9293
Majluf, S., 18
Management commitments, to
social/environmental sustainability, 13435

308
Managerial capitalism, 15657
Marin Institute (think tank), 223
Marketing function, in firms, 203
Market-price equilibrium, 15354
Marshall, Alfred, 15354
Masarang Foundation, 296
Master scheduling function, 202
Material requirements planning function, 202
Mattel Toys, 131
McClelland, David, 280
McDonald, Robert A., 135
McDonalds, 127
3M (Minnesota Mining and Manufacturing) Company, 288
Merchant, Nilofer, 237
Meyer, Christopher, 127, 129, 135
Meyer, Klaus, 177
Micro Compact Car AG (MCC), 217
Microsoft Corporation, 8792, 263,
288
Middle East, 61, 102
Miles, R. A., 26061
Military roots of strategy, 56
Miller, Danny, 33
Mills, Linda, 62
The Mind of the Strategist (Ohmae),
7, 10
Mintzberg, Henry, 15; coordinating
functions proposed by, 209; Crafting Strategy, 1011; on prediction
fallacy, 33; on strategic planning,
17
Mitchell, R. K., 69
Montessori, Maria, 295
Morgenstern, O., 8
Morning Edition (NPR radio), 95
Morton, M.S.S., 20
Nalebuff, B. J., 3637
Nascent entrepreneurs, 281
National Labor Relations Act
(NLRA), 100
National Public Radio (NPR), 95
Natural Products Association, 132
Necessity-driven entrepreneurs, 286
Neoclassical economic theory, 279

Index
Neocorporatism, 15859
The New How (Merchant), 237
New Jersey, 131
New product development function,
in firms, 2045
Newsweek magazine, 126
NGOs (nongovernmental organizations), 137, 260
Nichomachides, 6
Nightingale, Florence, 295
9/11 terrorist attacks, 61, 63
North American Free Trade Organization (NATO), 152
Northrup Grumman Corporation
(NGC): A+ financial rating of,
7476; computer system cyberattack on, 62; cybersecurity research
by, 6263, 73; future planning
strategy, 7678; hypothetical
assessment of capabilities, 75;
portfolio-analysis tool of, 75; strategic planning drivers, 69; use of
SWOT analysis, 5659, 60. See also
U.S. Department of Defense
Norton, David P., 21
Novice entrepreneurs, 281
Obama, Barack: budget deficit
reduction recommendations, 61;
domestic-needs oriented budget
of, 63; TARP program, 9596
Ohanian, Lee, 9293
Ohmae, Kenichi, 7, 10
Oliver, Jamie, 296
100 Best Corporate Citizens (Business Ethics), 126
On War (Clausewitz), 5
Open Market Committee (Federal
Reserve Bank), 60
OpenSecrets.org Website, 88
Opportunity entrepreneurs, 285
Oracle, 288
Ore-Ida (division of HJ Heinz), 234
Organizational culture. See Corporate
culture
Organizational design, 233, 24143,
246

Index
Organizational serendipity: enhancement of, 18283; obstruction of,
18384
Oslo Agreement (1996), 224
Outsourcing: asset return improvements from, 201; as business
model reconstruction element, 291;
interfirm collaborations on, 21011,
217; of logistics operations, 206; of
noncore activities, 217, 219; operational efficiency concerns, 30;
organized labor concerns about,
156; planning for, 2056
Owen, Robert, 295
Pacific Southwest Airlines (PSA), 90,
99100
Palestine community organizing case
study: background, 22324; BPCs
employee-engagement strategy,
22830; BPCs mission, 22628;
economic factors, 22425; lessons
learned, 23031; political factors,
22526; social factors, 226. See also
Employee engagement, as strategic
management tool
Pan American Airlines, 90
Partner drive stage, in SCM,
213
Pasteur, Louis, 185
Paulson, Henry, 94
Penrose, Edith, 55
PepsiCo Corporation, 127
Pinchot, Elisabeth, 287
Pinchot, Gifford, 280, 287
Pitelis, Christos, 153
Point-Of-Purchasing Advertising
International, 155
Policy and practice, in sustainability
strategy implementation, 14144;
facilities, 143; marketing and packaging, 142; operations, 14243;
product design, 141; purchasing,
142
Political action committees (PACs),
88, 114
Political entrepreneurship, 266

309
Political environment, navigation
of, 10723; direct vs. indirect lobbying, 11517; indirect lobbying,
grassroots, and media, 11720;
judicial system, 12021; locating lobbyists, 11112; need for
business-specific lobbyists, 10911;
personal lobbying efforts, 11215;
planning strategies, 109
Political forces/opportunities (SWOT
analysis), 63
Porter, Michael, 7, 910, 20; addressing of social issues, 126; concentrated industry focus of, 261;
criticisms of work of, 3637; five
forces model, 1516, 3436, 65;
influence on SWOT analysis,
6566; national competitive
advantage study, 162; on sustainable competitive advantages, 30;
underlying assumptions of, 7172
Post-It notes, 181
Powell, Walter W., 150
The Power of Pull (Brown, Davison,
Hagel, III), 182
The Practice of Management (Drucker),
8
Prahalad, C. K., 11
Predatory management styles, 70
Prediction fallacy (of strategic planning), 15, 33
Process mapping, 216
Process reengineering, 216
Proctor & Gamble: ecological product development, 130; global
influences on customers, 133; Sustainability Overview report, 133,
135; UNICEF partnership, 129
Production function, in firms,
205
Product safety issues, 127
Project/initiative driven stage, in
SCM, 213
Proprietary capitalism, 15356
Public Utilities Commission (U.S.),
99
Purchasing function, in firms, 2056

310
Q12 survey (Gallup Organization
poll), 22122
Quinn, J. J., 20
Raiffeisen, Friedrich Wilhelm, 295
Rational design school (of analysis),
56
RBV. See Resource-based view (RBV)
of the firm
R&D (research and development
function) in firms, 2045
Real-time connectivity stage, in SCM,
21314
Reengineering the Corporation (Hammer and Champy), 11
Reich, Robert, 158
Relationship-building, in firms, 217
Relationships: ambiguous causeeffect relationships, 73; building
of, in firms, 217; business-lobbyist
relationships, 111; collaborative
supply chain relationships, 206;
complex relationship studies, 13;
ethical aspects of, 136; with government-related officials, institutions, 151, 158, 165; importance of
in SCM, 217; interfirm relationships, 203, 214; intra-company
relationships, 200; network relationships, 164; reasons for failures
of, 23443; stakeholder relationships, 69; strategies for cultivation
of, 4; with suppliers, 212; vertical
vs. matrixed, 23435
Resource-based view (RBV) of the
firm, 19, 3746; assumptions of,
3839, 55; criticisms of, 3940; on
human resources, competitive
advantage, 4042; underlying
assumptions, 7172
Restriction of Hazardous Substances
Directives (EU), 130
Riboud, Frank, 125
Richards, M.D.V., 20
Rule makers, 256
Sales function, in firms, 2034
Sarasvathy, Saras D., 177

Index
Sarbanes-Oxley Act (U.S.), 136
Say, J. B., 280
Says Law, 154
Scenario analysis (in SWOT analysis),
6869
Schoemaker, P.J.H., 17
Schumpeter, Joseph, 157, 279, 280
SCM. See Supply chain management
Scorched earth strategy, 5
Sebelius, Kathleen, 91
Selznick, Philip, 8, 9
Semilla project (Mexico), 12930
Senge, Peter, 7, 11, 12
Serendipity: chance compared to,
184; characteristics and types,
18082, 18485; conditions for
happening of, 18788; contexts for,
18284; cultural aspects of, 182;
definitions of, 175, 17880, 18991;
obstacles to, 18687; openness,
curiosity qualities, 185; preparedness, alertness qualities, 18586;
reasons for worrying about,
17677; recognizing, taking advantage of, 18487; as strategic advantage, 17595; studies of, 17778;
tentative framework development
for, 19194. See also Floppy-eared
rabbit research; Organizational
serendipity
Serial entrepreneurs, 281
Service improvement strategies,
21617
Setting Strategic Goals and Objectives,
Vol. 2 (Richards), 20
Shapero, Albert, 280
Shapiro, Carl, 12
Sherif, Muzafer, 70
Sherman Antitrust Act, 89
Shoka, 296
Shonfield, Andrew, 155
Skak, Ane, 177
Skoll, Jeff, 294
Skoll Foundation, 294
Skunk Works group (Lockheed
Martin), 288
Sloan, Alfred, 6
Smith, Adam, 153, 278

Index
Smith, Evan, 22223
Smits, Willie, 296
Snow, C. C., 26061
Social entrepreneurs, 29396
Social forces (defined), 12526; issues
influencing businesses, 12628
Social forces influences, on firm strategy, 12545; bottom line management strategies, 12832; influences
on business issues, 12628; managerial implications, 14445; social
forces (defined), 12526; sustainability strategy implementation,
13244; 2006 executive survey
findings, 126
Social responsibility standard (ISO
26000), 137
Societal forces analysis (in SWOT
analysis), 5964; cyber forces,
6263; economic forces, 6061;
innovation forces, 6364; military,
terrorist forces, 6162; political
forces, 63
Societal strategy, 25469; behavior
and choices, 26061; elements of,
26567; environmental turbulence,
259; environment and, 25759;
environment-organization relationship, 258; ethical issues, 266;
legitimacy strategies, 265, 26768;
managerial capabilities for, 262,
26869; reasons for, 26265; rule
makers and, 256; social responsibility strategies, 26566; societal
performance and, 262; stakeholder
power, 25657, 25960; strategic
behavior, strategic choices, 26061;
transitional model (description),
25657
Sociopolitical legitimacy, 267
Soskice, David, 151, 160
South Africa, 12930
South Korea: business conglomerates (chaebol) in, 160; U.S. negative
goods trading imbalances with,
161
Southwest Airlines, 9091, 99
Specter, Arlen, 91

311
Stakeholder forces analysis (in SWOT
analysis), 6971
Stakeholders: aerospace, defense
industry, 77; airline industry, 48;
constructive dialogue with, 145;
engagement, in social/environmental sustainability, 13739;
Hinthornes view of, 6970;
opportunities created by, 69; power
of, in societal strategy, 37, 25657,
25960; sustainability strategy
implementation, 13739; value of
in corporate culture, 138; vs. stakeholders, 60
Starbucks, 234
Stevenson, Howard, 282
Stewart, Thomas, 12
Strategemata/strategema, 45
Strategic Control: Establishing Milestones for Long-Term Performance
(Goold and Quinn), 20
Strategic Control Systems (Lorange,
Morton, Ghoshal), 20
Strategic entrepreneurship, 28892
Strategic human resources management (SHRM): best practices of,
4446
Strategic management: basic elements of, 2930; DNA of, 30; failures of traditional management,
3234; historical background,
3132; reasons for management
failures, 23435
Strategic planning: fallacies of, 15,
33; Henry on functions of, 19;
Mintzbergs comments on, 17; use
of SWOT analysis in, 5556; vs.
general planning, 1819; vs. strategic management, 1720; vs. strategic thinking, 1317
Strategic Planning and Management
Control: Systems for Survival and
Success (Camillus), 20
Strategic thinking: Liedtkas major
attributes of, 16; strategic planning
vs., 1317
Strategy: chart of modern development, 7; competition and, 34;

312
derivation of term (strategy), 45;
developmental writers and works,
613; Haxs unifying dimensions,
14; issues in SCM, 2079; as a martial art, 46; military origins of,
56; resource-based view of, 19;
Webster dictionary definitions,
1314
Strategy and Structure (Chandler), 7, 8
Strategy of annihilation, 5
Student activist demonstrations, 127
Sugar, Ron, 5859
Sun Tzu, 46
Supplier relationship management,
in firms, 203, 206
Supply chain management (SCM):
characteristics, strategies of stages
of, 214; defined, 200201; examples
of flow in, 216; goals of, 202;
interfunctional coordination,
20910; key functional roles in,
2036; outsourcing interfirm
collaboration, 21011; stages of,
21114; strategy issues in, 2079
Supply chain orientation (SCO),
2012, 210
Supply chain production (chart), 206
Supreme Court (U.S.) decisions, 119,
121
Survival strategies, 34
Sustainability Overview report (Proctor & Gamble), 133, 135
Sustainability strategy implementation, 13244; ethical culture,
13637; functional integration,
13941; managerial implications,
14445; policy and practice, 14144;
stakeholder engagement, 13739;
top management commitment,
13435
SWOT (strengths, weaknesses,
opportunities, threats) analysis,
5578; application of Porters work,
6566; development of, 8; external
environmental analysis, 5971; five
force analysis comparison, 9; internal environmental analysis, 7175;
Northrup Grumman Corporation

Index
and, 5659; purposes of, 5556;
strategic planning importance,
2021; types of analysis of, 55
Syria, 62
Taiwan: U.S. negative goods trading
imbalances with, 161
Taleb, Nassim, 177
Technology: accelerating applications
of, 67; competitive advantage
influences, 42; defense, military
advances, 58, 6667; Icarus paradox and, 33; information technology, 37, 73; innovation forces,
6364; leap-frog technology, 67;
old technology of government,
1012; 20th century impact of, 5
Theory of Games and Economic Behavior (Von Neumann and Morgenstern), 8
Thomas, Lewis, 176, 186
Thompson, Loren, 58
Three Mile Island nuclear accident,
131
Thurow, Lester, 158
Timmons, Jeffrey, 28283
Too big to fail program, 96
Tools of strategic management,
2022. See also SWOT analysis
Top-down communications, 135, 235,
23940, 241
Top-down decisions, 231
Top-down initiatives, 139
Total quality management (TQM),
30, 204; 1990s embedding of,
200201
Towers Perrin HR Services, 220
Transparency International, 162
The 10 Trends You Have to Watch
(McKinsey & Company), 6364
The Triumph of Conservatism (Kolko),
86
Troubled Asset Relief Program
(TARP), 9596
UNICEF, 129
United Kingdom: corporate capitalism in, 163; corporate lobbying in,

Index
162; managerial capitalism in, 162;
NGC Fareham cyber range, 6263
United Parcel Service (UPS), 100
United States (U.S.): businessgovernment symbiosis, 108; corporate capitalism in, 163; corporate
lobbying in, 162; customer service
success example, 48; cyber attacks
in, 62; dispute resolution methods, 70; Enron failure, 93; Federal
Sentencing Guidelines, 136; free
market capitalism myth, 86; global
businesses in, 162; ideas about
business and government, 151;
increasing government mandates,
9798; managerial capitalism in,
162; mobility of human resources
in, 41; myth of free market capitalism, 8788; national security environment in, 5657; neoclassical
economic assumptions, 149; 1970s
lean production shift, 205; 9/11 terrorist attacks, 61, 63; overseas market assertions by, 158; proprietary
form of capitalism in, 154; recession
of 2007 onset, 60; Sarbanes-Oxley
Act, 136; toxic dump regulations,
131. See also Lobbying/lobbyists;
Supreme Court decisions
Unmanaged/managed by others
stage, in SCM, 212
Unruh, Jessie, 107
U.S. Air Force, 58
U.S. Department of Defense (DoD),
56; budget reduction recommendations, 61; F35 Joint Strike Fighter
program launch, 58; 9/11 influences on, 63; political party influences, 68; post-Cold War loss of
talent, 64; purchasing decision
influences, 66
U.S. Department of Health and
Human Services, 91
U.S. Department of Justice, 8788
U.S. House of Representatives, 91
U.S. Marines, 58

313
Van Andel, Pek, 180, 185
Varian, Hal R., 12
Varieties of capitalism (VOC)
research, 149, 160
Velcro, discover of, 176
The Visible Hand (Chandler), 156
Von Neumann, J., 8
Walmart, 15455
Walton, Sam, 277
Warnock, John, 288
Washington Mutual, 234
Wates Group, 230
Weak-state model (of Adam Smith),
153
Weber, Max, 257
Welch, Jack, 31
Western Airlines, 90
White collar crime, 97
Whitman, Meg, 238
Who or what really counts? principle
(Freeman), 69
Wikileaks saga, 62
Williams, Elizabeth Nutt, 185
Wilson, Charles E., 107
Winning Strategies for a Global
Workforce report (Towers Perrin
HR Services), 220
Wood, D. J., 69
World Commission on Environment and Development (1987),
129
Worlds Most Admired Companies
(Fortune), 126
World Trade Organization (WTO),
152
Wright, Jim, 91
Wright Amendment Reform Act
(2006), 91
Xerox Corporation, 288
Yahoo Japan, 164
Youth Venture, 296
YouTube, 91
Yunus, Muhammad, 296

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Strategic Management
in the 21st Century

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Strategic Management
in the 21st Century
Volume 2:
Corporate Strategy

Vijay R. Kannan, Editor

Copyright 2013 by ABC-CLIO, LLC


All rights reserved. No part of this publication may be reproduced, stored in
a retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording, or otherwise, except for the inclusion
of brief quotations in a review, without prior permission in writing from the
publisher.
Library of Congress Cataloging-in-Publication Data
Wilkinson, Timothy J.
Strategic management in the 21st century / Timothy J. Wilkinson and Vijay R.
Kannan, editors.
v. cm.
v. 1. The Operational environment v. 2. Corporate strategy v. 3. Theories
of strategic management.
Includes index.
ISBN 978-0-313-39741-7 (hbk. : 3 vol. set : alk. paper) ISBN 978-0-313-39742-4
(ebook) 1. Strategic planning. 2. Strategic alliances (Business).
3. Management. I. Title.
HD30.28.W524 2013
658.4'012dc23
2012041185
ISBN: 978-0-313-39741-7
EISBN: 978-0-313-39742-4
17

16

15

14

13

This book is also available on the World Wide Web as an eBook.


Visit www.abc-clio.com for details.
Praeger
An Imprint of ABC-CLIO, LLC
ABC-CLIO, LLC
130 Cremona Drive, P.O. Box 1911
Santa Barbara, California 93116-1911
This book is printed on acid-free paper
Manufactured in the United States of America

Contents

PART I: STRUCTURE
1. Making Sense of a Competitors Innovation: A Signaling
Perspective on Whether to Imitate or Ignore
the Competition
Brian S. Anderson and Matthew Semadeni
2. Strategic Alliances: Promise, Perils, and a Roadmap to Success
C. Jay Lambe and Aaron Hayden

3
23

3. A Phased Approach to Merger and Acquisition


Integration: Tapping Experiential Learning
David R. King

48

4. Contemporary Diversification via Internal


Corporate Venturing
Robert P. Garrett, Jr.

71

PART II: FUNCTIONAL STRATEGIES


5. Marketing Strategy
Robert D. Winsor
6. Maximizing the Firm Value Impact of
Outsourcing Decisions
James R. Kroes, Soumen Ghosh, and Andrew Manikas

95

121

vi

Contents

7. Strategic HRM: Building the Bridge between HR


and Business Strategies
Hwanwoo Lee and Steve Werner
8. Corporate Financial Strategy
Arindam Bandopadhyaya, Kristen Callahan, and Yong-Chul Shin

139
159

PART III: DRIVERS OF STRATEGIC CHOICES


9. Strategic Management of Quality
Amitava Mitra
10. Innovation
Laura Birou, William Christensen, and Alison Wall
11. Organizational Culture, Performance, and
Competitive Advantage: What Next?
Bianca Jochimsen and Nancy K. Napier

191
214

233

12. The Emergence of Business Ethics


Krishna S. Dhir

255

Index

279

Part 1

Structure

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Chapter 1

Making Sense of a Competitors


Innovation: A Signaling Perspective
on Whether to Imitate or
Ignore the Competition
Brian S. Anderson and
Matthew Semadeni

INTRODUCTION
The popular business literature admonishes managers to seek an elusive,
but inherently valuable, positionthat of the first mover. The colloquial
notion of beating a competitor to the punch and establishing a dominant
competitive position is often considered to be a strategic given. By going
first, the firm stands to capture significant market share, establish brand
preeminence, and exercise leadership over the markets development.
Such first-mover advantages should ostensibly result in higher levels of
firm performance, measured in terms of market share or other financial or
market metrics. As a recent Harvard Business Review article noted, Business executives from every kind of company maintain, almost without exception, that early entry into a new industry or product category gives any
firm an almost insuperable head start.1

Strategic Management in the 21st Century

Yet the scholarly literature suggests a far more nuanced relationship


between being first to market and accruing meaningful performance rewards. Some scholars suggest that first movers have an almost equal
likelihood of experiencing competitive disadvantages; depending on the
industry, being first to market may actually hamper the firms short- and
long-term performance.2 For example, Boulding and Christen found that
although first movers earned a top-line revenue advantage through their
pioneering activities, they were also less profitable over the long run than
those firms more circumspect in their new product introductions.3 Indeed, being the second, or even third or fourth, to the market may actually
be the most advantageous competitive position.4 Following the market
leader has a number of inherent benefits, most notably a reduction in risk.
The first mover establishes the relative market acceptability of the new
product or service while also passing on critical market intelligence, such
as the anticipated level of demand, preferred features or attributes of the
product, and pricing levels. In short, it may pay to go second; yet this begs
the question of when to follow the leader.
This chapter examines competitive product imitationthe whole or
partial duplication of a competitors innovationand the factors that influence whether or not to pursue imitation.5 Note that the discussion is
not meant to imply that firms should avoid innovation altogether, as research has consistently shown a positive relationship between innovation
and critical performance outcomes.6 Rather, given that sustained engagement in innovation is not generally feasible or necessarily advisable, the
argument offered is that imitation is a reasonable, and in some cases, a favored competitive response to the introduction of an innovation by a competitor.7 Our objective is to provide insight as to when and under what
conditions firms should consider competitive imitation. Drawing from
signaling theory and prior empirical work in the area of innovation and
imitation, the chapter suggests that actionable intelligence is embedded
within the innovations introduced by competitor firms and also resides
at the organizational level of the innovator firm itself.8 Such intelligence
provides potentially meaningful insights that may guide the decision of
whether or not to imitate, in whole or in part, the competitors innovation.
Specifically, the chapter suggests that the innovativeness (along a continuum from more incremental or basic advancements, to more radical or
extreme innovation) of the new product introduction signals the extent to
which the competitor possesses information that is consistent with or divergent from broader market knowledge.
For incremental innovations, the competitor firm is signaling that they
possess information that is generally in line with the information possessed by other market actors; incremental innovations are inherently low
risk and tend to build upon well-established products.9 The decision to
imitate such an innovation is thus relatively straightforward. The follower

Making Sense of a Competitors Innovation

firm is likely to possess similar market knowledge, and imitating the competitor is correspondingly low risk (though, importantly, also not likely to
generate significant performance returns). The signal sent by the competitor is, however, more difficult to parse for more radical innovations. On
one hand, the competitor may be signaling that they believe they possess
demonstrably better information about the market than other actors and
are therefore making an aggressive move to outmaneuver competitors.
Conversely, introducing highly innovative products is risky, and the innovator firm may be inadvertently signaling that they have misunderstood
current market needs and have overreached. In such circumstances, making sense of highly innovative new products presents a more challenging context for follower firms to determine an appropriate competitive
response (i.e., to imitate or to not).
At the organizational level of the innovator firm, the chapter suggests
that two characteristics of the innovator, its record of introducing successful innovations to the market over time, and its perceived competency in
a particular market space, also provide signals regarding the appropriateness of pursuing competitive imitation. For example, firms with a track
record of successful past innovation (e.g., Apple, Boeing, and Nike) signal not only a competency in developing and introducing successful innovations but also that they possess demonstrably superior knowledge
about current market needs and trends. In such cases, deciding to imitate
highly innovative firms may be appealing as any uncertainty surrounding whether or not to imitate is reduced by the innovator firms perceived
innovation competency. Similarly, firms with a known competency in a
given market space (e.g., Apples competency in mobile devices) may be
viewed by other market actors as possessing superior knowledge about
this market space. By introducing an innovation within their area of specialty, such innovator firms are signaling that based on their superior market knowledge the innovation is well aligned with market needs. Again,
imitation of these types of firms may prove attractive for other market
actors.
Imitation decision making is likely to be multilevel in nature. In evaluating whether to imitate, prospective imitators should consider signals at
the intersection of the innovation and organizational levels.10 The chapter
therefore also discusses the interaction of signaling levels, and delineates
suggested imitation outcomes under different combinations of innovation
and organizational-level variables. For example, imitating a highly innovative new product in a market space outside the innovator firms core
market competency is less compelling than imitation of an incremental innovation introduced by a firm with demonstrable innovation competency.
The chapter also discusses environmental contexts that tend to favor signal interpretation as a guide for imitation decision making. It concludes
by discussing the competitive implications for managers contemplating

Strategic Management in the 21st Century

imitation and how to develop improved heuristics for imitation decision


making.
SIGNALING THEORY
Signaling theory is generally concerned with the reduction of information asymmetry between two market actors.11 Briefly, information asymmetry arises because different people know different things; that is,
market actors inherently possess idiosyncratic stocks of information, and
differences in those stocks give rise to information asymmetry.12 Management scholars have eagerly adopted signaling theory as an effective
mechanism to describe how firms communicate information (e.g., beliefs, competencies, and intentions) through specific behaviors that lend
credence to the underlying informational value.13 For example, in his
seminal work, Spence suggested that job market candidates pursue highereducation degrees to signal intellectual competency to prospective
employers.14 Although the candidate might verbally express his or her intellectual abilities during an interview, possessing a college degree provides more tangible, behavioral evidence of intellectual competency to the
prospective employer, thereby lowering information asymmetry.
Signaling theory posits that the signaler (the firm sending the signal)
will engage in purposeful behavior to communicate information that reduces information asymmetry in a manner beneficial to the firm. For example, a start-up firm may add a high-profile executive to their board to
signal managerial competency. However, signaling theory also applies to
situations in which the signaler did not intend to engage in signaling behavior, but where the firms actions had the net effect of reducing information asymmetry in a manner that may or may not have been positive for
the firm. For example, Berkshire Hathaways $3 billion investment in General Electric (GE) in 2008 signaled that GEs cash position was weaker than
may have been previously thought, although the reputation of Berkshires
Warren Buffett also provided a vote of confidence in GEs long-term performance. Thus, whether purposeful or not, valuable information is embedded in the strategies, tactics, and behaviors pursued by all firms, and
are subject to interpretation and parsing by other market actors to reduce
information asymmetries.
A critical assumption underlying signaling theory is the notion of signal quality or the underlying, unobservable ability of the signaler to
fulfill the needs or demands of an outsider observing the signal.15 To illustrate, consider that firms vary in their abilities (e.g., managerial skills,
core competencies, and resource exploitation) and that each firm possesses
demonstrably superior understanding of its abilities than do exogenous
market actors.16 Each firm that engages in signaling behaviors, whether
intentional or not, is communicating information about its underlying
abilities; firms with greater abilities, and therefore of higher quality, send

Making Sense of a Competitors Innovation

correspondingly higher quality signals that are more likely to be noticed


by other market actors.17 This begs the question, however, of how exogenous actors evaluate the quality of the signaler. Although a variety of
proxies such as superior financial performance or market prestige exist,
one such proxy particularly salient to the current discussion is organizational reputation.18
As Lange, Lee, and Dai note in their recent review of the literature on
reputation, organizational reputation is a simple idea with intuitive appeal.19 The simple idea is the notion that over time and through the
engagement in consistent, purposeful behaviors, a generalized understanding forms in the minds of market actors as to the basic composition,
philosophies, and operating DNA of a focal firm. Such a reputation, be
it positive or pejorative, provides insight across a spectrum of organizational phenomenon (e.g., anticipating future behaviors, calculating how
the firm might react to new competitive threats, assumptions of the quality of the firms products, and the trustworthiness of its senior managers). In short, the reputation of the firm, particularly in light of inherent
information asymmetries across market actors, can be construed as being
representative of the perceived quality of the firm and thereby the perceived
quality of the signals that the firm sends. When a firm engages in signaling behavior, signal recipients draw on aspects of the signalers reputation
to gauge the quality of the signal sent. Importantly, such reputational elements can manifest at the level of the signal itself and at the organizational
level of the signaler.
It should be noted that the issue of reputation does not necessarily
mean that market actors overlook signals sent by firms of perceived lower
quality per se. Rather, signal recipients will judge the content of such signals differentially, with greater weight paid to those signals sent by firms
with reputational attributes that impart credibility to particular strategic
or tactical behaviors. For example, Apple has a reputation for introducing
innovative consumer technology products with appealing industrial designs. As such, market actors come to expect that Apples future product
introductions will be consistent with Apples reputation and will thus be
both innovative and aesthetically pleasing. Since the act of introducing a
new product to the market represents a tangible strategic behavior, such
an action is inherently a signaling behavior. Other market actors can draw
information from such signals, particularly reputational mechanisms, to
glean insights as to the intentions and beliefs of the innovator firm regarding current and anticipated market conditions. Such insights guide imitation decision making.
SIGNAL INTERPRETATION
As discussed previously, firm behaviors, whether intentional or not, are
subject to interpretation by other market actors for clues as to the beliefs,

Strategic Management in the 21st Century

assumptions, and operating philosophies possessed by the signaling firm.


Since such signals may encompass a wide swath of organizational phenomena, for example, from governance to strategic decision making, market actors looking to glean specific insights must be cognizant of those
signals most salient to their interests.20 For example, in assessing whether
a firm may pursue an initial public offering in the near term, other market
actors might explore if there were pertinent changes to the firms board
of directors. Identifying salient signaling behavior is more challenging,
however, when it comes to parsing innovative behaviors of competitor
firms to glean actionable intelligence for determining a competitive response. This chapter suggests, based on recent empirical work, that three
factors are most likely to yield appropriate data for determining an imitation response: the innovativeness of the new product introduction, the
competitors history for introducing successful product innovations, and
the competitors perceived competence in a particular market space.21
PRODUCT-LEVEL INNOVATIVENESS
Introducing a new product to a market is no trivial act. Such a behavior represents the physical manifestation of the considerable time, energy,
knowledge, and capital committed to the research, development, and
marketing of the product. As such, new product introductions are credible commitments that have particular significance among observers of
the innovator firms behavior.22 In the context of signaling theory, the significance of credible commitments is that behaviors backed by tangible
decisions lend credence to the behaviors and are therefore given greater
weight in signal interpretation. For example, in the mid-1990s when Apple
Computer was struggling, Microsoft publicly announced its intention to
continue developing its popular Microsoft Office suite for the Macintosh
platform. The announcement was later supported by Microsoft taking an
equity position in Apple. Many analysts interpreted this investment as a
demonstrable, or credible, commitment of Microsofts long-term commitment to building products for the Macintosh platform. Given that new
product introductions inherently represent specific and tangible resource
commitments made by the innovator firm, even allowing for differences
in the scale of the new introduction (i.e., a regional versus global product
launch), such introductions are ripe for signal interpretation.
Consider that embodied in the act of new product introduction is information that provides insights on the market and technological knowledge possessed by the innovator firm. Such information includes, but is
not limited to, the firms expectations of market acceptance of the product,
its belief in the growth trajectory of the new offering, its understanding of
current market needs and wants, and its ability to deliver a product that
is consistent with customer expectations. For example, IBMs push into

Making Sense of a Competitors Innovation

enterprise information technology (IT) outsourcing in the mid-1990s reflected their recognition of changing market expectations for technology
services and the need to respond to the growing complexity and cost of
managing large IT infrastructures. The act of offering such services, manifested by bidding on significant outsourcing contracts and engaging in an
aggressive marketing program, suggested to competitor firms that IBM
believed it had both accurately gauged market expectations and had the
resources necessary to meet them.
Importantly, however, whether IBM in the previous example believed
it had judged market needs appropriately and whether its competitors at
the time (i.e., Electronic Data Systems and Accenture) believed IBM was
correct, are two different things. Although the innovator firms behavior is
a reflection of its knowledge and resources, competitors must interpret the
information encompassed within the innovation signal relative to their
own stock of knowledge. Thus, signal interpretation is relative to the signal receiver, and each market actor will make sense of and evaluate those
signals differently. Under this rubric, we argue that the information conveyed by the signalthe innovator firms beliefs and understanding of
current market needs and expectationsis contrasted with the signal recipients own market knowledge. In interpreting this contrast, should the
signal recipient observe significant divergence between the information
conveyed in the signal and its own knowledge, it is not likely to believe
that the innovators knowledge is superior to its own. Imitation may thus
not be a preferable decision as this would effectively suggest that the signal recipient is abandoning its own knowledge and attributing information superiority to the innovator firm. This observation, however, begs
the question of how to measure, or estimate, the degree of divergence between the respective knowledge stocks of the innovator and the prospective imitator.
Although not meant to preclude the possible significance of other measures, we posit that the relative innovativeness of the new product is a
salient variable with which to evaluate prospective imitation. The act of
innovation inherently involves introducing something new to the market.23 However, newness in this context is subjective and can reflect either
a modest, incremental improvement in a (typically existing, though not
always) product or is an extreme departure from current market norms,
a breakthrough, as it were.24 For example, the addition of baking soda in
toothpaste would be representative of an incremental innovation (a modest improvement to an existing product), whereas the introduction of the
Sonicare toothbrush (now owned by Phillips Oral Healthcare) was a
radical innovation; for example, the use of high-speed vibration to create a new class of toothbrushes. Although classifying innovation as incremental or radical is admittedly a subjective endeavor, the assumption
made herein is that relevant market actors are able to appropriately judge

10

Strategic Management in the 21st Century

the innovativeness of a new offering. This assumption is predicated on the


observation by Porter that industry incumbents possess at least a baseline
level of common knowledge.25 The question now is how to apply signaling theory to the innovativeness of a new offering vis--vis the imitation
decision.
We suggest that the more innovative a new product is, the greater is the
likelihood that the information contained within the innovation signal
beliefs about current market expectations and other knowledgewill
diverge from the knowledge stock of prospective imitators.26 As this divergence increases, the desirability of imitation as a competitive response
will fall. In other words, as product innovativeness increases, imitation
should decrease since prospective imitators are likely to view the innovator firm as being out of step with market expectations. The prospective
imitator is likely to attribute knowledge superiority to itself rather than
to its innovator competitor, particularly if the imitator has above average
financial and/or market performance, and therefore, views imitation as a
risky response. In contrast, the information communicated by incremental
innovations is not likely to diverge significantly from the knowledge stock
of the prospective imitator. In this case, imitation becomes an attractive response because it essentially represents strategic consistency between the
innovator firms and the prospective imitators market knowledge. Notably however, there is empirical evidence suggesting that radical innovation is associated with the converse of the preceding argument. Despite
hypothesizing a negative relationship between innovativeness and imitation, one study found a positive, though weak, correlation between innovativeness and the extent of imitation.27 Nonetheless, although empirical
results are mixed, imitation of a radical innovation is likely to be a demonstrably risky proposition.28 As such, from a managerially prescriptive
view, the appropriateness of imitation as a competitive response is likely
to decrease as the innovativeness of new offerings increase.29
There are two caveats to the assumption of a negative relationship between product innovativeness and imitation. First, there is a competitive risk in ignoring a radical product introduction. Consider that before
the introduction of Apples iPad, tablet devices that lacked a tactile keyboard, mouse, and other common features were widely panned as being
a solution in search of a problem, being neither a smartphone nor a
laptop in terms of functionality. The iPad, however, became one of the
most successful consumer electronic launches in history in terms of capturing significant majority market share, and has given Apple an almost
insurmountable lead in the tablet market space (at least initially) despite
ongoing imitation. The argument here, however, is that such radical innovations are not likely to manifest in consistently successful outcomes,
and given this rarity, imitation decision making based solely on productlevel innovativeness is likely to be more risky for radical than incremental

Making Sense of a Competitors Innovation

11

new products. Second, there is the possibility that the prospective imitator possesses demonstrably similar market knowledge to the innovator
firm (i.e., very low divergence in knowledge stocks) but that the innovator
firm either beat the prospective imitator to the market or that the prospective imitator lacked the resources to capitalize on their market knowledge.
Such a possibility raises the specter of a moderator-like influence of, for
example, resource availability, on the product innovativeness-imitation
relationship. Ultimately, we believe that based on based prior empirical
evidence, the negative main effect is likely to predominate, though there
is more research to be done in this area, particularly regarding additional
contextual influences.
ORGANIZATIONAL LEVEL
In an imitation decision, there are additional considerations beyond
those that exist at the level of the new product offering. Innovation does
not occur in a vacuum, and although parsing information at the product
level is vital, such information is inextricably confounded with the firm
introducing the innovation. Indeed, there is arguably considerable informational value in understanding the characteristics of the innovator firm
itself from the signals it sends by introducing innovative new products.
Thus, while considering the innovativeness of a new product is necessary when developing an imitation strategy, it is not sufficient. We suggest
therefore that prospective imitators go beyond the product level and look
for insights at the organizational level of the innovator firm in crafting a
prospective imitation response. Specifically, we suggest two characteristics of the innovator: its innovative history, and its market competency, as
salient organizational influences on imitation decision making.
Innovative History
Innovative history refers to the innovator firms track record of introducing successful product innovations to the market. Notice specifically
the successful moniker in this definition. This is done purposefully
since some firms may be prolific innovators but may have market success that is poor or difficult to measure. For example, 3M is well known
for systemic innovation, though the market success of its products can be
difficult to evaluate independently, particularly since many of the companys innovations build incrementally on existing products and the
firm operates across a wide swath of industries. Conversely, Apple is not
known for having a large number of innovative new product offerings
(perhaps one to two per year), but those that Apple does offer tend to
have strong market acceptance. When evaluating innovative history, quality of innovation, not quantity per se, is thus the critical metric. Admittedly,

12

Strategic Management in the 21st Century

determining whether an innovation is successful or otherwise has impact


is subjective and highly influenced by prevailing industry norms. Furthermore, in many markets it is difficult to gauge a priori the value of a given
innovation, which introduces time as an element in determining innovation history as it may take considerable time for the market impact of an
innovation to become clear. For example, the snowboard was invented
in the early 1970s but it was not until two decades later that the product
and associated sport garnered widespread acceptance in the broader skiing industry. Collectively, these challenges imply that there is no simple
mechanism for accurately measuring the innovative history of a competitor. Industry norms and market histories should, however, provide ample
circumstantial evidence to at least develop a picture of innovation history.
We argue that the decision to imitate an innovation of a firm with a
favorable innovation history may be attractive. Although past behavior
is no guarantee of future results, prospective imitators can draw comfort
from correlating a competitors past innovation successes with future innovation outcomes. A favorable innovation history lends credibility to the
behavioral signals sent by the innovator firm such that past successes create a halo effect over new offerings and the inherent riskiness associated
with competitive imitation is decreased.30 In terms of signaling theory, the
firms innovation history is part of its organizational reputation. For firms
with an established track record of innovation, the signals they send will
be perceived by signal recipients as being of high quality. When they engage in innovation behavior, prospective imitators are thus likely to pay
attention to these behaviors and be inclined to pursue imitation. In other
words, imitating a firm that has a history of successful innovations is less
risky than imitating a firm that has not consistently introduced successful
new products.
Market Competency
Market competency refers to the innovator firms demonstrated fitness
in a given market context as characterized by the extent to which its operations are concentrated or diffuse. For example, Wal-Mart Stores is one of
the few dominant business firms (one industry representing a greater than
80% share of its revenue) in the Fortune 50, whereas GEs largest division
(by revenue) accounts for slightly more than 30 percent of its total gross.
Based on market competency, we would thus ascribe greater competency
at the firm level to Wal-Marts operations in the retail industry than we
would to GE.31
In a manner similar to that of innovation history, a firms market competency represents a salient component of its reputation. In this case, however, the reputational element is one of perceived knowledge superiority
gained by virtue of the firms sustained experience within a given market

Making Sense of a Competitors Innovation

13

space. Because tacit knowledge, which is argued to be more strongly associated with competitive advantage than explicit or codified knowledge,32
is acquired largely through experience, firms with concentrated operations are presumed to possess both a higher quantity of knowledge about
that particular market segment as well as knowledge of a higher quality
than firms whose operations are diffuse.33 To prospective imitators, a high
level of market competency also enhances signal quality by affirming perceived knowledge supremacy, thereby making imitation of such firms less
risky than those with more diffuse operations. In summary, if a prospective imitator does not have an equivalent level of concentration in a market space as an innovator, and if an innovation is introduced in a market in
which the innovator possesses competency, imitation may be a favorable
competitive response.
INTERACTION OF PRODUCT- AND
ORGANIZATIONAL-LEVEL SIGNALS
Ultimately, the decision to imitate is not predicated solely on signal interpretation at the product or organizational level because as mentioned
previously, the innovation itself is linked inextricably to the firm that introduced it to the market. As such, parsing innovation signals is multilevel
in nature, requiring the prospective imitator to evaluate the signals sent
by the offering in the context of the reputational elements of the innovator
firm. For imitation decisions where the signals at the product and organizational level are congruent, multilevel signal interpretation is straightforward. For example, an incremental innovation introduced by a firm
with high market competency represents a strong imitation signal combination. Incremental innovations are likely to be consistent with market
expectations (favoring imitation), and concentrated firms are perceived to
have substantial and high-quality market knowledge (also favoring imitation). Similarly, a highly innovative product introduced by a firm without
a demonstrable record of successful innovation introduction is not likely
to lend itself to imitation. Highly innovative products are not only risky
(depressing imitation), but the firms reputation provides no credibility to
enhance the quality of the signal (also depressing imitation).
The challenge in imitation decision making is when signals sent at
the product-level conflict with signals sent at the organizational level.
There are four specific cases when imitation signals at the product and
organizational levels would be contradictory: low innovativeness/low innovation history, low innovativeness/low market competency, high innovativeness/high innovation history, and high innovativeness/high
market competency. Based on past research, we offer the following prescriptive suggestions for signal interpretation in these situations with the
caveat that generally speaking, signals sent at the organizational level are

14

Strategic Management in the 21st Century

more pertinent when crafting an imitation response than signals sent at


the product level, with one notable exception.34
Under low levels of product innovativeness, the generic risk of competitive imitation is demonstrably low. As discussed previously, incremental
innovations signal a high level of congruence between the market knowledge possessed by the innovator firm and by the prospective imitator.
Imitation in this scenario represents a logical advancement of the prospective imitators product line, since adopting the incremental innovation is
likely to represent strategic consistency with the firms knowledge stock.
However, an incremental innovation introduced by a firm without a history of successful innovation results in the likelihood of imitation going
down (i.e., positive product-level imitation signal, stronger, negative
organizational-level signal). Although the incremental innovation is of
low risk, it is also of correspondingly low value.35 Introducing even an
incremental innovation requires the expenditure of time and resources.
However, there is no positive organizational signal to indicate that the innovator firm has introduced an innovation of material value to the market
such that the prospective gains from imitation outweigh its costs. In other
words, there is likely to be a higher opportunity cost from imitating an incremental innovation than there would be from devoting organizational
resources to potentially higher-value internally generated innovation.
Similarly, we would argue that an incremental innovation introduced
by a firm lacking demonstrable market competency as recognized by
competitors (e.g., the perennially struggling K-Marts introduction of a
layaway option for purchases), or the introduction of an incremental innovation outside of the firms market competency (e.g., Starbucks introduction of hot breakfast sandwiches), trumps positive imitation signals
at the product level. Without the high quantity/quality of market knowledge characteristic of market competency, both radical and incremental
innovations are inherently risky. At the extreme, such innovations may be
little more than a guess of current market expectations. The lack of market
competency thus lowers the quality of the product-level signal, making
the value of imitation questionable.
Under high levels of product innovativeness (effectively a negative
imitation signal), parsing positive organizational-level signals becomes
more nuanced. Because imitation of a highly innovative product carries
substantial risk, the question becomes whether signal quality is enhanced
enough either by innovation history or market competency to overcome
the inherent downward imitation pressure. We argue that in the case of
innovation history, even when an innovator firm possesses a track record
of successful innovation introductions, concern over whether they will
be able to replicate past successes with a highly innovative new offering
should deter imitation. Although a positive innovation history provides
some legitimacy to a highly innovative offering, the correlation between

Making Sense of a Competitors Innovation

15

successful prior radical innovation and future success with similar offerings is tenuous at best. Harley-Davidson Motor Company is a case in
point. Throughout its history, Harley-Davidson has oscillated dramatically between periods of significant leaps forward in motorcycle design
and long periods of stagnation. Significantly, research has found empirical
support for this assertion, indicating that although the imitation of highly
innovative new products of firms with a strong history of innovative was
more positive than that of firms without such a history, the likelihood of
imitation remained negative.36
We argue the opposite position, however, with respect to the imitation
of radical innovations offered by firms with demonstrable market competency. We suggest that market competency is more powerful than past
performance as a reputational signal and is able to overcome the riskiness associated with the imitation of highly innovative products. This is
because, as Van de Ven noted, innovation represents the physical manifestation of organizational knowledge. It encapsulates what is known,
and assumed to be known, by the innovator firm about market expectations.37 It therefore follows that firms with high quantity/quality of market knowledge are more likely to introduce innovations, both incremental
and radical, that are congruent with the needs of the market than those
that do not. Such a competency signals that uncertainty surrounding radical innovation is sufficiently mitigated to encourage imitation.
Research has also found empirical support for the imitation of highly
innovative offerings of firms with high market competency.38 Such imitation may be akin to lemming-like behavior in that prospective imitators are likely to copy both incremental and radical innovations of firms
that they perceive to possess high quantity/quality market knowledge.
From the perspective of competitive strategy, the imitation of firms with
demonstrable market competency, irrespective of the innovativeness of
their offerings, may prove to be attractive if for no other reason than
to maintain competitive parity. This will be particularly so if the prospective imitator is willing to concede information superiority to the
innovator.
There may be other pertinent product and organizational-level phenomenon that can serve as appropriate signal mechanisms. For example, the scope of the innovation, that is, the breadth of potential markets
the innovation is tapping, may be positively associated with the propensity to imitate.39 Furthermore, there may be a three-way interaction effect
between product innovativeness, innovation history, and market competency that may suggest more fine-grained imitation decisions. Thus,
although a highly innovative offering made by a firm with a strong innovation history should deter imitation, if the firm also has demonstrable
market competency, the joint consideration of the reputational elements
may be sufficient to overcome the riskiness inherent in imitating radical

16

Strategic Management in the 21st Century

innovations. These assertions are, however, empirical questions that remain to be explored.

INDUSTRY CONTEXT
Although competitive imitation may ostensibly be an appropriate
strategic response in any industry, there are particular market contexts
in which signal interpretation is more applicable than others. We suggest
that the level of information asymmetry among market actors within an
industry and the industrys level of dynamism, the extent to which change
in the industry is predictable (low dynamism) or fundamentally unknowable (high dynamism), influences the saliency of the imitation signals.
Understanding imitation in competitive contexts is straightforward in
markets where market actors are expected to possess demonstrably similar market knowledge and where change is relatively predictable.40 For
example, consider the commercial aircraft manufacturing industry, which
is dominated by two firms, Boeing and Airbus. This industry is characterized by long product delivery schedules, airframe development horizons
that can easily stretch beyond a decade in length, and industry forecasts
that often extend 25 years or more into the future. Collectively, this suggests that although the industry could be classified as hostileBoeing and
Airbus are bitter rivalsthe industry is arguably stable, and both Boeing
and Airbus could be reasonably expected to possess demonstrably similar
knowledge about market needs and expectations. In such a case, responding to a competitors innovation shifts from a reliance on signal parsing
(i.e., what does my competitor know that I do not?), to evaluating whether
the competitors innovation is consistent with the prospective imitators
market beliefs (i.e., if we know the same thing, is my competitors assessment of customer needs correct?).
To illustrate further, the Boeing 737 and the Airbus A320 are remarkably similar aircraft in terms of features and functionality, and compete
directly to meet airlines short-/medium-haul route needs. The 737, which
predates the A320 by almost two decades, quickly established a market
leadership position in this highly profitable market segment. Sensing a
competitive opportunity due to the growing number of airlines worldwide (particularly in developing countries), Airbus largely imitated the
737 in developing the A320. To Airbuss credit, the A32x family of aircraft has now reached approximate parity with the 737 in terms of
number of aircraft delivered each year. In a similar vein, though with
a different outcome, Boeing and Airbus diverged in their offerings targeted toward long-haul routes, with Airbus undertaking development
of what is now the worlds largest airliner, the A380, and Boeing developing the smaller, though still wide-body, Boeing 787 Dreamliner, while

Making Sense of a Competitors Innovation

17

also making incremental advances to their existing and successful Boeing


747 airframe. Both manufacturers possessed reams of similar data regarding market forecasts and customer expectations, yet took substantially
different approaches based on that data. In other words, when market actors possess similar knowledge, and change in the environment is largely
predictable, imitation is driven predominantly by internal factors, that is,
the firms endogenous interpretation of its knowledge stock, with less
consideration given to exogenous signals.
Conversely, consider the global wealth-management industry. Although there is a high level of rivalry between market actors, there are
also two complicating factors. The first is the high level of information
asymmetry among competitors in the industry. Competitors are likely to
possess highly idiosyncratic knowledge stocks as a function of the scope
of their practices, proprietary analytical tools and research, and the education and experience of their employees. Furthermore, a high level of
dynamism typifies the wealth-management industry. Market actors are
continually developing new investment products, the global regulatory
environment is constantly shifting, and investment strategies are heavily
influenced by changing market conditions in the sectors in which the firm
is invested. In short, change happens with irregularity though arguably
frequently, and the scope and significance of these changes are difficult,
if not impossible, to predict a priori. As such, we argue that exogenous
signal interpretation in these industries becomes more salient, as the internal confidence in the veracity of a firms market knowledge decreases
as a function of the increasing levels of information asymmetry and dynamism. In other words, market actors will constantly reevaluate their confidence in the efficacy of their own knowledge, and look to other market
actors for insight into their evaluations of market expectations and needs.
In summary, signals sent by the innovator firm are more salient in crafting
an imitation strategy when the industries are characterized by a high level
of information asymmetry and dynamism.
COMPETITIVE IMPLICATIONS
There are three principal competitive implications stemming from the
discussion in this chapter. The first is the importance of recognizing the
multilevel nature of imitation decision making. While understanding
the causal influence of product and organizational-level signals as independent predictors of imitation, it should also be recognized that these
signals are inextricably linked and must thus be accounted for jointly to
craft a more complete imitation strategy. For example, we suggest that as a
general heuristic, imitating highly innovative products should be avoided
since such innovations are likely to reflect a significant difference between what a competitor signals as their understanding of current market

18

Strategic Management in the 21st Century

conditions and that of the prospective imitator. The innovator firm has not
provided any enhancement to the quality of the product-level signal that
would compel prospective imitators to jettison their own market knowledge and imitate the radical innovation. Yet, if we look at this signal in
the context of a firm with strong market competency, and that innovation
is based on that competency, the positive organizational-level imitation
signal effectively trumps the negative product-level signal. Although this
admittedly increases the complexity of imitation decision making, understanding its multilevel nature should assist in crafting more fine-grained
imitation responses.
The second implication is that radical innovation can serve as a competitive differentiator. At its most basic level, imitating radical innovations is discouraged; thus firms pursuing radical innovation may enjoy a
temporary differentiation advantage.41 Such an advantage is also the case
when firms with a track record of introducing successful innovations pursue radical innovation. However, for firms with a high level of market
competency, the imitation of their innovations is highly likely and arguably should be encouraged, regardless of whether they are radical or incremental. These firms are, in a sense, victims of their own success, as their
reputational strength and perceived information superiority encourage
the wholesale copying of their offerings. Such firms are frequently given
the label of trendsetter or fashion leader, and are often the genesis behind
bandwagon behaviors wherein other market actors blindly follow market
leaders in the hope of riding their coattails.42 As such, firms with a high
level of market competency may be encouraged to look for other sources
of differentiation (i.e., not through new product innovation) as a basis for
competition. An exception to this are firms such as Apple who have high
market competency and are so successful in crafting unique and highly
valued products that competitors, even with outright imitation, are unable to develop competitive offerings.
The third implication is that the parsing of signals to guide imitation
decision making is more applicable in certain industry contexts, particularly those typified by high levels of information asymmetry and environmental dynamism. It is important to note that firms may pursue imitation
for a variety of reasons, including those that may not be grounded in
earning economic rents. For example, the sociology literature offers examples of imitation for the purpose of reputational enhancement; firms
copy more prestigious peers to burnish their own reputations.43 Such a
phenomenon can also be found in the economics literature in the context
of inferior managers mimicking the behavior of managers perceived to
be superior performers irrespective of the consequences of their actions.44
Interestingly, imitation may itself be a signaling mechanism in that the
imitator is signaling to other market actors a desire to keep pace with the
competition, and to ensure that it is not perceived as tired or staid.45 Such

Making Sense of a Competitors Innovation

19

motivations may occur irrespective of the structural characteristics of an


industry. What we are suggesting, however, is that assuming imitation is
motivated predominantly by financial considerations (i.e., the desire to
improve firm performance); for firms operating in dynamic industries in
which market actors are likely to possess highly idiosyncratic knowledge,
being attentive to signals encapsulated within a competitors innovation
and understanding how to interpret those signals can be an effective guide
in crafting an imitation strategy.
CONCLUSION
We broadly suggest that the decision to imitate can be attractive when
the innovation is incremental and thus imitation is low risk and likely
to be congruent with the prospective imitators existing market knowledge and capabilities. Conversely, the decision to imitate more radical
innovations will generally be less attractive. Imitating an incremental innovation is most likely to lead to positive performance outcomes when
the innovator firm also has a history of introducing successful innovations to the market. Imitating will minimize the innovator firms advantage and, hopefully, enable the imitator to hold if not gain market share.
The value of imitating a radical innovation by such a competitor remains
questionable, however, as past innovation performance is only weakly
correlated with future performance. In the context of either incremental or radical innovations introduced by a competitor with demonstrable
competency in a particular market space, there is potential benefit from
pursuing imitation. Deep market knowledge of the innovator is generally associated with the introduction of innovations that are congruent
with current market conditions; thus the risk inherent in mimicking innovation is low, regardless of whether the innovation itself is radical or incremental.
From a strategic perspective, the introduction of an innovation by a
competitor is a disruptive event, and will cause at least some consternation among other market actors who will have to determine whether their
current offerings are sufficient to compete with the new. They will have
to decide whether to remain with existing products, copy the competitors
offering, or pursue new product offerings that are different from those of
the competitor. The overarching challenge, as with developing any competitive strategy, is that the decision to engage in imitation is highly fluid,
and likely to be predicated not just on the desire to imitate, the focus in this
chapter, but also on the ability to imitate, that is, the capacity to actually
put forth a new offering that mimics all or a portion of the innovation. Indeed, it may not be practical or advisable for a firm to shift resources from
its ongoing product development foci to counter a competitors innovation through imitation. Moreover, as mentioned previously, long-term

20

Strategic Management in the 21st Century

firm performance is not likely to improve by always copying the competition. Nonetheless, imitation can be a useful competitive tool to minimize the potential advantage to the innovator of going first, and to ensure
that the prospective imitator does not miss critical market developments
by failing to keep pace with the competition. What this chapter has provided is a practical discussion of how to make sense of a competitors
innovation in determining the appropriateness of competitive imitation,
and what signals encapsulated within that innovation assist in crafting an
imitation response.
NOTES
1. Suarez, F., and Lanzolla, G. The half-truth of first-mover advantage, Harvard Business Review 83 (2005): 121127.
2. Ethiraj, S. K., and Zhu, D. H. Performance effects of imitative entry, Strategic Management Journal 29 (2008): 797817.
3. Boulding, W., and Christen, M. First-mover disadvantage, Harvard Business
Review 79 (2001): 2021.
4. Pfeffer, J., and Sutton, R. I. Evidence-based management, Harvard Business Review 84 (2006): 6274.
5. The terms product and offering are used generically in this chapter to
refer to either a new product or a new service.
6. Rosenbusch, N., Brinckmann, J., and Bausch, A. Is innovation always beneficial? A meta-analysis of the relationship between innovation and performance
in SMEs, Journal of Business Venturing 26 (2011): 441457.
7. March, J. G. Exploration and exploitation in organizational learning, Organization Science 2 (1991): 7187.
8. Connelly, B. L., Certo, S. T., Ireland, R. D., and Reutzel, C. R. Signaling theory: A review and assessment, Journal of Management 37 (2011): 3967; Semadeni, M., and Anderson, B. S. The followers dilemma: Innovation and imitation
in the professional services industry, Academy of Management Journal 53 (2010):
11751193.
9. Dewar, R. D., and Dutton, J. E. The adoption of radical and incremental innovations, Management Science 32 (1986): 14221433.
10. Semadeni and Anderson, The followers dilemma.
11. Connelly et al., Signaling theory.
12. Stiglitz, J. E. Information and the change in the paradigm in economics,
American Economic Review 92 (2002): 469.
13. Spence, M. Job market signaling, Quarterly Journal of Economics 87 (1973):
355374; Spence, M. Signaling in retrospect and the informational structure of
markets, American Economic Review 92 (2002): 434459.
14. Spence, Signaling in retrospect.
15. Connelly et al., Signaling theory, 43.
16. Kirmani, A., and Rao, A. R. No pain, no gain: A critical review of the literature on signaling unobservable product quality, Journal of Marketing 64 (2000):
6679.
17. Connelly et al., Signaling theory.

Making Sense of a Competitors Innovation

21

18. Ross, S. The economic theory of agency: The principals problem, American Economic Review 63 (1973): 134139; Certo, S. T. Influencing initial public
offering investors with prestige: Signaling with board structures, Academy of
Management Review 28 (2003): 432446.
19. Lange, D., Lee, P. M., and Dai, Y. Organizational reputation: A review,
Journal of Management 37 (2011): 154.
20. Ocasio, W. Towards an attention-based view of the firm. Strategic Management Journal 18 (Special issue, Summer 1997): 187206.
21. Semadeni and Anderson, The followers dilemma.
22. Fein, A. J., and Anderson, E. Patterns of credible commitments: Territory
and brand selectivity in industrial distribution channels, Journal of Marketing 61
(1997): 1934.
23. Lumpkin, G. T., and Dess, G. G. Clarifying the entrepreneurial orientation
construct and linking it to performance, Academy of Management Review 21 (1996):
135172.
24. Banbury, C. M., and Mitchell, W. The effect of introducing important incremental innovations on market share and business survival, Strategic Management
Journal 16 (1995): 161182.
25. Porter, M. E. Towards a dynamic theory of strategy, Strategic Management
Journal 12 (1991): 95117.
26. Semadeni and Anderson, The followers dilemma.
27. Lee, H., Smith, K. G., and Grimm, C. M. The effect of new product radicality and scope on the extent and speed of innovation diffusion, Journal of Management 29 (2003): 753768.
28. Ibid.
29. Semadeni and Anderson, The followers dilemma.
30. Ibid.
31. There are other ways to operationalize market competency; for example,
relative market share, with greater competency attributed to the firm with the
largest share. We suggest that operationalizations of market competency may be
industry specific, and prospective imitators may wish to evaluate market competency congruent with the most salient measure in their respective industry. Furthermore, it may also be appropriate in the case of highly diversified firms, such
as GE or Berkshire Hathaway, to ignore the corporate level and focus instead at
the business unit level for determining market competency. This is because very
high levels of diversification may obscure demonstrable competencies at the segment level.
32. Kogut, B., and Zander, U. Knowledge of the firm and the evolutionary
theory of the multinational corporation, Journal of International Business Studies 24
(1993): 625645.
33. Berman, S. L., Down, J., and Hill, C.W.L. Tacit knowledge as a source of
competitive advantage in the National Basketball Association, Academy of Management Journal 45 (2002): 1331; Semadeni and Anderson, The followers dilemma.
34. Semadeni and Anderson, The followers dilemma.
35. Banbury and Mitchell, The effect of introducing important incremental
innovations.
36. Semadeni and Anderson, The followers dilemma.

22

Strategic Management in the 21st Century

37. Van de Ven, A. H. Central problems in the management of innovation,


Management Science 32 (1986): 590607.
38. Semadeni and Anderson, The followers dilemma.
39. Lee et al., The effect of new product radicality.
40. Lieberman, M. B., and Asaba, S. Why do firms imitate each other? Academy of Management Review 31 (2006): 366385.
41. Notice the term here is differentiation advantage, and not competitive advantage. We do not mean to imply that pursuing radical innovation will automatically lead to a competitive advantage through a lack of imitation; such advantage
would be predicated on market acceptance of the radical innovation.
42. Abrahamson, E. Management fashion, Academy of Management Review 21
(1996): 254285.
43. Fligstein, N. The spread of the multidivisional form among large firms,
19191979, American Sociological Review 50 (1985): 377391.
44. Palley, T. I. Safety in numbers: A model of managerial herd behavior, Journal of Economic Behavior and Organization 28 (1995): 443450.
45. Lieberman and Asaba, Why do firms imitate each other.

Chapter 2

Strategic Alliances: Promise,


Perils, and a Roadmap to Success
C. Jay Lambe and
Aaron Hayden

Strategic alliances are collaborative business efforts between two or


more firms in which the firms combine their resources to achieve mutually compatible goals that could not be easily achieved by any firm
alone.1 They represent an interfirm alternative for companies that wish
to pursue strategic business opportunities that would be difficult (if not
impossible) to successfully undertake on their own.2 Strategic alliances
are of considerable interest to both executives and researchers for two
important reasons. First, because firms increasingly employ them to facilitate strategic outcomes, alliances have a vital impact on the business
performance of the majority of firms.3 For example, in the mid-2000s,
30 percent of the revenues of large firms were produced through strategic alliances, with such revenue having an annual growth rate of
25 percent and an estimated total value of $40 trillion.4 Second, despite
the substantial strategic impact of alliances on firm performance, many
gaps still exist regarding the factors that drive alliance performance,
as a result of the considerable organizational complexity of strategic
alliances.5

24

Strategic Management in the 21st Century

OVERVIEW: ALLIANCE CONCEPTS AND TERMINOLOGY


The chapter begins with an overview of alliance concepts and terminology that will act as the foundation on which the rest of the chapter
will build. Within the study of strategic alliances, one can find a mix of
views regarding terminology and the definition of concepts. This chapter presents definitions that are generally well accepted within the field.
The topics discussed apply not only to business firms but also to a wide
variety of organizations including nonprofit organizations.
Strategic alliances, as noted earlier, are joint efforts between two or
more firms in which the firms combine their resources to achieve mutually compatible goals that the companies would find difficult to achieve
alone. A key distinguishing characteristic of alliances is the degree to
which there is a need for a collaborative working relationship between
firms. Hence, when interfirm endeavors require close collaborative relationships as opposed to those that are at arms length or guarded in
nature, a wide variety of different types of (formal and informal) business relationships may be classified as alliances. Examples include joint
ventures, outsourcing partnerships, strategic purchasing arrangements,
a variety of research and development consortia, and complex technology licensing agreements.
Resources (in both firm and alliance contexts) are commonly defined
as intangible or tangible entities (e.g., a capability or physical asset)
available to a firm to employ in marketplace competition.6 Examples of
intangible resources include assets such as brand equity, organizational
culture, and knowledge possessed by employees. Examples of tangible
resources include assets such as capital, IT hardware/software, buildings, and other physical facilities.
Alliance business outcomes (i.e., outcomes that determine alliance performance) are often measured by an index of metrics that capture the
multidimensional aspects of one or both of the following broad types of
outcomes:7
Profit Performancethe degree to which the alliance business efforts
generate a sufficiently high and growing level of profits for the
partner firms.
Alliance Competitive Advantagesthe degree to which the strategic
alliance has achieved or developed advantages in its arena that
cannot be matched by competitors.
Alliance relationship refers to the working relationship between alliance partners and plays a critical role in alliance performance. In general, relationships that facilitate superior alliance performance and
outcomes are characterized by the existence of high levels of a number

Strategic Alliances

25

of key variables. Three of these variables are trust, commitment, and cooperative norms.
Trust can be thought of as a willingness to rely on an alliance partner.8 This is a critical aspect of the alliance relationship as there are
many important aspects of a partners behavior that a firm cannot observe. Without a sufficient level of trust, firms are less likely
to feel that they can rely on a partner, which in turn reduces the
degree of close collaboration among the partner firms.
Commitment is an alliance partners belief that an alliance is important enough to justify maximum (or even substantial) efforts to
maintain the alliance. In other words, a committed party believes
the alliance is worth working on and investing in to ensure that it
is successful and endures.9
Cooperative or relational norms form a social governance mechanism
or social contract based on the partners belief that a joint expectation guides each partner to behave in a manner that is mutually beneficial and supportive.10 The degree to which cooperative
norms emerge and exist is strongly influenced by the degree to
which sufficient levels of alliance partner trust and commitment
exist.
Alliance relationship phase refers to the evolution of functional alliance relationships (and their characteristics of trust, commitment, and
cooperative norms) over time.11 Phases are descriptive of the alliances
current value-creation performance and potential, and the strength and
certainty of the relationship between alliance partners. Phases occur in
one manner or another in all alliances, regardless of whether the alliance
is a formal or informal arrangement. It has been found that alliance partner interactions develop the relationship over time as positive social and
business outcomes take hold. These create deep, noncontractual mutual
dependence between the partners that bind them to the alliance, and
lead to further increases in commitment to the alliance. Through interactions over time, partners develop relationship norms that guide them to
think of each other as part of the same team, and to work toward common goals and mutual benefits.
Through partner interactions over time, the alliance relationship
passes through initial relationship development milestones (or, phases)
of exploration and expansion, before entering the commitment phase
during which relational exchange attributes are acute and highly developed. Relationships develop to reach the maturity phase during which
commitment to the exchange partnership is at its highest. Mature relationships eventually pass through phases of decline and deterioration. It
is important to note that the process of decline can be reversed. Alliances

26

Strategic Management in the 21st Century

can reenter earlier phases as alliance partners find new, attractive opportunities to employ their complementary resources, and/or find ways
to address issues that may have damaged the relationship. A summary
of the five phases of the alliance relationship is as follows:12
Exploration: Partner firms discover and test goal compatibility, integrity (trustworthiness), and mutual performance, as well as potential
obligations, benefits, and burdens involved with working together
on a long-term basis. Generally, small, initial joint efforts/projects
take place that enable partners, in a learning by doing process,
to evaluate each other. It is not usual in this phase for alliances to
create value for their firms, value creation being limited due to the
process of discovery and trial and testing.
Expansion (buildup): Partner firms receive increasing benefits from
the relationship, and a sufficient level of trust and satisfaction has
been developed that they are more willing to become committed
to the relationship (and its expansion) on a long-term basis. Value
creation is much more significant than in the exploration phase.
Maturity: Partner firms are now in an ongoing, long-term relationship
in which they each receive high levels of satisfaction and benefit
from the relationship, and are firmly committed to its continuance.
Value creation is at or near its highest levels during this phase.
Decline: One or more of the alliance partners has begun to experience
significant dissatisfaction, are contemplating relationship termination, considering alternative partners or business arrangements,
and/or beginning to communicate intent to end the relationship.
Deterioration: Partners have begun to negotiate terms (formal or
informal depending on the formality of the alliance) for ending the
relationship, or are in the process of dissolving the relationship.
Benchmarks are employed by many firms to determine relationship
phase and the ongoing fit and health of their alliances.13 For example,
in the pharmaceutical industry, Eli Lillys Office of Alliance Management uses data, gathered from both their own and their partners organizations, to create an index of alliance characteristics that gives them a
sense of alliance phase.14 The specifics of the metrics Eli Lilly employs
are, understandably, proprietary, but it is known that they assess alliance
development and value-creation health on both hard metrics of relationships such as alliance performance and goal alignment, and soft metrics
such as trust, fairness, and leadership.
Interimistic alliances are an important and prevalent type of alliances
that are interim in nature. Interimistic alliances are close, collaborative, fast developing, and (often) very short lived, in which partner
firms pool their resources to address a fleeting, but critical, business opportunity or threat.15 They exist in many industries, but are especially

Strategic Alliances

27

prevalent in high technology (including biotechnology) and/or outsourcing due to short product and exchange relationship lifecycles.16
The pace of technological change often requires a rapid alliance (rather
than go it alone) R&D/new product development response to immediate threats posed to firms existing product lines, and/or short-lived
opportunities for competitive edge and associated revenue growth. A
sense of the rapid response required and the fleetingness of the mission is provided by a senior director at Microsoft who said, I used to
tell people that Internet years were like dog years. These days I feel as
if Internet months are like dog years. The rate of change is stunning.17
Interimistic alliances are often formed at short notice (and frequently
with partners with whom the firm has little or no experience), must
produce immediate results, and are expected to end quickly (whether
successful or not) since they often have a very specific mission. In the technology arena, there have been numerous rapidly formed, time-pressured,
collaborative, and short-lived R&D or new product development alliances going back as to the 1980s.18 For example, the rapid transformation of the payments industry that resulted from the unleashing of the
Internet prompted both technology firms (e.g., Microsoft and IBM, and
start-up firms such as CyberCash, now part of PayPal), and payments
firms (e.g., MasterCard and Visa), to form portfolios of quickly developed, collaborative payments-technology alliances that were expected
(successful or not) to be short lived, as they were intended to guide
rapidly evolving technology standards/practices in the industry.19
Networks are often characterized in an alliance context as business relationships (which can also involve other alliances) that alliance partners have with firms or organizations outside the alliance. Given the
scope of this chapter, the only aspect of networks to be covered in detail
is network effects.
Network effects are the relationship and performance impacts an alliance has on each partner firms respective network. Network effects are
an important consideration because (1) an alliance can significantly impact the business performance of other business relationships partners
have with firms outside the alliance, and (2) each partners business relationships with firms outside the alliance can significantly impact their
relationships with each other as well as the business performance of
the alliance. Measures of a networks effects are sometimes employed
by firms to gauge the degree to which an alliance has a positive or negative impact on the business performance of its own network of business
relationships. For example, Eli Lillys Office of Alliance Management
tracks and assesses not only the performance of an alliance with respect
to its primary operations, but also the impact the alliance has on other
alliances within the Eli Lilly network.20
If the measurement of network effects leads a partner to conclude
that the alliance has a positive overall impact on its network business

28

Strategic Management in the 21st Century

performance, the partners commitment to the alliance will be strengthened, as such an outcome (even if it is considered to be indirect) provides another indication that the alliance is creating value for partner
firms. Conversely, if the partners assessment is that the alliance has
a negative impact on the performance of its network, this will understandably dampen their commitment to the alliance. The magnitude and
direction (positive/negative) of an alliances network effects on the partners network performance are influenced by a number of factors. These
generally fall into one of three categories:21
Resource transferability: The extent to which the alliances resources
can also be employed by other business relationships in the partners network.
Activity complementarity: The degree to which the efforts of the alliance complement the efforts of other business relationships in the
partners network.
Collaborative attractiveness: The extent to which the alliance sends
positive or negative signals to firms in the network about the partners business relationship attractiveness. This can be characterized in terms of (1) the partners ability and inclination/tendency
to have cooperative and mutually beneficial business relationships
with other firms, and (2) the attractiveness that results from the
potential for other firms in the alliance to also form rewarding
business relationships with firms in its network.

CROSS-BORDER (INTERNATIONAL) ALLIANCES


AND CULTURAL DIFFERENCES
When an alliance involves partner firms from different countries, it is
often referred to as a cross-border or international alliance. It has been
argued that the fundamental mechanisms and considerations that determine alliance performance/success are similar regardless of whether
an alliance is cross-border or within border. However, it is important
to note that the cross-border context of an alliance can bring into play
a number of cross-border contextual considerations that might impact
the influence of fundamental mechanisms of alliance performance/
success.22 Though it is beyond the scope of this chapter to give detailed treatment of all such considerations, one particular consideration
is the cultural differences that exist between countries/regions of the
world. These can impede effective cross-border cooperation between
firms, and can have implications for the degree of reliance placed
on various mechanisms firms use to make alliances work. For example, cultural differences in attitudes toward formal contracts have

Strategic Alliances

29

implications for how contracts are used, and to what degree they can be
relied upon.
THE RESOURCE-BASED MOTIVATION
FOR FIRMS TO ENGAGE IN ALLIANCES
Given the definition of strategic alliances provided earlier, it is clear
that resources are a critical consideration when considering entry into
an alliance and with regard to alliance relationship dynamics and performance outcomes. In general, there are two broad types of resources
that partners bring to an alliance: complementary resources and idiosyncratic resources. Complementary resources are those that eliminate
deficiencies in each firms individual portfolios of resources, and thus
enhance each others ability to achieve business goals by supplying
distinct capabilities, knowledge, or other assets.23 For example, in 1997
Cargill and Dow formed an alliance to develop and commercialize plastic made from corn that could be used as a replacement for plastic produced from traditional petroleum feedstock.24 The resource that Dow
needed but lacked (and that Cargill possessed) was technology related
to the production of lactic acid and polylactic acid. Conversely, Cargill
needed but lacked the market access that Dow possessed. By pooling
their respective resources, Dow and Cargill were able to eliminate deficiencies in each others individual portfolios of resources, and achieve
business goals that would have been difficult for either firm to achieve
alone. It is important to note, however, that complementary resources
are a necessary but not sufficient condition for alliance success. To extract the competitive advantage potential of complementary resources,
an alliance must also develop idiosyncratic resources.
Idiosyncratic resources are often defined as those that are developed by alliance partners through the process of synthesizing (or combining) the complementary resources that the partner firms bring to
the alliance.25 More precisely, they possess all of the following characteristics: (1) they are developed by the partners during, and for, the
alliance, (2) they are unique and specific to the alliance, and (3) they
are required to facilitate the combination and use of the distinct complementary resources that are brought to the alliance by each of the
partner firms. Idiosyncratic resources may be either tangible (e.g., a
joint-manufacturing facility) or intangible (e.g., a common customer
service routine).
Idiosyncratic resources play a vital role in enabling an alliance to leverage the value-creation potential of the complementary resources that
partner firms bring to the alliance. Consider the example of an airline alliance whose goal is to provide passengers with seamless travel. Though
the partner airlines may have the necessary complementary capabilities

30

Strategic Management in the 21st Century

to serve the different geographic regions traveled to by each airlines


customers, the alliances ability to provide the seamless travel desired
by their customers would require the development of idiosyncratic systems to effectively integrate the complementary capabilities. Complementary capability in this example is characterized by the independent
route networks served by each airline that exist pre-alliance. A customer
could book two tickets and use each airline for different segments of the
journey. However, in the context of an alliance, this would not provide
passengers with much advantage or provide competitive advantage to
the partner airlines. To leverage their complementary capabilities and
provide truly seamless travel, the partners would need to develop idiosyncratic resources such as joint customer service offerings that take service inquiries regardless of airline, specialized IT investments to provide
a common Internet interface between individual IT platforms, revenuesharing processes, and joint training of sales and service personnel on
both airlines product/services and procedures. These idiosyncratic
capabilities would not only be specialized resources developed by the
partners, during and for the alliance, but since they are highly specific
or idiosyncratic, they would be difficult to redeploy outside the alliance.
The magnitude of partner investments to develop idiosyncratic resources will depend on the complementary resources the partners bring
to the alliance.26 High degrees of resource complementarity provide incentives to invest in the development of idiosyncratic resources since
they increase the likelihood that further investments in idiosyncratic resources will result in creating competitive advantage.27 This is a critical observation since idiosyncratic investments are usually quite costly.
Consider, for example, the cost of system integration required to provide
the seamless travel experience in the airline alliance example. Moreover,
the motivation to build and maintain the alliance will, over time, become more and more tied to the partners increasing investments in idiosyncratic resources. There are two explanations for this. First, since
idiosyncratic investments are of little value if the alliance were to end,
they create a mutual dependence that motivates the partners to make
the alliance work and endure. Second, as partners increase their investments in idiosyncratic resources, they also increase their ability to integrate and exploit each others individual complementary resources. This
allows the alliance to extract more of the potential competitive advantage offered by the pooled complementary resources.28 This aspect of
increasing partner investments in idiosyncratic resources creates a more
positive partner dependence that provides the partners with a profitmaking motivation to make the alliance work and endure.
To further impart competitive advantage, idiosyncratic resources
should be unique to the alliance and constantly evolve to help maintain
the sustainability and inimitability of the alliances resource advantage,
both of which are promoted by increasing levels of joint investment.29

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31

All else equal, ongoing investment in the development of idiosyncratic


resources provides the alliance with resource advantages that are difficult for competitors to replicate, and certainly not without requiring
a substantial amount of time to do so. Even if competitors knew the
secrets behind an alliances idiosyncratic resource advantage (a highly
unlikely assumption), they would still have to overcome so-called time
compression diseconomies associated with attempting to replicate the
advantage.30 In other words, most idiosyncratic resource capabilities
can only be developed effectively through painstaking efforts over long
periods of time. Competitors that use accelerated efforts to try to capture similar resource outcomes are likely to both incur greater costs than
if the investments/effort were made over a longer period of time, and
achieve results that are less effective than those of the alliance they are
attempting to mimic.31
MAKING ALLIANCES WORK: GOVERNANCE OF ALLIANCES
There are a significant number of mechanics to consider in building
successful alliances. The focus here will be on how to make an alliance
work (i.e., achieve or exceed the partner firms goals) assuming an alliance possesses, prior to its formation, the necessary resource potential
for success. One crucial factor is having a set of mechanisms that ensures
partners fulfill their obligations to each other, and work cooperatively toward mutually beneficial outcomes. These can be thought of as governance mechanisms. Governance mechanisms reduce uncertainty between
partners and inhibit self-interest seeking by one partner at the expense of
another.32 Three key governance mechanisms are contracts, noncontractual mutual dependence, and a partner relationship based on cooperative
norms. It has been suggested that reliance on only one of these forms of
governance does not sufficiently ensure a successful alliance as each has
inherent weaknesses. It is thus ideal for an alliance to utilize multiple governance mechanisms.
Contracts (and contractual dependence) are based on a formal, legal
document that defines the roles, responsibilities, and obligations of each
partner. A contract provides a legal safeguard against a lack of cooperation and actions motivated by self-interest.33 Partners that do not fulfill
contractual obligations may pay a heavy price through the legal system. A
contract thus creates a form of obligation dependence that often motivates
cooperation and concern for mutually beneficial outcomes. However, contracts have inherent weaknesses that make them an insufficient form of
alliance governance when used on their own.34 First, it is impossible to
write a complete contract, and the more complex the business situation,
the less complete a contract will be.35 Second, the exercise of contractual
power often (if not usually) results in negative consequences as it tends to
create ill-will between partners. This often leads to retaliatory actions that

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Strategic Management in the 21st Century

damage the partners working relationship and the performance of the alliance. At the very least, the exercise of contractual power is not conducive
to building a relationship between partners that is characterized by trust,
commitment, and a belief that cooperative norms exist. Indeed, it has been
noted that once the contract is referred to, the relationship is dead.36
The preceding quote urging caution about the exercise of contracts has
been attributed to James R. Houghton, former chairman of Corning and
considered to be an early alliance visionary at Corning. The point was not
that having contracts per se is detrimental to effective alliance governance
(indeed, contracts represent a safety net if all else fails). Rather, it was that
one should apply caution since contracts can signal a lack of a cooperative
spirit and trust that can irreparably damage perceptions that relational
norms exist. This will make effective alliance governance more difficult as
the strength of the relationship between alliance partners is arguably the
most critical alliance governance mechanism. On this point there is strong
consensus. For example, Kenichi Ohmae, an expert on alliances at McKinsey Consulting, points out that Good partnerships, like good marriages,
dont work on the basis of ownership or control. It takes effort and commitment and enthusiasm from both sides if either is to realize the hopedfor benefits. You cannot own a successful partner any more than you can
own a husband or a wife.37 Ben Gomes-Casseres, a scholar on alliances,
further notes that there is value to being flexible with partners and taking
a dynamic approach to managing alliances:38
Just as the broader strategy is more important than the individual
deal, so too the evolution of the relationship over time is more important than the initial deal. Automobile companies today are discovering this fact as allies try to use alliances to rationalise their global
operations. Renault and Nissan, DaimlerChrysler and Mitsubishi,
Ford and Mazdaeach pair is trying to integrate its supply chains,
share technology, and produce expensive components jointly. Doing
so requires much more than signing a deal for part-ownership or
for a joint venture. It requires close planning, continual adjustments,
and deep relationships among partner organisations and managers.
The reason why this kind of post-deal management is so important
is that alliances by their very nature are open-ended and ever changing. If all the terms between two companies can be specified and
agreed at the outset, there is no need for an alliance; a contract will
do. A true alliance is an organisational structure that enables control
over future decisions to be shared and that governs continual negotiationsit is recognition that the initial agreement is incomplete.
That is why success in alliances depends so much on governance
structures and on the relationship between companies, including
personal relationships between managers.

Strategic Alliances

33

When structuring cross-border alliances and considering the use of


contracts, it is particularly important to take cultural factors into account.39 For example, executives at firms in Western countries have often
had the notion that companies in some Asian countries tend to expropriate intellectual property. This fear leads Western firms to attempt to
employ elaborate legal safeguards, which, if care is not taken, can unwittingly create a climate of distrust. This can be particularly damaging
given the importance individuals in some Asian cultures place on relationships as a governance mechanism. For example, the entrepreneurial
tradition in China is built around close family ties, and is based in large
part on a lack of faith in legal systems. The importance of the relationship as a governance mechanism can also heighten cultural differences
in attitudes toward ownership, intellectual property, and the enforcement of laws. In some countries, firms should not expect that contracts
will be strongly and enthusiastically enforced, if enforced at all.
Noncontractual mutual dependence is a reasonably symmetric dependence that partners have on each other based on the potential costs that
would be incurred if the alliance ended prematurely or failed.40 There are
two types of such cost, nonrecoverable real costs and opportunity costs.
Real costs: These are transaction-specific investments that partners
make in an alliance that represent a potential, nonrecoverable, real cost
should the alliance end prematurely or fail, as they are specific to the alliance (i.e., nonfungible) and would be lost if the alliance were to end.
For example, idiosyncratic resources represent mutual, transactionspecific investments in the alliance; thus they would be lost, or at least
significantly nonrecoverable, if the alliance ended prematurely or failed.
A partners investments in relationship-specific assets increase the costs
of prematurely terminating the alliance as the firm stands to lose their
investment. If investments are both substantial and mutual, they create
significant mutual dependence on the continuation and success of an alliance. Such dependence motivates partners to act in a nonopportunistic
manner, and to cooperate to ensure a collaborative relationship that will
promote the success and continuation of the alliance.41
Opportunity costs: Opportunity costs that could be incurred if an alliance were to end prematurely or fail will be a significant consideration
to partners if the alliance were formed based on extensive and reliable
due diligence indicating that the firms complementary resources held
significant potential for competitive advantage. Early in the life of an alliance, partner firms often already feel a strong sense of interdependence
that motivates cooperation to reduce the risk of missing out on the profit
and/or strategic benefit potential of the alliance. As the alliance develops over time and its value-creation capabilities increase and become
more certain, the mutual dependence of the partners will also increase.
The partners will increasingly recognize the opportunity costs should

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Strategic Management in the 21st Century

the alliance end prematurely or fail. They will thus be increasingly motivated to build and maintain a collaborative relationship that will further
facilitate alliance success.42
Whether based on real or opportunity costs or both, noncontractual
mutual dependence motivates partners to work in ways that are beneficial to the alliance even when they might be tempted to do otherwise. Research has also shown that alliances with a significant degree
of asymmetric dependence among partners results in power imbalances
that often lead to unstable and underperforming alliances.43 Consider
for example the alliances that General Motors (GM) had with suppliers
in the 1990s.44 GM held far more power in these alliances than its suppliers since it accounted for a large percentage of most of its partner suppliers annual revenues. Since these were partnerships, it was still critical
that GM act in a manner that would maintain a climate of collaboration.
In the early 1990s, however, GMs purchasing organization, led by Jose
Ignacio Lopez de Arriortua, started to take a hard line in price negotiations, using its purchasing power to, in essence, squeeze many partner
suppliers. While this initially resulted in significant cost savings for GM,
it also had a devastating effect on its suppliers, and, as a result, damaged
(in some cases, irreparably) relationships GM had with some of its partners. Understandably, GMs exploitation of the power imbalance led to
supplier resentment and ill-will, leading to some partners defecting and
many underperforming alliances. This ultimately diminished or eliminated any initial price savings to GM. When asked about some of the
costs associated with these damaged relationships, one automotive consultant stated, I dont know of any major supplier who will take a new
design to GM today, because, in the end, GM will give it to the lowest
bidder. When you shut down that innovation spigot, you get a product
that is less competitive.45
Despite its effectiveness as an alliance governance mechanism, it
should be noted that noncontractual mutual dependence is, on its own,
an insufficient form of alliance governance. Business opportunities and
needs constantly evolve, and as a result, levels of dependence can fluctuate significantly enough to create significant asymmetric dependence.46
Having a contract to define such parameters as responsibilities and revenue sharing can help to balance partner dependence and act as a safety
net should shifts occur in the nature of the noncontractual dependence.
A partner relationship based on cooperative norms (or relational norms) has
been shown to facilitate a close collaborative relationship and alliance success.47 Cooperative norms represent a relational or social contract that has
developed between partners over time and through their history of interactions with each other. This jointly informs and guides partner behavior
within the alliance. These norms are based on the mutual belief that a common understanding and expectation exists, and that governs each partners
behavior to be mutually beneficial and supportive.48 In such relationships,

Strategic Alliances

35

the enlightened (but not nave) partners do not view the alliance as an
adversarial zero sum game with respect to the split of alliance benefits and
profits, but as an opportunity to expand the benefits/profits for all partners
by working together in mutually supportive ways. The development of cooperative norms is strongly influenced by the degree to which the firms and
their alliance managers possess skills and exhibit behaviors that facilitate
interfirm teamwork and coordination that is motivated by a desire to expand positive business outcomes for all parties involved.49
A relationship based on cooperative norms not only creates noncontractual mutual dependence, but it also can address critical governance
shortcomings that might arise when contracts or noncontractual mutual
dependence alone are used as governance mechanisms. In the case of
contracts, cooperative norms can address the inherent shortcomings of
incomplete contracts.50 A relationship between alliance partners that is
based on the cooperative norm that the partners will work together and
be flexible may result in mutually acceptable solutions to differences and
disagreements that cannot be captured in a contract. Indeed, partners that
enjoy such a relationship tend not to consider a binding formal contract to
be a governance option even if one exists. A partners referral to a contract
when disagreements arise also represents an exercise of power that often
causes ill-will and conflict between partners. This frequently damages a
formerly cooperative relationship and leads to diminished alliance performance if not failure of the alliance. Cooperative norms can also be used to
address changes in the balance of noncontractual mutual dependence that
can occur during the life of the alliance, and be helpful when it is difficult
to gauge mutual dependence. Cooperative norms encourage partners to
take a long-term stewardship approach to overcoming periodic fluctuations in mutual dependence, and can motivate continued efforts to achieving mutual benefit and addressing potential conflict.
A relationship based on cooperative norms is not in itself a sufficient
form of governance since the relationship may not always hold. Alliance
managers or other individuals central to the alliance can change. As a result, there may not always be individual relationships where cooperation
is considered the norm. Furthermore, issues related to interpersonal dynamics and managerial skills can lead to damaged relationships or to reduced confidence that a climate of cooperative norms exists. In such cases,
contracts and noncontractual mutual dependence can act as a safety net to
ensure continued cooperation as well as serve as the last line of defense to
protect partners interests in the alliance.51
A SPECIAL NOTE ON RELATIONSHIP
DEVELOPMENT IN INTERIMISTIC ALLIANCES
As with all alliances, a prerequisite of a functional, and ultimately successful interimistic alliance is the partners development of a sufficiently

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Strategic Management in the 21st Century

close working relationship (i.e., trusting and collaborative rather than


arms length). Until a firm feels certain about a partners intentions, future
behavior, and commitment to the alliances success, a collaborative relationship is impossible to achieve. Such a relationship requires the firm to
be confident in the partners reliability as collaboration requires not only
expensive outlays of scarce firm resources, but also the sharing of valuable proprietary information which, if compromised or expropriated by a
partner, can damage a firms competitive advantage. With interimistic alliances, however, it is important to understand a few critical differences in
the partners approach to alliance relationship development.
In noninterimistic alliances, the sufficient emergence of key relational
attributes such as trust is highly influenced by the history of partner interactions in the alliance over a substantial period of time.52 An extended history of interactions allows partners to make judgments about how much
they can trust and rely on each other. If the interactions are consistently
positive, this history will be a powerful facilitator of a close and collaborative working relationship. In interimistic alliances, however, time constraints lead to a far less substantial history of partner interactions; thus
this history exerts less influence on relational perceptions than it does in
noninterimistic alliances. A key question is thus: how can sufficient levels of relational attributes, such as trust, be developed absent a substantial history of partner interactions in the alliance? The answer is that
partners are forced to rely more on structural, or quickly provided, credible evidence of relational intent and likely future behavior, than on
consistent, behavioral evidence provided over an extended period of
time. Such credible evidence that partners can have in place upfront or
early in the alliance can include (1) positive signals of relationship intent based on a partners alliance specific investments (i.e., significant,
nonfungible investments that would be lost if the alliance were to end),
(2) environmental incentives for firms to cooperate in the alliance, (3) a
partners reputation for fairness (an asset that in the world of alliances, firms
are financially motivated to protect), and/or (4) significant pre-alliance
interactions the partner firms had in dealings outside of the alliance.53
Microsofts alliance with WebTV illustrates how environmental conditions can motivate an interimistic alliance despite the lack of a history of partner interactions. It was based largely on substitutes for real
trust that came in the form of mutual recognition of an opportunity,
and resource interdependence in an industry that was quickly evolving due to the convergence of TVs and PCs.54 In contrast, Corning has
been able to develop cooperative alliances quickly when needed due to
their reputation for fairness. This gives partners, pre-alliance, significant
reason to believe they can rely upon Corning to be fair.55 The alliance between IBM and Toshiba to develop advanced display technologies was
driven by mutual confidence in each others collaborative intent based

Strategic Alliances

37

on substantial nonalliance dealings rather than on their history of interactions in the alliance in question.56
In industries such as the biotechnology and high-technology industries where many interimistic alliances exist, an almost clan-like culture
has emerged amongst firms that allows managers to move from company to company, and, importantly, bring with them experiences, expectations, and contacts. As a result, there exists an almost incestuous set of
linkages among executives who have worked together in the past, and
have left to either work for other Silicon Valley firms or form start-ups.
Needless to say, this environment often provides a rich set of pre-alliance
interactions that managers and firms can rely on when needed to act as a
substitute for trust developed through the alliance in question.57

MAKING ALLIANCES WORK: ALLIANCE


CAPABILITY AS A CORE COMPETENCE
Ensuring that resources and relationships are sufficiently developed
so as to achieve alliance success is a difficult and complicated task. If it
were easy, the percentage of alliances considered to be successful would
be much higher. A critical question is thus: how can partner firms enhance
the degree to which alliance success factors are developed and maintained? The answer is that firms must make a substantial and ongoing
effort to develop their ability to effectively deploy and manage alliances.
Furthermore, given the strategic nature of alliances, some have argued
that all firms should view alliance capability as a core competence.
That an alliance capability can and should be viewed as a core competence is suggested by empirical research that reveals that firms that tend
to outperform their peers are superior at finding, developing, and managing alliances.58 Alliance capability does not guarantee alliance success
but does significantly increase the degree to which such firms are successful in their alliance efforts. It also appears to increase overall performance, including the stock price performance of publicly held firms.59
Alliance competence has been argued to comprise a sufficiently high
degree of three key elements of alliance capability: alliance experience,
alliance management skill, and the ability to identify/secure alliance opportunities. Corning, Hewlett-Packard, and Eli Lilly are three examples
of firms that both possess these dimensions of alliance competence, and
have been noted for the alliance success that results from it.60
Alliance Experience
Though firms are well served by taking advantage of literature, books,
and training programs, much of the requisite knowledge required to develop alliance competence must be acquired from experience. It is important

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Strategic Management in the 21st Century

for firms without alliance competence to recognize that developing such


competence requires failure in some early attempts at alliances, and that
this failure will comprise a key part of their learning. To this end, firms
early attempts with alliances should be of relatively low importance, modest, and uncomplicated. With increasing experience and knowledge of
best practices, firms can then take on more ambitious alliances.61
To effectively leverage alliance experience, firms must develop a
knowledge and skill infrastructure. This is the institutional memory, in
the form of a repository of lessons learned and best practices, that facilitates the growth of a firm-wide alliance competence. For example, a
business development manager at Hewlett-Packard said that for each
alliance, we hold a postmortem with all the involved (HP) parties. We
look at the original objectives, the implementation, what went right
what went wrong.62 This information then goes into a written management briefing, and subsequently an alliance database. Hewlett-Packard
thereby uses its alliance experiences to create a knowledge resource that
helps the entire organization. It should be noted that effective investments in alliance experience can constitute a competitive advantage that
is fairly unique and hard for competitors lacking similar investments to
imitate. It has been shown that firms who attempt to quickly develop alliance capabilities are in general less successful than those that thoughtfully develop required levels of alliance experience over a period time.63
Alliance Management Skill
Firms do not manage alliances, rather this is the role of alliance managers and an alliance management group within firms.64 Firms that wish
to develop alliance competence must therefore build the capability of
alliance managers. This is vital because alliance managers are responsible for the most important human interactions between alliance partners, and thus set the tone with respect to relationships and the degree
to which a climate of cooperative norms exists. It is these managers who
are most directly involved in the planning and navigation of the mechanics and processes of the alliance, as well as being most intimately involved in ensuring that roles and responsibilities are clearly spelled out
and mutually agreed upon. They are also responsible for assessing, on
an ongoing basis, the fit of the mission and processes of the alliance with
a changing environment, and for making modifications as necessary.
Since alliance managers are the face of the collaboration and the
focus of the firms alliance efforts, it is not surprising that firms that
have better-than-average alliance success also have highly skilled alliance managers.65 Research suggests that competent alliance executives
possess several key attributes. In particular, they have the emotional
intelligence required to relate to others, and a full range of leadership
and managerial acumen.66 Research has also explored the role of alliance

Strategic Alliances

39

management with respect to the differing requirements of prescribed


and emergent structures. Managers must address the thorny question
of how to reconcile the demands of both the formal and the evolving/
emerging network.67 Given the evolving nature of alliances, effective alliance management thus requires that managers be flexible and possess
the ability to work outside well-defined and/or prescribed routines.
They should also be able to leverage persuasion and influence within
the emergent social network of the alliance.
Research on alliances points to the criticality of social bonds and the
central role they play in the development of an alliance and in its ongoing ability to create value and endure. Management by fiat will simply
not work and is indeed a recipe for alliance failure. Since alliance management must span the boundaries of independent partner firms, managers of the respective firms must agree to work together for there to
be effective collaboration. Moreover, compromise, influence, and trust
are key operative conditions whose emergence one cannot dictate. One
must gain a partners willing agreement on mutually compatible goals,
and jointly/collaboratively develop processes to achieve these goals. In
this context, formal contracts have, at best, a nominal effect on sustaining the relationship between partners. Indeed, studies have consistently
shown that alliance managers discount the relevance of a contract. Research indicates that relational norms and trust far more accurately reflect the strength and reality of the alliance, and its ability to hold at bay
the intrinsic instabilities that make alliances so delicate.
To successfully address the management challenges of alliances, managers must also possess strong functional skills and knowledge across
a variety of areas in addition to possessing strong interpersonal skills.
Managerial capabilities thus go beyond those required to be a competent
line manager. Indeed, research indicates that successful alliance managers are different from successful line managers.68 Due to the complexity of alliances and their management, it has been suggested that the
most effective alliance managers are those whose perspectives accentuate both learning and creativity. Further, parallels have been drawn
between the roles played by, and the requisite attributes of, successful
project leaders, team leaders and/or parallel team leaders, and those for
competent alliance managers:
[A] commitment to learning, to seek challenges, to reflect honestly
on success and failure is consistent with the suggested profile. The
successful alliance manager is the symbol of the learning organization . . . [a] life-long learner as one who is risk taking, reflective, a
careful listener, and open to new ideas.69
Finally, capable alliance managers also possess significant and systematic hands-on alliance experience. This is epitomized by Corning, a

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Strategic Management in the 21st Century

firm widely and consistently viewed as having effective alliance managers. At Corning, there has long been a realization that alliances are
both incredibly important to the company and pervasive throughout
it. As a result, Corning needs a lot of people who are good at managing these things. Senior management, who has historically been
responsible for staffing alliances, certainly knows this. Young, highpotential managers are often rotated into a joint venture very early
in their career. At first, they are likely to be in a support role, learning the special dynamics of collaboration. If they prove themselves
there, then they might get a little joint venture to run themselves.
And, if they continue to prove themselves, they could become the alliance manager representing Cornings interests on a billion-dollar
alliance.70
Ability to Identify/Secure Attractive Alliance Opportunities
Firms with alliance competence also have well-developed capabilities with respect to identifying attractive alliance opportunities.71 They
have superior processes to proactively and systematically scan the environment for potential partners with complementary resources that can
be used to develop competitive advantage through an alliance. They also
have effective capabilities to enable them to quickly and efficiently conduct due diligence to confirm partner potential with respect to complementary resources and their track record with alliances. These alliance
identification and assessment capabilities often provide the opportunity
to develop a first-mover advantage with respect to finding and securing the most attractive partners. As a result, these firms can preempt
competitors in securing scarce resources, making it even more difficult
for competitors to match the resource capabilities of their alliances. For
example, Swiss pharmaceutical companies such as Roche and Novartis
(formerly Sandoz and Ciba-Geigy) have over the years garnered significant first-mover competitive advantages due to their early identification
of and partnering with promising emergent firms in the biotechnology
sector.72 By doing so, they have been able to not only produce new drugs,
based on biotechnology discoveries, more quickly than their competitors, but by gaining timely access to these innovations, they also have
additional barrier-to-imitation competitive advantages. Their ability to
beat their competition to alliances is due largely to the emphasis they
place on processes for scanning the environment for emergent firms possessing promising new technology. Not only did they invest heavily in
biotechnology partnerships and processes (at the time, Roche, for example, was spending 50 percent, or $700 million of its basic research budget
on efforts focused outside the company), but within their firms they developed high-level biotechnology alliance czars who were in charge of

Strategic Alliances

41

processes and results. As a managing general partner of a biotechnology


venture capital fund noted about Novartis, They know about companies were starting when theyre just in the crystal ball.73
ALLIANCE CHALLENGES
Despite the seductive strategic appeal of alliances, firms that seek to
use them face substantial challenges. Not only do firms frequently report difficulties in managing alliances,74 alliances yield disappointing
returns75 and high failure rates that are reported to be up to 70 percent
in some sectors.76 For example, unexpected delays and other problems
arising from Boeings underperforming alliance to build and commercialize its 787 Dreamliner have inflicted significant damage in the
marketplace (including considerably strengthening the competitive
position of its rival, Airbus), along with billions of dollars in unanticipated losses.77 Some of the more important challenges to alliance success
include alliance complexity, organizational control/oversight issues,
and critical alliance knowledge gaps.
Alliance Complexity
Alliances involve a highly complicated form of organization as they
have both intrafirm and interfirm alliance management considerations
and processes. They often also operate as standalone businesses, structures that pose yet more management issues and complexities. Many
alliances fail due to firms insufficient knowledge about how to effectively employ, structure, and manage the alliance. Specific areas where a
lack of expertise has contributed to alliance misuse and mismanagement
include the identification and selection of qualified potential partners,
partner goal alignment and negotiation, the development of appropriate
structures and processes, alliance management (including partner firm
conflict management), and exit strategy. Even if firms are sufficiently
knowledgeable about the art and science of alliances, two other related
issues pose significant challenges; partner firms that lack sufficient alliance experience and knowledge of alliance processes will often cause
an alliance to fail despite the expertise and best efforts of more knowledgeable partners, and the complicated organizational nature of alliances often contributes to alliance failure despite all partners possessing
strong alliance-making and alliance-management skills.
Organizational Control/Oversight Issues
An often noted challenge to alliance success is the relative lack of
formal control and administrative oversight of alliance activity in

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Strategic Management in the 21st Century

comparison with the oversight of activity resulting from vertical integration. In the latter case, all activities, processes, and oversight occur within
the firm itself. Indeed, many consider the issue of control and oversight
to be the most fundamental explanation behind alliance underperformance and failure, and a significant advantage of vertical integration.78
The difficulties Boeing experienced with alliances in building the Boeing
787 Dreamliner illustrate the inherent shortcomings of alliances relative
to vertical integration with regard to control. The project has suffered
many substantial delays that have cost Boeing billions of dollars in unanticipated losses. The main cause of these delays has been insufficient
oversight and control of suppliers, which has been attributed in large
part to Boeings decision to engage in an outsourcing alliance instead
of keeping processes in-house, thereby weakening their control of key
processes.79 Representative examples of this include:80
Wachovia Capital Markets senior analyst Joe San Pietro cited contacts deep within Boeings supply chain in contending that problems with overseas suppliers are endangering Boeings aggressive
schedule to deliver the 787. He downgraded the stock.
San Pietros report said the first center wing boxthe key structural element of the center fuselage that holds the wingsdelivered
last week from Fuji in Japan to Global Aeronautica in Charleston,
S.C., was sent without the wiring, hydraulics and many of the fasteners that were to be pre-installed.
This is now requiring a scope rework between Boeing and
Global Aeronautica, as GA would be forced to become responsible
for supplying the innards, San Pietro reported.
San Pietro said Boeings other 787 partners also have fallen behind schedule, especially Mitsubishi, which is making the wings in
Japan; and Alenia, making the rear fuselage in Italy.
Alenia . . . appears to be the major culprit at this time, and we
understand that Boeing has sent an army of engineers to help get
the program back on track, he wrote.
San Pietro said he was told the suppliers are unhappy with the
costs of maintaining schedule and are demanding more money
from Boeing.
He said that, having outsourced the fabrication of most of the
787s airframe, Boeing has no internal capability to manufacture the major components so it lacks leverage to oppose such
demands.
While a lack of control is a potential shortcoming of alliances, in some
business contexts it can be an advantage of alliances (relative to vertical
integration) as a form of business organization. Specifically, evidence
from both research and practice indicate that there are business activities

Strategic Alliances

43

where less control and formalization (explicit rules/procedures to govern business activities) may benefit business outcomes. For example,
in the context of radical new product innovation, the bureaucratic controls that often accompany vertical integration may inhibit the freedom
of action and spontaneity needed for successful innovation.81 Research
suggests that high-velocity and high-uncertainty environments call for
simple routines and a reliance on people over process.82 This is why
radical innovation has typically occurred in the domain of entrepreneurial start-up ventures. These ventures reject bureaucratic systems,
processes, and the infrastructure of large established firms in favor
of flexible, discovery-based approaches to developing groundbreaking technologies and products. Indeed, the success of small, entrepreneurial start-up firms with regard to innovation provides some of the
motivation behind the popularity and growth of alliances formed to engage in radical new product innovation. Such alliances not only offer
the opportunity to partner with firms that are not constrained by bureaucracy, but the inherent limits of cross-firm/alliance governance (relative to vertical integration) constrains the ability of bureaucratic control
to be applied to the interorganizational innovation team as, naturally
and desirably, each partners influence over the other firms behavior is
marked by partial impotence.83
CONCLUSION
Alliances are widespread in todays business world due to their potential to improve business performance and allow firms to achieve
goals that they could not easily achieve alone. Increased competition,
rapid technological change, and technological discontinuities that are
occurring in almost all industries mean that organizations continue to
enter a growing number of alliances to enhance their ability to enter
new markets, access new resources, explore new business opportunities,
and/or minimize risk. However, despite the potential of alliances, firms
often fail to reap the anticipated benefits. This chapter has introduced a
number of ways in which organizations can address this apparent paradox. In particular, two key ways in which the likelihood of alliance
success may be improved is to engage in two distinct tiers of analyses
that focus on specific alliances and on developing alliance capability.
With respect to specific alliances, they are more likely to succeed if partners are selected on the basis of their ability to offer complementary resources, for being strategically compatible, and for being committed to
the alliance. Further, the alliance will need to be carefully managed, as
it evolves through critical phases of development, by utilizing appropriate coordination/governance mechanisms to build interdependence
and trust between partners. The chapter also discussed how an increasingly common form of fast-moving short-lived alliances, interimistic

44

Strategic Management in the 21st Century

alliances, alters the degree to which firms can and should rely on various forms of governance to manage such alliances.
Regarding alliance capability, organizations will benefit particularly from making the development of this capability a strategic priority, and systematically investing over time to develop alliance processes
and managerial expertise. Alliance capability requires focused attention to develop both a dedicated alliance function and institutionalized processes to accumulate, store, communicate, and leverage alliance
experiences organization wide. Having a champion for this within senior leadership is crucial as organizational restructuring and changes
in leadership and/or leadership philosophy can limit the embracing of
alliance-capability initiatives and result in a costly loss of accumulated
experience-based learning. The challenges associated with developing alliance capability should not be underestimated, and expectations
should be set accordingly. The path to developing alliance capability is
inexact, time consuming, and not well suited to premature assessments
of return on investment.
With a view to the future, it should be expected that executives and
firms will undoubtedly face fresh challenges and issues regarding the
successful use of alliances. Even if a firm possesses effective alliance
capability, steps will need to be taken to continue the process of alliance
learning to respond to new alliance opportunities that emerge, and to
continue to create value as existing alliances evolve. In sum, a firms
future ability to enjoy the benefits and strategic advantages of alliances
will depend on their unflagging quest to extend their alliance capabilities and to become, or remain, an effective relationship-based virtual organization whose success is elevated by its competence in managing the
key interfirm relationships.
NOTES
1. Lambe, C. Jay, Robert E. Spekman, and Shelby D. Hunt (2002), Alliance
Competence, Resources, and Alliance Success Conceptualization, Measurement,
and Initial Test, Journal of the Academy of Marketing Science, 30 (2): 141158.
2. Bucklin, Louis P. and Sanjit Sengupta (1993), Organizing Successful
Co-Marketing Alliances, Journal of Marketing, 57 (April): 3246.
3. Sarkar, M.B., Raj Echambadi, S. Tamer Cavusgil and Preet S. Aulakh (2001),
The Influence of Complentarity, Compatability, and Relationship Capital on
Alliance Performance, Journal of the Academy of Marketing Science, 29 (4):
358373.
4. Parise, Salvatore and Lisa Sasson (2002), Leveraging Knowledge Management Across Strategic Alliances, IBM White Paper Series, available at www.ibm.
com.
5. Rindfleisch, Aric and Christine Moorman (2003), Inter-Firm Cooperation
and Customer Orientation, Journal of Marketing Research, 40 (November): 421437.

Strategic Alliances

45

6. Lambe, Spekman, and Hunt (2002).


7. Jap, Sandy D. (1999), Pie-Expansion Efforts: Collaboration Processes
in Buyer-Supplier Relationships, Journal of Marketing Research, 36 (November):
461475.
8. Morgan, Robert M. and Shelby D. Hunt (1994), The Commitment-Trust
Theory of Relationship Marketing, Journal of Marketing, 58 (July): 2038.
9. Ibid.
10. Grzeskowiak, Stephan, C. Jay Lambe, James R. Brown, and Kre Sandvik
(2003), Antecedents of Relational Norms in Developing and Mature Relationships, Winter AMA Educators Conference Proceedings, February.
11. Dwyer, F. Robert, Paul H. Schurr, and Sejo Oh (1987), Developing BuyerSeller Relationships, Journal of Marketing, 51 (April): 1127; Jap, Sandy D. and
Shankar Ganesan (2000), Control Mechanisms and the Relationship Life Cycle:
Implications for Safeguarding Specific Investments and Developing Commitment, Journal of Marketing Research, 37 (May): 227245.
12. Jap and Ganesan (2000).
13. Kale, Prashant and Harbir Singh (2009), Managing Strategic Alliances:
What Do We Know Now, and Where Do We Go from Here? Academy of Management, 23 (3): 4563; Kale, P. and H. Singh (2007), Building Firm Capabilities
through Learning: The Role of the Alliance Learning Process in Alliance Capability and Success, Strategic Management Journal, 28 (10): 9811000; Kale, P., J. Dyer,
and H. Singh (2002), Alliance Capability, Stock Market Response and Long-Term
Alliance Success: The Role of the Alliance Function, Strategic Management Journal,
23 (8): 747767.
14. Gueth, A. (2005), Entering into an Alliance with Big Pharma: Benchmarks
for Drug Delivery Contract Service Providers, Pharmaceutical Technology, 25 (10):
132135.
15. Lambe, C. Jay, Robert E. Spekman, and Shelby D. Hunt (2000), Interimistic Alliances: Conceptualization and Propositional Development, Journal of the
Academy of Marketing Science, 28 (2): 212225.
16. Ibid.
17. Ibid.
18. Ibid.
19. Bruner, Robert F., Mark R. Eaker, R. Edward Freeman, Robert E. Spekman, Elizabeth Olmsted Teisberg, and S. Venkataraman (2003), The Portable MBA,
4th ed. Hoboken, NJ: John Wiley and Sons.
20. Gueth, Anton (2001), Entering into an Alliance with Big Pharma: Benchmarks
for Drug Delivery Service Providers, Pharmaceutical Technology, October, 132138.
21. Anderson, James C., Hkan Hkansson, and Jan Johanson (1994), Dyadic
Business Relationships within a Business Network Context, Journal of Marketing,
58 (October): 115.
22. Parkhe, Arvind (1998), Understanding Trust in International Alliances,
Journal of World Business, 33 (3): 219240; Parkhe, Arvind (1998), Building Trust in
International Alliances, Journal of World Business, 33 (4): 417447.
23. Lambe, Spekman, and Hunt (2002).
24. Schildt, H. A., Maula, M. V. J., and Keil, T. (2005), Explorative and Exploitative Learning from External Corporate Ventures, Entrepreneurship Theory and
Practice, 29 (4): 493515.

46

Strategic Management in the 21st Century

25. Lambe, Spekman, and Hunt (2002).


26. Ibid.
27. Hunt, Shelby D. (2000), A General Theory of Competition. Thousand Oaks.
CA: Sage.
28. Lambe, Spekman, and Hunt (2002).
29. Ibid.
30. Day, George S. (1995), Advantageous Alliance, Journal of the Academy of
Marketing Science, 23 (4): 297300.
31. Lambe, Spekman, and Hunt (2002).
32. Heide, Jan B. (1994), Inter-organizational Governance in Marketing Channels, Journal Marketing, 58 (January): 7185.
33. Lambe, Spekman, and Hunt (2000).
34. Heide, Jan B. (1993), Plural Governance in Industrial Purchasing, Journal
of Marketing, 67 (October): 1829.
35. Lambe, Spekman, and Hunt (2000).
36. Ibid.
37. Ohmae, Kenichi (1989), The Global Logic of Strategic Alliances, Harvard
Business Review, MarchApril, 143154.
38. Gomes-Casseres, Benjamin (2004), Strategy: Managing beyond the Alliance, CriticalEYE Publications LTD, JuneAugust, pp. 48.
39. Parkhe (1998); Parkhe (1998).
40. Lambe, Spekman, and Hunt (2000).
41. Ibid.
42. Ibid.
43. Ibid.
44. Wilson, David T. (1995), An Integrated Model of Buyer-Seller Relationships, Journal of the Academy of Marketing Science, 23 (4): 335345.
45. Ibid.
46. Lambe, Spekman, and Hunt (2000).
47. Lambe, C. Jay, C. Michael Wittmann, and Robert E. Spekman (2001), Social
Exchange Theory and Research on Business-to-Business Relational Exchange,
Journal of Business-to-Business Marketing, 8 (3): 136.
48. Grzeskowiak, Stephan, C. Jay Lambe, James R. Brown, and Kre Sandvik
(2003), Antecedents of Relational Norms in Developing and Mature Relationships, Winter AMA Educators Conference Proceedings, February.
49. Ibid.
50. Lambe, Spekman, and Hunt (2000).
51. Ibid.
52. Ibid.
53. Ibid.
54. Beerkens, B. and C. Lemmens (2001), Tech Alliances: Managing Your Alliance Portfolio, in The Allianced Enterprise: Global Strategies for Corporate Collaboration, edited by Adrianus Pieter de Man, Geert Duysters, and Ash Vasudevan.
London: Imperial College Press, pp. 93107.
55. Lambe, Spekman, and Hunt (2002).
56. Lambe, C. Jay and Robert E. Spekman (1997), Alliances, External Technology Acquisition, and Discontinuous Technological Change, Journal of Product Innovation Management, 14 (2): 102116.

Strategic Alliances

47

57. Ibid.
58. Lambe, Spekman, and Hunt (2002).
59. Kale, Dyer, and Singh (2002).
60. Ibid.
61. Lambe and Spekman (1997).
62. Ibid.
63. Lambe, Spekman, and Hunt (2002).
64. Ibid.
65. Ibid.
66. Spekman. Robert E., Lynn A. Isabella, and Thomas C. MacAvoy (1999), Alliance Competence: Maximizing the Value of Your Partnerships. New York: John Wiley.
67. Ibid.
68. Ibid.
69. Ibid.
70. Lambe, Spekman, and Hunt (2002).
71. Ibid.
72. Lambe and Spekman (1997).
73. Ibid.
74. Sivadas, Eugene and F. Robert Dwyer (2000), An Examination of Organizational Factors Influencing New Product Success in Internal and Alliance-Based
Processes, Journal of Marketing, 64 (January): 3149.
75. Ario, Africa and Yves Doz (2000), Rescuing Troubled Alliances: Before
Its Too Late, European Management Journal, 18 (2): 173182.
76. Duysters, Geert, Gerard Kok and Maaike Vaandrager (1999), Crafting
Strategic Technology Partnerships, R&D Management, 29: 343351.
77. Weitzman, Hal and Jonathon Soble (2008), 787 Delay Could Cost Boeing
Billions, Financial Times, April 9.
78. Williamson, Oliver E. (1985), The Economic Institutions of Capitalism: Firms,
Markets, Relational Contracting. New York: The Free Press; Weitzman and Soble
(2008).
79. Dickie, Lance (2009), Span of Control, Seattle Times, September 14.
80. Gates, Dominic (2007), Analysts 787 Doubts Burn Boeing, Seattle Times,
January 23.
81. Lambe, C. Jay, Robert E. Morgan, Shibin Sheng, and Gopal Kutwaroo
(2009), Explaining Success in New Product Development Alliances: Distinguishing between Exploration and Exploitation Strategy and the Moderating Role of
Formalization, Journal of Business to Business Marketing, 16 (3): 242275.
82. Eisenhardt, K. M. and J. A. Martin (2000), Dynamic Capabilities: What Are
They? Strategic Management Journal, 21: 11051121.
83. Parkhe (1998).

Chapter 3

A Phased Approach to Merger


and Acquisition Integration:
Tapping Experiential Learning
David R. King

A merger and acquisition (M&A) is not a strategy, but a means to pursue


one. Although there are multiple reasons to pursue an acquisition, the primary challenge in doing so is that M&A consistently fails to improve firm
performance.1 Poor integration between the acquiring and target firms
provides an explanation for M&A performance falling short of expectations, because integration is pivotal in creating value from M&A. Without
integration there is little justification for paying premiums for targets that
average 40 percent.2 Integration, however, is difficult to execute, and existing frameworks describing M&A integration and its impact on performance have limited usefulness.
The shortage of definitive guidance on integration is consistent with the
focus of M&A research in general. The variable most commonly examined
in M&A research is relatedness, or the degree of similarity between an acquirer and target.3 Despite expectations that a relationship exists, research
has not found empirical evidence that relatedness between an acquirer
and target influences M&A performance.4 Although multiple explanations
for this exist, two are most relevant to the current chapter. First, research

A Phased Approach to Merger and Acquisition Integration

49

generally examines simple relationships that fail to consider what relatedness means for the integration of an acquirer and a targets resources
and operations. Emerging research suggests a complex relationship exists
whereby related acquisitions perform well when there is enough difference between firms and resource combinations to create value, but performance of unrelated acquisitions falls when differences become too great.5
Second, whereas different acquisitions may require unique integration approaches, research largely groups all M&A activity together. Specific types
of acquisitions, such as those involving high-technology targets or those
that involve diversification, may exhibit important differences.
Given lackluster M&A outcomes, a need for integration to improve performance, and limited available guidance on integration, improving M&A
integration is an urgent and compelling management challenge.6 A key to
responding to this problem is to recognize that M&A is not an event but a
process. One approach to viewing M&A in this light is to look at decisions
made during each phase of an acquisition, and outlining practices that can
be expected to improve results. This chapter applies this approach to the
acquisition of smaller firms in related industries, an M&A scenario generally considered to have more potential for improved M&A performance.
Integration is an important factor in related acquisitions as it is needed to
transfer resources and skills. Similarly, relative size between an acquirer
and target is a key variable, as research suggests that a target needs to
be small enough to be easily integrated yet large enough to influence an
acquirers performance.7 Using a phased approach in examining a specific type of acquisition can offer guidance that will help in identifying
other circumstances where positive M&A outcomes can be achieved. It
also offers acquirers the opportunity to unlock the power of experiential
learning.

EXPERIENTIAL LEARNING
Instead of merely thinking about a problem, experiential learning involves a direct encounter with a problem and active attempts at finding a
solution. Viewed this way, learning then involves reflecting on cumulative
experience to guide behavior.8 The implication is that ideas are not fixed
and immutable, but are formed and reformed through experience where
early decisions have implications for later performance. Tension between
expected and actual experience is inherent in Kolbs iterative model of
learning.9 This model consists of four stages: (1) concrete experience,
(2) reflective observation, (3) abstract conceptualization, and (4) active experimentation. Although experiential learning follows a continuous spiral
that can be entered at any stage, learning generally begins with an actual
experience where a particular action is taken and the effects of the action

50

Strategic Management in the 21st Century

are observed. The next two stages relate to reflection on these effects, and
the transformation of the experience into a sense of order using a set of
guiding principles. Plans are then made to test developed models, leading
to a continuing cycle of improvement as resulting observations are made.
Applied to M&A integration, experiential learning suggests that early
consideration of issues leads to better results, as there will be a smaller gap
between desired and actual results. Broadly speaking, the M&A process
can be segmented into three phases: target selection and deal structuring,
integration planning, and integration implementation. Prior experience
and available knowledge guide target selection, whereas deal structuring
relates to reflective observation. Integration planning involves the conceptualization of the desired combination of target and acquirer, and the
development of blueprints for making it reality. As implementation of the
developed M&A plans progresses, outcomes inconsistent with expectations help to refine actions, leading to active experimentation in pursuit
of the M&A goals. In the next section, principles of M&A are integrated
with those of experiential learning to develop suggestions for M&A integration across the phases of M&A.
M&A PHASES
Each phase of the M&A process has the potential to establish conditions
for improving subsequent performance. However, there is no guarantee
that they will; thus implementation may be unable to overcome errors
committed earlier.10 The implication is that achieving better M&A performance requires considering integration issues early in the process, beginning with having a clear strategic rationale for the M&A. What provides a
good rationale is not specifically developed here. However, any rationale
for M&A needs to incorporate the importance of acting quickly. Speed is
the primary advantage of M&A compared to internal development since
its results can be seen faster, and the need for speed can counter the potential limitations of an acquisition. Explicit recognition that a high hurdle
exists in reaching M&A goals also requires that managers develop a clear
strategic rationale for an acquisition. This must aid target selection, and
carry through the stages of integration planning and implementation.
Target Selection
Improving M&A integration begins with a focus on target selection
and deal structuring in order to minimize challenges during implementation. Target selection involves management of the acquiring firm identifying a target firm and setting deal characteristics, such as an offer price.
Most deal characteristics are fixed after negotiations are complete and
a deal is announced, so poor selection only increases the challenges of

A Phased Approach to Merger and Acquisition Integration

51

implementation. For example, the premium paid for a target firm is negatively related to M&A performance and paying too high a premium can
preclude improved performance.11 Still, there are a multitude of things
that managers need to consider in selecting a target, and surprises from
areas not considered will be inevitable. The focus here will be on a handful
of observable attributes managers can influence in selecting a target and
their expected impact on performance.
Resource Combinations
Acquisitions are a means of managing the resources available to firms,
and improved M&A performance often depends on an interdependence
between an acquirers and a target firms resources.12 Research suggests
acquisitions that enable acquirer and target strengths and weaknesses to
offset each other are most likely to create value.13 In the case of knowledge
integration, positive outcomes can be expected for firms in related industries. For unrelated acquisitions, the negative impacts of dissimilarity increase as knowledge becomes more dissimilar.14
Acquisition strategies for resources either involve supplements, obtaining more of a resource, or complements, obtaining another resource that
combines effectively with resources the acquirer already controls.15 Although a strategy based on supplements results in adding to the resource
base, a drawback of such a strategy is that resource redundancy following
the combination of firms can lower performance.16 In contrast, a strategy
that pursues complements focuses on combining different but mutually
supportive resources and can create new value.17 For example, value can
be added if an acquirer gains access to new customers and segments that
complement existing product or service.18 Complements can also provide
a valuable source of asymmetry that can allow an acquirer to gain access
to target resources at a price below their value to the acquirer. Although
complementary resources are difficult to value, acquirers may pay a lower
price compared to the potential value of a resource combination because
the value of a given target varies for different acquirers with dissimilar resource profiles.19
The value that can be obtained from a target firm varies by bidder. The
offer price of different acquirers should reflect the anticipated value of
each expected combination with a target. However, to be accepted, the
price of a winning bid need only exceed that of competing bids. Therefore,
the price paid will exceed the value that could be created in the secondbest combination, an outcome that should remain true even if a bid is not
contested. Any surplus value for an acquirer over the price paid can be
translated into higher performance. In contested acquisitions, competitors
may attempt to bid a targets price above an acquirers value in an attempt
to sabotage a successful combination. If bids remain rational, winning bids

52

Strategic Management in the 21st Century

can create value from the difference between the value estimated for the
next best combination and the estimated value of the combination for the
acquirer. The value achieved could be even higher for resources that complement one another because they often generate unanticipated benefits,
such as easier collaboration.20 This logic is consistent with early advice for
acquisitions that suggested acquiring firms avoid unrelated acquisitions
and select firms that complement them.21
Target Environment
Different environments place different demands on resource needs, so
resources targeted through acquisition are those that are valuable in the
environment where they will be used.22 An implication that a target firms
environment makes a difference is that not all targets will be equally attractive. Still, acquirers do not consistently consider the impact of a target
firms environment during target selection. For example, acquirers often
discount the role of a target firms environment in assessing the performance of a target firms management.23
Industry environment relates to three factors: munificence, dynamism,
and complexity. Munificence relates to the degree that the environment
supports growth for firms within the industry.24 Growing industries are
expected to positively impact firm performance, but this may simply be
an enabling and not a direct cause of firm performance.25 Although high
munificence will not guarantee a better target, target firms operating in
environments with low munificence may focus internal resources on competitive defensive moves that offer less upside potential than resources developed by firms in munificent environments.26 Dynamism corresponds
to the level of unpredictability within an industry and relates to the difficulty of discerning patterns from environmental change.27 Environmental
uncertainty may lower the frequency of acquisitions by contributing to
doubt about the value of other firms resources. However, the advantage
of speed, or quickly gaining resources in acquisitions, may make resources
that are needed and owned by a target firm in a changing environment
more attractive.28 For example, Walgreen paid more than twice the prior
closing price for drugstore.com, but the acquisition enabled them to access
vendor relationships and achieve a 50 percent increase in customers that
would have required significant time to accomplish separately.29 Complexity relates to the number of organizations a firm contends with in an industry.30 Although complexity can arise from different sources, the factor
salient in M&A relates to concentration, or the extent to which monopoly
power exists within an industry.31 Monopoly power tends to increase with
industry concentration and decrease with industry fragmentation. Fragmented industries are more complex as resources are widely distributed
across multiple firms.32 Although the resources of firms in concentrated

A Phased Approach to Merger and Acquisition Integration

53

industries will likely generate interest from potential acquirers, it is less


likely that these firms can be purchased without a paying high premium
or other complications.33 Early acquirers when consolidation has begun in
an industry are able to pick the better targets and leave behind a smaller
and less competitive pool of firms.34 It is also possible that early acquirers
are better-managed firms that are responding proactively to industry contraction by improving efficiency.35
Successful acquirers not only consider the target, but also its industry
environment. Selecting targets early in the consolidation of a targets industry or around times of rapid change may provide more favorable starting points for performance. Targets in growing industries also provide a
more forgiving environment for successful integration. The implication is
that target selection needs to consider more than internal characteristics of
potential target firms.
Friendly Fit
In a friendly acquisition, there is an increased chance that the combined
firm will achieve easy and fast synergistic resource combinations that lead
to higher performance. Challenges associated with hostile acquisitions include paying a higher premium to overcome resistance and greater difficulty in carrying out due diligence.36 However, the primary reason that
hostile acquisitions are less desired is that they involve high management
turnover that reduces the ability to integrate a target firms resources.37
Managers represent a valuable resource in the combined firm, and successfully moving into new markets may depend on retaining target managers with relevant market knowledge. Although there may be positive
elements of management turnover such as target firm managers becoming
redundant in a combined firm or the elimination of managers who contributed to poor performance, the loss of knowledge often outweighs any
benefits from target manager turnover.38
Although managers of firms in related industries can be expected to
have common perceptions, there are no guarantees, and the question of
whether to integrate management of the target must be addressed. Three
methods are suggested for evaluating this issue. First, acquirers need to
consider the ability of the acquirer and the target management to work
together, something that will be easier in friendly deals. However, during
negotiations, people are likely to put their best face forward. One option
is to role play a target decision to assess compatibility, as improved fit will
likely result when an acquirer finds that they would make a similar decision under similar circumstances.39 This concept corresponds to two of
Ciscos rules for target selection, which require that a target have a similar vision and a compatible culture to help ensure that it has a complementary philosophy.40 The challenge of combining companies is likely to

54

Strategic Management in the 21st Century

be proportional to any cultural gap and can be lessened by picking firms


with similar cultures.
Second, successful acquirers are likely to include a termination fee to
align interests when completing an announced acquisition. Including a
termination fee provides some protection for the acquirer when facilitating integration planning by enabling the acquirer to reveal private information to a target firm.41 The buying and selling of a home offers an
analogy in that when the buyer makes a security deposit the seller provides property disclosures. In the context of an acquisition, the target firm
agrees to termination fees that serve as an enabler for the acquiring
firm to disclose the strategy for combining the firms and the role of target
firm employees following the acquisition.
Third, successful acquirers avoid targets with golden parachutes or
comparable takeover defenses. If stock options vest when a takeover occurs, it makes integration more challenging because an acquirer needs
time to transfer skills, something made difficult when key people in a target stand to benefit financially as a result of a takeover.42 Even if they stay,
target employees who experience significant financial windfalls from an
acquisition will likely focus more on their newfound wealth than the on
interests of the continued success of a combined firm. As a result, successful acquisitions generally avoid conditions that hinder an alignment of interests and knowledge transfer.
Method of Payment
Firms can pay for an acquisition using either cash, a combination of cash
and stock, or with stock alone. Research suggests that managers finance
acquisitions in the manner perceived to be the most profitable. Managers who believe their stock is undervalued will thus pay for an acquisition using cash, and pay with stock when they think their firms stock is
overvalued.43 However, the choice of payment may also consider the type
of acquisition. Related acquisitions are often paid for with stock because
this shares the risk inherent in the acquisition with the target firm.44 Additionally, paying with stock can help align a target firms interests with
improving performance in a combined firm. For example, stock payment
may provide a means for coping with information asymmetries between
an acquirer and its target.45 The use of stock to align target firm interests
with a successful outcome is similar to how stock options are used to align
executives interests with those of shareholders. Another way to align target executive interests is with an earnout, or an arrangement where the
final price paid depends on meeting performance targets.46
The use of stock as a form of payment should also help an acquirer to
avoid the negative effects associated with taking on too much debt when
paying for an acquisition with cash. Debt can lower an acquiring firms

A Phased Approach to Merger and Acquisition Integration

55

financial performance. The stock price of a firm with higher debt will be
discounted in comparison to that of a firm with less debt (assuming everything else is equal) to reflect the higher risk of investing in the firm.
This discount results from equity investors having a lower priority than
bondholders when making claims against the assets of bankrupt firms.
Accounting measures of financial performance will also be poorer when
levels of debt increase as a greater share of a firms earnings are allocated
to servicing debt payments. As a result, high debt levels raise the bar for
the performance needed to improve performance and can lead to strict
controls that negatively impact the adaptation needed to improve performance following an acquisition.47 In summary, there is reason to believe
that successful acquirers take steps to align target interests by paying for
their acquisitions with stock or using an earnout.
Integration Planning
The time between an M&A announcement and its completion is typically called due diligence, and represents the start of integration planning.
There is a growing chorus of voices from institutional and other investors calling for more rigorous due diligence. Greater justification is needed
from managers for their rationale in pursuing an acquisition to overcome
resistance attributable to there being managerial incentives from M&A yet
low average M&A performance. Though the purpose of due diligence is
not to identify reasons to abandon an acquisition, it is the last chance for
avoiding an acquisition that does not make sense. Conditions where deals
should be terminated include distrust between acquirer and target management, a combination that threatens important customer relationships,
or expectations that key employees will leave a combined firm.48 Necessity often dictates involving only a few key people in acquisition planning. However, it is better to err on the side of including more people to
ensure that as many potential problems are identified and potential solutions considered.
Most firms do not efficiently use the time between announcement and
completion as optimism from successful negotiations delays planning for
implementation. Indeed, a sense of accomplishment from bringing negotiations to a close when a deal is announced tends to shorten due diligence. However, taking more time for due diligence can improve success
and avoid problems that hinder improved performance.49 One positive
result of taking additional time for planning is that unexpected information uncovered during due diligence will usually be negative, which in
turn requires more time to evaluate its implications.50 Focusing on the
right things can also help firms make better use of the time available. This
can be facilitated by establishing and communicating clear goals that can
be used in making decisions, something that can make a difference in

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Strategic Management in the 21st Century

developing an executable plan. Integration planning typically focuses on


the depth and speed of integration, but developing an integration plan begins with considering M&A goals.
The goals for an M&A should have already been established; thus integration planning relates to the experiential learning stage of applying
theories or models in relation to what has been observed. Stakeholder
analysis represents an existing tool that applies to M&A integration,
and the interests of stakeholders in achieving M&A goals can first be addressed during integration planning.51 A stakeholder is any group that
can affect or is affected by a firms objectives.52 Managers can be caught
by surprise and have initiatives derailed by an unanticipated negative reaction from a stakeholder group. With effective stakeholder analysis, urgent concerns can be identified and addressed. A stakeholder group that
should have already been considered when making a public bid is important target shareholders such as institutions or family holdings. By
performing an analysis of additional stakeholder interests, an integration
plan can balance the interests of different groups in pursuing M&A goals.
Obvious additional stakeholders in an acquisition involve government
regulators, customers, employees, and competitors. However, additional
stakeholders, such as vendors or other business partners exist and need to
be considered. Once identified, it helps to prioritize stakeholders to better
manage how to approach them. One method is to build a matrix for prioritizing stakeholders along dimensions of stakeholder power and interest.53
Resulting stakeholder groups are shown in Table 3.1 and each is discussed
in the following sections.
Government Regulators
Regulators have a high level of power over the completion of any deal,
but likely have low interest in all but a minority of announced combinations. One way to strengthen regulatory resistance is to announce a deal
as a fait accompli before or during the regulatory review process. The
focus for this stakeholder group thus involves meeting conditions established by policy makers. Because regulatory requirements vary across the

Table 3.1
Prioritizing M&A Stakeholders
High Interest

Low Interest

High Power

Manage closely (regulators)

Keep satisfied (customers)

Low Power

Keep informed (employees)

Monitor (competitors)

A Phased Approach to Merger and Acquisition Integration

57

nations comprising the European Union,54 the discussion here is limited


to the review under the Hart-Scott-Rodino (HSR) Antitrust Improvements
Act of 1976. This U.S. law requires that before most M&A transactions
can complete, filings describing the proposed transaction and the firms
involved must be submitted to the Federal Trade Commission and the
Department of Justice. The rules, filing requirements, and associated fees
are fairly complicated and interested readers can learn more at the Federal
Trade Commissions Website.55 After filing for HSR review, there is generally a 30-day waiting period to allow regulators to review information and
consider anticompetitive implications. During the waiting period, there
are limits on data sharing and joint decision making between firms that
are part of the acquisition. The regulatory review may be shortened or extended, but it must be satisfied before a transaction can close. Although
most firms wait until the review is complete, firms can begin planning for
integration sooner. One option is to use third parties, such as consulting
firms, to perform needed analysis of joint data and provide relevant summaries.56 In doing so, companies need to ensure that incentives paid to advisors do not lead to higher costs.57
Regulatory reviews by other government bodies may also be required
before an acquisition can complete. For example, the European Union
can impact acquisitions of U.S. companies as illustrated by Intel having
to make concessions to gain regulatory approval of its McAfee acquisition.58 The potential for additional regulatory reviews reinforces the
need to consider regulatory issues and remedies as part of target selection, as any accommodations to gain regulatory approval will influence
integration implementation. By anticipating regulatory reviews, firms
can minimize planning delays. Firms with active acquisition programs
or strategically important deals may want to establish a team dedicated
to government relations or liaison with regulatory agencies. For example, AT&T has announced it will make concessions to regulators to complete an acquisition of T-Mobile. AT&T has a skilled team of 93 lobbyists
in Washington, DC, and has spent $46 million in campaign contributions
to both major U.S. political parties.59 The primary focus of successful
acquirers during regulatory review is continuing integration planning
while keeping government representatives informed and regulatory requirements satisfied.
Customers
A sometimes overlooked group that likely has high power and interest
in an acquisition is customers of both acquirer and target firms; thus the
concerns of customers need to be managed carefully. Acquirers often focus
on internal issues during integration at the expense of external market issues.60 Having a short-term focus on integration planning can sacrifice

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Strategic Management in the 21st Century

long-term results that depend on serving customers. For example, customer service quality often declines during the turmoil surrounding an
acquisition, and results in two-thirds of businesses losing market share
following a merger.61 In contrast, an emphasis on creating value for the
customer as part of an acquisition facilitates the building of trust between
the customer and the new firm, reduces customer uncertainty, and lowers
dissatisfaction and defection.62
In planning for integration, retaining customers may be more important to acquisition performance than reducing costs.63 Research suggests
that acquisition performance suffers significantly from negative customer
reactions.64 A lack of communication with customers to allay concerns can
be expected to have consequences. For example, IBM cut its orders in half
following the combination of two high-technology firms because no one
communicated what the acquisition meant to this customer.65 Acquirers
that remain committed to serving their customers and improving customer value as part of the integration will be more successful

Employees
Just as a deal needs to be sold to customers it also needs to be sold to
employees.66 The best strategy will fail if it does not consider the people needed to execute it. Employees represent a challenging group to deal
with in that they have high interest yet low power on an individual basis.
Employees need to be kept informed about an acquisition and its implications. When employees learn of a merger, they expect and are prepared
for dramatic changes.67 Most employees anticipate that when an acquisition is announced there is already a plan for integration; thus the need exists to educate employees about the M&A process.68 M&A announcement
simply begins the regulatory review and planning needed to answer employee concerns.
Employees will have little tolerance for delays that fail to set a clear direction for a firm and communicate their place in it. Successful acquirers
recognize that silence is not an option even if there is a lack of definitive
answers.69 Employees will be hungry for information to help deal with the
uncertainty created by the acquisition, and will be looking for the strategic rationale for the acquisition. Employees want to know that a plan for
creating a better organization exists, that it signals that people matter, and
that it addresses what the acquisition means for individual employees.70 A
lack of information shared with employees about plans or their development will only lead to employee speculation and the resulting anxiety that
complicates integration efforts. An integration plan needs to use frequent
and effective communication to gain momentum with small wins that increase employee buy-in.

A Phased Approach to Merger and Acquisition Integration

59

Achieving M&A goals depends on ensuring that key people do not leave
soon after an acquisition is announced. Further, reestablishing leadership
continuity with a target is critical.71 Under the best of circumstances, employees experience uncertainty following an acquisition announcement
and employee commitment will be lowest during the planning prior to
acquisition completion. Acquisitions are often motivated by gaining tacit,
socially constructed knowledge in a target, but that knowledge may not
survive attempts to integrate it, leading to employee turnover becoming
a primary suspect in poor M&A performance.72 The first employees to
leave are generally the best and brightest because they have the most options. The primary causes of departures include decreased employee
perceptions of control, and discounted past contributions. Typically 12 to
25 percent of personnel are viewed as redundant.73 The combined effect of
layoffs, employee defections, and the need for growth to meet M&A goals
often drives resumed hiring. Care is required to avoid the need to recruit
old employees back at a higher salary.74 Achieving M&A goals depends
on ensuring that key people do not leave soon after an acquisition is announced. As a result, the focus of employee retention begins with top and
middle managers, or the people most likely to influence employees.
Top Managers
Reestablishing leadership continuity with a target is critical as the
conditions created by an M&A are stressful in that they require employees to update their organizational identity.75 Limiting political behavior
will also require aligning actions and words, and top managers in both
firms need to communicate commitment to an acquisition before it is
completed. Successful acquirers likely avoid statements that best practices from each firm will be implemented, as they recognize that this
is unrealistic. Making comments that an acquisition will take the best
practices from each firm also leads people to justify their processes at
a time when new processes are often required.76 The need to retain and
motivate people to work together makes it imperative to include top
managers from a target firm in integration planning. The importance of
this goes beyond what was discussed in considerations about selecting
targets with a friendly fit.
An obvious decision needing input from the target firm relates to the
assigning of top jobs in a combined firm where multiple people in the acquirer and target firms perform similar duties. The management of the
acquiring firm will typically need to make these decisions, but they will
have less knowledge about employees of the target firm than of their own.
Meanwhile, a majority of M&A integration issues are political or emotional in nature. Instability and insecurity over power bases can contribute to feelings of gain or loss that increase political activity to preserve

60

Strategic Management in the 21st Century

self-interests.77 How top jobs are assigned during integration planning can
mitigate political activity and enable faster implementation.78 Cisco again
provides an example of how this is done well. They announce new roles
and titles immediately upon completion of an acquisition, and as a result,
Cisco enjoys lower turnover of acquired employees than overall levels of
corporate turnover.79

Middle Managers
The management of acquiring firms need to keep in mind that there
are consequences of filling managerial positions following the acquisition
mostly from within their own ranks. A blended top management team
that retains a targets top management can help to motivate middle managers.80 Middle managers require special consideration as they represent
the primary means of translating strategic objectives to workers and implementing M&A objectives. When excluded from decisions surrounding
an acquisition, middle managers can feel left out and foolish as employees
come to them for answers they dont have.81
Middle managers who see top managers being treated fairly in a combined firm can be expected to have a more positive attitude, which can be
important in reducing employee anxiety.82 Cisco has established a reputation as a good acquirer because no target firm employees lose their
jobs unless both CEOs assent.83 An example of where this did not happen is Oracles $7.4 billion acquisition of Sun Microsystems. Oracles CEO,
Larry Ellison, expressed a low opinion of Suns top management84 and
placed Oracle managers in positions of responsibility, contributing to a
brain drain of Sun employees.85 By comparison, working to reduce middle managers uncertainty allows them to better understand M&A goals
and more quickly begin the task of achieving them. A potential exception
would be when there are inefficiencies or poor management in a target
firm. Regardless, top management assignments should pull from both the
acquiring and target firm, and be followed by communication to educate
and explicitly enlist the support of middle managers.

Competitors
Acquirers need to remember that competitive pressures that drove the
selection of M&A as a strategy to meet goals do not end once an acquisition is announced, and that competitor reactions need to be monitored.
Although M&A announcements are public and create uncertainty for customers and employees of combining firms, they clarify what competitors
can expect. Competitors often treat the distraction caused by integrating
firms as an opportunity. When not bound by restrictions of regulatory review, competitors can immediately plant seeds of doubt in the minds of

A Phased Approach to Merger and Acquisition Integration

61

employees and customers. For example, quality disruptions frequently


occur during M&A due to the downsizing of manufacturing capacity and
transferring of work to facilities with people unfamiliar with the products
or the processes used to produce them.
Employees will typically not know what a merger means for them,
let alone be able to answer questions from customers. As a result, competitors will be actively recruiting employees and customers of firms involved with an M&A at the same time that those firms are least prepared
to answer external challenges. Informal industry networks that make
employees valuable to an acquirer can work against acquirer interests as
competitors actively solicit employees experiencing uncertainty. Many
employees will get job offers from competitors within five days of an acquisition announcement.86 To the extent that competitors can leverage the
uncertainties faced by firms involved in M&A to their advantage, the task
of implementation only becomes harder. This challenge can be minimized
by carefully monitoring competitor actions following an acquisitions
announcement.
Prudent Planning
The amount of time that managers spend after an acquisition announcement to evaluate a target firm and plan for its integration varies.
However, with an average time between announcement and completion
of approximately 60 days for U.S. firms, the prevailing length of integration planning is probably not adequate.87 Given that regulatory review of
announced transactions can take up half of that time, it seems lamentable
that coordination is limited to only one month of planning for multimillion dollar combinations. This is even more so when related firms require
greater coordination of activities, or when there are particular challenges
during integration planning to examine how acquirer and target firms fit
together.88 Additional time may also be needed to address any nonpublic
information uncovered after the acquisition announcement because any
new information is likely to be negative.89 Successful acquirers recognize
that prudent planning lays the foundation for the integration implementation needed to create value. A study of the appropriate time frame, based
on an examination of the average time to complete acquisitions, suggests
that acquirers should wait at least 120 days after an announcement before
closing a transaction.90
Implementation
Although actions taken prior to completion of the acquisition will influence success, implementation is the true test of strategy. Making M&A
work is one of the hardest business tasks, and implementation requires
active experimentation to ensure that goals are met. When an acquisition

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Strategic Management in the 21st Century

is completed, two firms legally become one, yet internal barriers remain
and complete integration may be spread out over several years.91 Although
initial performance will decline as integration disrupts normal work processes, achieving higher levels of performance depends on the regular review of progress toward meeting desired performance and organizational
goals. This requires executives to take the concepts that drove a deal and
make them operational realities by shifting from prudent planning to fast
execution. Implementation will be facilitated by two tasks: the assigning of
clear responsibility for integration management and continuing adaptation.
Integration Management
M&A increase peoples workloads, but there is often a failure to prioritize work and thus the right thing gets done only by chance. After the initial excitement surrounding deal announcement, acquiring firm managers
typically turn their attention back to prior tasks.92 However, issues arising
from implementation will need immediate attention. Managing integration thus needs to be kept separate from the day-to-day demands of firm
operations.93 This means it is necessary to make integration implementation a managers only responsibility. In many successful acquirers, this
person is called an integration manager.
An integration manager with full-time responsibility and accountability for making integration work can help avoid the problem of having
managers who participated in integration planning simply returning to
the demands of their regular jobs. Used effectively, integration managers
perform the task of keeping others focused on creating value, and maintaining the momentum from integration planning.94 Successful acquirers
select this person from the integration planning team, empower them, and
then track progress toward achieving integration goals through reviews
that help identify needed changes. These reviews focus on making business units respond to the integration manager, and, by extension, help the
combined firm be successful. They can keep uncertainty from stalling integration by maintaining a focus on implementation and by providing a
mechanism for addressing issues and making decisions.
Integration managers require good project management skills, but more
importantly, they need to be general managers. Assigning an executive
from the acquiring firm that has been made redundant due to the blending of the top management team gives the new top management team an
integration manager they trust. If the team is announced early, the person
selected can also be ready to start integration the moment the acquisition completes. However, attracting the right talent to this role requires
acknowledging that the position has limited duration (about one year)
and is part of a leadership pipeline. The reward to the integration manager is increased visibility with the promise of a promotion. Meanwhile,

A Phased Approach to Merger and Acquisition Integration

63

the reward to the organization is better integration, and managerial talent


with firsthand knowledge of M&A difficulties, as experienced managers
form part of the firms acquisition capability.95 Another alternative would
be to select someone close to retirement so as to leverage their experience
and provide them with a transition event that is meaningful for both the
individual and the organization.96
Continuing Adaptation
The plan that begins any successful endeavor is not the same path that
is ultimately followed, and any single acquisition will be only part of a
larger corporate strategy. As an acquisition is planned and integrated, new
information becomes available, setbacks occur, and competitive dynamics change, all circumstances that require adaptation. Feedback mechanisms to maximize learning and performance guide dynamic adjustment
by firms in order to reach aspiration levels.97
Despite managers best efforts, it is unlikely that targets will be optimally integrated the first time, and restructuring will need to be repeatedly applied to unlock as much value as possible. Managers confront
messy problems through a process of considering alternatives then assess
results that follow experiential learning. As experience with integration
and restructuring is gained, managers will be able to make better decisions when recombining units.98 This process, however, takes time, and
it can take years after an acquisition before changes in firm performance
are observed. Though each context will be different, different researchers
have suggested three years may be needed before positive results can be
achieved from an acquisition.99
Successful implementation also requires recognition that there is more
than one way to achieve a goal, so implementation should focus more on
the desired end and remain flexible on how goals are accomplished. Restructuring may require creating new divisions from existing resources
or new acquisitions, dividing divisions into different groups, eliminating
divisions by reallocating resources or divesting assets, or additional options. However, successful acquirers capitalize on each success, while recognizing that continued improvement requires additional restructuring.
Two gauges of success to monitor during implementation are how well
talent and customers are retained. These will provide early indications of
whether improved performance is being achieved or additional changes
are required.
DISCUSSION
Aspects of successful M&A have been explored to show how early decisions impact integration success. Evidence from successful acquirers

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Table 3.2
M&A Phases and Integration Decisions
Target Selection

Integration Planning

Integration Implementation

Integration manager
Continue restructuring

Related target
Consider environment
Friendly fit
Partial stock payment

Focus on stakeholders
Announce executives
Enlist middle managers
Prudent planning

across M&A phases suggest that early decisions are likely to have consequences during integration implementation. Bringing together established concepts may not necessarily have yielded new individual insights.
However, the application of experiential learning to M&A phases offers
an improved framework for understanding M&A integration decisions. A
summary of decisions related to M&A integration is presented in Table 3.2
and illustrates that more decisions that impact integration are made before implementation begins than during it. The ideas presented also suggest implications for both management theory and practice.
IMPLICATIONS FOR MANAGEMENT THEORY AND PRACTICE
An insight with a theoretical implication provides a possible explanation for why M&A continues to be used as a strategic tool when evidence
suggests acquisitions fall short of expectations. Cultural differences are
a common explanation for M&A failure, but this explanation may serve
simply as a scapegoat for poor decisions that amplify differences between
acquirer and target firms, or for failing to account for stakeholder reactions to an acquisition announcement.100 Further, the consequences of decisions made in target selection before an acquisition is announced have
implications for integration and performance. It is possible that decisions
made when negotiating a deal, such as offer price, could preclude improved results regardless of the effectiveness of integration.
Other insights also have implications for both managers and researchers. First, a single acquisition will likely be part of a larger strategic goal or
initiative. This means that additional restructuring that may include further acquisitions or divestment of assets may be required to achieve firm
goals. For researchers, this means that the treatment of M&A as an isolated
event is likely to be inappropriate. This also raises the importance of managers recognizing how the strategic rationale for an acquisition may guide
later decision making. Second, explicit recognition and handling of stakeholder issues during integration planning will be of interest to researchers and managers. For researchers, insights gained about stakeholder
interests and power may help to explain observed decisions in M&A. For

A Phased Approach to Merger and Acquisition Integration

65

managers, consideration of stakeholders will enable an acquirer to move


quickly from careful deliberation to fast execution. Specifically, reflecting
on relationships and then actively experimenting to improve them during implementation, can enable an acquirer to start from a better position
and more quickly move to capture value. Third, a case has been made for
a greater role of middle managers as facilitators of integration and meeting M&A goals. Extending research beyond the impact of firm characteristics or top management teams (e.g., CEO) to consider middle managers
may help to explain the variance in M&A performance. For managers,
improved employee assimilation may also result from a strategy that includes publicly recognizing middle manager role models.
Another implication for management practice that is drawn from the
research presented here involves the need for managers to consider integration issues across the phases of M&A beginning with target selection.
The reasons for considering integration early in the M&A process include
bringing up issues when they can be best addressed, and improving prospects for experiential learning or well-informed decision making. By considering a target firms environment and pursuing related acquisitions
with a friendly fit, an acquirer may be able to negotiate a price below the
value of its anticipated combination with the target by benchmarking the
value of potential competitors. To the extent that complementary resource
combinations exist and contribute to information asymmetry, an acquirer
has the opportunity to access resources at prices below their value, while
offering the potential to unlock value through effective integration planning and implementation. Once a deal is announced, the engagement of
management in negotiations needs to be extended in time and scope to
include additional people. To the extent that regulatory review hinders
coordination, third-party consultants can provide information for making
decisions. Decisions made between the announcement of the acquisition
and its completion will define responses from customers, employees, and
other stakeholder groups whose support is needed to meet established
goals. Following completion, steps need to be taken to avoid management
attention shifting back to day-to-day issues, and to keep integration and
strategic goals in clear focus. Strategic goals motivating acquisitions need
to be pursued by multiple means to find the ones that work.
Three cautions related to the application of the advice contained in this
chapter are worth mentioning. First, the suggestions offered here are not
considered to be definitive. In other words, the relationships described
represent possible ways to improve M&A integration and performance,
and are not considered to be either inevitable or the only paths to improved M&A performance. For example, the role of middle managers in
determining M&A performance, and how to effectively enlist this group
to translate strategy into results, will likely vary. A second related limitation is that the suggestions focus on the acquisition of smaller, related

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Strategic Management in the 21st Century

targets or conditions viewed as conducive to good M&A performance.


Conditions conducive to the success of M&A with different starting characteristics (e.g., diversifying acquisitions, mergers of equals) will likely
diverge from the relationships developed here. Further, there are likely
specific circumstances where an acquirer may elect to not integrate a target firm. Third, the need for a strategic rationale for M&A is mentioned
consistently throughout, but examples of rationale that can lead to high
performance are limited. Although the motivation to act fast and pursue complementary resources is mentioned, clarifying the actual motivations for M&A and likely performance outcomes represents an ongoing
challenge.
In conclusion, the primary contribution of the chapter is a pragmatic
recognition of the fact that the failure of most M&A to meet expectations
raises the importance of early consideration of the prospects for effective
and successful integration. Addressing integration issues during each
phase of the M&A process will improve integration planning and implementation. To the extent that implementation clarity is achieved and there
is a clear strategy for selecting a target, a foundation for active experimentation can provide a less elusive path to improved M&A performance by
leveraging experiential learning.
NOTES
Special thanks to Marissa Blomstrom for her support and willingness to always find just one more reference. Additionally, I would like to thank Kathleen
Park, Vijay Kannan, and Richard Taylor for commenting on prior versions of this
chapter.
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61. David Harding and Ted Rouse, Human Due Diligence, Harvard Business
Review, 85 (2007): 124131.
62. Christian Homburg and Matthias Bucerius, A Marketing Perspective on
Mergers and Acquisitions: How Marketing Integration Affects Postmerger Performance, Journal of Marketing, 69 (2005): 95113.
63. Katherine Morrall, Managing a Merger without Losing Customers, Bank
Marketing, 28 (1996): 1823.
64. Homburg and Bucerius, A Marketing Perspective on Mergers and
Acquisitions.
65. Marks and Mirvis, Joining Forces.
66. Copeland et al., Valuation.
67. Feldman and Spratt, Five Frogs on a Log.
68. Marks and Mirvis, Joining Forces.
69. Feldman and Spratt, Five Frogs on a Log.
70. DiGeorgio, Making Mergers and Acquisitions Work: What We Know and
Dont KnowPart II.
71. Jeffrey Krug and Walt Shill, The Big Exit: Executive Churn in the Wake of
M&As, Journal of Business Strategy, 29 (2008): 1521.
72. Saikat Chaudhuri and Benham Tabrizzi, Capturing the Real Value in
High-Tech Acquisitions, Harvard Business Review, 77 (1999): 123130.
73. Marks and Mirvis, Joining Forces.
74. Feldman and Spratt, Five Frogs on a Log.
75. Krug and Shill, The Big Exit.
76. Feldman and Spratt, Five Frogs on a Log.
77. David Schweiger and Phillippe Very, Creating Value through Merger and
Acquisition Integration, Advances in Mergers and Acquisitions, 2 (2003): 126.
78. Marks and Mirvis, Joining Forces.
79. Bunnell, Making the Cisco Connection.
80. Krishnan et al., Diversification and Top Management Team Complementarity.

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81. Feldman and Spratt, Five Frogs on a Log.


82. Srikanth Paruchuri, Atul Nerkar, and Donald Hambrick, Acquisition Integration and Productivity Losses in the Technical Core: Disruption of Inventors in
Acquired Companies, Organization Science, 17 (2006): 545562.
83. Bunnell, Making the Cisco Connection.
84. Eric Savitz, Oracles Ellison: Sun Execs Were Astonishingly Bad Managers, Barrons, May 13, 2010, accessed December 14, 2010, http://blogs.bar
rons.com/techtraderdaily/2010/05/13/oracles-ellison-sun-execs-were-aston
ishingly-bad-managers.
85. Andy Patrizio, Defections Batter Sun Microsystems, Internetnews.
com, July 31, 2009, accessed December 14, 2010, http://www.internetnews.com/busnews/article.php/3832666/Defections%20Batter%20Sun%20Microsystems.htm.
86. Carol Brown, Greg Clancy, and Rebecca Scholer, A Post-Merger IT Integration Success Story: Sallie Mae, MIS Quarterly Executive, 2 (2003): 1527.
87. Mario Schijven and David King, Investor Reactions to Strategic Announcements: Counter-Signals That Impact Firm Behavior and Performance,
Working Paper (Milwaukee, WI: Marquette University, 2011).
88. Rikard Larsson and Sydney Finkelstein, Integrating Strategic, Organizational, and Human Resource Perspectives on Mergers and Acquisitions: A Case
Survey of Synergy Realization, Organization Science, 10 (1999): 126.
89. Puranam et al., Due Diligence Failure as a Signal Detection Problem.
90. Kevin Boeh, Contracting Costs and Information Asymmetry Reduction
in Cross-Border M&A, Journal of Management Studies, 48 (2011): 567590.
91. Annette Ranft and Michael Lord, Acquiring New Technologies and Capabilities: A Grounded Model of Acquisition Implementation, Organization Science,
13 (2002): 420441.
92. Jeffrey Perry and Thomas Herd, Mergers and Acquisitions: Reducing
M&A Risk through Improved Due Diligence, Strategy & Leadership, 32 (2004):
1219.
93. Ashkenas, et al., Making the Deal Real.
94. Michael Shelton, Managing your Integration Manager, McKinsey Quarterly, June 2003, accessed December 13, 2010, https://www.mckinseyquarterly.
com/Managing_your_integration_manager_1305.
95. Tomi Laamanen and Thomas Keil, Performance of Serial Acquirers:
Toward an Acquisition Program Perspective, Strategic Management Journal, 29
(2008): 663672.
96. Special thanks to Kathleen Park for this insight.
97. Henrich Greve, Organizational Learning from Performance Feedback, (Cambridge: Cambridge University Press, 2003).
98. Harry G. Barkema and Mario Schijven, Toward Unlocking the Full Potential of Acquisitions: The Role of Organizational Restructuring, Academy of
Management Journal, 51 (2008): 696722.
99. Kenneth Carow, Randall Heron, and Todd Saxton. Do Early Birds Get the
Returns? An Empirical Investigation of Early-Mover Advantages in Acquisitions,
Strategic Management Journal, 25 (2004): 563585; King et al., Performance Implications of Firm Resource Interactions in the Acquisition of R&D-Intensive Firms.
100. Feldman and Spratt, Five Frogs on a Log.

Chapter 4

Contemporary Diversification via


Internal Corporate Venturing
Robert P. Garrett, Jr.

Diversification involves the selling of new products in new marketssimultaneous novelty in both dimensions, products and markets, is an essential element of diversification. According to this definition, product
development is not considered to be diversification because although it
involves developing and selling new products, the products are delivered to markets that are already targeted by the firm. Similarly, market
development involves selling a firms existing products to new groups of
customers. This scope of diversification was defined by Ansoff, who developed a typology (Figure 4.1) for categorizing growth strategies based
on the two dimensions of product and market novelty.1
Although diversification involves newness on both dimensions of Figure 4.1, some diversification strategies are related to a firms existing businesses. This type of related diversification exists when there are physical
linkages (in terms of products or geographical markets) or knowledge
linkages between the businesses of a diversified firm. There are a variety
of drivers for related diversification. First, separate products may arise
naturally from a shared input; thus a firm finds itself in possession of two
or more diverse products due to its own processes. Second, fixed production units may not be fully utilized for a single product, causing a firm to

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Strategic Management in the 21st Century

Figure 4.1
Adaptation of Ansoff s Typology of Growth Strategies

wish to fill existing production capacity with new products. Third, there
may be economies of joint production of networked products (the airline industry is a good example). Fourth, a firm may possess intangible
assets that can be shared between products (e.g., multiple products can
be supported by common R&D). In sum, growth through diversification
stems from the discovery of varied and previously unrealized uses for a
firms resources.2 Through diversification, a firm leverages its existing resources to discover new products and services, thereby expanding its pool
of resources.
MOTIVATION FOR DIVERSIFICATION
Economic
An economic rationale for diversification exists when the common ownership and operation of multiple businesses allows for better performance
than that obtained merely by adding the performance of the businesses
had they operated independently.3 Superior performance outcomes are realized from diversification because a firm is able to share and leverage its
assets and capabilities across multiple businesses, resulting in economies
of scope.4 Economies of scope are obtained when a firm is able to lower
average costs by producing two or more products. This makes diversification efficient if the products are based on common firm resources and/
or knowledge. For example, a sales force selling multiple products can do
so more efficiently than if they are selling only one product since the cost
of travel is distributed over a larger revenue base. However, as the degree
of diversification increases, costs may increase significantly if the firm attempts to coordinate businesses that have little in common.5 When firms

Contemporary Diversification via Internal Corporate Venturing

73

engage in unrelated diversification, top managers often have little firsthand knowledge of a particular divisions industry, technology, or geographic region; thus managerial costs increase.6 This had led researchers
to believe that there is an inverted U-shaped relationship between diversification and performance, with small amounts of diversification resulting in increases in performance, but too much diversification resulting in
poorer performance.7
The performance effects of diversification have been researched extensively in the strategy and finance literature. Much of this literature
focuses on the economic rationale behind the diversification-performance
relationship, and reflects the two types of diversification, related and
unrelated, described earlier. Since related diversification involves operating businesses in related industries, opportunities exist for the firm
to share operating assets and capabilities across businesses. In contrast,
with unrelated diversification, opportunities to share operating assets
and capabilities across businesses are limited. As a result, related diversification is believed to lead to better performance than unrelated diversification because although the former leverages business synergies, the
latter requires more learning and monitoring, and allocates resources
inefficiently.8
Although the literature is theoretically and empirically rich, the empirical findings have not been consistent. Resources can be applied in different ways that result in different productive uses or services, whether or
not the resultant products are related or unrelated to the organizations
core business(es).9 On the one hand, related diversification enables resources to be used in complementary combinations, allowing new businesses to leverage existing firm resources, and in return, develop them
for better use when re-leveraged by the core businesses.10 For example,
PCTEL, a designer, developer, and distributor of antenna solutions for
cellular networks, recently used internal diversification initiatives to develop capabilities in WiMAX, a family of telecommunications protocols
that provide fixed and mobile Internet access. PCTEL was able to leverage their knowledge of antenna solutions to create a new market entry in
WiMAX. At the same time, they were able to use the WiMAX business and
its partners to generate new knowledge about communication standards
and protocols that they could apply to their more mature businesses. Both
new and core businesses thus benefited from resource sharing and development in related diversification. To the extent that new growth builds
upon an organizations prior experience, the lessons learned in past diversification initiatives can also be leveraged to exploit future diversification
opportunities.11 The general direction of diversification is thus closely related to the nature of existing resources, how they have been used in the
past, and the type and range of products and services they can be combined to render.

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Strategic Management in the 21st Century

On the other hand, empirical evidence finds that firms diversify more
broadly than predicted by theory that prescribes related diversification.12
Not only do firms engage in unrelated diversification but recent research
indicates that unrelated diversification performs at a premium.13 Due to
this recent evidence, scholars have increasingly argued that favoring related diversification for reasons of resource synergies and leveraging past
learning may give an incomplete view of diversification. Diversification
into domains related to the core businesses of the parent company certainly affects the ability of the parent to provide resources and knowledge
to the new businesses. However, two arguments suggest that the value of
these resources may be diminished if there is significant overlap between
the businesses. First, when resources are shared, the allocation of the resources may be contentious as managers spend time and energy fighting
for access to them.14 Overcoming these disputes may distract managers
from more value-creating activities. Second, when diversified businesses
are too similar to the core businesses, the expected performance of the
new businesses is likely to match that of the core businesses. Rather than
creating truly novel developments that corporate managers might have
envisioned, business managers may pursue innovations that are closely
aligned with those of existing businesses in order to sustain current customers and products. Christensen called this the innovators dilemma,
where business managers are hamstrung by the close alignment of businesses and are limited in their ability to think outside the box.15 In essence,
related diversification often pursues the low hanging fruit to leverage
existing corporate assets, whereas unrelated diversification has the potential for higher performance by delivering truly disruptive and innovative
new product revenue streams.
Firm Level
Firms diversify for many reasons. Diversification may generate economies of scale and scope by transferring capabilities and competencies
developed in one business to a new business without significant additional costs.16 This will primarily motivate related diversification, where
activities can be shared across multiple business units. Two operational
economies allow firms to create value from economies of scope: the sharing of activities and the transferring of core competencies. When related
businesses share activities, they may, for example, have a joint production facility or share sales and distribution networks. Research has shown
that when related businesses have the potential to share activities, higher
returns may be obtained,17 and the firm may have lower risk since if one
unit does poorly, resources can still be utilized and leveraged by another.18
The transferring of core competencies, however, deals not with tangible
assets or established business functions, but with complex sets of capabilities that link businesses primarily through managerial and technological

Contemporary Diversification via Internal Corporate Venturing

75

knowledge, experience, and expertise.19 Disney, for example, has developed a core competency in innovation and invention, which they have
leveraged across a diverse range of businesses, including movies, theme
parks, television, toys, book and magazine publishing, department stores,
and even fast-food restaurants. Developing core competencies is an
investment-intensive process that is difficult for competitors to understand
or imitate. The ability of a firm to transfer its core competencies from one
business unit to another can thus enhance its strategic competitiveness.20
Firms may also use related diversification to gain market power and
competitive advantage through vertical integration.21 Vertical integration
occurs when a company produces its own inputs (backward integration)
or owns sources of distribution for outputs (forward integration). Vertical integration thus allows a firm to better control its own supply chain
by owning downstream suppliers and upstream buyers. Exxon Mobil engages in the exploration and extraction of crude oil, thus supplying its
own refineries with raw materials. The products of its refineries often find
their way to Exxon or Mobil service stations where the end-consumer
purchases gasoline. Additional integration occurs by way of Exxon Mobils other businesses, including, chemicals, plastics, and business services. Vertical integration often results in savings in operations costs, the
avoidance of market costs, better control of quality, and the protection of
technology, and it enables a company to strengthen its position and gain
market power.22 There are, however, limits to vertical integration. When
outside suppliers can produce an input at a lower cost, transaction costs
arising from vertical integration may be expensive in comparison. In addition, costs associated with bureaucracy are incurred when creating new,
integrated units within a firm. Vertical integration can require substantial
amounts of capital to be invested in specific technologies, creating problems when the technology changes and is rendered obsolete. In summary,
whereas vertical integration may create value and increase a firms strategic competitiveness, it does not come without its costs and risks.
Overall, firms diversify to improve performance. Firms plagued by
poor performance often seek to increase their diversification, hoping that
growth will occur as a result of the discovery of new, varied, and heterogeneous uses for a firms resources.23 This growth, however, should not be
perceived as being random, but rather directed to the growth of related
resources and uses.24
Managerial
Managerial motives for diversification are sometimes quite different
from those of the firm, and may have little to do with firm performance
and resources. These include managerial risk reduction and a desire for
increased compensation.25 When a corporation possesses a diverse group
of businesses, corporate-level risk is lower than that of a single-business

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Strategic Management in the 21st Century

company. If one business fails, the remaining businesses are typically able
to ensure the survival of the parent corporation. In contrast, singlebusiness firms are frequently unable to survive when confronted with the
failure of the business unless they can make radical changes in strategy.
Since the survival of a firm affects the employment of corporate executives, they often diversify the firm to diversify their own employment risk,
assuming in doing so that the profitability of the corporation will not suffer.26 Diversification and firm size are also highly correlated and executive
compensation increases with firm size.27 Large firms are more complex
and difficult to manage than small firms; thus managers of large firms are
compensated more highly.28 Corporate executives may choose to diversify
simply as an avenue for increased personal compensation.
The governance literature addresses the agency problem involving
conflicts of interest between owners and managers over potentially conflicting goals of growth and profit.29 The agency problem occurs when
shareholders hire a manager or executive, the agent, to act in the best interests of the shareholders. Shareholders, however, are not always able to
observe the actions of the agent directly; thus the agents may act to pursue
their own best interests even when these are divergent from shareholder
interests. Agency theorists contend that managers seek to diversify to increase the sales growth rate to levels that are not optimal for shareholder
profit maximization.30 By doing so, they are able to earn higher pay, power,
status, and prestige for themselves at the expense of shareholder returns.31
Agency problems are frequently addressed by increased monitoring of the
agents and providing them with incentives (e.g., stock options) that align
their personal interests with those of shareholders.
DIVERSIFICATION: HISTORY AND CURRENT TRENDS
In 1950, more than 60 percent of the largest Fortune 500 industrial companies were either single-business or dominant-business firms, meaning
they generated less than 25 percent of their revenues from diversified activities.32 However, in the 1960s and 1970s, the trend was for firms to diversify to reduce their dependence on any single industry. By 1974, the
percentage of single-business or dominant-business firms in the Fortune
500 had dropped to 37 percent.33 Although firms were able to spread business risk across different industries, shareholders were less than enthusiastic about this, believing that they could accomplish similar returns
themselves by purchasing equity in firms in different industries. Diversification only made sense to the extent that it added more value to the
shareholder than what they could earn acting individually. The industries chosen for diversification thus needed to yield consistently higher returns and synergies across operating divisions than the businesses could
achieve in isolation.

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77

The late 1970s and 1980s saw a reversal of the trend to diversify as
firms began to refocus on core businesses, and divested business units
unrelated to core business activities. Between 1981 and 1987, approximately 50 percent of Fortune 500 firms refocused on their core business,34
and by 1988, the percentage of single-business or dominant-business
firms on the Fortune 500 had risen to 53 percent.35 In the words of Michael Porter, Management found it couldnt manage the beast.36 The
complexities of managing different businesses under one corporation
caused firms to sell or close less-profitable divisions in order to focus on
their core businesses.
Although modern businesses remain more likely to invest in their core
businesses than to engage in unrelated diversification, current thinking
acknowledges innovation as crucial to the long-term survival and growth
of the firm.37 As such, current thinking on diversification focuses on corporate innovation, manifested as internal entrepreneurial activity. This is
being embraced by executives as being not just a component of a companys strategy but as the focus of an organizations success.38 According to Hamel, In these suddenly sober times, the inescapable imperative
for every organization must be to make innovation an all-the-time, everywhere capability.39 Firms with a corporate innovation strategy signal
their strategic intent to continuously and deliberately leverage entrepreneurial opportunities for growth and advantage-seeking purposes.40
Rather than react to changes in a complex external environment, these
firms define themselves as agents of change, aggressively creating new
markets and rewriting the rules of the competitive game.41
DIVERSIFICATION THROUGH INTERNAL
CORPORATE VENTURING
Firms that create internal entrepreneurial initiatives to explore new
products and markets are engaging in a practice known as internal corporate venturing. Internal corporate ventures (ICVs) are vehicles for firm
diversification that result from a deliberate effort on the part of the firm to
create new businesses internally. ICVs have been defined as entrepreneurial initiatives that originate within the corporate structure (or within an
existing business of the corporation), and are intended from inception as
new businesses.42 Since there is no consensus regarding what constitutes
a new business in a corporation, Morris, Kuratko, and Covin developed
a new businesses identification growth matrix43 (Figure 4.2) based on Ansoffs product/market growth matrix. The matrix includes intermediatelevel variations in product and market novelty, thus allowing for more
degrees of newness. For example, a market can be new to the firm or
new to the world, and a product can be new for the firm in its current industry or take the firm into a new industry. The matrix also allows new

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Strategic Management in the 21st Century

businesses to be classified as extensions on one dimension (product or


market) as long as they are new on the other. To be classified as a new
business, a business organization thus need not be situated in new product and market domains simultaneously. Rather, certain variants of pure
market development activity and pure product development activity are
consistent with the definition of ICVs.
Although they operate within an existing organizational domain, ICVs
are nonetheless independent units, and are formed with the specific purpose of developing new products or entering new industries.44 They are
seen as being increasingly important for corporations seeking new competitive advantages with which to face accelerating global competition.45
However, despite widespread agreement about their implications for
competitive advantage, there continues to be a lack of agreement among
scholars and practitioners regarding the factors that determine whether or
not ICVs will succeed.46
Much of the literature on ICV success has been anecdotal in nature,
coming from researchers and practitioners who observe a venture and

Figure 4.2
New Business Identification Matrix

Source: Morris, M.H., D.F. Kuratko, and J.G. Covin. 2008. Corporate Entrepreneurship and Innovation.
Mason, OH: Thomson South-Western.

Contemporary Diversification via Internal Corporate Venturing

79

then report on what managerial actions succeeded or did not succeed. Empirical research on the antecedents of ICV performance began as early as
197747 but there have been few quantitative studies on ICV performance
since. Even some of the most recent research continues to use anecdotal
evidence from a small number of cases to gain insight into the corporate
venturing process.48 This has led to the assertion that research on ICV has
typically relied on field study investigations, focusing on the construction
of useful process models for ICV.49
ICVs have a high incidence of failure. A study of 68 ventures launched
by 35 Fortune 500 companies found an average return on investment
(ROI) of 40 percent in the first two years and an average of eight years
required to break even.50 Despite the difficulties inherent in the venturing process, Burgelman and Valikangas indicated that it is imperative
to understand more about ICV performance and its antecedents so that
firms can benefit from the learning outcomes, increased innovativeness,
and improved firm performance that are postulated to be important
outcomes from ICVs.51 Prior studies have asserted that a critical obstacle to ICV success is the structural relationship between the venture and
the mainstream businesses of the parent companyin other words, the
larger organizational context. The systems and processes of established
businesses are hostile to an ICVs more uncertain activities. Specifically,
new ventures and established businesses frequently differ in their objectives, patterns of hierarchy, evaluation systems, rewards and incentives, and risk orientations.52 These differences make it difficult for ICVs
to exist under the same roof as established businesses. Indeed, recent empirical research indicates that structural separation has a positive effect
on ICV performance.53
By their very nature, ICVs operate within a unique organizational contextthat is, they are businesses within a businessand frequently face
challenges navigating the complex sociopolitical maze inside their parent corporations.54 Venkataraman, MacMillan, and McGrath suggested
that venture managers often have trouble building a coalition around the
idea of the new business, finding protection when corporate routines are
disrupted, procuring the necessary strategic assets for the venture, and
preparing the venture for institutionalization by creating fit between the
new business and the parent corporation.55 Shifting assets and resources
from corporate managers to ICVs is frequently marked by intense power
struggles and considered to be the central dynamic of the venturing process.56 Overcoming the power struggles involved in transferring strategic resources from the corporate parent to the ICV, championing, or top
management support of the venture, is often required. Senior managers committed to the success of the ICV lobby on the behalf of the venture, and help to ensure that it gains the strategic resources it needs to be
successful. What motivates and enables corporate-level top managers to

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support internal venturing activity is thus critical to understanding the


ICV phenomenon.
Top management support of ICVs, defined as the corporate parents
senior-level executives support of and commitment to the ICV, involves
more than just helping in the acquisition of necessary financial and organizational resources. It embodies how aggressively top management
advocates for and acts on behalf of the ICV.57 Top managers can provide
valuable knowledge, expertise, and legitimacy to nascent ventures. ICVs
can often lead to tensions in corporate rules, processes, and procedures,
and corporate managers might need to resolve resulting conflicts or advocate for the ICVs activities. In addition, there is often pressure within
a firm that prevents venture management from altering venture plans,58
which support from parent-level top management can offsets. The support of top management can not only help ICVs navigate the complex
organizational and political climate in which they find themselves in, but
also create a facilitative environment for the ventures ultimate success.
Motives for Internal Corporate Ventures
Corporations start new businesses for many reasons, many of which
overlap with the motivations for diversification provided earlier. Although some top managers may engage in internal corporate venturing
for selfish reasons such as increased compensation or job security, having
a clear understanding of the positive motives for venturing is critical to effective ICV management. Based on a study of 60 ICVs, Tidd and Taurins
concluded that there are two sets of motives that drive the practice of internal corporate venturing: leveraging and learning.59
Leveraging involves exploiting existing corporate competencies in new
product/market domains. One manifestation of leveraging is the extraction of new value from existing resources. In this case, the firm builds
a new business around corporate knowledge, capabilities, and other resources that have value in product/market domains in which the firm
does not currently compete. A second form of leveraging involves firms
exploiting underutilized resources by building a new business around internal capabilities that have remained idle for a long period of time, possibly using the new business to outsource the firms capabilities to others.
The firm may also use the new business to divest noncore activities. Such
a new business would pursue business opportunities that the firm is in a
favorable position to exploit, but in which the firm has no strategic interest. Such an ICV would likely be created with the intention of eventually
selling it off.
An example of a company that engaged in internal corporate venturing to leverage and exploit existing competencies is Dukane Corporation. Dukane was the original developer of the underwater acoustic

Contemporary Diversification via Internal Corporate Venturing

81

beacon used in the aviation industry. The device activates when in contact with water, emitting an acoustic signal that recovery workers can
use to locate an airplanes wreckage. Working with the Federal Aviation
Authority (FAA), Dukane gained capabilities in designing, building, and
manufacturing acoustic beacons at Dukanes own facility. They quickly
became a global supplier of underwater acoustic beacons to most major
airlines and military organizations. However, had they continued to use
their technological capabilities to produce only underwater acoustic beacons, they would have found themselves in an industry with significant
governmental regulation and thus limited profitability. Dukane experimented with venturing by applying their technological capabilities in
the domain of under-car neon light kits. This was a radical departure
from Dukanes core business, but allowed them to explore a new competitive domain with greater profit potential. Although this particular
venture was not ultimately retained as a successful business unit, Dukane went on to develop new businesses in audiovisual products, laser
welding, and ultrasonic food processing, among others. Although these
businesses may appear to be in quite different industries, they represent
Dukanes ability to leverage common technological capabilities across all
their new business ventures.
Learning, as described by Tidd and Taurins, involves the acquisition of
new knowledge and skills that may be useful in existing product/market
domains.60 There are several motives behind a firm using an ICV to learn.
First, the ICV may be used merely to learn more about the process of venturing itself. In this case, the new business serves as a laboratory in which
the innovation process can be studied. Second, the firm may create an ICV
to acquire new knowledge and skills pertaining to technologies, products,
and markets of potential strategic importance. Finally, ICVs may be used
to develop new managers, using the ICV as a training ground for developing individuals with general management potential. The 3M Corporation
is a good example of a company that ventures to learn. 3M encourages its
employees to try new things even if projects fail, so that learning may be
developed from them. 3M has a long history of stimulating internal entrepreneurship and developing small autonomous business units in order to
learn about new technologies, develop managers, and improve their venturing processes.
Measuring ICV Performance
Due to the diverse motives for establishing ICVs, measuring their performance can be a challenge for firm-level managers. For example, some
ICVs are founded for the purpose of leveraging a corporations preexisting assets in new business arenas, whereas others are founded as market probes where success is best measured in terms of the knowledge

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Strategic Management in the 21st Century

generated through the venturing effort.61 Moreover, many financial performance metrics commonly used to assess corporate performance (e.g.,
sales growth rate, return on assets [ROA]) can be problematic when assessing ICV performance. For example, ICVs all start with zero sales and
are young businesses, factors that greatly skew and render incomparable
the year-to-year computations of sales growth rate often used to assess the
performance of more established businesses. Profitability-related criteria,
such as ROA, are equally troublesome due to the variety of accounting
methods and decision policies corporate parents adopt when allocating
costs to corporate ventures. Moreover, many ICVs are too nascent to be
profitable; thus although they may achieve the performance milestones
and benchmarks established by their managers, they may not initially
generate sufficient (or any) revenues to match the parent companys initial investment in the ICV.
In light of these considerations, the most defensible approach to measuring ICV performance may be to use subjective perceptions of ICVs
outcomes. Subjective perceptions allow managers to judge ventures based
on their ability to meet the expectations of the parent, achieve critical milestones on schedule, and perform well in terms of the criteria (e.g., market
share, returns, or learning) that the parent considers most important to the
ventures success. Subjective measures of performance are useful when
objective measures are not readily available as is the case with ICVs. Subjective measures also provide insight into managers perceptions of and
satisfaction with an organizations performance, insights that cannot typically be drawn from objective measures.
Position and Control as Determinants of ICV Performance
Although the importance of ICVs for innovation, revenue growth,
profitability, and even survival have been long understood, the factors
associated with successful corporate entrepreneurship are less certain.
Prior research, which is far from universal in its assessment of the organizational conditions contributing to performance, has often pointed
to the positive influence of two factors, structural positioning of the
ICV within the firm,62 and the degree of autonomous decision making
granted to ICV managers.63 Corporate parents typically have bureaucratic structures and systems. These create boundaries between ventures
and their parents that result in increased transaction costs. Furthermore,
ventures may be established with the intention of keeping them separate
from the corporate parent. This creates even more boundaries between
the venture and its parent than those that exist inherently. When considering the structural positioning of an ICV with respect to its parent
corporation, there are two main issues to be considered: whether a given
ICV should be part of an organizations internal structure or developed

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83

externally, and, if it is to be part of the internal structure, what structural


design should be employed.
Burgelman proposed that structural designs for entrepreneurial initiatives should be chosen according to the strategic importance of the initiatives to the corporation, and their operational relatedness to the core
capabilities of the corporation.64 An initiatives strategic importance helps
to determine the degree to which the corporation needs to maintain control over the development of the initiative. In assessing strategic importance, corporate managers should focus on the following:
The consistency of the initiative with the corporations current scope
of business operations.
The potential for the initiative to help the corporation transition to
new and more attractive business domains.
The ability of the initiative to create options for the corporation to
explore new strategic directions.
The potential for the initiative to enhance the corporations competitiveness in the chosen product-market domain or to reposition the
firm within the domain.
The operational relatedness of the initiative has implications for how
efficiently the operations of the initiative can be managed with respect to
the corporations current operations. Operational relatedness can be assessed by the following criteria:
The extent to which the initiative requires product, technology, or
market-related knowledge not currently possessed by the corporation.
The extent to which the initiatives functional area activities are complementary to the corporations existing businesses.
The extent to which the corporations core competencies provide a
basis for strategic advantage in the competitive domain of the initiative.
The ability of the corporation to transfer strategic resources and
capabilities to the initiative.
Burgelman suggested that initiatives with high strategic importance be
integrated into the corporations existing structures, whereas those that
are not strategically important can be handled as independent business
units or even spin-offs.65 Similarly, initiatives that have strong operational
relatedness to their corporate parents should be integrated and nurtured
by the parent, whereas those that do not have operational relatedness

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benefit from a more hands-off approach by corporate management. Dukanes under-car neon lighting business was, for example, operated as an
autonomous business and eventually spun off.
Corporations frequently establish internal venture divisions to identify, launch, and grow promising new businesses in structurally independent entrepreneurial islands.66 Since these divisions focus on
entrepreneurship, their cultures, norms, objectives, time horizons, and
reward systems may differ significantly from those of mainstream corporate operations. Internal venture units value experimentation and creativity, and have a high tolerance for risk and a low focus on immediate
profitability. However, this often leads to an uneasy coexistence with the
rest of the corporation, with mainstream businesses increasing pressure for
tight oversight and control of the unit. For this reason, new venture units
typically have short life spans, and corporate enthusiasm for new ventures tends to be cyclical.
Another important design consideration for ICVs is how much autonomy will be granted to venture managers. Freedom from parental
oversight and involvement in the venture is typically referred to as venture autonomy.67 Previous research has indicated that autonomy may be
positively associated with ICV performance68 because the control systems used by the parent are typically too restrictive for ICVs. Venture
autonomy may empower venture managers and permit them greater
flexibility to pursue worthwhile opportunities, especially in cases where
corporate managers might not have the necessary knowledge or strategic expertise to effective manage venture activity.69 Bureaucratic executives who guide an ICV with an iron fist can squelch innovation and risk
taking within the ICV, especially if resource provisions are contingent
on the ICV achieving a timeline or performance threshold demanded by
corporate executives.
Providing venture management with complete operations autonomy
also has risks. Autonomy may create boundaries between the venture
and its parent that are detrimental to the ICV. Too much autonomy, while
reducing the ICVs dependence on its parent, may cause the venture to
incur significant losses, and make it difficult for corporate managers to
set expectations for the venture, evaluate its success, or provide it with
necessary assets.70 As a result of their separation from the corporation,
autonomous ICVs may not benefit as much from corporate advocates as
from more tightly managed counterparts. Although the autonomous ICVs
benefit from more venture-level managerial discretion, they thus also have
a more distant relationship with the larger organization upon which they
are dependent for resources. In the case of allocating assets, corporate executives may want to maintain greater control over a ventures operations
after the investment of strategic assets has been made. Balancing the level
of autonomy given to ICVs is a significant managerial challenge.

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85

Parent-Venture Product Similarity


The level of similarity between an ICVs products and its parents products may also be influential in the ICV process. Corporations often choose
to initiate ventures that pursue opportunities and venture down paths
that are quite different from existing corporate strategies and capabilities.
The farther a ventures competitive domain is from that of its corporate
parents product and market channels, the less relevant the parents resources, knowledge, and expertise may become.71 Such divergence can
seriously undermine the ventures ultimate success. However, if the products of the parent and the ICV are too similar, the success of the venture
might be compromised as the venture might be limiting its opportunity to
create novel, truly innovative products and services. Fighting for and relying too strongly on the existing strategic assets of its parents might not
only hamstring the ICV politically but prevent venture managers from
thinking outside the box.
It is generally accepted in the scholarly literature that ventures will be
most likely to succeed if they compete in product domains that are similar to those of the parent company.72 However, recent empirical research
suggests that product similarity between the parent and its ICVs is only
marginally important to ICV success.73 The inconsistent relationship between parent-venture similarity and ICV performance may be explained
by the application of the parenting advantage perspective.74 Parenting
advantage occurs when multiple businesses that could otherwise operate independently are managed by a single parent whose influence adds
to the performance of the businesses. It is likely to occur when the parents skills, knowledge, and resources fit well with the needs of the businesses. However, where there is no fit, parent involvement is likely to be
disruptive.
The literature on relatedness offers insight on the conditions when
a parenting advantage might exist between parents and their ventures.
Relatedness has been defined as how close a new business is to its parent
companys current activities.75 Previous research has explored relatedness
using a variety of theoretical constructs, including product relatedness,76
manufacturing relatedness,77 technological relatedness,78 and knowledge
relatedness,79 among others. Firms pursue related ventures for many reasons, among these to keep development costs low by exploiting corporate
know-how and skills,80 and to take better advantage of existing production facilities.81 In general, higher degrees of relatedness are expected to
be associated with greater parenting advantage opportunities between
the corporate parent and its ICVs. Relatedness assures that ICVs will operate in a business space that is adjacent in some meaningful way to
the space already occupied by the parent corporations other, more established businesses.

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Similar business knowledge provides opportunities for exploitation


across multiple parent businesses, and creates cross-business synergies.82
When parent-venture similarity is high, the parent corporation has relevant knowledge and resources in the ICVs product-market domain. To
facilitate the transfer of the parents knowledge and resources, the parent may choose to position the venture structurally close or within core
business operations, and closely control the venture in order to provide
oversight. Such involvement from the parent may be helpful to the ICV.
On the other hand, when parent-venture similarity is low, the parents
knowledge of the determinants of success in the ventures product-market
domain may be minimal. In these cases, the parent company may choose
to position and control the ICV as an independent and autonomous unit.
Since the parent has little value to add to the venture, venture management should be free to plan and manage operations. Parent involvement
in the ICV would likely be detrimental to ICV performance, and rather
than helping the ICV, the parents involvement would be more akin to
meddling. A model of ICV performance that proposes relationships such
as those described here may go far in explaining the ambiguous effect of
parent-venture similarity on ICV performance.
FUTURE DIRECTIONS FOR INTERNAL
CORPORATE VENTURING
Developing sound corporate venturing practices is a critical challenge
for companies today. As scholars continue to develop empirical findings
that contribute to our understanding of the drivers of ICV performance,
there are a few key prescriptions that corporate managers would do well to
remember as they initiate internal corporate venturing in their companies.
First, managers should remember that ICVs are essentially new businesses of their corporations. It may thus be unreasonable to expect that
corporate parents will be able to add significant value to the operations
of their ICVs. This is a fundamental reason why granting planning autonomy to new ventures may generally be good corporate policy. Stated
differently, the newness of ICVs to their corporate parents creates opportunities for venture mismanagement on the part of the corporate parents
since parent knowledge of the drivers of success in the ICVs productmarket arena will often be weak or poor.
Second, parenting advantage opportunities are created when corporations create ICVs whose products are similar to those of existing corporate businesses. The presence of parent-venture similarity suggests that
the parent possesses knowledge that is potentially valuable to the ICVs
operations. Under such circumstances, parental involvement becomes
more desirable, and a hands-on approach to the ICVs operations by
higher-level corporate managers may add value to the venture. As such,

Contemporary Diversification via Internal Corporate Venturing

87

the common observation that diversification is most successfully accomplished when firms enter adjacent product-market spaces can be extended
by recognizing that new business performance is not simply a matter of
knowing where to operate relative to a firms other business domains.
Knowing when to get involved as a corporate parent and when to stay out
of the strategic management of a new business is also critical.
Third, it is important to remember that top management support is one
of the strongest determinants of ICV performance. Although top managers often fulfill the role of securing initial resources for the ventures
start-up, top management support is also believed to have a direct effect
on ICV performance. When an ICV has top management support, internal and external coalitions can be built and mobilized to strengthen support for the new business. In addition, there are often pressures within
a parent company that prevent venture managers from changing plans.
Support from top management in the parent corporation can offset these
pressures.
There are many promising areas for future understanding of the internal corporate venturing process. For example, it remains unclear whether
the parenting advantage considerations change as ICVs evolve. For example, air cover is often needed to shield ICVs from deleterious influences
within the corporate environment.83 As ICVs mature, their demonstrated
performance often makes them less vulnerable in the context of the larger
corporation, making air cover less important to venture success.84 Among
ICVs that have matured to the point where they are perhaps returning a
profit to the parent corporation, it becomes increasingly important for the
parent to consider how the ICV will be structurally integrated into the
mainstream businesses of the company. In short, it is likely that parenting
advantage considerations will evolve as ventures develop. Research that
investigates the importance of these considerations across venture development stages will be of great theoretical and practical significance.
The effect of the motivation for creating of an ICV on subsequent ICV
performance is a little-explored area of the internal corporate venturing
process. As described earlier, ICVs are not founded exclusively with the
motive of generating profits for the parent company. They may be created
for learning purposes, to leverage latent resources of the parent company,
or to simply increase the size of the parent company and secure greater
job security and compensation for top executives. The motives for creating an ICV may not only define the intended outcomes by which ICV
performance is measured, but also influence the amount of managerial
attention given to the ventures and how they are managed. Consistent
with the attention-based view (ABV) of the firm,85 managers direct their
time and attention to the most strategically important initiatives in the
firm. ICVs that are founded in competitive arenas or are of strategic importance to the parent corporation should thus receive more managerial

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attention than those founded for reasons with a basis in exploration or


learning. Future researchers may consider the ABV to be a useful theoretical perspective when developing models of ICV performance, and
when describing its implications to managers engaged in internal corporate venturing.
In conclusion, when corporations choose internal corporate venturing
as a path to corporate growth and renewal, they are, by definition, diversifying into new business arenas. Concepts drawn from the corporate strategy literature on diversification, particularly those related to parenting
advantage and adjacency, thus represent useful reference points around
which an ICV performance model might be constructed. How to diversify through innovation is a critical challenge facing companies today. In
response, executives are embracing corporate entrepreneurship as a critical path to firm success. In doing so, they promote entrepreneurial actions that result in innovations that renew firms, their markets, and their
industries.
NOTES
1. Ansoff, I. 1965. Corporate Strategy. New York: McGraw-Hill.
2. Helfat, C. E. and R. S. Raubitschek. 2001. Product sequencing: Coevolution of knowledge, capabilities, and products. Strategic Management Journal
21:961980. Matsusaka, J. G. 2001. Corporate diversification, value maximization,
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3. Porter, M. E. 1987. From competitive advantage to corporate strategy.
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4. Teece, D. J. 1980. Economies of scope and the scope of the enterprise. Journal of Economic Behavior and Organization 1:223247.
5. Chari, M.D.R., S. Devaraj, and P. David. 2008. The impact of information
technology investments and diversification strategies on firm performance. Management Science 54(1):224234.
6. Ravichandran, T., Y. Liu, S. Han, and I. Hasan. 2009. Diversification and
firm performance: Exploring the moderating effects of information technology
spending. Journal of Management Information Systems 25(4):205240.
7. Ibid.
8. Jones, G. R. and C. Hill. 1988. Transaction cost analysis of strategystructure choice. Strategic Management Journal 9(2):159172.
9. Ravichandran, T., Y. Liu, S. Han, and I. Hasan. 2009.
10. Kor, Y., and J. T. Mahoney. 2000. Penroses resource-based approach:
The process and product of research creativity. Journal of Management Studies
37(1):109139. Teece, D. J., R. Rumelt, G. Dosi, and S. Winter. 1994. Understanding corporate coherence: Theory and evidence. Journal of Economic Behavior and
Organization 23:130.
11. Teece, D. J., R. Rumelt, G. Dosi, and S. Winter. 1994.
12. Mayer, M., and R. Whittington. 2003. Diversification in context: A crossnational and cross-temporal extension. Strategic Management Journal 24(8):773781.

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McGrath, R. G., and A. Nerkar. 2004. Real options reasoning and a new look at the
R&D investment strategies of pharmaceutical firms. Strategic Management Journal
25(1):121.
13. Khanna, T., and K. Palepu. 2000. The future of business groups in emerging markets: Long-run evidence from Chile. Academy of Management Journal
43:268285.
14. Greene, P. G., C. G. Brush, and M. M. Hart. 1999. The corporate venture
champion: A resource-based approach to role and process. Entrepreneurship Theory & Practice 23(3):103122.
15. Christensen, C. 1997. The Innovators Dilemma: When New Technologies Cause
Great Firms to Fail. Boston: Harvard Business Press.
16. Lu, J., and P. W. Beamish. 2004. International diversification and firm performance: The S-curve hypothesis. Academy of Management Journal 47(4):598609.
17. Brusch, T. H. 1996. Predicted change in operational synergy and postacquisition performance of acquired business. Strategic Management Journal 17:124.
18. Lubatkin, M., and S. Chatterjee. 1994. Extending modern portfolio theory
into the domain of corporate diversification: Does it apply? Academy of Management Journal 37:109136.
19. Chatterjee, S., and B. Wernerfelt. 1991. The link between resources and type
of diversification: Theory and evidence. Strategic Management Journal 12:3348.
20. Argyres, N. 1996. Capabilities, technological diversification, and divisionalization. Strategic Management Journal 17:395410.
21. Hitt, M. A., R. D. Ireland, and R. E. Hoskisson. 1999. Strategic management.
Cincinnati: South-Western.
22. Ibid.
23. Kor, Y., and J. T. Mahoney. 2000. Sirmon, D. G., M. A. Hitt, and R. D. Ireland.
2007. Managing firm resources in dynamic environments to create value: Looking inside the black box. Academy of Management Review 32(1):273292.
24. Farjoun, M. 1994. Beyond industry boundaries: Human expertise, diversification and resource-related industry groups. Organization Science 5(2):185199.
25. Cannella, A. A., and M. J. Monroe. 1997. Contrasting perspectives on strategic leaders: Toward a more realistic view of top managers. Journal of Management 23:213237. Finkelstein, S., and D. C. Hambrick. 1996. Strategic Leadership: Top
Executives and Their Effects on Organizations. St. Paul: West Publishing.
26. May, D. L. 1995. Do managerial motives influence firm risk reduction
strategies? Journal of Finance 50:12911308. Amihud, Y., and B. Lev. 1981. Risk
reduction as a managerial motive for conglomerate mergers. Bell Journal of Economics 12:605617.
27. Gray, S. R., and A. A. Cannella. 1997. The role of risk in executive compensation. Journal of Management 23:517540. Tosi, H., and L. Gomez-Mejia. 1989.
The decoupling of CEO pay and performance: An agency theory perspective.
Administrative Science Quarterly 34:169189.
28. Finkelstein, S., and R. A. DAveni. 1994. CEO duality as a double-edged
sword: How boards of directors balance entrenchment avoidance and unity of
command. Academy of Management Journal 37:10701108.
29. Brush, T. H., P. Bromiley, and M. Hendrickx, 2000. The free cash flow hypothesis for sales growth and firm performance. Strategic Management Journal
21:455472.

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30. David, P., J. OBrien, T. Yoshikawa, and A. Delios. 2010. Do shareholders or


stakeholders appropriate the rents from corporate diversification? The influence
of ownership structure. Academy of Management Journal 53:636654.
31. Kim, H., R. E. Hoskisson, and W. P. Wan. 2004. Power dependence, diversification strategy, and performance in keiretsu member firms. Strategic Management Journal 25:613636.
32. Rumelt, R. P. 1974. Strategy, Structure, and Economic Performance. Cambridge,
MA: Harvard University Press.
33. Ibid.
34. Markides, C. C. 1995. Diversification, restructuring, and economic performance. Strategic Management Journal 16:101118.
35. Hoskisson, R. E., M. A. Hitt, R. A. Johnson, and D. S. Moesel. 1993. Construct validity of an objective (entropy) categorical measurement of diversification
strategy. Strategic Management Journal 14:215235.
36. David, F. R. 2011. Strategic Management: Concepts and Cases. Boston: Prentice Hall.
37. Kuratko, D. F., J. G. Covin, and R. P. Garrett. 2009. Corporate venturing: Insights from actual performance. Business Horizons 52:459467.
38. Ibid.
39. Hamel, G. 2000. Leading the Revolution. Boston: Harvard Business School
Press, p. 115.
40. Shane, S., and S. Venkataraman. 2000. The promise of entrepreneurship as
a field of research. Academy of Management Review 25(1):217226.
41. Morris, M. H., D. F. Kuratko, and J. G. Covin. 2008. Corporate Entrepreneurship and Innovation. Mason, OH: Thomson South-Western.
42. Kuratko, D. F., J. G. Covin, and R. P. Garrett. 2009.
43. Morris, M. H., D. F. Kuratko, and J. G. Covin. 2008.
44. Burgelman, R. A. 1983. Corporate entrepreneurship and strategic management: Insights from a process study. Management Science 29:13491364. Burgelman, R. A., and L. Sayles. 1986. Inside Corporate Innovation: Strategy, Structure, and
Managerial Skills. New York: Free Press.
45. Burgelman, R. A. 1988. Strategy making as a social learning process: The
case of internal corporate venturing. Interfaces 18(3):7485.
46. McGrath, R. G., S. Venkataraman, and I. C. MacMillan. 1994. The advantage chain: Antecedents to rents from internal corporate ventures. Journal of Business Venturing 9:351369.
47. von Hippel, E. 1977. Successful and failing internal corporate ventures: An
empirical analysis. Industrial Marketing Management 6:163174.
48. For example, McGrath, R. G., T. Keil, and T. Tukiainen. 2006. Extracting
value from corporate venturing. MIT Sloan Management Review 48(1):5056.
49. Shortell, S. M., and E. J. Zajac. 1988. Internal corporate joint ventures: Development processes and performance outcomes. Strategic Management Journal
9(6):527542.
50. Biggadike, R. 1979. The risky business of diversification. Harvard Business
Review 57(3):103111.
51. Burgelman, R., and L. Valikangas. 2005. Managing internal corporate venturing cycles. MIT Sloan Management Review 46(4):2634.

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52. Garvin, D. A. 2002. A note on corporate venturing and new business creation. Harvard Business School Note 9-302-091. Garvin, D. A., and L. C. Levesque.
2006. Meeting the challenge of corporate entrepreneurship. Harvard Business Review 84(10):102112.
53. Burgers, J. H., J. Jansen, F. Van den Bosch, and H. Volberda. 2009. Structural differentiation and corporate venturing: The moderating role of formal and
informal integration mechanisms. Journal of Business Venturing 24(3):206220.
54. Day, D. 1994. Raising radicals: Different processes for championing innovative corporate ventures. Organization Science 5(2):148172.
55. Venkataraman, S., I. C. MacMillan, and R. G. McGrath. 1992. Progress in
research on corporate venturing. In The State of the Art of Entrepreneurship edited
by D. L. Sexton and J. D. Kasarda, 487519. Boston: PWS-Kent.
56. Van de Ven, A. H., S. Venkataraman, D. Polley, and R. Garud. 1989. Processes of new business creation in different organizational settings. In Research on
the Management of Innovation edited by A. H. Van de Ven, H. Angle, and M. S. Poole,
221297. New York: Harper & Row.
57. Greene, P. G., C. G. Brush, and M. M. Hart. 1999.
58. Block, Z. 1989. Damage control for new ventures. Journal of Business Strategy 10(2):2228.
59. Tidd J., and S. Taurins. 1999. Learn or leverage? Strategic diversification
and organizational learning through corporate ventures. Creativity and Innovation
Management 8(2):122129.
60. Ibid.
61. Ibid. Covin, J. G., and M. P. Miles. 2007. Strategic use of corporate venturing. Entrepreneurship Theory and Practice 31(2):183207.
62. Burgelman, R. A. 1984. Designs for corporate entrepreneurship in established firms. California Management Review 26(3):154166.
63. For example, Simon, M., S. M. Houghton, and J. Gurney. 1999. Succeeding
at internal corporate venturing: Roles needed to balance autonomy and control.
Journal of Applied Management Studies 8(2):145158.
64. Burgelman, R. A. 1984.
65. Ibid.
66. Garvin, D. A. 2002.
67. Simon, M., S. M. Houghton, and J. Gurney. 1999.
68. Ibid. Birkinshaw, J., and S. Hill. 2005. Corporate venturing units: Vehicles
for strategic success in the new Europe. Organizational Dynamics 34(3):247257.
69. Block, Z., and I. MacMillan. 1993. Corporate Venturing: Creating New Businesses with the Firm. Boston: Harvard Business School Press.
70. Simon, M., S. M. Houghton, and J. Gurney. 1999.
71. Campbell, A., M. Goold, and M. Alexander. 1995. Corporate strategy: The
quest for parenting advantage. Harvard Business Review 73(2):120132.
72. Hill, S. A., and J. Birkinshaw. 2008. Strategy-organization configurations in
corporate venture units: Impact on performance and survival. Journal of Business
Venturing 23:423444. Thornhill, S., and R. Amit. 2001. A dynamic perspective of
internal fit in corporate venturing. Journal of Business Venturing 16(1):2550.
73. For example, Kuratko, D. F., J. G. Covin, and R. P. Garrett. 2009.
74. Campbell, A., M. Goold, and M. Alexander. 1995.

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75. Sorrentino, M., and M. L. Williams. 1995. Relatedness and corporate venturing: Does it really matter? Journal of Business Venturing 10:5973.
76. Rumelt, R. P. 1974.
77. St John, C.H.S., and J. S. Harrison. 1999. Manufacturing-based relatedness,
synergy, and coordination. Strategic Management Journal 20(2):129145.
78. Robins, J. A., and M. F. Wiersema. 1995. A resource-based approach to the
multibusiness firm: Empirical analysis of portfolio interrelationships and corporate financial performance. Strategic Management Journal 16(4):277299. Silverman,
B. S. 1999. Technological resources and the direction of corporate diversification:
Toward an integration of the resource-based view and transaction cost economics. Management Science 45(8):11091124.
79. Tanriverdi, H., and N. Venkatraman. 2005. Knowledge relatedness and the
performance of multibusiness firms. Strategic Management Journal 26:97119.
80. Fast, N. D. 1979. The future of industrial new venture departments. Industrial Marketing Management 8(1):264273.
81. Sorrentino, M., and M. L. Williams. 1995.
82. Teece, D. J. 1980.
83. McGrath, R. G., T. Keil, and T. Tukiainen. 2006.
84. Garvin, D. A., and L. C. Levesque. 2006.
85. Ocasio, W. 1997. Towards an attention-based view of the firm. Strategic
Management Journal 18:187206.

Part II

Functional Strategies

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Chapter 5

Marketing Strategy
Robert D. Winsor

STRATEGIC MARKET ORIENTATION


Revenue can be characterized as the energy that feeds a business organizations existence. Because the flow of revenue is indispensable to
organizational survival, marketing is perhaps the most critical function
within a business organization. Although revenues (and, consequently,
profits) can be generated through a variety of ever-evolving market
strategies, the most fundamental distinction among these strategies can
be viewed as a preference between margin and volume. That is, marketing strategy at its most basic level reduces to a choice between selling
goods and services at a higher-than-average markup (gross margin) or a
higher-than-average volume. Although either approach can be desirable
and worthy, they require implementation approaches that are largely
incompatible. A business may aspire to achieve both supra-normal volume and supra-normal margins, but the simultaneous attainment of
these goals is difficult in a competitive marketplace. Basic marketing
strategy can thus be seen as reflecting an organizational focus on one, or
sometimes both, of these paths. These three alternative marketing strategies are referred to as a margin orientation, a volume orientation, and a
margin-volume-differentiation (MVD) strategy.1

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Margin-oriented (MO) businesses focus primarily on maintaining or


improving their per-unit markups or margins, and concerns for volume
are largely subordinate to this. MO businesses are by definition those that
sell goods and services that have high prices in relation to total costs and
for which in most cases, a large proportion of total costs are variable in nature. These high variable costs tend to confound efforts to discount prices,
even though margins are high. The relatively small minor proportion of
fixed costs also means that few opportunities for scale economies are present. As a result, incentives for volume expansion within an MO organization
are limited and provide little advantage from a cost perspective. Faced with
having to make a trade-off, the organization will generally be more interested
in preserving its markup than its sales volume. MO firms thus use product
differentiation as a competitive weapon, and find competitive shelter by
pursuing markets in which demand is price inelastic.
A volume-oriented (VO) strategy has several defining characteristics. First, it embodies the pursuit of scale economies in both production
and marketing activities. These are made possible through the use of
operating leverage (capital investments) in both areas, resulting in a cost
structure that is dominated by fixed costs. As a result, volume expansion is motivated by the need to not only increase sales but also reduce
unit costs. VO businesses must continually seek to expand sales because
larger volumes allow the allocation of fixed costs across more units, effectively lowering fixed costs per unit. Lower unit costs can in turn lead
to enhanced profitability or expanded sales and market share, depending upon whether price discounts follow the cost savings. At the same
time, utilization of capacity must be high, as unused capacity serves to
inflate average fixed costs.2 As a result, VO firms will often embrace
strategies that preserve or expand unit sales even if these require the
sacrifice of unit gross margins. VO companies may even pursue volume
to the point that sales are made at a price below the firms average total
costs. For example, due to their high operating leverage, airlines often
sell seats at prices below the average cost for a passenger. Since the negative effects of unused capacity on profits exceed those of discounted
prices (and thus reductions in contribution margin), the VO firm will
generally discount when necessary to fill capacity.
Second, due to the VO strategys singular focus on volume, mass
production is combined with mass marketing.3 That is, to achieve the
highest possible sales volumes, markets must be defined as broadly as
possible. As a result, marketing strategy for the VO firm is based on selling a good enough product with broad appeal. The drive to minimize
average production cost also motivates the firm to produce and market a
small number of models, as this enables them to fully exploit experience
effects and scale economies. Mass marketing supports this by exploiting market homogeneity, or the ways in which consumer preferences

Marketing Strategy

97

are similar. In other words, the VO strategy succeeds by identifying


needs that consumers share in common and satisfying these needs efficiently. Since consumers of such products are typically price sensitive,
VO companies must typically offer goods and services that are at or near
the low end of the price spectrum. The goal of a volume orientation is
thus to competitively provide the greatest perceived value to the greatest number of consumers. In this way, the emphasis on cost reduction
strategically complements the low-price marketing strategy necessary
for achieving volume, and creates a virtuous cycle whereby low prices
drive sales volume, which through scale economies push costs lower.
The emphasis on volume and cost reduction coupled with the reliance
on standardized output make the VO strategy highly effective when employed in developing economies, but more risky in environments characterized by significant fluctuations in demand.4
A volume-margin-differentiation (VMD) strategy represents an attempt to simultaneously pursue high sales volume and unit margins
through product differentiation. Whereas a VO business maximizes efficiency by combining mass production with mass marketing, a VMD
strategy sacrifices some efficiency by adopting target marketing in an effort to gain pricing power. In other words, whereas a VO strategy seeks
to exploit economies of scale in both production and marketing, a VMD
strategy attempts to increase margins through product differentiation
and market segmentation, and represents an attempt to improve margins while sacrificing as little volume as possible. It exploits market
heterogeneity by identifying product or service dimensions for which
consumer preferences differ (or for which customers desire variety),
and fulfilling these unique or diverse needs (through product differentiation) in order to extract a price premium over competitive offerings
that fail to reflect these differences. VMD embraces a group of target
marketing strategies that enable an organization to move away from the
relentless and challenging price pressures typical in a volume orientation. In a sense, VMD represents an abandonment of price competition,
and seeks the greener pastures of the margin-boosting dimensions of
brand and company strategy.
COMPETITIVE EVOLUTION AND
THE INTERACTION OF STRATEGIC MODES
Over the course of history, businesses in most industry sectors have
tended to evolve through the three strategic market orientations in a predictable pattern. Agricultural endeavors have typically been the first to
venture aggressively into a VO strategy, employing animals, slaves, and
eventually machines in order to exploit economies of scale and drive
down costs while increasing output. The production and marketing of

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agricultural products using a volume orientation goes back thousands of


years and represents one of the most noteworthy advances in the evolution of economies. At later points in the development of most economies, the manufacturing and service sectors typically follow this path
toward a volume orientation.
Prior to the late 19th century, most businesses in the United States
(with the exception of those in agriculture) utilized a margin orientation,
largely because technologies did not exist to exploit scale in either production or marketing. Although craftsmen had acquired sufficient skills
to produce highly sophisticated and precise objects (such as elaborate
clocks, optics, and firearms), machine tools had not yet been developed
that could be used to efficiently produce large quantities of identical
parts. As Hounshell notes, even the most proficient of early large-scale
producers such as the Singer Manufacturing Company (of Singer sewing machine fame) had tremendous difficulty in surmounting this critical aspect of mass production.5 As a result, true mass production was
delayed. On the marketing side, inefficiencies in transportation (and to
some extent communication) precluded mass-marketing efforts until
railroad networks had blanketed the majority of the United States, allowing rapid and reliable distribution of merchandise. Furthermore,
large, middle-class societies with significant purchasing power did not
typically exist; thus a volume orientation in production would have
been met with inadequate demand.
With advances in production, transportation, and communication
technologies in the late 19th century, the volume orientation in the
United States evolved rapidly as a coherent and compelling strategy
within many goods-based manufacturing and retail industries. Thanks
to pioneers such as Samuel Colt, Isaac Singer, Adolphus Busch, Henry
Ford, and Henry Leland in production, and Aaron Montgomery Ward
and Richard Sears in retailing, the volume orientation rapidly demonstrated its competitive advantage in many industrial sectors. Somewhat
later, the volume orientation was effectively adapted to the services
sector by innovators such as the McDonald brothers. Because of its inherent efficiency, the volume orientation also quickly and profoundly
altered the overall U.S. economy. Simply stated, the VO approach
solved the problem that had previously dominated economic history:
an inadequate supply of affordable goods and services relative to everexpanding demand. As a secondary effect, the volume orientation has
been largely responsible for the creation of an economic middle class in
those countries in which it has been vigorously applied.
The Breakdown in Profitability
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growth-oriented firms in a wide range of industries quickly adapted it to


meet their unique circumstances. Due to the competitive advantage that
was often gained by rivals embracing the volume orientation, firms in
many industries hastily adopted the approach out of concern that they
would be at a competitive disadvantage and would be unable to retain
a viable share of the market. Yet, as competitors in various industries
began to compete aggressively for sales volume, the weakness of the VO
approach was quickly revealed.
As noted earlier, the success of a volume orientation relies upon high
levels of operational leverage. As more and more firms within an industry adopt a VO strategy, this leverage forces them to compete for sales
volume at almost any cost. Price competition begins to develop as efforts
to utilize high levels of capacity generate pressure to liquidate the large
volume of output.6 As a result, prices and thus profit margins quickly
erode, leading to suppressed industry returns.7 Firms embroiled in this
battle typically seek relief by attempting to secure market share through
mergers with, or the acquisition of, rivals, but this remedy has limitations in that it neither expands demand nor reduces excess capacity.
Eventually, strategic solutions emerge that focus on regaining pricing
power and stimulating organic market growth, and lead to the adoption
of an MVD approach to competition.
VO competitors that are experiencing cutthroat competition and
suppressed profitability eventually realize that when feasible, pricing
power is most effectively derived from the judicious use of product differentiation.8 Adoption of an MVD strategy represents a natural progression from a VO strategy, since production methods remain largely
unchanged. However, marketing methods underlying an MVD strategy
represent a shift away from mass marketing toward market segmentation and product differentiation.
Evolutionary Equilibrium
Many researchers have observed that the vast majority of industries
tend to evolve toward a structure in which a few large firms dominate
the general market, and numerous smaller firms fill specialized niches.9
Henderson,10 Sheth and Sisodia,11 and Uslay, Altintig, and Winsor12 argued specifically that three large competitors and a number of small specialists commonly dominate stable markets. Yet, despite the remarkable
consistency of past findings regarding firm size and numerical distribution, few if any have been accompanied by either empirical or theoretical
assessments of which specific competitive strategies might be common
or effective within these pervasive industry structures. In other words,
despite widespread agreement that industries commonly share distinctive configurations, discussion of how strategies might be developed to
exploit these regularities has been conspicuously absent.

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Despite this normative deficiency, certain strategic configurations


frequently emerge in the evolutionary patterns of industry competition.
Specifically, many industries evolve toward a stable competitive population consisting of either one or no VO firms, two to three large MVD
firms, and a number of small MO nichers or product/market specialists.13 Where more than one VO firm exists within an industry or where
more than three large companies contest the general market, rivalry
will be intensified and profitability will be suppressed. As noted earlier,
when one VO firm competes against another, ruinous price competition
leads to the reduction and eventual elimination of both firms profits.
As a result, rivalry among multiple VO firms will tend to be short-lived
wherever product differentiation is possible, and the firms will readily
evolve toward MVD strategies in order to escape the price competition.
Where such differentiation is more difficult, as illustrated by the airline
industry, instability and depressed profits will tend to persist indefinitely, and the industry will tend toward competitive instability.
Environmental Influences in Competitive Evolution
There exist a number of factors that can disrupt or alter the pace of
industry evolution. The most significant of these allow or facilitate the
entrance of new rivals in markets that were formerly competitively discrete or isolated. As Blackhurst and Henderson note, competitive barriers can be annulled through either technological or political processes.
Additionally, economic and environmental crises can often lead to evolutionary shocks by directly or indirectly spurring political or technological responses.14
Technology has historically had a significant impact on evolutionary processes concerning competition. As noted earlier, advances in production technology made the volume orientation possible. Yet technology
as applied to the marketing process has exerted even greater influence on
evolutionary progress. Advances in transportation and communication,
for example, have had profound effects on competitive populations, since
market equilibrium is often artificially preserved when geographic isolation or market inaccessibility prevails.15 The fact that regional monopolies
and oligopolies arise as an inevitable result of inefficient transportation
technologies is a common observation in the economics literature.16
Efficiencies in transportation can disrupt competitive equilibria
through either of two means. First, producers can utilize lower-cost
transportation technologies to distribute products to areas that may have
previously been economically inaccessible. Improvements in transportation thus allow distant rivals to compete with local producers by lowering the costs associated with inter-region transactions relative to those
of intra-region transactions.17 More efficient means of transportation also

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allow producers to access numerous smaller markets that would have


formerly been unprofitable to enter. Second, improvements in transportation can allow consumers to more easily access distant producers.
The rapid growth of the interstate railroad network in the United
States in the second half of the 19th century illustrates the competitive
effects of advances in transportation. The development of this network
led to a substantial shift from regional economic competition to national
competition as the costs of long-distance transportation declined precipitously accompanied by quantum increases in speeds. Competitive
conditions in most industries were altered significantly as businesses
that had been geographically isolated from potential competitors gained
reciprocal access to each others markets and began to interact competitively. As a result of this completion, most U.S. industries during this period experienced substantial turmoil. As Scherer describes:
As the railroads expanded their coverage from 9000 miles of road
operated in 1850 to 167,000 miles in 1890, . . . something resembling a true national market emerged for the first time. Firms interpenetrated each others former home territories and competition
flourished.18
The railroad network thus broke apart local monopolies and oligopolies,
and new business models (such as those of catalog retailers Montgomery Ward and Sears, Roebuck and Co.) became viable due to the reduced
trans-portation costs the railroads yielded. These effects combined to intensify competitive rivalry and led to fierce market-share battles, competitive shakeouts, and massive waves of horizontal mergers.19 The brewing
industry provides an example of the market disruption precipitated by
the development of the U.S. railroad system. Prior to the existence of an
efficient mode of transportation, the distribution area of brewers was limited to a few miles by the perishability and bulk of the product. As a result, over 4,000 breweries coexisted in the United States in 1870, with each
experiencing little intermarket competition. With the development of railroads, and with improvements in bottling, refrigeration, and pasteurization methods, distribution territories expanded significantly.20 These
developments allowed regional and national brewers to emerge to serve
integrated markets, and the intensified competition resulted in a reduction of over 75 percent in the number of brewers by 1919.
Changes to Political Barriers and Other
Political Accommodations
The effects of political barriers on competitive evolution can be seen
in many aspects of business history. Political barriers can exist in the

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form of government-imposed restrictions on transportation, communication, or market accessibility, and if these barriers are reduced or
eliminated, competitive equilibria become disrupted. For example, the
reduction in trade barriers that resulted from the creation of the European Union intensified the competition that many firms in European
markets experienced. Similarly, Chinas recent liberalization of its trade
policies has seen it emerge as both a major supplier as well as a market
for many goods and services, creating both opportunities and also hazards for competitors across the globe.
Competitive barriers may also be raised or lowered during periods of
war and as the result of wars. Wars can move national boundaries and
divide or merge previously sovereign geographic territories, thereby altering the dynamics of competition. In the aftermath of World War II, for
example, Germany was divided into East Germany and West Germany,
and competitive trade patternsboth within these regions and with
other countrieswere altogether reformulated. Further, during times of
war, governments can grant protection from competition in the form of
monopolistic contracts. For example, the Gillette Safety Razor Company
won a government contract to provide all U.S. troops with a field razor
set during World War I. As discharged soldiers were allowed to keep
these razor kits after the war was over, a large and stable market for
Gillette replacement blades was ensured. The Coca-Cola Company was
similarly awarded a government contract during World War II allowing
them the exclusive right to provide all U.S. military forces with Coke in
every theatre of operation. During World War II, over five billion bottles
of Coca-Cola were provided to service personnel, and 64 international
bottling companies were constructed to supply this volume.21 After the
war, returning troops exhibited loyalty to Coca-Cola, and international
markets (and distribution networks) had been firmly established.
Economic and environmental crises can often directly or indirectly
provoke substantial political or technological responses, and thus instigate competitive disruptions. Crises can also alter patterns of consumer
demand. An excellent example of such a crisis was the petroleum embargo of the early 1970s in the United States, which led to the disruption
of equilibrium in the U.S. automobile industry.
Competitive Destabilization from Globalization
Entrants to U.S. markets from developing countries typically cause
great competitive disruption. Many of these companies enjoy cost advantages derived from lower wages, home-government subsidies, or
both. Yet many of the competitive challenges posed by these entrants do
not derive merely from lower input costs, but rather due to their basic
competitive mode, which is typically one of volume orientation. These

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firms have successfully used a VO strategy to satisfy basic demand in


their home markets, and as they have improved their product quality,
they have typically sought to improve margins by exporting to more affluent markets in the United States and other postindustrial countries.
Additionally, they are not likely to have made significant investments
to cultivate goodwill or brand familiarity among U.S. consumers. Possessing cost advantages and lacking the potential for rapid development
of consumer loyalty, these firms have little choice but to aggressively
attack the domestic competition from a low-price, undifferentiated position. In other words, a forceful volume orientation is the logical approach for most new foreign entrants seeking to conquer market share
in established markets in developed countries. The entry of overseas VO
producers typically results in strategic confounding for the established,
domestic firms. These domestic firms have often invested significantly
in branding, advertising, and other MVD-based approaches, collectively
reaching a point of equilibrium based on nonprice competition. The
entry into the market by aggressive VO, cost-advantaged competitors
thus destroys any competitive harmony that may have existed. Since
the established domestic firms are typically unable to compete on a cost
basis, they may lose significant market share.
Ultimately, the evolution of competition within global markets introduces both an excess of VO competitors and a disequilibrating mlange
of competitive strategies and objectives. This makes predicting and responding to rival actions more challenging than in the past. Globalization can thus not only disrupt the existing equilibrium in markets, it
can also forestall or prevent progress toward reaching a new equilibrium. Whereas prior periods in the history of market evolution have
been frequently characterized by a relative consistency of objectives and
strategies that allows for a level of predictability regarding competitive
behaviors, the chaos of globalization makes competitive planning and
decision making vastly more complex. It can also lead to disorder and
discord within supply and distribution channels, consumer disorientation, and generalized industry confusion.
Patterns of Competitive Evolution in a Global Context
At least two patterns of competitive evolution can be seen as being
common, both historically and contemporarily. When economies initially develop in relative isolation from trade (as was common prior to
globalization), industries typically evolve toward an equilibrium pattern characterized by two or three large domestic MVD competitors
and numerous niche (MO) participants. As these economies become exposed to global competition, equilibrium will be disrupted and competition will intensify. Consistent with Schumpeters notion of creative

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destruction, changes in competitive dynamics will progress through


three distinct stages: evolution, equilibrium, and disruption and new
evolution. Of particular significance is the expectation that carnage will
likely result when new entrants disrupt an equilibrium stage.
In contrast, when an industry develops within an extant environment
of global competition, evolution can be expected to progress more directly
toward a global, dynamic competitive equilibrium without undergoing
an intermediate stage of domestic equilibrium (and thus disruption). An
example of this can be seen in the video game industry in which three
MVD competitors have battled for global market dominance throughout much of the industrys history. Although the technological platforms
and the identities of individual competitors have evolved, the overall
market structure has remained relatively invariant. The early big three
of Atari, Nintendo, and Sega were thus transformed into the later trio of
Nintendo, Sega, and Sony. This subsequently metamorphosed into the
current lineup of Nintendo, Sony, and Microsoft.
Competitive equilibrium should not, however, be considered to be
inevitable. Impediments to competitive equilibrium can forestall or prevent global industries from reaching this desirable state. For example,
government subsidies may allow inefficient firms or those with weak
strategies to survive artificially. Ongoing global economic development
also means that the number of new industrializing countries, characterized by expanding manufacturing capacities and relatively inexpensive
labor is increasing relentlessly. Increasing affluence in more developed
countries also transforms them from net exporters to net importers of
finished goods, enabling the new low-cost production capacity of VO
firms in emerging economies to displace production in more developed
nations.22 In short, globalization tends to cause and perpetuate the entrance of low-cost VO firms into competitive markets, and this influx
and resultant industry turmoil exerts pressure on profit margins and
prevents or retards competitive equilibrium.
U.S. economic history over the last half-decade offers an example
of the effects of global competition. The entry into the United States of
low-cost Japanese producers and products that characterized the 1970s
was superseded by the arrival of even lower-priced goods from Taiwan and South Korea two decades later. Today, the river of goods from
those countries is being overwhelmed by goods from China, resulting
in the suppression of industry profits from the powerful phenomenon
known as the China Price.23 Despite the compelling cost advantages
of Chinese producers, history suggests that other countries will follow
(perhaps quickly) and surpass the productive might of China. Emerging opportunities for investments and marketing programs may now be
greatest in areas that currently lie in Chinas economic shadow, such as
India, Brazil, Mexico, and Thailand.

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AN ILLUSTRATION OF COMPETITIVE EVOLUTION:


THE U.S. AUTOMOBILE INDUSTRY
The history of the automobile industry in the United States illustrates
how strategic evolution and interaction occurs within a single industry. Four distinct phases can be identified in the competition for market
share.
18951908: The Margin-Orientation Era
Competition during the early history of the industry was largely characterized by a margin orientation. Hundreds of small producers each
built a handful of automobiles using small-scale production methods,24
and competition took place on the basis of quality or design. Most car
chassis were built in small quantities and then fitted with handmade
bodies that were customized to each buyers unique specifications or
preferences. As a result, variable costs per unit, and thus prices, were
necessarily highgenerally above $2,500 or the price of an average
house at that time. These prices were not, however, considered to be a
major impediment to sales since the prevailing wisdom of virtually all
producers was that automobiles were luxury goods for the very rich.
Since there were few paved roads and early automobiles were largely
unreliable from a mechanical standpoint, few envisioned the future of
automobiles as practical replacements for horse-drawn vehicles.
19081925: The Volume-Orientation Era
The volume-orientation era began with Henry Fords introduction of
the Model-T in late 1908. Ford was visionary in that he foresaw the future of automobiles as practical transportation for the average person,
rather than merely recreational toys for the wealthy. He understood that
the automobile market was largely price sensitive, and although in retrospect this appears obvious, at the time it was considered lunacy. As
a result, Ford lost many investors due to his persistence with this vision. Fords domination during the VO era was unassailable and competitively devastating. Competitors eagerly attempted to copy Fords
production methods, which were based on a number of innovations
including the then-revolutionary moving assembly line, but none approached the level of efficiency needed to be truly competitive. By 1925,
Ford was selling cars for less than $300, and competing cars were priced
at nearly twice this amount. By the time production of the Model-T came
to an end in 1927, Ford had sold over 15 million cars, and half of the cars
on the road were Model-Ts. In the 19 years during which the Model-T
was sold, 90 percent of automobile producers either left the automobile industry or were absorbed by one of the few survivors. Indeed, it is

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likely that Fords success with the VO approach contributed to the brevity of this period in the auto industry, since competitors (such as General
Motors) were forced to develop a viable alternative strategy merely to
survive.25
19251974: The Margin-Volume-Differentiation
Equilibrium Era
Fords single-minded commitment to cost reduction and volume production eventually became self-defeating, as the company discovered
by the mid-1920s. As the automobile market approached saturation (by
this time, nearly 70% of U.S. households owned an automobile),26 prospects for stimulating further sales using price reductions alone began to
dim. Moreover, industry margins had virtually evaporated, with Ford
making as little as $2 per car in profit by 1924.27 Since automobiles were
a durable good, it was also difficult to sell additional units to existing
owners. As a result, the major automobile producers began resorting to
mergers and to cultivating export markets in an attempt to preserve production volumes. For a short period of time, these measures allowed
some U.S. car producers to survive in the face of a saturated domestic
market and cutthroat pricing.
The MVD era began in the mid-1920s as General Motors discovered
that product differentiation and target marketing of multiple product
lines not only generated higher margins but also expanded the market
beyond the economy-minded buyer of basic transportation.28 Moreover,
it provided a means to compete with Ford on factors other than price.
GM implemented this MVD strategy using multiple product lines, the
annual model change, the extension of consumer credit, and lifestyle advertising.29 These strategies shifted consumer perceptions of
automobiles from commodities that offered simple transportation toward their being objects of fashion or status, allowing GM to sell more
expensive (higher margin) automobiles. It also allowed carmakers to
accelerate consumer repurchase rates, since obsolescence in style was
accepted by consumers that would have contested functional obsolescence. The MVD approach allowed General Motors to quickly overtake
all other car companies in terms of sales volume. For the next 50 years,
the automobile industry was characterized by worldwide dominance of
the Big Three U.S. carmakers: General Motors, Ford, and Chrysler.30
Schumpeter31 noted that by the 1940s, the Big Three controlled over
80 percent of the market, and, facilitated by this domination, tended to
refrain from practices that would have been injurious to their profits
(such as price competition). This resulted in the gradual increase in average profit margins as the industry enjoyed competitive equilibrium.

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The Post-Equilibrium Era


As noted earlier, environmental crises can disrupt competitive equilibrium. The highly profitable domestic equilibrium phase of the U.S.
automobile industry was fractured in the early 1970s, as instability in the
crude oil market compromised the supply of gasoline and led to consumers questioning their loyalty to the Big Three. For the 40 years prior to
this, the industry had consisted of the Big Three, whose profits were
typically robust and relatively consistent, followed by the smaller American Motors and a number of small and competitively insignificant independent carmakers. The limited availability of gasoline that resulted
from the oil embargo and price controls disrupted this equilibrium by
motivating consumer acceptance of smaller and more fuel-efficient Japanese automobiles, thus opening the door to foreign competitors. Consumer preferences were now misaligned with the traditional strengths
of U.S. car makers that had been developed over the prior five decades
(namely, differentiation based on styling, lifestyle, and luxury). Instead,
consumers placed greater emphasis in purchase decisions on value,
which played to the strengths of Japanese brands that were produced
using a volume orientation.
Because of their skills in implementing this volume orientation, Japanese competitors entered the U.S. market from a low-price, high-value
position. U.S. producers, with their margin-focused MVD approaches,
were too entrenched in the more car per car mentality to respond.
As a result, U.S. car makers willingly ceded the low-price segment of
the market to the Japanese firms, based on the perilously erroneous assumptions that Japanese cars were of poor quality, the market segment
comprising price-sensitive buyers was small, and Japanese entrants
would be unable to later broaden their appeal to higher-margin market
segments. As a result, U.S. hegemony in both domestic and global automobile markets began to deteriorate, leading to a more competitive
environment for all car producers, characterized by increasing complexity and risk.
Subsequent to their entry into the U.S. market in the 1970s, Japanese
car makers gradually moved upmarket by shifting from pure VO approaches to more profitable MVD strategies. Following the example
set by their U.S. rivals five decades earlier, they offered more variety,
higher-end options, and eventually introduced luxury brands such as
Acura, Infiniti, and Lexus. Beginning in the mid-1980s, Korean producers emulated prior Japanese successes, first entering the U.S. market
using a volume orientation and a low-price market position but, by the
first decade of the 21st century, adopting many aspects of MVD strategy. Today, low-priced Chinese-made automobiles such as the Chery are

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poised to enter the U.S. market as Chinese car makers seek to repeat the
pattern of market entry using a VO strategy.
The global center of gravity in terms of both automobile production
and demand has also shifted. In 2009, China surpassed the United States
as the largest automobile market in the world.32 One year later, Chinese
companies set an industry record by producing and selling over 18 million cars.33 About half of these were produced through joint ventures
with established foreign companies such as Toyota and General Motors, but the rest represent the solo efforts of Chinese firms such as BYD
Auto, Chery, and Great Wall Motor. Most of these efforts have utilized
a VO strategy, but as the domestic Chinese market becomes more saturated, these companies will likely transition toward adopting MVD approaches. India is also rapidly emerging as one of the worlds largest
producers and consumers of automobiles, with companies such as Tata
Motors and Chinkara Motors aggressively pursuing strategies based on
volume orientation and introducing very low-priced cars into a number
of global markets.
THE FUTURE OF MARKETING STRATEGY
IN A GLOBAL ENVIRONMENT
From a corporate strategy perspective, the most important truth that
a company should acknowledge is that marketing in the future will require increasingly unique approaches compared to those that proved effective in prior eras. The primary reason for this, as noted earlier, is that
the Pandoras box of globalization has been opened. Competitive environments of the future will bear little resemblance to those of the past,
and companies must thus develop entirely new methods for competing
rather than relying upon proven derivations of past strategies.
Whereas companies have previously competed with domestic rivals
with similar strategies, they now clash with firms originating from a variety of different countries. As noted earlier, economic development typically drives the evolution of basic marketing strategies: less-developed
economies accommodate primarily MO strategies, developing economies spawn VO strategies, and MVD strategies usually dominate in
developed economies. However, as transportation becomes faster and
less costly, few markets are likely to remain competitively isolated. As
a result, as globalization allows competitors from diverse economies
to interact, substantially dissimilar competitive strategies and orientations are likely to be represented across the mix of rivals. This increased
diversity of strategic orientations will not only disrupt any competitive equilibrium that may have previously evolved, it will create an
environment in which competition is likely to remain both complex
and intense, and be characterized by increased risk. This environment

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will, in turn, call for a larger and more complex repertoire of marketing strategies.
Consumer Confusion in Global Branding
Because of the disparities that exist across the globe in terms of input
costs (labor and material), market preferences, economic development,
and governmental priorities, new strategic contradictions and dilemmas
are likely to appear in global competitive arenas. Just as many industries
in developed countries have experienced shakeouts, mergers, competitive turmoil, and other forms of disorder as they evolved toward domestic equilibrium, globalization is now exposing previously sheltered
firms to fierce rivalry from new forms of competition. Goods manufactured in the United States rest on retailers shelves immediately beside
those produced overseas, forcing consumers to make careful comparisons of features and quality. Both products and companies are also rapidly losing their national identities, such that consumers rarely know
where their products were designed or manufactured.34
According to one study, consumers do not know the home country
of even well-known brands or companies.35 For example, most people
surveyed believed that Nokia, Hyundai, Motorola, and Samsung were
Japanese companies. Adidas, LG, Land Rover, Lego, and Ericsson were
similarly most often misidentified as being U.S. companies. Volvo,
SAAB, and Heineken were most commonly misidentified as being German companies. The increasing frequency of global mergers no doubt
also confuses consumers. The top three domestic beer brands in the
United States (Budweiser, Miller, and Coors) are now all produced by
foreign-owned companies. Further, it is even more likely that few consumers are able to correctly identify the country of manufacture of most
branded products, which frequently differs from the producers home
country. For example, many Japanese automobiles (such as Toyota,
Honda, Subaru, and Nissan) are manufactured in the United States or
Canada, and many of the Volkswagens sold in the United States are produced in Mexico. Similarly, most consumer electronics products with
Japanese brand names are produced in China. As a result, competition
for consumer purchases and loyalty has become more challenging, and
prospects for future competitive equilibrium would appear unlikely.
Complexities in Global Partnering
Until recently, many U.S. and European firms viewed globalization
as an opportunity to expand markets through exports, and to lower
production costs by accessing low-cost foreign labor. These opportunities presented compelling enticements to invest in developing markets.

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However, the competitive threats posed by the evolution of these opportunities were often likely discounted or ignored. An example of this tendency to overvalue opportunities and underestimate risks can be seen
in the joint ventures that are often required to satisfy foreign government regulations regarding indigenous ownership. Whereas companies
from developed nations view strategic partnerships as a way to provide market access, enterprises from developing nations view them as
a low-risk approach to knowledge transfer and to acquiring proprietary
expertise and technology. As the transfer of technology and methods
progresses, however, partners from these developing nations (which by
now have largely acquired the necessary technology and know-how)
will begin to question whether further value can be derived from continued collaboration. Once the perceived relative value of these alliances
falls to a certain point, domestic partners will make efforts to dissociate
from their mentors and begin independent operations.
Having leveraged foreign expertise and successfully adopted VO
strategies in their home markets, the insatiable drive for sales underlying this approach motivates companies in developing economies to
turn to exporting as a method for filling expanding production capacity.
Following the path of industrial development modeled in the international product life cycle,36 firms in developing countries that once represented export markets for U.S. and European companies evolve into
competitors for market share in the home markets of their foreign partners. For example, Mahindra & Mahindra formed a joint venture in 1963
with the U.S.-based International Harvester to build tractors in India for
the Indian market.37 Today, Mahindra brand tractors are the top-selling
brand of tractors in the world by volume,38 and since 1994 have earned
a strong reputation and growing loyalty in the U.S. market.39 As this illustrates, foreign firms that begin collaborations as marketing or manufacturing partners may eventually end up as competitors. The evolution
of alliances with foreign partners in developing economies thus represents two potential hazards to those (U.S. and European) firms that initially sought out the alliances: when the partner abandons the alliance
to become a competitor in their domestic market (and thus reduces or
eliminates a market for the U.S. and European exports), and then by
eventually exporting these products to U.S. or European markets.
GLOBAL PARTNERSHIPS OF THE FUTURE
In the future, not only will competition be more challenging but strategic partnerships will also likely be more indispensable and more perilous. Although the model in which proficient companies from developed
countries partner with weaker firms from lesser-developed countries
has in the past been employed with success, reliance on these partnerships is likely to be less advantageous in the future. Reasons for this

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include the increasing pace of technological advancement, the growing


ease of knowledge transfer, and the problematic nature of intellectual
property protection in developing countries. Moreover, as noted earlier, firms in developing economies typically employ VO strategies, and
as a result, they often discount the value of both branding and design
(strategic strengths of the MVD strategy) as company assets, and conceptualize the value of a product based only on its tangible inputs and
characteristics.
Within the last few years, for example, Ford, General Motors, Toyota, Nissan, Honda, Suzuki, Mazda, Daihatsu, Mitsubishi, Fiat, Isuzu,
and Volkswagen have all entered into joint ventures with Chinese
firms to manufacture automobiles in China. Yet many of these partnerships are now either breaking down or are expected to do so shortly,
as the Chinese partners are now moving into independent production
and marketing.40 Not only are these Chinese firms competing with
their former partners, they are doing so by selling highly derivative
automobiles at lower prices.41 BYDs vehicles are, for example, considered to be fairly complete copies of Toyota products.42 Fiat has sued
Great Wall Motor for copying its cars, and Mercedes-Benz has sued
Shuanghuan. Similarly, General Motors has sued Chery for copying
GMs Daewoo Matiz.43 Indeed, the name Chery is understood to be a
close and deliberate derivation (both visually and in pronunciation) of
Chevy, General Motors trademarked nickname for its Chevrolet division. In pursuing these copycat strategies, none of the Chinese firms
have admitted any wrongdoing, and the attitude projected by their executives seems to be one of bewilderment that emulation could be considered unreasonable.
These examples are not presented to suggest that the future holds few
opportunities for firms to thrive and develop exchange relationships. Globalization and the new mix of competitive strategies it presents can provide fertile soil for firms willing to rethink past approaches to finding,
exploiting, and defending markets. Partnerships will be increasingly indispensable for firms seeking to leverage their unique strategic advantages to capitalize on global opportunities. However, the nature of these
partnerships is likely to evolve. In the past, joint ventures have often been
formed to enable collaboration on distinct, grand projects that exceeded
the individual capabilities or legal authority of the individual firms. In
the future, partnerships are more likely to represent integrative efforts
designed to create networks of interdependent organizations working
toward a common goal. These cooperative interorganizational relationships, as Ring and Van de Ven44 call them, are likely to embrace multiple goals and evolve through multiple structures over the course of the
collaboration. Additionally, these partnerships are likely to reach beyond
traditional conceptualizations of joint ventures into collaborative efforts
between private sector firms, NGOs, and public sector organizations.45

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An example of the new opportunities created in global markets can


be seen in the mobile phone industry, in which cooperative interorganizational relationships are now ubiquitous. The spread of mobile phones
offers at least three distinct opportunities for marketers, and the exploitation of each of these requires the creation and maintenance of interorganizational relationships. Moreover, these relationships may have to
evolve rapidly to exploit opportunities that can emerge at short notice,
and may result in new forms of business and/or interorganizational relationships. Although the discussion here relates to the mobile phone
industry, it may become relevant to other sectors in the future. The examples merely illustrate broader collaborative opportunities that will be
present in the future.
Opportunity One: Partnerships for Satisfying
Global Demand
The telephony industry was originally highly vertically integrated,
with single telephone companies developing infrastructure, manufacturing consumer equipment (telephones), and providing both business and
household service. This level of integration and concentration offered
few opportunities for partnerships and retarded the fulfillment of consumer demand. Although the telephone was invented in 1876 by Alexander Graham Bell,46 the diffusion of this technology in the United States
and other countries was dependent upon the creation of substantial infrastructure. This in turn typically necessitated either direct government
investment and construction, or governments granting monopoly status
to an individual firm.47 Contrary to their original purpose, these monopolies served to further slow the diffusion of telephone service in many
countries. Even in the United States where limited regional competition
emerged to advance the diffusion of telephones, it was not until the mid1950s that 70 percent of U.S. families had phone service.48 In contrast, in
the 25 years from 1902 to 1927, car ownership in the United States expanded from less than 1 percent of families to over 70 percent.49 This difference is even more impressive considering the relatively high price of
car ownership in comparison to telephone service.
During the 27 years from 1983 to 2010, mobile phone ownership
worldwide grew from less than 1 percent of individuals owning a mobile phone to more than 116 mobile phone subscriptions per 100 inhabitants in developed countries, and nearly 70 percent of individuals in
the developing world having mobile phone service.50 In a worldwide
population of seven billion, there are now in excess of 5.3 billion cellular
phone subscriptions.51 This unprecedented scale of market penetration
represents the first opportunity for marketers: meeting demand for mobile phone devices and service. Exploiting this opportunity, from either

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the device or the service side, requires collaboration with partners on the
other side. The rapid expansion in mobile phone ownership can undeniably be attributed in part to the complex network of collaborative partnerships that distinguish this sector in contrast to the integration and
autonomy that characterized the original phone industry.
Opportunity Two: Partnerships for
Developing Complementary Products
Although the mobile phone industry illustrates a new model of collaboration and partnership that can rapidly quench seemingly insatiable
demand, it also exemplifies how manifold marketing opportunities are
created by new technologies. Similar to the development of railroads in
the United States 130 years ago and the rapid penetration of automobiles
100 years ago, the global spread of mobile phones represents both an illustration of the new competitive environment and a new medium for
marketers to achieve their goals. Certain technologies can present both
marketing opportunities in themselves, and also serve as a medium for
new marketing strategies. For example, nearly 1.6 billion mobile phone
devices were sold worldwide in 2010, and sales are growing rapidly.52
This has created significant market potential for organizations that provide accessory goods and services to phone owners. To exploit this again
requires that new forms of collaborative partnerships be developed. For
example, consider the potential growth in mobile phone software applications. The first independently developed phone application was sold
in July 2008, yet by January 2011, there had been over 10 billion downloads from Apples Website alone, which offered over 350,000 different
applications for the iPhone.53 Worldwide revenues for mobile phone applications were estimated to be $5.2 billion in 2010.54 It is projected that
by 2014, there will be over 185 billion downloads of mobile phone applications, generating annual revenues that will reach $58 billion.55 In
short, the mobile phone may have driven the most dramatic velocity
and scale of product penetration and accessory product development
in the history of marketing. This is all the more remarkable given the
relatively high price of the product when compared to many other consumer goods, and the significant infrastructure needed before demand
can be cultivated.
Opportunity Three: Partnerships for New
Marketing Approaches
The rapid global diffusion of mobile phones offers new marketing
opportunities for companies that operate in different industry sectors.
Advertisements, store displays, product packages, and even billboards

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now frequently display a quick response code (QR), a pattern that can
be scanned by mobile phones enabling consumers to directly access
marketing information (via Website, phone, or video). Through partnerships with mobile phone handset manufacturers, service providers, and marketing agencies, organizations can use QRs to provide new
levels of customer service and new ways of connecting with potential
customers. For example, mobile phones can now be used for checking
and comparing store prices, as instruments of consumer education regarding goods and services, and as methods of making electronic paymentsa method that may soon eclipse or supplant debit card use in
many countries. Since many mobile phones are now equipped with GPS,
Wi-Fi, WiMAX, and/or Bluetooth capabilities, they can also be used in
a variety of other applications that empower both consumers and marketers. For example, mobile phones can be used to track the geographic
movement of owners, as a medium for advertising and sales promotion,
and as devices for automatically accessing and modifying phone applications and files, all while the user is mobile.
To illustrate how the new capabilities of mobile phones can be leveraged in a synergistic manner and create new opportunities from a
strategy perspective, consider the following example. Phones can automatically compile shopping lists for consumers based on existing
consumer home inventory, search for available coupons on the listed
merchandise, and provide directions to, and operating hours of, relevant stores nearby. Since many retailers now have in store hardware
that can detect the presence and type of smartphone a shopper possesses
as well as its user history, store maps, customized messages, and targeted coupons can be sent to patrons as they enter the shopping environment. Updated messages can be sent as the shopper moves through
the store, notifying them of merchandise shelf locations and promotional offers. Upon the customers exit from the store, the phone can
provide directions to his/her car, provide a summary of the shopping
trip acquisitions and expenses, and convey a thank-you message
to the consumer for their patronage. In summary, global ownership
rates for mobile phones that are rapidly approaching 100 percent represent an unprecedented panorama of opportunities for marketers to
reach consumers, provide exceptional customer service, and facilitate
exchange.
CONCLUSION
Although the competitive options established in the past (MO, VO,
and MVD) will continue to represent the foundations upon which
marketing strategies are constructed, organizations should anticipate
that the types of competitive interaction and the manners by which

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strategies are implemented will differ in the future. The following


propositions are offered to highlight the realities of future global marketing strategies:
1. Increasing numbers of competitors of all types, more intense
rivalry, and a greater diversity of strategies will characterize future
competition in nearly every market.
2. Consumer demand will likely be more volatile than in the past
as rapid advances in technology lead to new product and service
opportunities, and increase the speed and reach of global diffusion of new ideas. Moreover, as economic development raises
consumer affluence in increasing numbers of countries, consumer
tastes and spending power will evolve and grow at an increasing
rate. This will result in an increased number and variety of market
opportunities.
3. Although new market opportunities are likely to emerge with escalating frequency, they are increasingly likely to be identified and
exploited by multiple global companies simultaneously. The globalization of technology and the global proliferation of competitors,
many of which will benefit from government subsidies, mean that
uncontested market opportunities will tend to be short-lived. Thus,
whereas opportunities may proliferate in the future, they may also
be less enduring. As a result, the time period during which profits
can be harvested (the interval between product introduction and
substantial competitive entry) will be compressed, rendering many
ostensible market opportunities ultimately unprofitable. This will
mean:
Less time is available for the judicious analysis of market opportunities if they are to be profitably exploited. New processes for
market analysis must therefore be developed, and decision models and heuristics that enable quicker managerial decision making must be constructed. Higher levels and varieties of risk must
also be incorporated into these models, and new methods for
understanding and moderating these risks developed.
Existing processes for product development are likely to be ineffective for exploiting new market opportunities when competitive entry is swift and geographically dispersed. Development,
production, and distribution times need to be significantly shortened, or more agile competitors will steal and exploit opportunities.
4. New marketing strategies must be developed by businesses using
each of the underlying modes of competition. For example,

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Due to their agility and closeness to customers, small MO companies are most capable of adeptly envisioning and exploiting
new opportunities (as illustrated by the producers of mobile
phone applications). MO firms must remain vigilant for subtle
changes in market preferences and should develop the capability to respond rapidly to these changes.
Larger firms using a VO strategy should be able to benefit from
the new sales potential offered by global markets. However,
they should direct their marketing resources toward countries
with developing economies in which demand is less heterogeneous and is price elastic. Where feasible, VO firms should build
production capacity in developing countries to meet this new
demand since low production costs there will enable them to
quickly capture market share. VO firms must also remain vigilant in the event that VO competitors enter the market, as this
will introduce impediments to profitability.
Large companies that adopt a MVD strategy will need to
embrace global marketing strategies with local differentiation,
as the MVD approach has the greatest capacity to serve multiple and diverse customer segments. These organizations can
also prosper by insightfully and selectively acquiring successful small companies in different geographic markets, and either
retaining their market focus or adapting their ability to differentiate in order to appeal to the larger market.

NOTES
1. Although the three strategies may appear similar to Michael Porters generic strategies of segmentation, low cost/low price, and differentiation (Competitive Strategy: Techniques for Analysing Industries and Competitors [New York:
Free Press, 1980]), these similarities are more apparent than real. Porters strategy of low cost/low price is indeed similar to the volume orientation described
here, but the other two strategies described by Porter (segmentation and differentiation) describe marketing tactics rather than business strategies. Additionally, Porters schema describes the market segmentation strategy as a focus
approach that is limited in scope. In the framework presented here, the lowvolume strategy (margin orientation) is most appropriately characterized as a
product-differentiation strategy, whereas market segmentation is often used
as a necessary corollary whenever very highly differentiated offerings are offered. Typical examples of the margin orientation include businesses providing professional services (e.g., accountants, independent law offices), specialty
publishers, independent bakeries and restaurants, niche automobile manufacturers, and other businesses with high variable costs. Furthermore, although
Porters original schema described these three generic strategies as mutually exclusive, many marketing and strategy scholars have pointed out that

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117

product differentiation and market segmentation are frequently used concurrently in practice. In the typology presented here, both margin orientation and
margin-volume-differentiation describe basic business strategies in which market
segmentation and product differentiation are likely to be used together. The marginvolume-differentiation strategy has also been demonstrated in practice to effectively and profitably combine both a volume and differentiation approach,
which Porter initially described as untenable. Indeed, most large businesses in
developed countries now implement a MVD approach, utilizing both economies
of scale and product differentiation, and typically targeting multiple market segments simultaneously.
2. P.J.D. Wiles, Price, Cost, and Output (New York: Frederick A. Praeger, 1961).
3. The volume orientation should not be confused with the American System of Production (David A. Hounshell, From the American System to Mass Production, 18001932: The Development of Manufacturing Technology in the United
States [Baltimore, MD: Johns Hopkins University Press, 1984]), which describes
a mass-production approach to making durable products. A VO strategy is typical in process industries such as brewing and refining, is essential to many highoverhead service industries (such as airlines), and may be effectively utilized in
retailing (such as exemplified by Amazon and Wal-Mart).
4. Eliot Jones, Is Competition in Industry Ruinous, Quarterly Journal of Economics, 34 (May) (1920): 473519. Frederick M. Scherer, Industrial Market Structure
and Economic Performance, second edition (Boston: Houghton Mifflin, 1980).
5. Hounshell, American System.
6. Thomas Nagle, The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making (Englewood Cliffs, NJ: Prentice Hall, 1987).
7. Jones, Is Competition in Industry Ruinous; Scherer, Industrial Market
Structure.
8. Of course, collusion also offers relief from price competition, although
this solution is typically illegal.
9. R. E. Quandt, On the Size Distribution of Firms, American Economic Review, 56 (1966): 416432; Herbert A. Simon and C. P. Bonini, The Size Distributions of Business Firms, American Economic Review, 48 (September) (1958):
607617.
10. Boston Consulting Group, The Rule of Three and Four, Perspectives,
No. 187, Boston: Boston Consulting Group, 1976.
11. Jagdish N. Sheth and Rajendra S. Sisodia, The Rule of Three: Surviving and
Thriving in Competitive Markets (New York: Free Press, 2002).
12. Can Uslay, Z. Ayca Altintig, and Robert D. Winsor, An Empirical Examination of the Rule of Three: Strategy Implications for Top Management, Marketers, and Investors, Journal of Marketing, 74 (March) (2010): 2039.
13. Uslay, Altintig, and Winsor, An Empirical Examination of the Rule of
Three.
14. R. Blackhurst and D. Henderson, Regional Integration Agreements,
World Integration and the GATT, in Regional Integration and the Global Trading System, ed. K. Anderson and R. Blackhurst (New York: St. Martins Press, 1993), 408435.
15. C. Cherry, The Telephone System: Creator of Mobility and Social
Change, in The Social Impact of the Telephone, ed. I. de Sola Pool (Cambridge,
MA: MIT Press, 1977), 112126.

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16. R. E. Low, Modern Economic Organization, (Homewood, IL: Richard D.


Irwin, 1970), 111. As Low observes, feudal lords, although constrained by inefficient scales of production, profited because they owned the entire supply of grain
sold in the village market. The one missing link which prevented local monopolies from merging into a purely competitive market was good transportation.
17. Blackhurst and Henderson, Regional Integration Agreements.
18. Scherer, Industrial Market Structure, 6768.
19. K. D. George and A. Silberston, The Causes and Effects of Mergers,
Scottish Journal of Political Economy, 22 (June) (1975): 179193; Jesse W. Markham,
Survey of the Evidence and Findings on Mergers, in Business Concentration
and Price Policy, ed. George J. Stigler (Princeton, NJ: Princeton University Press,
National Bureau of Economic Research, 1955), 141182; Scherer, Industrial Market Structure.
Similarly, the second wave of U.S. mergers in the 1920s has been attributed to heightened competitiveness resulting from the rise of automobile
transportation and radio advertising (Markham, Survey). Automobile ownership enabled the rise and subsequent dominance of supermarkets, discount
stores, and regional shopping malls as competitive retail forms by increasing
the trading areas available to these distributors. As these new retail forms came
into dominance, thousands of smaller mom and pop retailers that served
small, local markets, were displaced. The elimination of barriers through improved communications also parallels the phenomenon of transportation enhancements, as the impediments of space and time are transcended. As Cherry
(The Telephone System) noted, new communication technologies such as the
telephone network profoundly impacted the conditions of economic organization by allowing scattered branches of an industrial unit to operate as a unified
whole. This further enhanced the ability of producers to expand their distribution and become national in scope, enabling them to compete with distant rivals.
Those with expanded distribution could then exploit economies of scale in advertising that were unavailable to those with exclusively local scopes (Scherer,
Industrial Market Structure).
20. K. G. Elzinga, The Beer Industry, in The Structure of American Industry,
seventh edition, ed. W. Adams (New York: Macmillan, 1986), 202238.
21. Buy. Drink. Smile. 2008 Annual Review and Report to Shareowners, The
Coca-Cola Company: 37.
22. Jagdish N. Sheth, Impact of Emerging Markets on Marketing: Rethinking Existing Perspectives and Practices, Journal of Marketing, 75 (July) (2011):
166182.
23. Alexandra Harney, The China Price: The True Cost of Chinese Competitive Advantage (New York: Penguin, 2008).
24. The only significant exception to this was the R.E. Olds Company, which
made the first mass-produced car. During 19011903, Olds produced nearly
7,000 units of the Curved Dash Runabout model that accounted for about onefourth of all car production during 1902 and 1903. These cars were powered by
one-cylinder, 47 horsepower engines, and sold for approximately $850.
25. Alfred P. Sloan, Jr., My Years with General Motors (Garden City, NY: Doubleday & Company, 1964).
26. Harold Katz, The Decline of Competition in the Automobile Industry, 1920
1940 (New York: Arno Press, 1977).

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27. Lendol Glen Calder, Financing the American Dream: A Cultural History of
Consumer Credit (Princeton, NJ: Princeton University Press, 1999).
28. Sloan, My Years with General Motors.
29. James Wren, Advertisements, in Encyclopedia of American Business
History and Biography: The Automobile Industry, 18961920, ed. George S. May
(New York: Facts on File, 1990), 46; James D. Norris, Advertising and the Transformation of American Society, 18651920 (New York: Greenwood Press, 1991).
30. Ford and Chrysler made up the Big Three.
31. Joseph Schumpeter, Capitalism, Socialism, and Democracy (New York:
Harper & Brothers, 1942).
32. More Cars Are Now Sold in China than in America, The Economist, October 23, 2009, accessed April 24, 2011, http://www.economist.com/daily/
news/displaystory.cfm?story_id=14732026&fsrc=nwl.
33. Chinese Auto Sales Set New World Record of 18 Million Units
in 2010, ChinaAutoWeb.com, January 10, 2011, accessed April 24, 2011,
http://chinaautoweb.com/2011/01/chinese-auto-sales-set-new-world-recordof-18-million-units-in-2010/.
34. Kenichi Ohmae, The Borderless World: Power and Strategy in the Interlinked
Economy (New York: Harper Business, 1990).
35. Brand and Countries: Its from Where? College Students Clueless on Where Favorite Products Come From, Anderson Analytics, LLC, 2007: 2.
36. The international product life cycle model is commonly used to illustrate
why developed countries tend to be producers of finished goods and exporters of these goods to both lesser-developed countries and postindustrial countries. See Sak Onkvisit and John Shaw, An Examination of the International
Product Life Cycle and Its Application within Marketing, Columbia Journal
of World Business, 18(3) (1983): 7479; Raymond Vernon, International Investment and International Trade in the Product Cycle, Quarterly Journal of Economics, 80 (May) (1966): 190207; and Louis Wells, Jr., A Product Life Cycle for
International Trade? Journal of Marketing, 32 (July) (1968): 16.
37. Originally known as the International Tractor Company of India (ITCI).
38. Mahindra Website, http://www.mahindra.com/What-We-do/FarmEquipment, accessed June 1, 2011.
39. Mahindra USA Website, http://www.mahindrausa.com/company.php,
accessed June 1, 2011.
40. Frank Williams, China to Foreign Automakers: Drop Dead, The Truth
about Cars, August 16, 2007, accessed April 24, 2011, http://www.thetruth
aboutcars.com/2007/08/china-to-foreign-automakers-drop-dead/.
41. David Brierley, Road Rage in the West as Copycat Cars from China Start
to Make Their Marque Overseas, The Independent (UK), September 9, 2007, accessed April 24, 2011, http://www.independent.co.uk/news/business/news/
road-rage-in-the-west-as-copycat-cars-from-china-start-to-make-their-marqueoverseas-401770.html.
42. Ben Berkowitz, Kevin Krolicki, and Lee Chyen Yee, Special Report: Warren Buffetts China Car Deal Could Backfire, Reuters, March 9,
2011, accessed April 24, 2011, http://www.reuters.com/article/2011/03/09/
us-wiki-buffett-byd-idUSTRE72848X20110309?pageNumber=4.
43. GM Sues Chinese Firm for Copying, BBC News, May 9, 2005, accessed
April 24, 2011, http://news.bbc.co.uk/2/hi/business/4528565.stm.

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44. Peter Smith Ring and Andrew Van de Ven, Developmental Processes of
Cooperative Interorganizational Relationships, Academy of Management Review
19(1) (1994): 90118.
45. Sheth, Impact of Emerging Markets.
46. Travis Brown, Historical First Patents (Lanham, MD: Scarecrow Press,
1994).
47. Gerald W. Brock, The Telecommunications Industry: The Dynamics of Market Structure (Cambridge, MA: Harvard Economic Studies/Harvard University
Press, 1981).
48. Bronwyn H. Hall, Innovation and Diffusion, in The Oxford Handbook of
Innovation, eds. Jan Fagerberg, David C. Mowery, and Richard R. Nelson (New
York: Oxford University Press, 2005), 459485; Michael H. Riordan, Universal
Residential Telephone Service, in Handbook of Telecommunications Economics,
eds. Martin Cave, Sumit Majumdar, and Ingo Vogelsang (Amsterdam: Elsevier
Science, 2001), chap. 10.
49. Katz, The Decline of Competition.
50. The World in 2010: ICT Facts and Figures, International Telecommunication Union, 2010, accessed April 24, 2011, http://www.itu.int/ITU-D/ict/mate
rial/FactsFigures2010.pdf.
51. The World Factbook, 2011, Central Intelligence Agency, accessed
April 24, 2011, https://www.cia.gov/library/publications/the-world-fact
book/index.html; The World in 2010.
52. Gartner Says Worldwide Mobile Device Sales to End Users Reached 1.6
Billion Units in 2010; Smartphone Sales Grew 72 Percent in 2010, Gartner, Inc.,
February 9, 2011, accessed April 25, 2011, http://www.gartner.com/it/page.
jsp?id=1543014.
53. The App Store Has Reached 10 Billion Downloads, Apple, Inc., accessed April 25, 2011, http://www.apple.com/itunes/10-billion-app-count
down/; Apple iPhone App Store, Apple, Inc., accessed April 25, 2011, http://
www.apple.com/iphone/apps-for-iphone/.
54. Gartner Says Worldwide Mobile Application Store Revenue Forecast to
Surpass $15 Billion in 2011, Gartner, Inc., January 26, 2011, accessed April 25,
2011, http://www.gartner.com/it/page.jsp?id=1529214.
55. Gartner Says Worldwide Mobile Application Store Revenue.

Chapter 6

Maximizing the Firm Value Impact


of Outsourcing Decisions
James R. Kroes,
Soumen Ghosh, and
Andrew Manikas

INTRODUCTION
The outsourcing of business activities to third parties is now an integral
component of many firms competitive business strategies. Since the
1990s, outsourcing has increasingly resulted in the relocation of business
activities to foreign locations. This increased reliance on outsourcing as a
business strategy raises a number of challenges and concerns. Most importantly, although the purported goal of outsourcing is usually to derive
a competitive advantage in the marketplace, it is not clear if outsourcing has consistently generated value for organizations. In addition, it is
not clear if outsourcing decisions made by firms are always strategically
aligned with their overall competitive strategy or if outsourcing generates the value firms expect. This chapter presents details of an investigation that was conducted to evaluate the impact that outsourcing decisions
have had on the shareholder wealth of U.S. firms, and to identify the strategies used by firms that have had both successful and unsuccessful outsourcing experiences.

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Strategic Management in the 21st Century

The outsourcing of activities to third parties located in other countries, offshore outsourcing, has become a common practice for U.S. firms
attempting to increase their competitiveness.1 One study found that
21 percent of firms in the United States outsourced some of their internal business functions to offshore locations,2 and reports estimate that the
value of offshore-outsourcing contracts grew approximately 29 percent
annually between 2003 and 2008 and is expected to continue to grow by
17 percent annually through 2012.3 With this growth, the types of activities that are outsourced have changed dramatically. In the past, firms typically considered outsourcing only noncore, peripheral activities, but now,
many businesses consider outsourcing even strategic activities in an effort
to gain a competitive advantage.
Firms that consider offshore outsourcing are conducting a make or
buy decision. Those that choose to make vertically integrate a function,
thus maintaining control over business activities.4 Conversely, firms that
choose to buy or outsource activities partner with an external vendor and
possibly give up some control over their activities. The dramatic growth
of the Internet and broadband technologies throughout the 1990s stimulated the growth of offshore outsourcing by enabling the communication
of information and the collaboration of activities across large geographic
distances.5 The elimination of these geographic obstacles led many firms
to consider offshore outsourcing to take advantage of the perceived lower
costs found in many offshore locations.
The main driver of offshore-outsourcing decisions is the desire to reduce costs.6 Cost savings can result from many factors, such as the service
providers ability to perform services at lower cost, the avoidance of fixed
costs, being able to maintain a smaller or more efficient labor force, and access to a vendors highly skilled workforce. The labor savings associated
with offshore outsourcing can be significant. A study published by the National Association of Software and Service Companies estimates that U.S.
companies saved nearly $8 billion annually in labor costs by outsourcing
business functions to firms located in India.7 This is mainly due to lower
wage scales in offshore locations; for example, the cost of skilled technology workers in India can be 50 to 60 percent lower than the cost of similar
labor in the United States.8 Lower labor costs are not the only workforcerelated driver. Many firms outsource to offshore locations to access highly
skilled and talented workforce that provide better-quality services and
often in a shorter time frame, than can be acquired domestically. As educational systems throughout the world have advanced, the number of
offshore workers with advanced degrees has grown substantially. For example, India now produces as many engineering and science masters and
doctoral graduates annually as the United States.9 Outsourcing internal
business functions may generate value through labor cost savings due to
reductions in workforce,10 or through the avoidance of the costs associated

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123

with the hiring and training of new workers.11 Offshore outsourcing may
also lead to a reduction in material costs by transitioning an operation to
a supplier located in a resource-rich location. In addition, a focused and
experienced external partner may be able to provide higher-quality services by leveraging capabilities that the outsourcing firm does not possess.
Finally, by outsourcing noncore business functions, a firm may be able to
refocus its limited internal resources on its core business activities.12 This
may in turn allow it to free up cash by avoiding the need for certain capital and overhead expenditures. When activities are outsourced, a firm can
avoid investing in equipment and facilities it would otherwise need to
complete an activity. Instead, the main costs to the firm are the direct cost of
the outsourced product or service and any associated transportation costs.
The outsourcing of activities also creates risks for organizations that
must be considered, especially when the activities are moved across national boundaries. Firms that outsource services to offshore locations risk
losing a degree of control over their business processes. This loss of control can impact a firms ability to monitor process quality and the working conditions at the outsourcing partners facilities. A dramatic example
of the consequences of this loss of control occurred in 2007 when Mattel
was forced to recall nearly 1,000,000 toys manufactured by a supplier in
China that were found to contain lead paint.13 In addition, the loss of control may potentially result in a loss of trade secrets and thus a diminished
competitive advantage. Information and intellectual property security issues are difficult to manage when working with offshore firms located
thousands of miles from the home country.14 Moreover, many countries
do not have rigorous laws or transparent legal systems that can be used to
protect a firms information.15 Offshore outsourcing also lengthens supply
chains, which can increase lead times, transportation costs, and magnify
the impact of supplier disruptions on the firms business. From a human
resource perspective, outsourcing initiatives that result in a workforce
reduction in the home country may also create a morale issue among a
firms remaining workers, as they may feel a reduced sense of loyalty to
the organization and a fear that their job will be also be outsourced and
eliminated.16
In addition to the risks just discussed, as offshore outsourcing has
grown over the past two decades, the practice has been increasingly criticized by industry experts, government officials, and the media, who argue
that offshore outsourcing results in lost jobs in the home country, a loss of
control of business activities, and lower service quality.17 The movement
of jobs from the United States to offshore locations, in particular, has fueled an escalating debate about offshore outsourcing. Studies have estimated that over one million jobs have already moved from the United
States and Europe to developing nations, a number that is expected to
exceed 2.3 million by 2014.18 Proponents of outsourcing argue that the

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Strategic Management in the 21st Century

number of jobs offshored annually equates to only a small fraction of the


job market, and that the efficiency improvements offshore outsourcing
generates creates additional jobs in the United States.19 Studies that advocate offshore outsourcing also predict that traditional theories related to
free trade will hold and that the cost savings generated will translate into
lower final goods costs for consumers in the United States.20 However, it
is unclear if traditional free trade economics can be applied to offshore
outsourcing. Traditional free trade theory states that the loss of jobs in the
country moving work offshore will be offset by long-run improvements
in the global economy. A country shifting work offshore will thus benefit
from lower-cost outsourced goods or services. In contrast to this theory,
Nobel laureate economist Paul Samuelson argues that the current wave
of offshore outsourcing will not generate the benefits predicted by traditional theory.21 He believes that shifting work offshore will allow foreign
firms to develop a comparative advantage that will result in a permanent
loss of per capita income in the country moving work offshore.
The debate and negative connotations associated with offshore outsourcing has also led to a political interest in outsourcing.22 Opponents
cite the large number of jobs displaced to offshore locations as a justification for laws restricting outsourcing. Over 80 legislative measures have
been considered in the United States in an effort to prevent jobs from moving to lower-cost countries.23 The U.S. Congress has repeatedly considered
a number of measures, including requiring firms to provide assistance for
displaced workers, establishing regulations that force firms to publicly
disclose all offshore-outsourcing projects, eliminating federal aid for firms
that outsource to offshore locations, and creating tax penalties for offshore
outsourcing.24
The remarkable growth of offshore outsourcing may lead one to assume
that firms find the practice to add value. Although numerous arguments
have been made both for and against offshore outsourcing, most of these
arguments have been based on emotion and anecdotal evidence. An alternate way of looking at the ongoing debate is to examine how these initiatives affect shareholder wealth. Offshore outsourcing can impact many
aspects of a firms performance, and the stock markets reaction to offshore outsourcing provides evidence on whether it is perceived as creating or destroying value for the average firm.25 Similarly, it is also not clear
if the perceived competitive advantages of offshore outsourcing are still
relevant as the practice has become widespread among businesses and
target nations have developed. To shed light on these issues, we describe
a two-part investigation into the effects of offshore outsourcing on firms.
In the first stage of the study, we investigate several aspects of the impact
of offshore outsourcing on shareholder wealth. Specifically, we examine
the effect of publicly released announcements about outsourcing activity on the shareholder wealth of contract-granting firms, and compare the

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125

impact of offshore-outsourcing announcements with the impact of announcements to outsource activities to onshore locations. We also investigate the impact of the growing debate around offshore outsourcing by
comparing the stock market reaction to outsourcing before and after the
scrutiny into the practice escalated starting in 2001. Based on the results
of our investigation, we then develop a strategic framework for successful
offshore outsourcing
THE IMPACT OF OUTSOURCING
ON SHAREHOLDER VALUE
To examine the impact of offshore-outsourcing announcements on firm
value, we utilize the event-study methodology to estimate the shareholder wealth effects of outsourcing announcements. This methodology
estimates the stock markets reaction to events, while adjusting for industry and market-wide influences.26 Event studies have been widely used
to evaluate the impact of operational events on the firm value of publicly traded firms.27 The method determines the impact of an event on
firm value by calculating the adjusted stock market return (commonly
referred to as an abnormal return), which reflects the portion of change
in a firms stock price due to the firm specific event. In an efficient market, stock prices will adjust immediately to new information contained in
an event.28 The effects of an event on shareholder value can thus be estimated by observing stock price behavior over a short time period. The
market model is used to estimate the abnormal returns in this study. This
model predicts the relationship between the return of a stock and the return of the market portfolio while adjusting for the systematic risk of a
stock.
The event-study methodology can be used to determine the abnormal return over a variety of time periods (i.e., daily, monthly, yearly).
However, the one-day period is commonly used because it reduces the
chances that the observed abnormal return can be influenced by other
factors. The use of a one-day time period requires the precise determination of the day and time of each announcement in the sample. The event
day of interest in this study is the first trading day during which the stock
market can respond to an announcement; this day is designated as day 0.
The calendar day of an announcement was converted into the event day
according to the following guidelines. If the announcement was made in
the Wall Street Journal (WSJ), the announcement calendar day is day 0 in
event time and the previous trading day is day 1. If the announcement
was made in the Dow Jones News Service (DJNS), PR Newswire (PR), or
Business Week (BW) before the stock market closed (4 p.m. Eastern Standard time), the announcement calendar day is day 0 in event time, and
the previous trading day is day 1. If the announcement was made in the

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DJNS, PR, or BW after 4 p.m., the next trading day is day 0 in event time.
If an announcement was released in any news service on a nontrading
day (on which the market is closed), the next trading day is designated
day 0 in event time.
Our analysis focuses on the impact of outsourcing on firms based
within the United States. A search of the WSJ, DJNS, PR, and BW identified 152 relevant announcements between 1998 and 2010. Of these,
75 announcements indicated the movement of business activities from the
United States to an offshore location, and 77 announcements reflected that
activities were being transferred to a third party that conducted business
in the United States. A total of 70 of the 75 offshore announcements involved the movement of activities to locations in the Asia-Pacific region
and five announced movement to locations in Central America. It should
be noted that there appears to be a large shift toward offshore announcements after 2001. The annual sales of the firms in the sample ranged from
$12 million to $180 billion, with a mean of $20 billion. Examples of an offshore and onshore announcement are provided in Table 6.1.
The Impact of Offshore Outsourcing on Shareholder Value
The share price of firms in our study experienced an average increase
of 0.64 percent (above the expected return) on the day that an offshoreoutsourcing decision was announced. Moreover, nearly two-thirds of
the firms experienced an increase in share price. These results provide
strong evidence that the market reacts positively to offshore-outsourcing
announcements. They are not unexpected considering the large number
of firms that have outsourced services to offshore locations to take advantage of the cost savings. The findings suggest that the stock market
believes that the potential benefits of offshore outsourcing outweigh the
Table 6.1
Sample Outsourcing/Offshoring Announcements
Offshore Announcement
Source: PR Newswire
December 19, 2001

Mascot Systems Ltd., a global e-solutions company,


has entered into a long-term agreement with Hewlett
Packard Personal Systems Division Asia-Pacific (PSDA)
to establish a world-class facility in Singapore, equipped
with state-of-the-art hardware and software, to support
Hewlett Packards mission-critical business applications.

Onshore Announcement
Source: Dow Jones News
Service
March 5, 1999

SCB Computer Technology Inc. (SCBI) received a


three-year outsourcing contract from Promus Hotel
Corp. (PRH) for $3 million. In a press release on Friday,
SCB said it will manage data centers in Memphis and
Phoenix for the Memphis-based hotel company.

Maximizing the Firm Value Impact of Outsourcing Decisions

127

associated risks, and that outsourcing will improve a firms financial performance. Though the observed abnormal returns may seem miniscule to
the casual observer they can be substantial when put in perspective. For
example, a hypothetical firm with a market capitalization of $5 billion that
experiences an increase in share price increase of 0.64 percent would realize a $32 million increase in shareholder value.
A Comparison of Onshore and Offshore Outsourcing
Compared to onshore outsourcing, prior evidence suggests that offshore outsourcing can provide a firm with greater cost savings and higher
performance while exposing a firm to a greater risk of losing control of
processes and information. Although offshore service providers can often
leverage lower costs than onshore providers and thus generate greater
savings, the distance between the onshore party and its offshore partner
makes the management of the outsourced activity inherently difficult. Despite the increased risks, the potential for lower costs makes a compelling argument for deciding to select an offshore rather than an onshore
partner. To examine this proposition, announcements of offshore- and
onshore-outsourcing agreements were compared to determine if offshore
announcements had a more positive effect on a firms stock price than
the onshore announcements. The average abnormal share price increase
for onshore-outsourcing decisions was 0.30 percent. Although the mean
abnormal return for offshore announcements was slightly higher than
this, a statistical comparison of the two showed that announcements of
onshore- and offshore-outsourcing arrangements did not generate increases in share price that were statistically significant from each other.
In other words, any differences could be attributed to chance, and thus
offshore outsourcing does not have a significantly more positive impact
on shareholder wealth than onshore outsourcing. This suggests that the
perceived benefits of offshore versus onshore outsourcing, such as lower
costs and higher performance, may be offset by the higher potential risks
associated with offshore outsourcing.
The Decline in the Value of Offshoring
There is also evidence that the cost advantages associated with offshore
outsourcing have been diminishing in recent years. As more companies
move operations to lower-cost countries, the demand for skilled workers in those countries has increased, driving up their value. For example,
the annual wage increase in India over the past decade has ranged from
10 percent to 30 percent.29 The cost advantages offered by some offshore
vendors have further deteriorated due a rise in the value of offshore nations currencies compared to that of the contract granting firms home

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currency.30 This shift in exchange rates is forcing some offshore vendors


to increase the rates charged for services. The combination of declining
financial benefits and increased controversy concerning offshore outsourcing leads us to propose that more recent offshore-outsourcing announcements will have a less positive effect on a firms stock market value
than earlier offshoring announcements.
To examine this proposition, the sample of offshore-outsourcing announcements was divided into three groups based on the announcement
date. The first group contained announcements released before the end
of 2000, the second group contained announcements released from 2001
until 2005, and the final group contained announcements released from
2006 until 2010. The day 0 mean abnormal return for announcements released before the end of 2000 group was 1.85 percent (82.76% of the announcements generated positive abnormal returns). In contrast, the
announcements released from 2001 to 2005 generated an average abnormal return of 0.13 percent, and announcements released from 2006 until
2010 generated a mean abnormal return of 0.09 percent. A statistical
comparison of these results found that the difference in the average abnormal return for the earliest and latest groups of announcements was significant, but that corresponding differences between the first two groups
or the last two groups were not. The results can be interpreted as evidence
that the value proposition associated with offshore outsourcing decreased
significantly around the year 2001 and has not improved since. Again,
using the hypothetical example of a firm with a market capitalization of
$5 billion, the decreased mean abnormal returns represent a change in the
anticipated wealth impact of an offshore-outsourcing announcement from
an expected shareholder value gain of $92 million before 2001 to a loss
ranging from $4.5 to $6.5 million after 2001.
Changes in the stock markets reaction to more recent offshoreoutsourcing announcements are most likely the result of a combination
of several factors. The increased value of offshore services coupled with
higher exchange rates has driven up the bottom line costs of offshore
outsourcing. The increase in media backlash against offshore outsourcing, along with increased recognition of the high level of risk involved
with offshore arrangements, may also explain the observed variation between earlier and more recent announcements.31 An additional possible
explanation for the decline in value associated with offshore outsourcing
may be the overall decline in the stock markets valuation of all outsourcing.32 To investigate if the reduction in returns is unique to the offshore
group, onshore announcements were examined to see if they experienced
a similar reduction in mean abnormal returns occurring after 2001. Prior
to 2001, the average abnormal return for onshore-outsourcing announcements was 0.42 percent, whereas after 2001 it declined to 0.12 percent. Although this decline parallels that for offshore announcements, a

Maximizing the Firm Value Impact of Outsourcing Decisions

129

statistical test did not find the difference between pre-2001 and post-2006
announcements of onshore outsourcing to be significant. This suggests
that the reduction in the abnormal returns for recent offshore announcements is not explained by an overall decrease in the value of all outsourcing decisions.
STRATEGIES FOR SUCCESSFUL OUTSOURCING
The decision to outsource requires decision makers to carefully weigh
the benefits against the potentially higher level of risk. An important question to ask in making the decision is whether there are specific strategies
that can improve the likelihood that an outsourcing project will be successful and add value. We propose that the alignment of corporate goals
and the goals of an outsourcing decision are a major factor in determining the success of outsourcing decisions. This belief comes from extending previous research on the relationship between strategic alignment
and performance. The strategy literature has generally shown that a fit
between strategy and structure has a positive impact on firm performance.33 However, the fit between operations strategy and drivers of outsourcing decisions has not been widely studied. Although a large body
of anecdotal and case-based literature is available to help guide decision
makers on outsourcing decisions, few empirically based studies have explored the alignment between what drives a firms outsourcing decisions,
its competitive priorities, and key indicators of firm performance. Given
the increasingly important strategic nature of the outsourcing of supply
chain activities, we examine the alignment of outsourcing decisions with
broader strategic objectives.
The Benefits of Alignment
In a seminal paper, Skinner asserted that operational decisions should
be made in alignment with a firms business strategy.34 The alignment
between a firms operations strategy and its operational activities has
since been examined extensively in the operations literature. Boyer and
McDermott stated that an operations strategy should guide an organizations activities.35 Similarly, Hayes and Wheelwright, in developing the
product-process matrix that dictates that a firms manufacturing processes need to be aligned with the types and volumes of products they are
producing, argue that manufacturing processes should be developed in
alignment with the competitive priorities of a firm.36
The role that a firms business or competitive strategy plays in determining the firms functional manufacturing and supply chain management strategies has been the subject of a considerable body of previous
research. Competitive strategies usually drive a firm to compete as a cost

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Strategic Management in the 21st Century

leader, differentiator, or focused provider.37 In manufacturing firms, the


competitive business strategy is translated into competitive priorities and
executed via operational action plans.38 Competitive priorities are the
strategic business objectives and goals of the manufacturing organization.39 In the manufacturing domain, there are five traditionally accepted
competitive priorities: cost, time, innovativeness, quality, and flexibility.40
The determination of the competitive priorities of a firm can be related to
a firms core competencies in two ways. First, a firms competitive priorities may lead to the development of a supporting set of competencies and
capabilities. Second, a firm may possess core competencies and capabilities that play a role in determining the priorities on which a firm chooses
to focus.41
In the context of outsourcing, we believe that alignment between the
competitive priorities at the product level and the drivers of outsourcing
decisions for that product will lead to improved performance for a firm.
Figure 6.1 presents a graphical depiction of our proposition.
We suggest that that when making an outsourcing decision, all five
competitive priorities should be considered and each should be weighed
based on its relative importance to the firm. For example, a firm positioning a low-cost product should weigh cost higher than the other competitive priorities, whereas a firm marketing a high-quality product should
not focus on cost.

Figure 6.1
Outsourcing Alignment and Business Performance

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131

Competitive Priorities and Outsourcing


Industry experts have previously identified cost savings as a leading
driver of outsourcing decisions.42 Outsourcing supply chain activities often
improves cost competitiveness because a firm can eliminate inefficient
activities and refocus its resources toward reducing costs. Cost-related
outsourcing drivers also include the selection of a partner that offers lower
total, logistics, regulatory, and/or legal costs to perform an activity.
Firms that focus on flexibility when making outsourcing decisions are
motivated to respond effectively to changing customer requirements.43
Changing requirements may take the form of demand fluctuations or
changes in required product characteristics. Outsourcing drivers that support flexibility include a desire to increase process responsiveness and the
ability to change production volumes and supply chain activities in response to changing market demands.44 Outsourcing an activity to multiple suppliers can improve a firms preparedness to react to the uncertainty
of the manufacturing environment. In addition, outsourcing may free internal resources and allow them to be allocated where needed throughout
the firm for flexibility.
Firms that emphasize innovativeness when making outsourcing decisions focus on rapidly delivering products featuring new technologies
and features. Outsourcing can improve innovativeness by allowing a firm
access to skilled labor and specialized expertise not available in-house.45
Similarly, firms may consider outsourcing routine activities so that inhouse employees with innovative skills and expertise not available to
competitors can focus on value-adding activities. Additionally, outsourcing also may provide access to suppliers with new technologies.46
Outsourcing decisions with quality as the key priority should consider
both the conformance and performance quality of products.47 The outsourcing of activities may be motivated by the availability of a supplier
with superior expertise that can improve the conformance and/or performance of an activity for a firm. Conversely, a firm with superior in-house
skills may be driven to insource an activity if this would give it a competitive advantage. Outsourcing may also allow firms to reassign employees
to roles focused on quality improvement.
A focus on time when making outsourcing decisions implies that the
firm is competing on the ability to perform activities more quickly or
to attain better on-time performance than its competitors.48 To improve
product delivery speed and the ability to develop and deliver products
on time, a firm will be driven to choose sources that can conduct activities with shorter lead times than other potential sources.49 Similarly, a firm
may choose a source that offers comparatively faster process capability
and reduced cycle times.50 Firms also may be driven to outsource some

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activities so that internal resources can be reallocated to tasks related to


reducing cycle, lead, and development times.
Alignment of Priorities, Activities, and Performance
Empirical research has confirmed that the degree of alignment, or fit,
between a firms competitive priorities and its operational activities is
positively related to performance. For example, Devaraj, Hollingworth,
and Schroeder found that the fit between manufacturing strategies and
manufacturing objectives is positively related to plant performance,51
Tarigan found that agreement between general managers and manufacturing managers on the strategic priorities of their firm correlated positively with business performance,52 and da Silveira found that a lack of
strategic alignment between a firms product profile and its manufacturing configuration was related to lower market share.53 Throughout the
literature, studies have also called for additional empirical research to investigate the role the alignment between a firms manufacturing strategies
and its operational actions on firm performance.54
Evaluating the impact of alignment in a manufacturing organization is
complicated by the interdependencies that exist among the wide assortment of possible process configurations. Moreover, firms may adopt multidimensional strategies to achieve their goals.55 To understand the impact
of outsourcing alignment on the performance levels of a business unit,
we examined the relationship between performance and the interaction
between the emphasis placed on a set of outsourcing drivers related to a
single competitive priority and the emphasis given to that associated competitive priority. We surveyed 196 U.S. manufacturing firms that engaged
in outsourcing, drawn from nine industry sectors. Over half of the firms
reported annual sales greater than $1 billion and more than 1,000 employees. For the firms in the sample, there was a strong positive relationship between business performance and the alignment of outsourcing
drivers and competitive priorities. Specifically, as the alignment between
outsourcing decisions and the emphasis placed on the related competitive
priorities increased across all five competitive priorities, firms typically
experienced significantly higher levels of business performance. This result validates the proposition that alignment between corporate strategies
and outsourcing strategies can significantly impact business performance.
To shed more light on the impact of alignment on performance, we
also examined it with regard to each of the five competitive priorities individually. Overall, performance increases when the alignment between
the emphasis placed on cost when making outsourcing decisions and
the emphasis placed on cost as a competitive priority increases. For the
firms investigated, the emphasis placed on cost varied significantly, with
cost being the dominant competitive priority for some, whereas others

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133

placed little emphasis on low cost. Across the spectrum of firms, performance was most substantially (and negatively) impacted when firms that
competed primarily along dimensions other than cost made outsourcing
decisions that were driven primarily by a desire to lower costs. This is
consistent with the cases in 2007 of tainted pet food and toys made with
lead-based paint, two incidents that were widely publicized in the United
States. These occurred when outsourcing decisions were made to reduce
costs by firms that were actually competitively positioned along other dimensions.56 These types of incidents not only harm the firms involved,
but also contribute to the stigma and controversy often associated with
outsourcing activities to certain regions of the world.57 In contrast, there
was no substantial performance difference associated with misalignment between outsourcing drivers and competitive priority for firms that
competed primarily on cost. This finding may be explained by a previous study that found that outsourcing arrangements entail a number of
hidden costs that decrease the actual cost savings that firms experience.58
Potential cost reductions resulting from outsourcing may also be smaller
for cost-focused firms than for noncost-focused firms, thereby magnifying the impact of hidden costs and decreasing the impact of outsourcing
alignment.
Relationships between alignment and performance for the remaining
competitive priorities also follow the general trend of improved performance in the presence of alignment. However, alignment has a greater
impact on performance for firms that compete primarily on flexibility, innovativeness, and time. These findings are perhaps managerially more
intuitive than those for the cost priority, suggesting as they do that firms
competing on these three dimensions should make outsourcing decisions
that are in alignment with their competitive priorities. Apple Computer, a
firm known for its focus on innovation, has repeatedly found success by
partnering with innovative suppliers to procure cutting-edge components
for use in its products.59
The relationship between alignment and performance when quality
is the primary competitive priority also demonstrates improved performance in the presence of alignment. Moreover, the impact of alignment
on performance is nearly symmetric for firms that emphasize quality and
those that do not. In other words, whereas firms for whom quality is a
competitive priority exhibit better performance when they also emphasize
quality when making outsourcing decisions, the performance of firms that
are not focused on quality can suffer when their outsourcing decisions are
driven by quality-related factors. This leads us to conclude that regardless of the emphasis firms place on quality as a competitive priority, they
should consider if the emphasis they place on quality when making outsourcing decisions is consistent with the importance that they place on it
as a competitive priority.

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Managerial Implications of Outsourcing Alignment


The key managerial lesson from the discussion of outsourcing and
competitive positioning is that when considering outsourcing, careful attention should be paid to the overall level of alignment between the emphasis a firm places on all five competitive priorities and the emphasis it
places on corresponding drivers of the outsourcing decision. These findings highlight the importance of scrutinizing the alignment of outsourcing decisions across multiple dimensions rather than focusing on a single
dimension. The recent emergence of India as a destination for outsourcing
in the pharmaceutical industry provides an example of how outsourcing
decisions are made in alignment across multiple competitive priorities.60
Although cost is important to pharmaceutical firms, quality and innovativeness are also critical, and perhaps more important, competitive factors
for the industry. The attractiveness of Indian pharmaceutical manufacturers is due to their ability to deliver products that not only meet the required high quality and innovation standards of buying firms, but to do
so at a lower cost than their European and North American counterparts.
Hence, the alignment of the competitive priorities of the buying firms and
what drives their outsourcing decisions creates synergy that leads to positive performance outcomes.
Anecdotally, the sheer number of horror stories related to outsourcing
that have been publicized in the media indicates that firms are not consistently aligning their outsourcing decisions with their strategic business
interests. Although, it is not clear if these failures are a result of firms not
understanding their competitive priorities or simply ignoring them, a critical early step in the outsourcing process should be a thorough assessment
of the firms goals and competitive priorities. Only once a firm understands their competitive goals are they in a position to begin evaluating
their fit with a potential outsourcing partner.
Taken together, our findings can be interpreted as demonstrating that
the choice of whether or not to outsource an activity, particularly when
an offshore partner is being considered, should be viewed as a strategic
decision due to the significant potential impact the choice has on the organization and its shareholders. The need to carefully and strategically
consider outsourcing decisions has become further magnified by the decrease over the past decade in the value associated with offshore outsourcing. Outsourcing programs are complicated and multifaceted endeavors
that require the full attention of firms in order to maximize the likelihood
of success.
NOTES
Portions of this chapter are reprinted from Outsourcing congruence with
competitive priorities: Impact on supply chain and firm performance, Journal of

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135

Operations Management 28 no. 2, pp. 124143. Copyright 2010, with permission


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50. C. A. Weber, J. Current, and Benton, W. C., Vendor selection criteria and
methods, European Journal of Operational Research 50 no. 1 (1991): 218.
51. Devaraj, Hollingworth, and Schroeder, Generic manufacturing strategies
and plant performance, 316318.
52. Tarigan, An evaluation of the relationship between alignment of strategic
priorities and manufacturing performance, 592.
53. da Silveira, Market priorities, manufacturing configuration, and business
performance, 664.

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54. Bozarth and McDermott, Configurations in manufacturing strategy,


437; Ravi Kathuria and Stephen Porth, Strategy-managerial characteristics alignment and performance: A manufacturing perspective, International Journal of Operations and Production Management 23 no. 3/4 (2003): 255256.
55. Harold Doty and William H. Glick, Typologies as a unique form of theory
building: Toward improved understanding and modeling, The Academy of Management Review 19 no. 2 (1994): 233.
56. D. Farquhar, State legislatures prepare to address environmental public
health issues in 2010 legislative sessions, Journal of Environmental Health 72 no. 4
(2009): 2628.
57. James Bandler, Is Lou Dobbs of two minds on offshoring? Wall Street
Journal, June 21, 2004, B1.
58. Garaventa and Tellefsen, Outsourcing, 2831.
59. Justin Fogarty, Learning from Apple: Supplier innovation and huge margins, Seeking Alpha, April 17, 2009, accessed December 2, 2011, http://seekingal
pha.com/article/131346-learning-from-apple-supplier-innovation-and-huge-mar
gins.
60. C. H. Unnikrishnan, Low costs a draw for foreign drug makers, liveMint.com, August 9, 2009, accessed August 9, 2009, http://www.livemint.com/
2009/08/09220823/Low-costs-a-draw-for-foreign-d.html?d=2.

Chapter 7

Strategic HRM: Building the Bridge


between HR and Business Strategies
Hwanwoo Lee and
Steve Werner

The importance of strategic human resource management (SHRM), which


emphasizes the role of human resource management (HRM) in facilitating business strategies and achieving organizational goals, has increased
steadily over the last two decades. Although the concept of SHRM has
gained considerable traction among human resource (HR) professionals,
there is little guidance available on different HR strategies and when they
may be best given the business strategy being adopted. It is easy to say
that a company should have an HR strategy that is aligned with business strategy to achieve competitive advantage. However, specifying action plans that link HR strategies and practices with business strategies
has been more difficult.
SHRM integrates corporate strategy and human resource management,1
thus drawing business strategy and strategic perspectives into HRM is not
a novel concept. Nonetheless, although numerous authors have emphasized the need to integrate business strategy and HRM,2 it is surprising
to see a persistent gap between business strategy and HRM in practice.
Many believe that an organizations business strategy is the major determinant of its HR strategy.3 Indeed, HR strategy is traditionally seen as

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being the most important link between business strategy and HRM in the
SHRM research. However, there is little literature that dissects HR strategy, functional HR strategies, and HR practices, and integrates them with
business strategy to create a set of choices that can guide managers.
Providing a birds-eye view of business strategy and HRM to HR professionals is a way of facilitating evidence-based management (EBM).4
The goal of this chapter is to use EBM to provide professionals with a tool
for designing HR strategy and implementing a hands-on action plan. Providing HR professionals with versatile and practical guidelines for integrating strategy and HR so they can apply them immediately could have
important implications for firms and HR professionals. The chapter begins by briefly exploring the history of SHRM and discussing conceptual
issues in SHRM. A framework that maps out different HR strategies and
strategic management perspectives is then provided. We then develop an
organizing framework for the horizontal alignment of HR functional strategies and vertical alignment of HR strategies and business strategies. The
chapter will also specify the HR practices appropriate with each HR functional strategy, providing a blueprint for designing strategic HR sets.
HISTORY OF SHRM
The history of SHRM includes the overcoming of stereotypical HR roles
in organizations. Emerging from the function of welfare secretary at the
turn of the 20th century, personnel management had by the first quarter of
the century become the locus of all activities having to do with employee
relations.5 With the surge of the human relations movement (1930s1950s)
and the onset of operations research and systems rationalization (1960s
1970s), personnel directors saw their roles expand to include issues such
as collective bargaining and management by objectives. Nevertheless,
though the roles of the HR directors expanded, HR did not embrace the
notion of strategy until the 1970s. By the early 1980s, some researchers
viewed the effective management of human resources as the key to ensuring quality and a critical source of competitive advantage. They called for
the personnel function to take on a more strategic and business-oriented
role. The origin of SHRM viewed aligning HR practices vertically with
firm strategies. SHRM also considered the bundling of HR practices in
such a way that there was a synergy among them. This was known as
horizontal alignment. These two dimensions of alignment moved the HR
function from personnel management to SHRM.
The Role of Strategic Management Related to SHRM
Many view SHRM as largely dependent on strategic management. This
contingency perspective maintains that particular sets of HR practices are

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likely to yield better performance if they are matched with specific objectives, conditions, and strategic interests.6 It thus makes sense to look at
some of the current perspectives in strategic management and their implications for SHRM. One commonly held perspective considers the firms
internal characteristics. The resource-based view (RBV)7 is based on the
notion that a firms continued success is largely a function of its internal
and unique competitive resources.8 In contrast, past perspectives tended
to focus externally, toward industry structure and competitive position in
the industry. These perspectives have not, however, been considered by
HR professionals with respect to SHRM. We maintain that they should be
since HRM assists the business strategy, which is driven by a particular
strategic perspective. We propose that if the CEO or the top management
team (TMT) is oriented toward one or other of these perspectives in defining how their company will outperform competitors, it will affect not
only the business strategy but also the overall as well as functional HR
strategies.
HR Strategy and Vertical Alignment
We define SHRM as a process and HR strategy as an intended outcome.
The reason we see SHRM as a process is that it is fundamentally the same
as strategic management. Strategic management has been defined as a
process that deals with the entrepreneurial work of the organization, organizational renewal and growth, and, more particularly, with developing
and utilizing the strategy used to guide the organizations operations.9 In
strategic management, strategy has two meanings. Strategy is a plan or
equivalenta direction, a guide, or course of action into the future, a path
to get from here to there. Strategy is also a pattern or the consistency in
behavior over time. The former is intended strategy and the latter is realized strategy.
We define HR strategy as the intended implicit or explicit outcomes created through the process of SHRM, which aligns with the adopted strategic management perspective of the TMT. Hence, this chapter argues that
HR strategy can vary across firms but should be aligned with the adopted
perspective of the firm. As a result, it is important to present possible HR
strategies given different strategic management perspectives. This notion
is called vertical fit. Schuler and Jackson claimed that different strategy
types (cost reduction, quality improvement, and innovation) require different types of employee role behaviors, and HR practices should be used
to ensure those behaviors occur.10 Moreover, Lengnick-Hall and LengnickHall suggested that for human resources to affect strategy there needs to
be a fit between an organizations business strategy and its HR strategy.11
Vertical alignment has various levels (e.g., fit between business strategy
and HR strategy, or fit between HR strategy and HR practice). However,

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little attention has been given in the past to the vertical alignment between
HR strategy and functional HR strategy in SHRM. This chapter will address this shortcoming by showing the various vertical alignments, such
as business strategy, HR strategy, functional HR strategies, and HR practices, as a set of choices.
Horizontal Alignment
The concept of consistency among HR practices is not novel. Increasing
interest in HRM bundles is a reflection of the value that derives from
such consistency HR.12 Consistency can be characterized in at least three
different ways.13 First, single-employee consistency reflects the need for
different elements of HR policy that bear on a single employee to be consistent with one another. Second, among-employee consistency stresses
that if employee A is treated in a particular manner, a similarly situated
employee B should be treated the same way. Finally, temporal consistency means that the HRM philosophy and practices of the organization
should demonstrate some degree of temporal continuity. Most peoples
conception of consistency is of the first type, which is known as horizontal
alignment.
There are at least four good reasons for having horizontal alignment.
First, there are obvious technical benefits of horizontal alignment. For example, if a firm invests significantly in its recruitment processes, it does
not need to have an extensive training system. Since the two can accomplish the same thing, doing both can create redundancy. Second, horizontal alignment has implications for perception and cognition. HRM is
directly related to the contract between an employer and its employees.14
Many believe that HR practices contribute to and shape employee beliefs
regarding the psychological contract they have with their employer. Multiple HR practices should thus be aligned in the messages they send and
thus form a contract that not only works but can be sustained. Third, HR
practices have social implications. For example, Asian companies might
want to set up plants in small towns and rural locations in the United
States because in these environments the strong group ethic and family atmosphere sought at work may mirror workers roles outside of the workplace. Fourth, consistent HR practices can shape recruitment, selection,
and retention. A company hopes that prospective employees understand
the nature of employment that may be offered because a mismatched
worker may leave. Reinforcing messages through consistent HR practices
allows prospective employees to understand expected behaviors once
they have been employed.
In summary, strategic management perspective, HR strategy and vertical alignment, and the horizontal alignment of HR practices are all key
drivers of SHRM in organizations. In the next section, we introduce a

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framework that CEOs or TMTs can use to select specific strategic perspectives for their companies.
A FRAMEWORK: HR STRATEGY AND
STRATEGIC MANAGEMENT THEORY
Understanding different strategic management perspectives is essential
to the formation of a business strategy and an aligned HR strategy. Strategic management perspectives attempt to explain why the firm exists and
what the sources of competitive advantage are.15 It is thus axiomatic that
corporate strategy can vary based on different strategic management perspectives. For example, the traditional strengths-weaknesses-opportunitiesthreats model of firm performance suggests that firms can improve
performance only when their strategies exploit opportunities or threats.16
Recognizing that there are different strategic management perspectives
and that these may lead to different business strategies, it should be apparent that HR strategies can also vary so as to align with these business
strategies. Consequently, strategic management perspectives bridge HR
and business strategies. This raises the question of which strategic management perspective an organization should follow. The answer is not
obvious since no one strategic management perspective dominates. A possible reason for this is that leaders of organizations have different beliefs
or philosophies, and since adopting a perspective is a matter of choice,
this will lead to different perspectives being chosen. Moreover, there is
little guidance to help TMTs select a suitable strategic management perspective for their company.
Strategic management perspectives originated with two fundamental
questions: why do firms exist, and how can a firm perform better than
others? In distinguishing between the various answers to these questions,
it is useful to focus on two relatively independent dimensions. The first
reflects beliefs about the sources of survival of organizations and can be
characterized by the question, How can my company best survive? Two
schools of thought exist and reflect an internal and an external focus.17 During the early development of the field of strategic management, researchers
argued that a firms continued success depends primarily on its internal
and unique competitive resources. Strategic management perspectives
with an internal focus include the resource-based view (RBV) of the firm,
the knowledge- and learning-based perspective, the dynamic capabilities
(DC) perspective, and the strategic leadership perspective. The resourcebased view perceives the firm as a unique bundle of idiosyncratic resources
and capabilities, and that the primary task of management is to maximize
value through the optimal deployment of existing resources and capabilities, while developing the firms resource base for the future.18 The emerging knowledge- and learning-based view focuses upon knowledge as the

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Strategic Management in the 21st Century

strategically most important firm resource. It is thus an outgrowth of the


resource-based view. Teece, Pisano and Shuen describe dynamic capabilities as another extension of the resource-based view of the firm.19 They
define dynamic capabilities as the firms ability to integrate, build, and reconfigure internal and external competencies to address rapidly changing
environments. The strategic leadership perspective argues that organizational outcomes (e.g., strategic choices and performance levels) are partially predicted by the background of management, with an emphasis on
the role of upper echelons of management (i.e., TMT).20
Between the early development of the field in the 1960s and the rise of
the RBV in the 1980s, the prevailing view was that success was largely a
function of external factors, with industry structure and competitive position in the industry being the primary determinants of organizational
success. Corresponding perspectives include the industrial organization
(IO) economics perspective, the contingency perspective, and the strategic groups perspective. The essence of the IO economics view is that a
firms performance in the marketplace depends critically on the characteristics of the industry environment in which it competes.21 The contingency approach highlights those periods of time when business strategies
must be carefully reassessed, for example, during changes in the life cycle,
when any of the other basic environmental characteristics of the industry
change, or when a firm diversifies into product/market areas with economic characteristics significantly different from those of its core businesses.22 Strategic groups, defined by Porter as a group of firms pursuing
similar strategies, provide a means to classify firms within industries into
groups based upon the strategies that they choose to execute.23
The second dimension reflects beliefs regarding the competitiveness of
organizations and can be characterized by the question, How can my
company dominate others? We argue that this is a function of either
structure or process. In the field of organizational sociology, the conventional view of organizations is that they are arrangements of roles and relationships that emphasize structural features of the organizations. Scott
and Davis24 argue that organizations codify, either more or less explicitly,
how they do their work and how the parts of the organization relate to
each other. They label this the formal organization, and it includes elements such as HR practices (including hiring and compensation policies),
job design, and the overall organization structure. The organization structure groups together jobs into larger units such as teams and departments;
thus structural features are elements of the formal organization. Not all
aspects of the organization are, however, captured by the organization
chart. The informal organization refers to the emergent characteristics of
the organization that affect how the organization operates. This includes
the organizations culture, norms, and values; social networks inside and
outside the organization; power and politics; and the actions of leaders.

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In contrast to structure, which we characterize as being visible and


static, we characterize process as being invisible and dynamic. Whereas
some TMTs may believe that their organizations dominate competitors
as a result of well-established roles and responsibilities of employees and
operating units, others may believe that it is the result of spontaneous interactions of employees and units. Although process takes place within an
existing structure, we argue that the relative importance of structure and
process can vary across organizations.
The framework for distinguishing strategic management perspectives
is presented in Figure 7.1 and integrates the two dimensions (external/
internal, structure/process) of organizational survival and competitiveness. In the upper right-hand quadrant, the agency/transactions cost perspective is characterized by an internal survival focus and structure as the
driver of competitiveness. Firms that develop a strategy based on this perspective survive and compete through formalized static rules (e.g., goals
and policies) and well-established patterns of employee behavior without
considering the external environment. In the upper left-hand quadrant,
the IO economics perspective is characterized by a firm focusing on the
external environment to assess its survival, and structure as the source of
competitiveness. Firms adopting this perspective survive by understanding and exploiting the dynamics and advantages inherent in the industry
in which they operate, and compete by having better structure than their
competitors. Internally, they are likely to have organized rules and wellestablished patterns of employee behavior.

Figure 7.1
Framework for Selecting Strategic Management Theories

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In the lower left-hand quadrant, the strategic group process perspective is characterized by a focus on the external environment with respect
to survival, and process as the driver of competitiveness. Firms adopting
this perspective again survive by virtue of leveraging their understanding of the industry in which they operate, and compete based on having dynamic processes that enable them to respond quickly to changes
in the external environment. Finally, the dynamic capabilities perspective
is characterized by an internal focus with regard to survival, and process
as the driver of competitiveness. Firms adopting this perspective survive
and compete through the internally dynamic changes and discretionary
interactions among employees, which enable them to be innovative without considering the external environment.
Having adopted a perspective from the framework, top management
should then adopt a corresponding HR strategy. This will reflect the answer to a third fundamental question in the field of strategic management: what is the role of top management in organizations? One of the key
roles of the TMT is to create an HR strategy that facilitates and supports
the chosen strategic management perspective. Next, we map out possible HR strategies consistent with each of the four strategic management
perspectives.
The Agency/Transactions Cost Perspective and HR Strategy
Agency theory attempts to solve two problems (the agency problem
and the problem of risk sharing), which arise when the goals of the principal (employer) and the agent (employee) conflict; it is then difficult or
expensive for the employer to verify what the employee is actually doing,
and the employer and the employee prefer different actions because of
different risk preferences.25 The agency problem thus exists when one
party requires services from another under conditions of uncertainty and
when both parties behave out of self-interest. Transaction costs are the
costs associated with negotiating, monitoring, evaluating, and enforcing
exchanges between parties, and are incurred in order to make exchanges
more efficient.26 There are at least two ways of decreasing agency problems and reducing transaction costs. One is outcome-based contracts, and
the other involves monitoring to verify behavior.
The agency/transactions cost perspective seeks to explain control in organizations; thus it may be observed by a TMT whose assumptions regarding human behavior can be characterized by terms such as self-interest,
bounded rationality, and risk aversion.27 A TMT that believes that the sustainability of their company is internally driven, and competitiveness is
based on internal structures that efficiently manage the idiosyncratic goals
of employees might therefore adopt this perspective. The description of an
HR strategy based on this perspective might thus be along the lines of:

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We facilitate task conditions that allow employees to demonstrate


their unique contributions, and to benefit from those contributions.
The role of HR is thus to measure unique contributions and to provide adequate rewards for individual employee performance. We
view the aggregate performance of our company as contingent upon
the control systems used to monitor employee behavior.
We refer to this strategy as a bureaucratic HR strategy.
The Industrial Organization Economics
Perspective and HR Strategy
From an IO economics perspective, a companys success is dependent
on its industry.28 One paradigm from this perspective argues that industry
structure determines the behavior and actions of firms. It is the joint conduct of firms that determines their collective performance in the marketplace. The early literature on strategy identified three essential conditions
for a firms success.29 First, a company must develop and implement an
internally consistent set of goals and functional policies that collectively
define its position in the market.30 Second, goals and policies must fit the
firms strengths and weaknesses relative to external (industry) opportunities and threats. Third, a firm must focus on its distinctive competitiveness.
Although the perspective views firm performance as contingent on the
industry as a whole, performance differences within the industry exist due
to differences in management quality. In other words, competitiveness is
a function of the extent to which internal (organizational) structures (e.g.,
goals and policies) efficiently reinforce the firms strengths given industry
opportunities. An HR strategy consistent with this perspective might thus
read:
We consistently explore market opportunities within our industry,
while aligning our human resources capabilities with this opportunity.
We refer to this as an external fit HR strategy.
Strategic Group Process Perspective and HR Strategy
Proponents of the IO economics perspective believed that industries
contained homogenous firms whose overall success was driven by the industry, but whose individual success depended on the management of the
firm.31 Company success was viewed as being based on largely implicit
assumptions about the nature of firms and the environment in which they
operated. The distinction between the IO economics perspective and the
strategic group process perspective is that although both see the industry

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as being a major determinant of firm success, the latter stresses the dynamic interactions among firms more than the former. Whereas the IO
economics perspective views competitors as being homogeneous and the
industry as bring static, the strategic group process perspective views a
firms strategic choices as being critical to firm performance; thus there are
many alternative ways for a firm to gain a competitive advantage.
Due to its emphasis on change, this perspective might be appealing to
a TMT that believes that the sustainability of their company is externally
driven but that competitiveness is likely to increase when the internal (organizational) structures (e.g., goals and policies) are flexible enough to adjust to change within the industry. External (industrial) structures are also
perceived to be subject to change, for example, through strategic choices
such as mergers and acquisitions within the industry. A corresponding HR
strategy might thus be characterized by:
We actively search for opportunities within the industry through
strategic alliances with others, or through mergers and acquisitions.
We pursue flexible, quality human resources to respond quickly to
the changing strategic choices of competitors and ourselves.
We refer to this as an alliance HR strategy.
Dynamic Capabilities Perspective and HR Strategy
The dynamic capabilities perspective is an extension of the resourcebased view of the firm.32 It considers issues of firm strategy that are
modeled specifically on dynamics and high-velocity environments. The
perspective views firm performance as being largely contingent on internal (organizational) capabilities. Due to the critical emphasis on the internal (organizational) processes of a firm, this perspective may resonate
with a TMT that believes that the competitiveness and sustainability of
their company is likely to increase when the internal (organizational) processes are efficient given fluctuating external environments. It may also
appeal to a TMT that believes that the industry is unstable and thus company performance may be vulnerable depending on how it responds to
this instability. A possible HR strategy might thus be characterized by:
We always pursue the flexibility of our organizational processes so
that our company can adapt to the ever changing environment. We
therefore empower employees and nurture creativity and diversity
so that employees can respond effectively to unexpected conditions
that they have never encountered.
This strategy is referred to as a flexibility strategy.

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A BRIDGE BETWEEN HR AND BUSINESS STRATEGIES


The framework presented can be used by TMTs to first identify the
perspective they deem most applicable to their company and its environment. It can then be used to define a corresponding HR strategy. HR management must then decide which HR practices would be most effective
in achieving the objectives of the HR strategy. In this section, we show
how HR practices can be aligned with (corporate) HR strategy by using
subfunctional HR strategies. In addition, the set comprising HR strategy,
functional HR strategies, and HR practices, is linked to different business
strategies. This provides HR professionals with hands-on action plans that
bridge HR and business strategies.

Latticed HR Strategies:Vertical and Horizontal Alignments


Although companies usually have one (corporate) HR strategy, they
are likely to have multiple functional HR strategies since the HR department is typically divided into functions such as compensation and staffing. However, a challenge is that it is difficult to find companies that
explicitly delineate (corporate) HR strategy, functional HR strategies, and
HR practices. We argue that it is important for HR professionals to do so as
this facilitates the alignment of practices corresponding to different types
of HR strategies. By aligning functional HR strategies with (corporate) HR
strategy (i.e., vertical alignment), horizontal alignment among functional
HR strategies will naturally follow. We believe this to be one of the benefits of having an explicit (corporate) HR strategy. Moreover, since HR
practices are driven by functional HR strategies, the vertical alignment of
functional HR strategies with HR strategy is a key to facilitating SHRM.
Horizontal consistency among functional HR strategies is also crucial in
assisting SHRM since this enables HR practices under each functional HR
strategy to be aligned with (corporate) HR strategy, which is linked with
to business strategy and the strategic management perspective the TMT
deems most applicable to their firm.
Although there might be controversy about how to categorize HR functions, we identify five such functions: training and development, compensation, labor relations, performance management and staffing. A typology
of HR strategies and functional HR strategies is presented in Figure 7.2. According to this typology, the agency/transactions cost perspective would,
for example, correspond to a functional HR strategy for training and development characterized as follows: Tailored training and development
based on exact job analysis. The compensation strategy might be characterized by the statement, Hierarchical pay differences based on pay
for performance. Moreover, it is likely to lead to combative labor relations. For performance management, the strategy might reflect extensive

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Strategic Management in the 21st Century

Figure 7.2
Blueprint: Bridging HR and Business Strategies

performance management with management by objectives. Finally, a


possible strategy for the staffing area might be promotion based on rules
and selection based on skills. The figure also shows how each HR function can be vertically aligned with one of the four strategic perspectives.
This typology offers the TMT latticed HR strategies (corporate HR
strategy and functional HR strategies) given strategic management

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perspectives. In the next section, we show how TMTs can connect the latticed HR strategies into business strategies.
BUSINESS STRATEGIES
Many management scholars argue that organizations should adopt coherent and distinctive strategies, and adapt their internal characteristics
to reflect these strategies.33 This contingent perspective implies that sets
of HR strategies and practices should be tailored to the business strategy.34 Although one researcher lamented 20 years ago that there is still no
single commonly accepted set of strategies upon which recommendations
for matching can be based,35 it remains difficult to find generic business strategies with which HR sets should be aligned. We believe this reflects the difficulty inherent in categorizing actual business strategies. In
this section, we briefly overview two widely known typologies of generic
business strategies, and suggest which strategies match with our framework of strategic management perspectives and HR strategies.
Miles and Snows Typology of Defender,
Prospector, Analyzer, and Reactor
The Miles-Snow typology is one of the most popular classifications of
business-level strategies.36 Beginning in the early 1970s and continuing
through the mid-1980s, Miles and Snow explored the strategies of hundreds of companies in numerous industries.37 They almost always found
impressive and bold strategies and tactics. Over time, however, they realized that all of these strategies and tactics were related to a few underlying
business strategies. They identified four basic types of strategic behavior
and supporting organizational characteristics that they referred to as defender, prospector, analyzer, and reactor.
Defender
Defenders have narrow and relatively stable product-market domains. Top managers are highly expert in their organizations limited
area of operation. As a result, these organizations seldom need to make
major adjustments in their technology, structure, or methods of operation. Instead, they focus on improving the efficiency of existing operations. Defender characteristics include a limited product line, a single,
capital-intensive technology, a functional structure, and skills in production efficiency, process engineering, and cost control. Defenders take a
conservative view of new product development, seeking to maintain
the same, limited product line with an emphasis on high volume and
low cost. Since defenders aim to maximize the efficiency of internal

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procedures, Miles and Snow argued that they addressed administrative


problems by providing management with the ability to centrally control all organizational operations. A defender thus resembles a classic
bureaucracy in which only top-level executives have the necessary information and the proper vantage point to control operations that span
several organizational subunits.
We believe that this strategy is consistent with the agency/transactions
cost perspective in our framework. As a result, corporate and functional
HR strategies derived from the bureaucratic HR strategy would thus be
consistent with a defender business strategy.
Prospector
Prospectors continually search for product and market opportunities,
and regularly experiment with potential responses to emerging environmental trends. They often pioneer the development of new products and
are the creators of change and uncertainty to which competitors must respond. However, given their focus on product and market innovation,
they are not typically efficient. Prospector characteristics include a diverse
product line, multiple technologies, a product or geographically based divisional structure, and skills in product research and development, market
research, and development engineering. A prospector distributes power
across different parts of the organization in order to encourage flexible
and innovative behavior that will allow it to locate and exploit opportunities for new ventures. Its administrative system must be able to deploy
and coordinate resources among many decentralized units and projects
rather than to plan and control the operations of the entire organization
centrally.
We believe that this business strategy is consistent with the dynamic
capabilities perspective in our framework. Corporate and functional HR
strategies derived from the flexibility HR strategy would thus align
with the prospector business strategy.
Analyzer
Analyzers work in stable and changing product-market domains. In a
stable domain, analyzers operate routinely and efficiently through the use
of a formal structure and processes. In more dynamic domains, although
they are not usually first movers, competitors are closely watched for
new ideas. Analyzers then quickly adopt those ideas that appear to hold
promise. Analyzers tend to have a limited basic product line, a small number of related product and/or market opportunities, and technology for
stable and new products that is cost efficient. They also tend to have a
mixed (frequently a matrix) structure and are very skilled in production

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efficiency, process engineering, and marketing. In essence, analyzers share


elements of both prospectors and defenders.
We believe this business strategy is consistent with the IO economics
perspective in our framework. HR and functional HR strategies derived
from the external fit HR strategy would appear to fit with the analyzer business strategy.
Reactors
Reactors are organizations in which top managers perceive high levels of environmental uncertainty but lack any consistent strategy for responding to this. Miles and Snow describe reactors as seldom making
adjustments of any sort until forced to do so by environmental pressures.
Unlike defenders or prospectors, reactors have no predictable organizational structure; some may be centralized, whereas others are decentralized. They do not possess a set of mechanisms that would allow them to
respond consistently to their environment. The reluctance to centralize or
decentralize decision making could be more prevalent in public organizations because they are subject to a wider range of competing external pressures than private firms.
We believe this business strategy is consistent with the strategic group
process perspective in our framework. As a result, HR and functional HR
strategies derived from the alliance HR strategy would appear to be
consistent with the reactor business strategy.

Porters Typology of Cost Leadership, Differentiation, and Focus


Porters framework for competitive strategy is one of the most widely
accepted business planning models.38 Porter identifies three generic strategies that firms in an industry may adopt to gain a competitive advantage
over their rivals. He also characterizes firms that dont clearly follow one
of the strategies as being stuck in the middle.39
Cost Leadership
A firm can gain a cost advantage by exploiting economies of scale or superior manufacturing processes.40 In general, large firms with significant
access to resources are more likely to take advantage of cost-based strategies than small firms that are often forced to compete with highly differentiated products and services in niche markets. We believe this business
strategy is consistent with the agency/transactions cost perspective in our
framework, and thus with HR and functional HR strategies based on a
bureaucratic HR strategy.

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Product Differentiation
Some firms seek to be unique in the way they offer products and services
to customers since they believe customers view this as being valuable.
Extending Porters competitive strategy framework, Miller distinguished
differentiation strategies based on innovation from those based on operational and marketing efficiency.41 Differentiation strategies based on innovation can create a dynamic market environment in which it is hard for
competitors and customers to predict and react.42 This unpredictability
could give the innovator a substantial advantage over its competitors. We
believe this aligns with the dynamic capabilities perspective in our framework. This would suggest HR and functional HR strategies based on the
flexibility HR strategy.
Market Focus
A firm that adopts a market focus strategy concentrates its efforts on a
specific market segment. This is generally considered to be appropriate for
small firms with few resources since it allows them to compete with larger
firms and position themselves based on other strategic strengths. Firms
adopting a market focus typically use quality enhancement strategies. In
the retail book market, for example, traditional booksellers such as Barnes
& Noble attempt to take advantage of existing resources such as national
networks of bookstores, an experienced sales force, and established brand
appeal. In contrast, online sellers such as amazon.com compete by offering a wider availability of books, innovative customer services, and competitive pricing. We believe this business strategy is consistent with the IO
economics perspective in our framework. As a result, HR and functional
HR strategies derived from the external fit HR strategy would appear
to be appropriate.
Stuck in the Middle
We believe this business strategy aligns with the strategic group process perspective in our framework. HR and functional HR strategies
based on the alliance HR strategy would be most suited to this business
strategy.

THE LAST PIECE OF THE PUZZLE: HR PRACTICES


For each of the HR strategies proposed, Figure 7.2 identifies examples
of specific HR practices consistent with different HR functions. For example, corresponding to the agency/transactions cost perspective, training and development functional goals can be achieved by lecture-based

Strategic HRM

155

training and job gradebased training. For the compensation function,


practices such a mix of high base pay and low group-based incentives
would be consistent. The agency/transactions cost perspective might also
suggest a no union policy (labor relations function), clear individual objectives and periodic feedback on performance (performance management),
and performance-based promotion and succession planning (staffing).
Based on the IO economics perspective, training and development
functional goals can be achieved by, for example, minimal internal training. Similarly, compensation based on incentives tied to organizational
performance, labor relations characterized by industry-based collective
bargaining, individual objectives linked to organizational objectives (performance management), and promotion and succession planning based
on seniority (staffing) would all be consistent with the perspective.
Consistent with the strategic group process perspective, one might expect to observe competency-based training (training and development),
high base pay based on individual competency (compensation), the avoidance of collective bargaining (labor relations), flexible individual objectives (performance management), and job rotation (staffing). Finally, the
dynamic capabilities perspective would be consistent with creative training, incentives that are balanced between organizational and individual
performance, a cooperative management-labor relationship, informal performance management, and highly specialized labor selection. By aligning HR practices with functional HR strategies in the context of a given
strategic management perspective, TMTs are now equipped with a consistent set of HR and business strategies.
UNIVERSAL HR PRACTICES: HPWS
(HIGH-PERFORMANCE WORK SYSTEMS)
Although we have proposed that TMTs should align HR practices with
functional HR strategies derived from the HR and business strategy, we
also believe that action plans should reflect the imagination and judgments of the TMT that considers their idiosyncratic conditions. In this
sense, TMT capabilities are important in facilitating SHRM and subsequent company performance. For this reason, we offer some HR practices
that are accepted as being effective across firms. It is the mix of aligned
HR practices and universal practices that will drive the success of SHRM.
Internal career opportunities refer to the use of internal labor markets.
In other words, organizations can choose to hire predominantly from
within or from outside. Bundling training refers to the amount of formal
and customized training given to employees. Profit-sharing plans that tie
pay to organizational performance have been seen as an integral part of
a strategic HR system. The degree to which employees are given employment security has many strategic implications. Although it is apparent in

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Strategic Management in the 21st Century

todays economy that even the most senior employees are not free from
layoffs, particular groups of employees in organizations undoubtedly
have a greater sense of security in their jobs than others, either because of
a formal or an informal policy of employment security. Participative decision making (as well as formal grievance systems) have also emerged as
key factors. Finally, open communication is positively related to corporate
financial performance. These six practices are consistently supported by
HR researchers as being an integral part of high-performance work systems. We therefore encourage TMTs to use them in combination, when
possible, with the aligned practices from our framework.
CONCLUSION
Strategic management perspectives can differ across organizations
because TMTs have different beliefs or philosophies about what drives
success. There has, however, been little guidance to help TMTs select a
suitable strategic management perspective to drive strategic decision
making. The framework we have offered helps to address this gap. As we
have proposed, by identifying what it believes drives two dimensions of
performance, sustainability and competitiveness, a TMT can identify the
strategic management perspective that best applies to their firm. Based on
this, they can then develop an HR strategy that is consistent with the chosen strategic management perspective, using this to define specific practices that are aligned with individual functional HR strategies.
We conclude by emphasizing two points. First, we believe our framework can help HR professionals to bridge the divide between HR and
business strategy. However, although useful, strategic management perspectives have only been developed and tested empirically in academia.
It remains to be seen whether they will be viewed as relevant tools to
TMTs. Furthermore, although HR researchers have developed sophisticated tools and techniques to improve the effectiveness of organizations,
HR professionals remain reluctant to use the accumulated evidence,
doubting that the scientific evidence fits their organizational contexts. As
noted earlier, there is also only limited literature that dissects HR strategy,
functional HR strategies, and HR practices, and links them with business
strategies. We believe this chapter will be useful to practitioners by shedding light on the relationship between contextual conditions (business
strategies) and HR sets. Second, we recognize the need for communication and training throughout the organization when using the approach
we have proposed. The sharing of a TMTs values and philosophies with
employees is a key success factor. It is axiomatic that successful SHRM
occurs when employers and employees share the same values and philosophies, and when HR strategies and practices are consistent with these
shared beliefs.

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157

NOTES
1. Clint Chadwick and Adina Dabu, Human resources, human resource
management, and the competitive advantage of firms: Toward a more comprehensive model of causal linkages, Organization Science 20, no. 1 (2009).
2. David P. Lepak and Scott A. Snell, The human resource architecture: Toward a theory of human capital allocation and development, Academy of Management Review 24, no. 1 (1999). Susan E. Jackson, R. S. Schuler, and J. Carlos Rivero,
Organizational characteristics as predictors of personnel practices, Personnel
Psychology 42, no. 4 (1989).
3. Lee Dyer, Studying human resource strategy, Industrial Relations 23,
no. 2 (1984).
4. E. E. Lawler, Why HR practices are not evidence-based, Academy of Management Journal 50, no. 5 (2007).
5. Peter Bamberger and Ilan Meshoulam, Human resource strategy: Formulation,
implementation, and impact (Thousand Oaks, CA: Sage Publications, 2000).
6. Cynthia A. Lengnick-Hall et al., Strategic human resource management:
The evolution of the field, Human Resource Management Review 19, no. 2 (2009).
7. Jay Barney, Firm resources and sustained competitive advantage, Journal
of Management 17, no. 1 (1991).
8. Robert E. Hoskisson et al., Theory and research in strategic management:
Swings of a pendulum, Journal of Management 25, no. 3 (1999).
9. Henry Mintzberg, Bruce W. Ahlstrand, and Joseph Lampel, Strategy safari: A guided tour through the wilds of strategic management (New York: Free Press,
1998).
10. Randall S. Schuler and Susan E. Jackson, Linking competitive strategies
with human resource management practices, Academy of Management Executive
1, no. 3 (1987).
11. Cynthia A. Lengnick-Hall and Mark L. Lengnick-Hall, Strategic human
resources management: A review of the literature and a proposed typology, Academy of Management Review 13, no. 3 (1988).
12. M. Subramony, A meta-analytic investigation of the relationship between
HRM bundles and firm performance, Human Resource Management 48, no. 5
(2009).
13. J. N. Baron and D. M. Kreps, Strategic human resources: Frameworks for general
managers (New York: John Wiley, 1999).
14. D. M. Rousseau and M. M. Greller, Human resource practicesAdministrative contract makers, Human Resource Management 33, no. 3 (1994).
15. R. L. Priem and J. E. Butler, Is the resource-based view a useful perspective for strategic management research? Academy of Management Review 26, no. 1
(2001).
16. Barney, Firm resources and sustained competitive advantage.
17. Hoskisson et al., Theory and research in strategic management: Swings of
a pendulum.
18. Robert M. Grant, Toward a knowledge-based theory of the firm, Strategic
Management Journal 17 (1996).
19. David J. Teece, Gary Pisano, and Amy Shuen, Dynamic capabilities and
strategic management, Strategic Management Journal 18, no. 7 (1997).

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20. Donald C. Hackman and Phyllis A. Mason, Upper echelons: The organization as a reflection of its top managers, Academy of Management Review 9, no. 2 (1984).
21. Michael E. Porter, The contributions of industrial organization to strategic
management, Academy of Management Review 6, no. 4 (1981).
22. Charles W. Hofer, Toward a contingency theory of business strategy,
Academy of Management Journal 18, no. 4 (1975).
23. G. Leask and D. Parker, Strategic groups, competitive groups and performance within the UK pharmaceutical industry: Improving our understanding of
the competitive process, Strategic Management Journal 28, no. 7 (2007).
24. W. Richard Scott and Gerald F. Davis, Organizations and organizing: Rational, natural, and open system perspectives (Upper Saddle River, NJ: Pearson Prentice
Hall, 2007).
25. Kathleen M. Eisenhardt, Agency theory: An assessment and review,
Academy of Management Review 14, no. 1 (1989).
26. Patrick M. Wright and Gary C. McMahan, Theoretical perspectives for
strategic human resource management, Journal of Management 18, no. 2 (1992).
27. Eisenhardt, Agency theory: An assessment and review.
28. Porter, The contributions of industrial organization to strategic
management.
29. Chul Mo Koo, Chang E. Koh, and Kichan Nam, An examination of Porters competitive strategies in electronic virtual markets: A comparison of two online business models, International Journal of Electronic Commerce 9, no. 1 (2004).
30. Porter, The contributions of industrial organization to strategic
management.
31. Leask and Parker, Strategic groups, competitive groups and performance
within the UK pharmaceutical industry: Improving our understanding of the competitive process.
32. Kathleen M. Eisenhardt and Jeffrey A. Martin, Dynamic capabilities: What
are they? Strategic Management Journal 21, no. 10/11 (2000).
33. R. Andrews et al., Strategy, structure and process in the public sector: A
test of the Miles and Snow model, Public Administration 87, no. 4 (2009).
34. Lengnick-Hall et al., Strategic human resource management: The evolution of the field.
35. Cynthia D. Fisher, Current and recurrent challenges in HRM, Journal of
Management 15, no. 2 (1989).
36. Shaker A. Zahra and John A. Pearce, Research evidence on the Miles-Snow
typology, Journal of Management 16, no. 4 (1990).
37. Raymond E. Miles and Charles C. Snow, Designing strategic human resources systems, Organizational Dynamics 13, no. 1 (1984).
38. Koo, Koh, and Nam, An examination of Porters competitive strategies in
electronic virtual markets.
39. Michael E. Porter, Competitive strategy: Techniques for analyzing industries and
competitors: With a new introduction (New York: Free Press, 1998).
40. Koo, Koh, and Nam, An examination of Porters competitive strategies in
electronic virtual markets.
41. D. Miller, Configurations of strategy and structure: Towards a synthesis:
Summary, Strategic Management Journal (19861998) 7, no. 3 (1986).
42. Koo, Koh, and Nam, An examination of Porters competitive strategies in
electronic virtual markets.

Chapter 8

Corporate Financial Strategy


Arindam Bandopadhyaya,
Kristen Callahan, and
Yong-Chul Shin

The growth of a business depends on many factors. Strong leadership


is essential, product demand is critical, and careful financial planning is
imperative. In todays economic environment, it is more important than
ever for organizations to examine both assets and liabilities, incorporate
budget details into a feasible plan, choose the right investments, understand their financial implications, and validate their return. According
to the senior vice president at Ventana Research, An organizations
financial planning process must provide executives and management
across the entire organization with the ability to plan investments and
budgets that fit their corporate strategy. Moreover, its just as important
that they are able to change these plans and budgets quickly and easily
to adapt when business conditions change.1 Although there are many
aspects to sound corporate financial planning, much of the research and
conversation in the past five years has been on issues related to sources
of capital. In particular, discussion has focused on the following:
1. Questions about the existence of target debt-to-equity ratio, the
so-called capital structure of a firm, and the behavior of managers
toward readjusting when capital structure diverges from the target.

160

2.

3.

4.

5.

Strategic Management in the 21st Century

For example, do firm managers have a debt-to-equity ratio that


they would like to obtain, and do they take action when the actual
and target ratios differ?
Identifying what factors influence the selection of a capital structure.
For example, is there a relationship between capital structure and
(a) market-timing behavior, (b) macroeconomic conditions and business cycles, and (c) behavioral characteristics of managers?
Evaluating what the relative advantages and disadvantages of debt
and equity financing are. For example, what is the value of additional
debt? Although the addition of debt increases the tax advantage
to firms resulting from the interest tax shield, it also increases the
risk of bankruptcy and the likelihood of incurring associated costs.
Does the value of the interest tax shield compensate for the increase
in the default costs of debt? If there is indeed an optimal capital
structure, a debt-to-equity ratio at which the cost of additional debt
exactly offsets the marginal advantage, what are the costs of operating under suboptimal capital structures?
The identification of the optimal capital structure such that benefits and costs are balanced. For example, if the benefits and costs of
debt can be measured, can an optimal capital structure be identified?
Financial flexibility and off-balance sheet financing tools such as
leases, pensions, and Special Purpose Entities (SPEs). For example,
are there benefits and costs associated with raising capital using
these alternative methods and institutions?

The first part of the chapter examines these issues in detail. We begin
with a brief description of traditional theories on the choice between issuing debt or equity to raise capital. The two dominant schools of thought on
the question of capital structure, the Miller and Modigliani propositions
and the pecking-order theory are discussed, and traditional empirical evidence regarding these theories is presented. Recent literature suggests the
following:
1. Firm characteristics play a role in the choice of capital structure.
For example, firms with high market-to-book ratios and high stock
returns issue low levels of debt, whereas firms with significant tangible assets issue high levels of debt.
2. Macroeconomic conditions have an effect on the choice of capital
structure. Debt levels tend to be high when long-term interest rates
are perceived to be relatively low. They are also higher during boom
periods than during periods of economic contraction.
3. Capital structure seems to persist over years. Firms with high
debt-to-equity ratios in previous years tend to continue to be highly
leveraged in subsequent years.

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161

4. The characteristics of the CEO play a critical role in the firms capital
structure. CEOs with a military background issue more debt, those
who have experienced a market downturn as well as female CEOs
issue less debt, overconfident managers have an aversion to equity,
and black-owned businesses find it difficult to find external funding
of any kind.
5. Although firms may use less debt than is optimal, this is probably
because the cost of taking on too much debt is higher than the cost of
taking on too little debt.
The chapter also addresses issues related to the accurate calculation of
the cost to the firm of raising capital, the so-called weighted average cost
of capital (WACC). It is critical that the firm accurately determines the
WACC, as underestimation will result in the acceptance of unworthy projects, and an overestimate will lead to the rejection of profitable projects.
Discussion of capital structure relates closely to the issue of accurately calculating the WACC. Ultimately, the optimal capital structure is one that
minimizes the WACC. However, once a firm determines its capital structure, the precise calculation of the WACC requires the correct determination of the cost of issuing debt and equity. A study of the literature,
including survey-based studies, related to the calculation of the cost of
issuing debt and equity indicates the following:
1. The capital asset pricing model (CAPM) is the dominant measure of
the cost of issuing equity.
2. The risk-free rate is an important parameter in the CAPM. The interest rate on treasuries with maturities of 10 years or longer is typically
used as the risk-free rate.
3. The CAPM requires an estimate of the rate of return of the market. Different measures are used as proxies for the market, but the
New York composite index and the S&P500 index are the most commonly used.
4. The extent to which the firms equity return is related to market
return is measured by the beta coefficient of the firm. Accurate estimates of beta are central to obtaining precise estimates of the firms
cost of equity. Estimates of beta are sensitive to the length of time
chosen for estimation purposes, and to whether daily or monthly
rates are used to calculate the rate of return.
5. The difference between the expected rate of return of the market
and the risk-free rate is known as the market risk premium. Surveys
find large variance in the market risk premium used by managers
(4%6%) and analysts (7%7.4%).
6. Market conditions have little effect on the cost of equity.

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7. Firms use marginal cost when calculating the pretax cost of debt;
for new bond issues, the yield to maturity on bonds with equivalent
ratings is utilized.
8. Firms use marginal or statutory rates to calculate the tax benefit of
issuing debt.
After calculating the costs of raising debt and equity, a firm needs to use
appropriate weights, the so-called capital structure weights, to calculate
the WACC. The chapter concludes with a discussion of how capital structure weights are selected. The weight for equity is observable since the
market value of equity is known. The weight for debt is more difficult to
observe, especially if the debt is traded in a thin, illiquid market. Recently,
some firms have used off-balance sheet instruments such as leases and
SPEs to raise capital. These instruments are outlined in some detail, and
the implications for calculating the appropriate weights are discussed.

TEXTBOOK CAPITAL STRUCTURE THEORY


Miller and Modigliani (M&M) Theory
Franco Modigliani and Merton Miller were among the first to describe
how the capital structure decision affects firm value and the cost of capital.2 In its original form, Miller and Modiglianis (M&M) theory operated
in a purely frictionless economy. Among other considerations, this economy is free of tax, bankruptcy, agency costs, and information asymmetries.
The foundation of the theory is that the left side of the balance sheetthe
assets of the firm and the management of those assetsdrives firm value.
M&M assert that as long as the firm is able to fund opportunities that
create value, it does not matter how those opportunities are funded. Critics, however, were particularly troubled by the exclusion of tax considerations and the costs of bankruptcy. They claimed that the tax savings
due to the deductibility of interest payments to debt holders, added significant value to the firm. They also argued that the costs of financial distress could not be ignored since as debt levels increased, the likelihood of
financial distress also increased, causing the value of the firm to decline.
M&M revised their theory to include the impact of tax on the cost of capital and the value of the firm.3 M&M proposition I, which relates to firm
value, states that the value of a firm will increase as debt is added to the
capital structure. The increase in firm value is equal to the present value
of the interest tax shield, the tax savings that result from the tax deductibility of interest expense. M&M proposition II, which relates to the cost of
capital, states that the cost of capital will decrease as leverage is increased.
Although it is true that as leverage increases, equity becomes more risky
and thus requires a higher return, it also means that a greater proportion
of the firm is funded with debt. Since debt costs less and has a tax benefit,

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163

the cost of capital will decline with increased leverage, reaching a minimum when the capital structure is composed entirely of debt, at which
point the WACC is equal to the cost of debt. The theory concludes that
firm value is maximized and WACC is minimized with a capital structure
of 100 percent debt.
Financial Distress Costs and Trade-Off Theory
Although the tax benefit of debt will cause the value of a firm to increase as leverage is increased, this will only be true to a point since as
leverage increases, so too does the likelihood of default. The cost of financial distress eventually becomes so great that it erodes the benefits of the
tax shield, and firm value begins to decline. The implication is that there is
an optimal debt level. Beyond this level, firm value declines because of
the increased probability of default. Although the revised M&M theory
was an improvement by virtue of it incorporating the tax benefits of debt,
it still failed to address the costs of financial distress. Trade-off theory built
upon M&M, and addressed the impact of financial distress on the capital
structure decision.
The underlying premise of trade-off theory is that a firm will identify
an optimal target capital structure that they believe balances the benefits
of the tax shield against the costs of financial distress. A number of dynamic trade-off theories emerged in the 1980s to support the empirical
findings that despite the appearance of target capital structures, a firms
capital structure varies over time. They maintain that even though capital
structure may diverge from a target, firms aim for a capital structure that
they believe is optimal. Many forms of dynamic trade-off theories exist.
Some attribute deviations from target levels of leverage to various exogenous factors including the accumulation of profits, investment expenditures, and changes in market prices. Others attribute the deviations to
deliberate actions taken by managers to time the market. Dynamic tradeoff theories often include considerations of transaction costs, and suggest
that as capital structure fluctuates, managers will act to move the capital
structure back toward a target structure only when the costs of not doing
so exceed the transaction costs of rebalancing.
Pecking-Order Theory
An opposing theory of capital structure is the pecking-order theory.
This suggests that the choice of capital structure is not based on a target
capital structure nor is it influenced by tax shields or bankruptcy costs. Instead, the choice of capital structure reflects the tendency of firms to prefer
financing new projects with internal funds, and issuing debt rather than
equity when external financing is necessary. The tendency to avoid external finance is motivated by managements desire to avoid the scrutiny

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of capital markets and the costs associated with information asymmetries.


Management is concerned that the issuance of debt will draw attention
to the firms financial strength and may cause a reevaluation of its credit
rating. Equity is thought to be particularly sensitive to information asymmetries since the market knows that a firm is unlikely to issue equity if it
believes its stock to be undervalued. The market thus views the issuance
of equity as a signal that the stock is overvalued, and responds by driving
the stock price down. This effect is amplified by the fact that the market
may be unsure about the firms future prospects and what the firm plans
to do with the newly raised equity capital.
RECENT ACADEMIC FINDINGS
The primary distinction between the trade-off and pecking-order theories is that whereas the notion of target capital structure is central to the
former, it is entirely rejected by the latter. Not surprisingly, much of the
earlier research related to these theories focused on the merits of one theory and sought to criticize the other. However, some of the more recent literature finds support for components of each. In this section, we examine
some of the latest developments in capital structure theory.
Capital Structure Policy and Market Timing
Baker and Wurgler were one of the first authors to introduce a
market-timing hypothesis for capital structure theory.4 In the context of capital structure, market timing refers to managements effort
to take advantage of market conditions to minimize the cost of capital. A manager who is timing the market would choose to issue equity
when stock prices are perceived to be overvalued and repurchase equity when stock prices are relatively low. The authors looked at market-to-book ratios as a measure of relative valuation of equity and
showed that there is a strong, negative correlation between high levels of leverage and high market-to-book ratios. They interpreted this
as evidence that managers do indeed issue stock when prices are relatively high (market-to-book ratios are high) and repurchase stock
when prices are relatively low (market-to-book ratios are low). This results in higher levels of debt when stock prices are relatively low and
vice versa. This practice of market timing has a persistent impact on
long-term capital structure, leading to the conclusion that capital structure is related to historical market values. A comprehensive survey of
CFOs supported Baker and Wurglers findings.5 Two-thirds of respondents said that the perceived over/undervaluation of equity was an
important or very important determinant in the decision to issue equity,
second only to concerns about the dilution of earnings per share (EPS).

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165

Barry, Mann, Mihov, and Rodriguez explored the relationship between


interest rates and the decision to issue debt.6 They found that firms issued significantly higher amounts of debt when long-term interest rates
were perceived to be low relative to historical values. Although refinancing activity can explain some of this activity, nonrefinancing activity
is also considerably higher when interest rates are relatively low. Baker,
Ruback, and Wurgler synthesized the research related to the market timing of financing activities to determine whether or not these timing strategies payoff.7 They concluded that market-timing driven equity issuances
seemed to be beneficial because stock prices tended to decline after the
equity issuance. This resulted in a lower cost of equity for issuing firms
relative to their nonissuing peers. Barry, Mann, Mihov, and Rodriguez
found that firms can benefit by selecting the maturity of debt issues based
on market conditions.8 In particular, a firm that expects interest rates to
increase in the future should issue long-term debt. If the firm expects
decreases in interest rates, it should issue short-term debt today, and, at
maturity, issue longer-term debt at lower rates. Firms that appeared to be
successful at anticipating future interest rates experienced a decrease in
the overall cost of debt.
Capital Structure, Historical Stock, and Operating Performance
Hovakimian, Hovakimian, and Tehranian examined the relationship
between market and operating performance and the external financing
decision by focusing on firms that issued both equity and debt.9 Their
study supported hypotheses that firms with high market-to-book values
have low leverage ratios and that high stock returns are related to equity issuance. However, they did not find evidence that market performance has a bearing on debt issuance. Furthermore, the study found no
relationship between operating performance and target capital structure
but did find a relationship between profitability and a firms response to
deviations from target capital structure. As losses accumulated, unprofitable firms experienced a decrease in the value of equity, which caused
debt ratios to rise above their targets. These firms tended to issue equity
to correct these deviations from target levels of leverage. In contrast,
profitable firms experienced an increase in equity as profits accumulated, causing their debt ratios to fall below target values. However,
these firms did not issue more debt to correct the deviation. Under these
circumstances, firms behaved consistently with pecking-order theory,
whereby they used accumulated profits as a source of internal funding
rather than issuing more debt. In summary, firms tend to have a target
capital structure, but the preference for internal financing and the appeal of market timing tend to distract them from maintaining these target structures.

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Welch explored the relationship between historical stock prices and


capital structure.10 Sometimes referred to as inertia theory, Welch hypothesized that firms behave as though they have a target capital structure but are slow to act to reverse diversions from the target. In an analysis
of all publicly traded firms between 1962 and 2000, the study found evidence that firms had target debt ratios. In particular, a firms capital structure was highly correlated to the capital structure in the prior year. Testing
the hypothesis over a five-year period, the research found that correlation effects were long-standing, providing further evidence that firms
had target debt ratios. However, as stock prices caused a firms capital
structure to move away from its target, firms did not counteract this divergence despite frequent debt and equity issuing activity. Welch found
that 60 percent of capital structure was explained by such issuing activity
but that this activity was not intended to readjust capital structure when
debt ratios changed. In fact, over the long term, 40 percent of firms capital
structure was determined by debt ratio changes resulting from stock price
movements, and these changes did not seem to be followed by management actions to readjust capital structure.
Flannery and Rangan studied the capital structure trends of nonfinancial firms between 1966 and 2001.11 Although conceding that there are
many factors that influence a firms capital structure, for example, historical
stock prices, pecking orders, and market-timing tendencies, they disagreed
with Welchs assertion that firms do not readily take action to reverse divergences from the target capital structures due to stock price movements.
They suggested that pecking-order and market-timing theories tend to explain about 10 percent of capital structure changes and restructuring toward
target levels of leverage explained more than half. When capital structure
moves away from the target, firms take actions to move the capital structure
back toward the target structure at a rate of more than 30 percent per year,
three times more than what other research suggests.
Capital Structure and Firm Characteristics
Firms that seemed to be underlevered shared common characteristics.12 Underlevered firms were typically larger, more mature, and more
profitable than those that were not. They also had large intangible assets,
greater growth opportunities, and higher earnings volatility. Blouin et al.
suggested that these firms may also have other immeasurable characteristics that explain the apparent underleverage, including higher agency
costs than otherwise comparable firms.13 Agency costs can reflect a tendency for managers to engage in risky projects or to reject potentially profitable projects as debt increases in the capital structure.
Kayhan and Titman examined whether a firms capital structure is
driven more by its history or by a target capital structure.14 They found

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167

that variables such as past profitability, financial deficits, past stock returns, market timing, leverage deficit, and change in target capital structure will at times cause capital structure to deviate significantly from
targets, and that these deviations can be long-standing. The reason for
these deviations persisting may be that the transaction costs associated
with adjusting the capital structure are large relative to the perceived
cost of a suboptimal capital structure. Financial deficits and past stock
returns had the greatest and most enduring impact on capital structure.
These variables continue to affect capital structure over a 10-year period. However, although the influence of financial deficits is partially
reversed over a five-year period, the impact of past stock returns is not.
The latter may indicate a change in target capital structure if the stock
price increase is due to increased growth opportunities. Although these
effects persist, firms still tend to behave as though they have target debt
ratios, and act to move slowly back to their target capital structure.
Capital Structure Policy, Business Cycles,
and Macroeconomic Conditions
Trade-off theories suggest that the choice of capital structure is based
on achieving a balance between tax benefits and the costs of bankruptcy.
The value of the tax benefit depends on the cash flows of the firm, which
in turn depend on the business cycle. This suggests that there should be
a relationship between capital structure and macroeconomic conditions.
Trade-off theories suggest that when cash flows are high, firms should
issue more debt to take advantage of the tax shield. Furthermore, when
bankruptcy costs are low, firms can afford to bear more debt. Trade-off
theories would thus suggest that debt should be higher during expansions because cash flows are higher and bankruptcy is less likely. An
empirical relationship between business cycles and capital structure has
indeed been observed. However, the relationship is not what trade-off
theory would predict.
Korajczyk and Levy examined how firm-specific traits and macroeconomic conditions play a role in the capital structure decision.15 Their
research supports components of both the trade-off and pecking-order
theories. Trade-off theory states that firms balance the tax benefit of
debt against bankruptcy costs. The more a firm can benefit from the tax
shield (firms that are profitable and have high tax rates) and the lower
the cost of bankruptcy (firms that have a high credit rating and substantial collateral), the more debt they will be able to assume. The findings
were consistent with this. Firms with large tangible assets had relatively more debt (large tangible assets serve as collateral and therefore
decrease bankruptcy costs) than firms with unique or intangible assets
that tended to have less debt.

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The authors added another dimension to the analysis by dividing firms


into two categories: constrained and unconstrained. Constrained firms
were those with inadequate internal funding and that faced high information costs in external markets. Unconstrained firms were those with
adequate internal funds. High information costs arise from information
asymmetries whereby the market may be uncertain about a firms prospects, although management, with access to all the information, sees a
promising future. Findings showed a significant difference in choices of
capital structure between constrained and unconstrained firms. Target leverage is procyclical for constrained firms and countercyclical for unconstrained firms. In other words, constrained firms were more leveraged in
times of expansion and less leveraged during downturns. In contrast, unconstrained firms were less leveraged during expansions and more leveraged during downturns. Whereas the findings for constrained firms are
consistent with trade-off theories, the findings for unconstrained firms
are not. Instead, they are consistent with pecking-order theory that would
suggest that during an expansion, when there is greater availability of internal funding, firms can avoid external financing. Overall, the authors
found that the capital structure of unconstrained firms was closely related to the macroeconomic environment, but that of constrained firms
was driven largely by deviations from target capital structure. It seems
that constrained firms do not have the luxury of timing the market,
and that the choice to issue more debt is not a choice at all, but firms take
what they can get. Finally, it seems that the pecking-order theory works
well for unconstrained firms, whereas constrained firms tend to behave as
though they have a target capital structure.
Hackbarth, Miao, and Morellec also explored the relationship between capital structure and macroeconomic conditions and found that leverage is countercyclical, a firms debt structure being 40 percent larger
during booms than during periods of contraction.16 In a related paper,
Chen explained that the capital structure decision has more to do with
business cycles and macroeconomic conditions than trade-off theories
suggest.17 By modeling firms behavior under various economic conditions, he found that the capital structure of firms that are more sensitive
to systematic (market) risk should be countercyclical. The explanation for
this is that cash flows and required returns will be very sensitive to macroeconomic conditions. Chen also related the expected growth rate and
volatility of cash flows to the likelihood of default and managements
decision to issue debt. He found that low expected growth rates cause a
firm to wait to issue additional debt and lead a firm to default sooner.
Capital Structure Policy and Behavioral Influences
Malmendier, Tate, and Yan claimed that early life experience can play
a large role in corporate finance decision making.18 They examined the

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capital structure policies of CEOs who had served in the military and
those who had experienced an economic downturn early in their lifetime. They found that World War II veterans were more aggressive than
other CEOs. In combat, soldiers manage stressful and risky situations
that build their confidence in risk management. As a result, veterans
tend to be willing to bear more risk. In contrast, CEOs who have experienced economic downturns tend to be more conservative. Experiencing
an economic depression can have a deep and long-lasting impact that
causes an aversion to financial risk taking. The study also looked at the
effect of overconfidence on capital structure policy. CEOs who thought
their firms were undervalued perceived external financing to be prohibitively expensive. When external financing was needed, these CEOs
exhibited a marked aversion to equity. When issuing debt to finance a
deficit, overconfident CEOs also tended to issue about 33 percent more
debt than needed.
Robb and Robinsons examination of the capital structure decisions
of new firms provides useful insight into behavioral characteristics and
the capital structure choice.19 In particular, the study found that women
were less likely to issue debt, and black-owned businesses and businesses started by people without high school degrees were less likely to
obtain external financing of any kind. However, the authors also found
that firms that obtained formal external financing were more successful,
and that those that did not were more likely to fail within three years.
This is presumably due to the additional management oversight provided by external stakeholders and financial markets.
Estimating the Costs and Benefits of Debt
Trade-off theory suggests that there is an optimal level of debt that
balances the costs and benefits of debt. Various models suggest that the
optimal capital structure consists of about 65 percent debt, whereas observed debt levels have been, on average, about 30 percent. Only recently, however, has the research begun to adequately quantify the costs
and benefits of debt.
The Value of the Tax Shield
Graham examined the value of the tax shield and found that the aggregate tax benefits of the shield were significant. At their highest, tax
benefits of debt for a sample of 6,087 firms totaled $114 billion in 1990.20
He also created a model to measure the value of the interest tax shield
at the firm level and found that the tax benefits of debt amounted to
9.7 percent of firm value. However, despite the significant benefits of
debt financing, even large, well-established firms tended to have conservative debt policies. More than 44 percent of the firms examined

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underutilized debt despite the fact that even after taking into account
the costs of bankruptcy, firms could still benefit from the debt tax shield
if they were to double their debt. Blouin, Core, and Guay claimed that
Grahams study overestimated the tax benefits of debt, and that estimates of future tax-related cash flows were flawed since other tax benefits such as tax loss carryforwards and carrybacks had been ignored.21
Using an improved method to estimate marginal tax rates, they showed
that although firms were not as underleveraged as previously thought,
between 18.5 percent and 29.2 percent of them were underleveraged,
and that an increase in leverage could have added 13 percent of value
to the firm.22
The Costs of Debt
Studies of the cost of debt have historically focused on small samples
of bankrupt firms. These studies estimated bankruptcy costs to be between 3.1 percent and 20 percent of firm value. Building on Grahams
work, Van Binsbergen, Graham, and Yang developed a model to analyze the costs and benefits of debt.23 They used a model to develop an
optimal capital structure, and compared the costs and benefits of this optimal (equilibrium) capital structure to observed capital structures. Their
findings suggested that default costs amounted to 6 percent of book value
for investment-grade firms and 17 percent for low-grade firms. The average benefit of debt at the equilibrium level was 10.4 percent compared
to an observed benefit of 9.0 percent. The cost of debt at the equilibrium
level was 6.9 percent compared to an observed level of 7.9 percent. The
equilibrium net benefit of debt was 3.5 percent compared to an observed
benefit of 1.1 percent, which suggests that firms are underleveraged.
Costs of Suboptimal Capital Structure
Van Binsbergen, Graham, and Yang quantified the costs of operating
with suboptimal capital structures.24 Their results showed that the cost of
having too much debt was disproportionately higher than the cost of having too little debt. If the average firms with equilibrium capital structures
were to double their leverage, they would lose about 6.7 percent of firm
value, whereas if the same firms were to eliminate their debt they would
lose 4.5 percent of their value.
Using Cost-Benefit Analysis to Identify the
Optimal Capital Structure
The measurement of the costs and benefits of debt represents a significant advance in capital structure research. In an upcoming paper, Van Binsbergen, Graham, and Yang take these measurements further, using them

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to identify an optimal level of debt for individual firms.25 The foundation


of this new model is that capital structure is optimized when the marginal benefit of debt is equal to the marginal cost of debt. By modeling the
characteristics and behavior of firms that seem to operate under optimal
capital structures, the authors built a general model to estimate both the
benefits (tax shield and reduction in agency costs) and costs (financial distress costs) of debt that can work for any firm. In addition to consideration
of the marginal tax rate, the model accounts for tax-loss carry-forwards
and carry-backs. The model incorporates several variables in modeling
the costs of debt, including collateral (physical assets plus inventory divided by total books assets), book-to-market equity ratio, intangible asset
ratio, and cash flows to book asset ratio. The model also considers whether
a firm pays dividends. Outcomes from the model are consistent with empirical studies and commonsense inferences. For example, the model predicts that firms with a low collateral ratio will have higher costs of debt
than those with a high collateral ratio. Figure 8.1 depicts the cost and benefit curves for Six Flags and Performance Food Group. Relative to the optimal capital structures determined by the model, Six Flags was overlevered
and Performance Food Group was underlevered. The shaded areas depict
the net benefit (cost) of debt. For Six Flags, it indicates a net cost of debt
since the firms actual debt level is greater than the optimal level; the costs
of debt exceed the benefits of debt. In contrast, Performance Food Group
uses too little debt. The shaded area depicts the amount by which the benefit of debt exceeds its costs. Note that at the optimal level, the marginal
benefit of debt equals the marginal cost of debt, and debt levels beyond
this point will have a net cost. The model can also measure how the cost
of debt and firm value are affected by operating with a suboptimal capital
structure.26
The Cost of Capital
Capital structure policies are put in place in an effort to maximize shareholder returns. Managers do this by maximizing cash flows and minimizing the cost of capital. The calculation of the cost of capital is important
in part because it represents an important parameter in a firms capital
budgeting decisions. According to the Census Bureau, capital expenditures on property and equipment in 2010 were over $1 trillion for U.S.
nonfarm businesses. Without question, the cost of capital estimate was a
key determinant in these spending decisions. Miscalculating the cost of
capital can lead a firm to reject a potentially valuable project if the cost of
capital is overestimated, or accept a project that fails to meet investors required return if the cost of capital is underestimated. Here we look at the
considerations in estimating the cost of capital. The components of the
cost of capital include the required returns on equity and debt, and

Figure 8.1
Benefit of Debt for Six Flags and Performance Food Group

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the relative weighting of equity and debt in the capital structure. Although there are different types of equity and debt (e.g., preferred equity
and convertible debt), we focus on common shares and straight debt. Offbalance sheet items are also a source of capital, thus we discuss their impact.
The Cost of Equity
According to a study by Bruner, Eades, Harris, and Higgins, CAPM is
the dominant measure of cost of equity.27 They reported that 80 percent
of corporations and advisors and 100 percent of textbooks use CAPM as
the primary measure of the cost of equity. A more recent survey by Graham and Harvey found that 75 percent of corporations use some form of
the CAPM to measure the cost of equity.28 Some corporations and advisors
may also use multifactor models that consider not only market risk but
also sensitivity to other factors such as firm size and book-to-market value.
The return on a risky asset must provide compensation for the time
value of money and a risk premium based on the assets level of risk. The
CAPM recognizes two sources of risk: systematic risk and unsystematic
risk. Systematic (market) risk affects all assets in the market and reflects
sensitivity to variables including GDP, inflation, interest rates, and other
macroeconomic factors. Unsystematic risks are specific to a firm and reflect
variables that can include lay-offs, strikes, supply shortages, uppermanagement changes, and other firm-level factors. There are two underlying assumptions of the model: market prices are efficient (i.e., they are
fair and reflect all available information), and all investors hold a welldiversified portfolio (i.e., they are free of unsystematic risk exposure.
Since poor returns on some stocks will be offset by good returns on others,
the total risk exposure of a well-diversified portfolio is due only to market risk.) Accordingly, the CAPM states that investors should only be rewarded for systematic risk. This depends on the market risk premium and
the firms sensitivity to movements in the market. We examine different
proxies for the risk-free rate, the market risk premium, and the measure of
systematic risk (beta).
Risk-Free Rate
Theoretically, the risk-free rate should be a default-free return that represents compensation for the pure time value of money. Textbooks often
use an average of historical T-bill rates as a proxy for the risk-free rate.
Firms and analysts tend to use current interest rates on long-term treasuries
to match the time horizon of their investments. Bruner, Eades, Harris,
and Higgins reported that 70 percent of firms use treasury maturities of
10 years or longer.29 The spread between short-term and longer-term yields
has averaged about 1.5 percent and is currently 3.21 percent,30 so the choice
of maturities can have a significant impact on the cost of equity estimate.

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Beta
Since the market portfolio is not directly observable,31 providers of
beta use stock market indices to estimate the performance of the market
portfolio. The value of beta is calculated by regressing a stocks historical
price movements against those of the market proxy over the same period.
If the value of a stocks beta is one, the riskiness of the stock is the same
as that of the market portfolio. A value of greater than one means that
the stock is more sensitive to market risk factors than the overall market
proxy, and a value of less than one means that the stock is less sensitive to
market risk factors than the market proxy. Note that when using beta to
calculate expected returns, the implicit assumption is that future returns
are expected to behave like past returns.
Providers of beta differ in their estimates for many reasons. First,
they vary in their choice of market proxies. Some use the S&P
500 index whereas others use the NYSE composite index. Additionally, the length of time (e.g., 2 years or 5 years), and the periodicity
of returns (e.g., daily or weekly) used in computing beta may vary.
These variations can result in a range of beta estimates, which, in
turn, will cause a range of estimates for the cost of equity. The following are the parameters and beta estimate for Caterpillar (CAT) from
some of the most common beta sources: value line: NYSE composite,
five years of weekly prices, CAT beta = 1.30.
Bloomberg: S&P 500, two years of weekly prices in its default mode,32
CAT beta=1.53
Capital IQ (Yahoo):33 S&P 500, five years of monthly data, CAT
beta = 1.71.
Using the current 10-year T-bond rate of 3.568 percent34 for the risk-free
proxy and the historical market risk premium of 8.5 percent, the CAPM
yields a cost of equity for Caterpillar (CAT) of 14.61 percent using the
value line estimate of beta, 16.57 percent (Bloomberg), or 19.55 percent
(Capital IQ). The cost of equity thus varies from by nearly 5 percent depending on the source of beta.
Because estimates of beta are based on historical returns, they will
change over time. Fernandez demonstrated that beta estimates can
change dramatically over even short periods of time.35 For example, on
a daily basis over a two-month period, the value of AT&Ts beta varied from a low of 0.32 (January 14, 2002) to a high of 1.02 (December 27,
2001). Over a 10-day period between January 20 and January 30, 2002,
the value of Boeings beta varied between 0.57 and 1.22. During that
same period, AT&Ts beta was greater than Boeings 32 percent of the
time, which shows that, at times, beta estimates can even be unreliable

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as measures of relative risk. Many corporations and analysts understand that the estimate of beta has its limitations. It is thus common
for practitioners to adjust published estimates according to the perceived level of risk to provide a more appropriate measure of the assets systematic risk exposure. Blume observed that the value of beta
seems to regress toward a value of one over time and offered an adjustment to reflect this phenomenon.36 He suggested using a weighted average of the equity beta and one where the weight of the equity beta
is two-thirds. This adjustment is widely accepted and is used by many
practitioners.
Market Risk Premium
In theory, the market risk premium is the additional return above the
risk-free rate that investors require for bearing the risk of the market
portfolio. Surveys have found a wide range of estimates for the market risk premium. Bruner, Eades, Harris, and Higgins found that most
corporations use risk premiums between 4 percent and 6 percent, although 50 percent of analysts use estimates between 7 percent and
7.4 percent.37 Graham and Harvey reported that the market risk premium used by U.S. CFOs between June 2000 and November 2006 ranged
from 2.39 percent (November 2005) to 4.65 percent (September 2000).38
The average of 3.47 percent is notably lower than Bruner et al.s earlier
findings. Fernandez and del Campo found that the average market risk
premium used by analysts in the United States and Canada in 2010 was
5.1 percent and ranged from 2.9 percent to 10 percent.39 The corresponding figures for corporations were 5.3 percent and 1.9 percent to 11.2 percent. Textbooks tend to use the historical average risk premium over
T-bills, which is usually between 8 percent and 8.5 percent.
During the most recent financial crisis, managers have become particularly concerned about how increases in risk aversion may affect the
cost and availability of capital. Dobbs, Jiang, and Koller found that economic conditions have little influence on the cost of equity.40 For example, a 20 percent drop in share price and a 7.5 percent decline in profits
would amount to a 0.6 percent change in the cost of equity (Table 8.1).
They also pointed out that stock price changes are affected more by the
revision of earnings estimates than by changes in the cost of capital.
The Cost of Debt
The cost of debt is relatively easier to estimate than the cost of equity since market yields on bonds are directly observable. Fifty-two percent of firms tend to use their marginal cost when calculating the pretax
cost of debt.41 For new bond issues, firms observe the yield to maturity
on bonds with equivalent credit ratings. Thirty-two percent of firms use

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Table 8.1
Percentage Change in Cost of Equity Given Changes in Sales Price
and Earnings
% Change in Earnings
10
%
Change
in Sales
Price

7.5

5.0

2.5

25

0.8

0.9

1.1

1.2

0
1.3

20

0.5

0.6*

0.7

0.9

1.0

15

0.2

0.4

0.5

0.6

0.7

10

0.0

0.1

0.0

0.1

0.2

0.2

0.1

0.0

0.1

0.2

0.4

0.3

0.2

0.1

*A 7.5 percent decrease in earnings combined with a 20 percent decrease in price results in a 0.6 percent increase
in the cost of equity.

the weighted average of each of their outstanding bond issues, the


method that most textbooks and financial advisers endorse. To adjust for
the tax benefit of debt, 52 percent of firms calculate their after-tax cost of
debt using marginal or statutory tax rates. The majority of financial advisers and textbooks recommend using marginal tax rates. A minority of
corporations and financial advisers use the historical average tax rate to
estimate the cost of debt.
Weights on Debt and Equity in Estimating Cost of Capital
The WACC depends on the percentages of debt and equity in the capital structure. It is recommended that market values be used in estimating
these percentages since book values on the balance sheet are historical
and do not reflect current values. The market value of equity can be calculated by multiplying the closing price of a firms stock by the number
of shares outstanding. It is not generally easy to directly obtain the market value of debt. Although some bonds are traded, many firms have
debt that is not traded. Although the firms themselves have access to
their current loan balances, this information is often unavailable to the
public. In this case, it becomes necessary to rely on the book value of the
debt instead.
Another issue is the choice between target and actual capital structure.
Since debt and equity costs depend on the proportions of each source of
financing in the capital structure, this suggests that the current, actual proportions of each should be used in computing the WACC. However, if a
firms target weights are publicly known and investors anticipate the firm
changing the weights, the observed costs of debt and equity may reflect

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the target capital structure. The weights for debt and equity are complicated when firms have off-balance sheet financing instruments. These are
hidden debts; thus if they are not incorporated in estimating the WACC,
this estimate will not be accurate. The implications of off-balance sheet
financwing instruments will be discussed in a later section.
Implications for Decision Makers
The chosen risk-free proxy, market risk premium, or value of beta can
result in dramatic differences in estimates of the WACC; thus it is important to consider how the WACC is to be used. If it is used to gauge past
performance, one should use parameters that reflect past circumstances.
In contrast, if it to be used for capital budgeting purposes, one should use
parameters that reflect expectations for the future with the corresponding projects time horizon in mind. It is also imperative that the value of
beta used in capital budgeting reflects the risk of the project, not the risk
of the overall firm. Using the overall equity beta when a project has lower
risk than the company as a whole will lead to an overestimate of the cost
of equity and thus the rejection of a potentially profitable project and vice
versa. If new debt is to be issued to fund a project, it is appropriate to use
the yield to maturity on the new bond issues in computing the cost of
debt. Finally, the weights used to compute the WACC should reflect the
expected capital structure weights.
Financial Flexibility and the Use of Other Financing Tools
The primary concern of financial managers when facing long-term financing decisions is how a financing decision today might impact future
financing options. Sixty percent of respondents to a survey cited financial
flexibility as the primary concern when making debt policy decisions.42 In
particular, firms wanted to protect their credit rating and to preserve unused debt capacity to finance future investment opportunities. It is thus no
surprise that financial managers consider off-balance sheet financing tools
to meet their capital funding needs.
It is increasingly important for firms to remain flexible and to be able
to adapt quickly to a changing environment. This means that the old, physical assetintensive model may not work as well as it did in the past. Firms
need to raise capital to purchase long-term physical assets that may be hard
to sell in a timely manner. Raising capital is costly because debt financing
increases the leverage ratio and equity financing can dilute shareholder
value. However, some financing tools do not have to be classified as either debt or equity, and can thus be kept off a firms balance sheet, thereby
preserving the leverage ratio. Examples include operating leases and offbalance sheet entities for joint ventures, or research and development

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partnerships. Off-balance sheet financing has been attractive to many firms


especially when the addition of a large amount of new financing would
break their debt covenants. However, firms should be fully aware of both
the positive and negative consequences of using these instruments. Although they can have a positive effect when used to improve leverage ratios or financial flexibility, they can also lead to legal consequences if used to
artificially manipulate financial reports as was the case with Enron. Enron
created several off-balance sheet entities known as SPEs, whose financial
statements did not have to be consolidated with Enrons own statements.
Unprofitable assets were then transferred to these entities to hide losses
and make the company look financially healthy. After several accounting
scandals in the early 2000s, both the Securities and Exchange Commission
and the Financial Accounting Standards Board (FASB) increased disclosure
requirements for off-balance sheet financing instruments. Two commonly
used off-balance sheet instruments, leases and SPEs, will be explained in
detail in the following sections.
Leases
A recent SEC study estimated that total (undiscounted) cash flows associated with off-balance sheet operating leases for active U.S. issuers may
approach $1.25 trillion. This is 28 times more than the $45 billion of onbalance sheet capital leases.43 For companies in the S&P 500 stock index,
off-balance sheet operating-lease commitments, as revealed in the footnotes to their financial statements, totaled $482 billion.44 From a financial
viewpoint, the purpose of operating leases is to lower the conventional
way of reporting debt. Under current U.S. accounting rules (GAAP), there
are two types of leases, operating leases and capital leases. For a company
to record a lease as a capital lease, the lease must meet one or more of the
following four criteria:45
1. Transfer of ownership test: The lease transfers ownership of the
property to the lessee by the end of the lease term.
2. Bargain-purchase option test: The lease contains a bargain purchase
option. A bargain purchase option allows the lessee to purchase
the leased property for a price that is significantly lower than the
expected fair value of the property at the date the option becomes
exercisable.
3. Economic life test: The lease term is equal to 75 percent or more
of the estimated economic life of the leased property. However, if
the beginning of the lease term falls within the last 25 percent of
the total estimated economic life of the leased property, including
earlier years of use, this criterion shall not be used for purposes of
classifying the lease. If the lease period equals or exceeds 75 percent of the assets economic life, the lessor transfers most of the risks

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and rewards of ownership to the lessee. Capitalization is therefore


appropriate.
4. Recovery of investment test: If the present value at the beginning of
the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs such as insurance,
maintenance, and taxes to be paid by the lessor, equals or exceeds
90 percent of the fair market value of the leased property, then a lessee should capitalize the leased asset. Because if the present value of
the minimum lease payments is reasonably close to the market price
of the asset, the lessee is effectively purchasing the asset.
If the lease qualifies as a capital lease, it is reported as a leased asset
on the asset side of the balance sheet and a lease liability on the liability side, and the effect is the same as a purchase with borrowing. This
will in turn affect the total amount of debt and the calculation of the leverage ratio, cost of debt, and cost of equity. As a result, firms with a
high level of debt would prefer not to have a capital lease and may prefer to have an operating lease instead.
For an operating lease, the lessee records only periodic rental expenses
but not any liabilities, thus helping to maintain a lower debt level. This
makes the balance sheet and leverage ratios appear more favorable. Many
airlines make extensive use of lease arrangements to acquire aircraft rather
than purchasing them. According to 2009 company reports, between 16 percent (Southwest) and 42 percent (Republic) of the total fleet of airlines
was leased using operating leases.46 This resulted in considerable offbalance sheet financing; thus decision makers including analysts, investors, and managers should adjust reported debt levels to account for the
effects of the leases.
The following examples illustrate the financial impact of operating
leases:47
US Airways Group Inc., which filed for Chapter 11 bankruptcy protection, showed only $3.15 billion in long-term debt on its most
recently audited balance sheet, for 2003, and didnt include the
$7.39 billion in operating-lease commitments it had on its fleet of
passenger jets.
Drugstore chain Walgreen Co. shows no debt on its balance sheet,
but it is responsible for $19.3 billion of operating-lease payments
mainly on stores over the next 25 years.
When UAL Corp., filed for Chapter 11 bankruptcy protection in
December 2002, its audited balance sheet showed $25.2 billion
of assets and $22.2 billion of liabilities. Not included: $24.5 billion in noncancellable operating-lease commitments, mostly for
aircraft.

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Winn-Dixie Stores Inc.s reported debt of about $300 million is just


30 percent of its shareholder equity. The footnotes show a far more
leveraged company. Its off-balance sheet obligations at June 30, 2004
included about $4.1 billion of noncancellable commitments over
several years to lease the buildings for its stores.
In addition to the effect on debt levels/financial reporting, other reasons exist for leasing. Graham, Lemmon, and Schallheim documented
a negative relationship between a firms use of operating leases and its
marginal tax rates, and a positive relationship between debt levels and tax
rates, supporting the hypothesis that firms with low tax rates lease more
and have lower debt levels than firms with high tax rates.48 Krishnan and
Moyer also found that leases become more attractive than secured debt
as the potential for bankruptcy increases.49 Leases have lower associated
bankruptcy costs than debt due to the superior claim of lessors over lenders. Since the lessee (borrower) must compensate the lessor (lender) for expected bankruptcy costs, a firm with significant bankruptcy potential will
find leases to be available at a lower cost than borrowing.
One popular example of how a lease can be used for both tax incentives and financial-reporting purposes is a synthetic lease, a hybrid that
takes advantage of the benefits of both capital and operating leases. Synthetic leases allow a lease to be treated as an operating lease for financialreporting purposes to lower debt levels, while treating the lease as a loan
arrangement for tax purposes by claiming ownership of the property. A
firm can thus deduct payments for the property as interest payments on
debt (rather than a rent expense) for tax reporting purposes. Specifically,
investment bankers, in consultation with lawyers, structure the terms and
covenants of the lease so that they can obtain favorable treatment for tax
and financial-reporting purposes. At the end of the lease term, the lessee
has the option of either renewing the lease, purchasing the property (for
a predetermined price), or selling the property in the market. If it sells the
property with a gain or loss, tax authorities usually consider the firm to
be the virtual owner of the property as it assumed the risks and rewards
from the property. As a result, the lessee can take depreciation and interest deductions available to owners and borrowers. However, for financial
reporting purposes, it can design the lease terms so that it does not meet
any of the four capitalization criteria for capital leases. The lease contract
is thus accounted for as an operating lease, which in turn will not be recorded as a liability on the balance sheet.
Implication of Leases on Corporate Financial Strategy
Leasing is a gray area in capital structure. The exclusion of leases
may result in an incorrect assessment of a firms financial strength and

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creditworthiness since operating leases are off balance sheet and not therefore considered as part of debt. In addition, payments for operating leases
are reported as operating expenses although interest expenses on debt financing are not typically reported as operating expenses but under other
expenses. Consequently, managers and investors should adjust ratios
that are based on operating income accordingly. Damodaran suggested
the following adjustment procedure be used to convert operating leases
to debt:50
SFAS No. 13 requires that companies disclose future required minimum rental payments as of the date of the latest balance sheet presented, in the aggregate and for each of the five succeeding fiscal
years, and cumulated amounts thereafter in the footnotes to financial statements.51 Discount these payments back to the present using
a pre-tax cost of unsecured debt since the lease commitments are
pre-tax and the claims of lessees are similar to the claims of unsecured debt holders.
Special Purpose Entity
An SPE is a separate legal entity created by a firm to perform particular
activities related to the intended special purpose. SPEs have been used
since the 1970s, mainly for securitization purposes. The original intent
was to isolate financial risk and provide lower cost financing. By creating an SPE, a firm (sponsor) could insulate itself from risk when financing large project by separating the project from itself. The cost of financing
was also typically lower for an SPE than for the sponsor since as the business activities of the SPE were restricted only to their intended purpose.
Nowadays, objectives of firms in creating SPEs relate to off-balance sheet
debt, securitization, and tax-free exchanges.52 Securitization represents the
most common use of SPEs. In a typical securitization, a sponsor company
establishes an SPE and sells a bundle of assets, such as loans, receivables,
and patents to the SPE. The SPE then issues debt securities for cash and
uses the cash to pay the sponsor for the assets. Through this process, the
sponsor successfully securitizes the assets and turns them into debt instruments. However, this debt is not recorded on the sponsors balance
sheet if the sponsor does not have to consolidate financial statements.
Accounting Guidelines for SPEs
Sponsors did not have to consolidate the assets and liabilities of SPEs as
long as the equity interest of a third-party owner is at least 3 percent of the
SPEs total capitalization (the 3% rule).53 However, after various corporate
scandals in the early 2000s, FASB tried to bring off-balance sheet entities

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back onto the balance sheet. In 2003, FASB increased the 3 percent threshold to 10 percent, saying that an equity investment shall be presumed
insufficient to allow the entity to finance its activities without relying on
financial support from variable interest holders unless the investment is
equal to at least 10 percent of the entitys total assets.54 FASB also classified SPEs as variable interest entities (VIEs), and if they lacked the
ability to make decisions, the obligation to absorb losses, or the right to
receive returns, the financial statements of the VIEs must be consolidated
with those of the sponsor who was the primary beneficiary of the VIEs.
However, if a sponsor structured a VIE such that it had no legal control
over it, the sponsor could still keep the liabilities of the VIE off the balance sheet.
Implications of SPEs on Corporate Financial Strategy
Many firms still use financial engineering to make them look better
capitalized and less risky than they really are. Without transparent disclosure of off-balance sheet financing instruments, investors and regulators can no longer accurately assess risk. Only managers have accurate
information about the amount of off-balance sheet debt. They should thus
be aware of the liabilities not reported on the balance sheets and consider
them when making financial decisions. For example, managers should
include the hidden debt when calculating the cost of equity and the
WACC to be used in capital budgeting decisions. Although significant liabilities may be omitted from the balance sheets, they still exist somewhere.
Other IssuesPensions
Although pension liabilities or pension assets are not tools of corporate finance, the implications of pension plans on capital structure are
similar. Under the current U.S. GAAP, there are two types of pension
plans, the defined contribution plan (e.g., a 401k plan) and the defined
benefit plan. The former involves the employer, and at times, employees contributing specific sums of cash into a pension fund, the size and
timing of which are usually mutually determined. The cash benefits to
be secured upon retirement will depend on the size of contributions and
the efficiency of the pension fund in managing its investments. The corporation assumes no long-term obligations of the retirees benefits, the
latter bearing the risks should a shortfall occur. In contrast, the defined
benefit plans involves the employer having to assume long-term obligations for the amount retirees will receive. Employers thus bear the risk
of plans having inadequate assets to pay.
In 2005, FASB statement no. 158, Employers Accounting for Defined
Benefit Pension and Other Postretirement Plans, required that firms report

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183

whether their pension fund was overfunded or underfunded on the balance sheet. When projected benefit obligations (PBO) are larger (smaller)
than the fair value of the plan assets, the pension is underfunded (overfunded) and reported as a pension liability (asset). Market participants
criticized previous standards for not adequately communicating pension fund status in the financial statements, requiring only that details
be included in the footnotes. The nature and size of the pension deficit problem probably explains why some companies sought to understate the depth of their pension funding problems. For example, in 2004,
26 of the 30 firms included in the Dow Jones index had defined benefit
plans, with 22 of the 26 reporting total net pension assets of $119 billion.
The 22 pension funds were underfunded by a total of $46.9 billion or
$1.8 billion per firm.55 This represents $165.9 billion of off-balance sheet
obligations. For the entire population of 10,100 active U.S. firms in 2005,
it was estimated that a total of approximately $414 billion in net pension
liability may have remained off-balance sheet (net assets of $213 billion
less an underfunded amount of $201 billion).56
Implications of Pensions on Corporate Financial Strategy
Merton pointed out that the conventional WACC does not fully reflect
the riskiness of a firms operating assets since it includes only on-balance
sheet debt when estimating asset risk.57 He argued that pension funds
generally have different risk characteristics than other operating assets;
thus investors and managers should adjust the WACC accordingly. Jin,
Merton, and Bodie calculated the standard cost of capital (WACC) for
four large companies, Boeing, Du Pont, Eastman Kodak, and Textron for
2001 and then adjusted them for pension risks.58 They claimed that pension assets invested in equities had significantly higher beta risk than firm
debt, whereas the risks of pension liabilities and firm debt were similar.
After estimating pension asset and liability betas, they adjusted the cost
of capital by the pension values and their weights relative to those of operational assets. Of the four companies, the pension plans of Boeing, Eastman Kodak, and Textron were overfunded, whereas Du Pont had a small
pension deficit. The results (Table 8.2) of their analysis revealed that the
failure to incorporate pension plan risks could materially overestimate
discount rates for operating projects. For example, the correct cost of capital for Boeing was 6.59 percent, whereas the standard approach yielded
8.80 percent, an overestimate of about 34 percent. This shows that the
managers of these companies could have applied higher discount rates
for evaluating new projects, which would have led them to rejecting potentially profitable projects. It should be noted that the overfunding of the
pension funds was the result of a bullish stock market in the late 1990s
and early 2000s. As the stock market started to drop in 2002, the pension

Table 8.2
Estimating Cost of Capital for 2001
Pension Pension Pension Surplus Market Book Value
Assets Liabilities (Deficit) ($bil.)
Cap.
of Debt
($bil.)
($bil.)
($bil.)
($bil.)

Correct Cost
of Capital
Estimate*

Cost of Capital
Percent
Estimate Error Overestimate
1*
for Error 1

Boeing

33.8

32.7

1.1

30.9

12.3

6.59%

8.80%

34%

DuPont

17.9

18.8

(0.9)

42.6

6.8

8.37%

9.44%

13%

Eastman Kodak

7.9

7.4

0.5

8.6

3.2

7.91%

9.75%

23%

Textron

4.5

3.9

0.6

5.9

7.1

7.04%

7.98%

13%

*Cost of capital numbers are based on a risk-free rate of 5 percent and a market risk premium of 7 percent.
Source: Reconstructed from Tables 1 and 3 in Jin, Merton, and Bodie, 2006.

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185

status of many firms changed to underfunded, thus the effects illustrated


in Table 8.2 would have been different. Shivdasani and Stefanescu also examined the capital structure implications of pension plans, and showed
that the leverage ratios for firms with pension plans were about 35 percent higher when pension assets and liabilities were incorporated in the
capital structure.59
CONCLUSION
In corporate financial strategy, the capital structure question requires
thoughtful consideration. A firms choice of capital structure can help an
ailing business through tough times, or can mean financial ruin for oncepromising, successful businesses. The academic literature has come
close to identifying a firms optimal capital structure. However, empirical evidence suggests that for various reasons, many firms operate with
suboptimal capital structures. This could be due to behavioral influences
that cause firms to have a bias against debt, or market fluctuations that
cause managers to move away from targets. In the coming years, there
will likely be new financial innovations that provide funding for business ventures; thus further progress and refinement in capital structure
theory will be needed.
NOTES
We thank Si (Brande) Peng and Rammaharaj Sundareswaran for excellent
research assistance.
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37. Bruner, Eades, Harris, and Higgins. 1998.


38. Graham and Harvey. 2007.
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Part III

Drivers of Strategic Choices

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Chapter 9

Strategic Management of Quality


Amitava Mitra

INTRODUCTION
The 21st century has seen the introduction of major shifts in business paradigms. Ease of access of information globally, as well as its transmission
from single or multiple points dispersed geographically on a real-time
basis, have impacted the heart and soul of organizations. At the core of
every organization, the development of a strategic plan for survival and
growth drives the entity. Once the plan has been developed, its implementation is influenced by the internal and external environment within
which the company prevails. The paradigm changes in the current century have had an effect on the formulation of strategic plans since some of
the fundamental assumptions of the prior century have changed. In addition, the implementation of strategic plans have been affected by revolutionary changes in information technology that have changed the volume
and speed at which information is collected, stored, and transmitted. Because of such changes, a fresh perspective is needed for the strategic management of the quality function.
When one considers the quality management philosophies developed
in the 20th century, three names come to mind: W. Edwards Deming,1
Philip B. Crosby,2 and Joseph M. Juran.3 Demings approach advocated a
cultural transformation, where everyone (management and associates) accepts and follows a path to quality improvement. At the heart of Demings

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Strategic Management in the 21st Century

approach is the acceptance of the language of statistics. Statistical tools


such as statistical process control are fundamental to data-driven decision
making. Deming conceptualized fourteen points for management since
he viewed that the majority of the problems could be solved by action on
the part of management. Crosby identified four absolutes of quality management that deal with the definition of quality, a system for achievement
of quality through defect prevention, a performance standard of zero defects, and a performance measurement system, which represents the cost
of unquality. Juran defined a quality trilogy that consists of quality planning, quality control, and quality improvement. Within each of these three
phases, a process for managing quality is described. A discussion of these
three philosophies and a comparative analysis is found in Mitra.4
The formulation and implementation of the quality function serves as
a driver for setting the strategic and operational tone of the organization.
It plays an integral role in defining the companys vision and mission and
thereby its strategic plans. The quality policy is sometimes what bonds the
various entities of the organization. For example, the quality slogan used
by Ford Motor Company, Quality is Job 1, conveys the thrust of the corporation and reflects its organizational culture. Figure 9.1 depicts the central theme of the quality function in an organization.
The function impacts the long-term focus on selecting strategic plans
that are consistent with the company mission. Moreover, it influences the
implementation of the strategic plans through the setting of goals and objectives. All of these are set, however, in the context of the relative strengths
of the organization with respect to those of competitors. The customer is
also a critical element since the identification, meeting, and exceeding of
customer needs is fundamental to the successful implementation of quality initiatives.
Although the quality function is a main driver in setting the strategic
and operational tone, the other dimensions that form the organization
wheel are subdrivers. Each may impact the other, and do so in a dynamic
context. This implies that actions associated with the subdrivers may
change as a function of time. For example, customer satisfaction regarding product reliability may have improved in the past month; thus some
other functional attribute of the product may now have to be addressed to
further improve market share. Feedback on customer needs may identify
what the unmet needs are. Such information may then impact the choice
of appropriate quality initiatives that will assist in meeting the unmet
needs. An important dimension of Figure 9.1 is the two-way flow of information between the quality function and the various subdrivers of
the organization. Just as customer expectations or desires impact the quality function and the associated quality initiatives derived from it, so also
do the adopted quality initiatives influence the degree to which customer
needs and/or desires are fulfilled.

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193

Figure 9.1
The Role of the Quality Function in an Organization

Another message from Figure 9.1 is the importance of feedback and


its impact on strategic and operational decision making within the organization. The outer organizational wheel represents the sequential steps
that take place within the organization. A company sets it vision, broadly
stating what it wants to be. This influences how the mission statement is
defined and the development of the strategic plan needed to accomplish
the mission. Goals and objectives help to define specific metrics or performance measures that can be monitored to track the progress of the company, and thus drive corresponding adjustments.
The steps just described may collectively constitute the formulation
and development of a corporate strategy. Following these steps, however,
are processes that may have an effect on the implementation of the strategy. Identification of the relative competitive position of the company is
vital to the successful accomplishment of the company mission. Implicit

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Strategic Management in the 21st Century

in this step is the determination of the core competencies of the organization. Is the company a leader or does it exhibit best business practices in
certain areas? Where does its expertise lie? What are some niche areas in
which the company has the best technical talent? In what areas does the
company allocate a majority of its resources? With respect to intellectual
property such as patents, what is the company known for? Answers to
these questions will influence what the company wants to do, be it in a
manufacturing or service context. Depending on the defined core competencies, other functions that also need to be performed may be described
as supporting and be considered for outsourcing. It then becomes incumbent to identify an appropriate partner or partners to which the supporting functions are to be outsourced.
In addition to the nature of the function being outsourced and the technical competence of the vendor in performing that function, there are
other considerations that an organization should take into account when
selecting a vendor. There must be compatibility in the organizational cultures of the parent organization and the vendor. In a departure from past
norms, the vendor can no longer be viewed as merely a company that can
deliver the goods or services according to a technical specification. The
value system that prevails in the vendor company must be aligned with
that of the parent company. Indeed, to use a concept from Demings philosophy, the selected vendor should be viewed as part of an extended
process of the organization that is being outsourced.5 Information flow
between the parent organization and the vendor must be seamless and
timely. As updates are made to processes within the parent organization
based on changing customer needs, such information must be communicated to the vendor in a proactive manner. The two organizations should
in fact work collectively to improve processes for the good of the entire extended process. It is even possible and sometimes advisable for the parent
company to involve representatives from the vendor in their strategic and
operational decision making.
To create an effective and efficient implementation of the strategic plan,
one has to address the various issues described at the process, employee,
and organizational levels, and determine the appropriate needs of each
entity. A holistic approach must be adopted to address these needs with
the optimization of organizational performance in mind. As stressed in
earlier quality management philosophies in an effective system, the whole
is greater than the sum of the parts.6 In other words, optimization of the
performance of individual units/entities may not necessarily lead to optimal performance of the organization. Some of the needs may be in conflict
with one another, and achieving an appropriate balance is not necessarily
a simple task. However, it is an important task that cannot be overlooked.
Process needs are perhaps the easiest to delineate. These could be in
terms of equipment or technical requirements of suppliers. Employee

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195

needs may involve both tangible and intangible components. Although


monetary rewards are important, beyond a certain point, certain intangible rewards such as recognition, support, and opportunities for personal
development and team building may merit attention. Questions such as
what motivates a person to put forth his/her best effort, what drives a
person to strive for excellence, and what attributes inspire an individual
to work toward fulfillment of the goals of the organization need to be
asked and corresponding needs taken into account. The current business
environment has also generated another category of needs, labeled organizational needs. This might include needs driven by social responsibility toward the well-being of the community in which the organization
resides, and could take the form of assistance in meeting the educational
needs of local children. There could also be a need for corporate responsibility and accountability toward employees and other stakeholders. An
organizations quality initiatives will have to be framed to satisfy these
diverse needs.
Consideration of the needs of the customer no doubt plays a major role
in influencing the quality initiatives that are part of the adopted quality
function. Similarly, the quality initiatives embraced by management will
impact those customer needs that are unmet. An important concept in this
context is the ability to satisfy some excitement needs of the customer.
These are needs that, if met, satisfy the customer beyond their normal expectations. Satisfaction of these needs does more than merely help an organization to maintain market share, it can help them to increase market
share. Customers brag about the product or service when needs in this
category are satisfied.
According to the Kano model, customer needs and desires can be organized in three categories: basic needs, performance needs, and excitement needs.7 Basic needs represent those that are taken for granted.
Not meeting these needs will cause customer dissatisfaction and thus a
loss of market share. Meeting these needs, however, may not necessarily increase customer satisfaction. Performance needs are associated with
meeting customer expectations. The better these needs are met, the more
satisfied the customer will be. This leads to the maintaining and possibly
increasing of market share. Excitement needs are those that the customer
does not necessarily expect to be met. However, when they are met, an
exponential increase in customer satisfaction results leading to increased
market share. As competition becomes more global in the 21st century, it
is becoming harder to increase market share. Organizations that are able
to identify these unmet excitement needs and identify processes to meet
them will thus be at a competitive advantage. Such needs are not necessarily identified during routine customer surveys since the customer
may not express them. The ability to go beyond the normal responses
and identify product/service trends that will be of value in the future is

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Strategic Management in the 21st Century

what will distinguish the companies that will perform well in the current
environment.
There are other distinguishing features of the role of the quality function
shown in Figure 9.1. Note, for example, the feedback and feed-forward
nature of the structure. Information flow from both of these streams will
have an impact on the measures/action items adopted in a given phase.
Thus, for example, a particular company vision may impact the necessary
quality initiatives, in the quality function, to accomplish the vision. These
quality initiatives will influence the degree to which customer needs will
be met. Further, the unmet customer needs will also have an impact on
the quality initiatives that should be chosen to meet these needs. Based on
feedback regarding unmet needs, the quality initiatives may be modified,
which in turn, may have an impact on the company vision. The degree to
which customer needs are met could also influence the company vision as
the satisfaction of needs is not necessarily static. A change in the company
vision would then influence the mission statement. A similar phenomenon can be described for the other issues in the outer loop of the organizational wheel represented in Figure 9.1.
Another feature to observe in Figure 9.1 is the information flow that
may occur in any of the subcycles. The traditional task phases in an organization may follow the outer loop, that is, formation of a company vision
that leads to a mission statement, development of a strategic plan based on
the mission statement, and identification of measurable goals and objectives based on the strategic plan. Each of these task phases is linked to the
quality function through information flows that may take place in either
direction. Consider the subcycle consisting of the task phases of strategic
plan, goals/objectives, relative competitive position, quality function, and
strategic plan. Based on the relative strengths of the company with respect
to competitors, an appropriate set of quality initiatives may be chosen that
emphasizes the development of core competencies. The choice of quality initiatives may itself cause a change in the strategic plan itself. This, in
turn, may influence the selected goals and objectives, which must now be
chosen to reflect the core performance measures based on what the organization decides to adopt and what it chooses to outsource.
QUALITY FUNCTION IN THE 21ST CENTURY
The business environment of the 21st century is vastly different from
that of earlier periods. The quality function, which includes the quality
initiatives, is of prime importance in determining the competitive position
of the organization. It influences the strategic planning process as well as
the execution of strategy. As in the past, the quality function can no longer be compartmentalized to a single department/unit but must span the

Strategic Management of Quality

197

entire organization. Additionally, it plays an active role in strategy formulation as opposed to just execution. Quality in both products and services
is a central theme that must be considered and adhered to in developing short-term and long-term goals of the organization. Adequate representation of the quality function in the organizational structure and chain
conveys an important message to all stakeholders. The senior person in
charge of the quality function must have visibility at the strategic planning level with a direct report, in most cases, to the chief executive officer.
As company vision and mission statements are formulated, they must reflect the strategic importance of the quality function. Accordingly, as goals
and objectives are developed, appropriate metrics for quality should be
incorporated. We now discuss some paradigm shifts that are taking place
and their impact on the development of the quality function as well as its
implementation.
Explosion in Information Technology
If there is one area of business that has experienced revolutionary
changes in the current era, it is information technology. This has changed
the manner in which businesses operate. The volume of data that can be
accessed has increased exponentially. This has led to larger and richer
sources of information that companies can utilize to strategically plan
their future courses of action. Although more information can help in
making informed decisions, it can also pose certain challenges.
The Ability to Decide What Information Is Useful for Long-Term
Planning and What Should Be Used for Short-Term Decision Making
With the advent of the Internet and the data/information that may be
accessed through it, it has become a challenge to extract that information
that is relevant and constructive in charting a roadmap for the company.
This information will have an impact on all of the issues shown in the
outer loop of the organizational wheel in Figure 9.1. For example, information on competitors can be utilized in evaluating the relative performance of an organization. Subsidiary issues in this context could include
the choice of the attributes and corresponding performance measures to
be utilized. In most situations, there is more than one dimension on which
performance can be compared. For example, price might be one dimension, while delivery lead time could be another. The relative competitive
position of an organization may, however, be different for the various metrics. Information specific to each attribute may thus influence the action
plans to be followed by the company. These may in turn influence the
strategic plans, goals, and objectives as the feedback loop is completed.

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Strategic Management in the 21st Century

Consider, for example, a company that has an efficient manufacturing operation that enables it to maintain low unit product cost. Implementation
of quality initiatives may focus on methods to maintain or improve manufacturing efficiency, and the company may be ranked relatively highly on
this dimension. However, suppose that in terms of delivery lead time, it
has been found that transshipment time is long as products must wait on
completion of production and must then follow a network of intermediate modes before arriving at the final destination. The relative position of
the company on this dimension may thus be low. In analyzing information on potential alternatives with regard to distribution, it finds that it
can outsource transshipment activity to a vendor, which will significantly
reduce delivery lead time. This information not only will influence implementation of an existing strategy but may also impact the formulation of
a revised strategy.
Another item of significance in this context is the ability to decipher
critical information from among all that is available. This is a similar
issue to the often used Pareto principle where the task is to identify the
vital few from the trivial many. We are bombarded by data on a continual basis through a variety of media such as television, the Internet, journals, and annual reports. It is a not insignificant task to process the data
and integrate it into a cohesive form that provides meaningful information. Management must have adequate processes to extract information
from relevant sources. Conversion of data into information is a crucial
part of this process, for strategic and tactical decision making relies on
information. The depth of information requirements will depend on the
level of decision making. For setting a company vision, mission, and strategic plans, macrolevel information is typically utilized. This may include
information on opportunities and threats relative to the environment in
which the company operates. For operational decisions, more detailed microlevel information, categorized and segmented based on the purpose of
decisions, will be necessary. Such microlevel information might be that
used to identify strengths and weaknesses of the organization, determine
employee and organizational needs, and evaluate customer needs and the
extent to which they are satisfied.
Because of the inherent complexities and interrelationships among
units within an organization, it may not be feasible to come up with a
quantitative model that adequately captures the relationships between inputs and outputs. This does not, however, mean that the available information cannot be utilized for decision making. The availability of newer
hardware and software technologies is making it increasingly feasible
to combine the available sources of data and transform them into useful knowledge. For example, artificial intelligence tools can use historical data to provide possible solutions to problems similar to those that
have occurred in the past. Advances in computing power mean that what

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a mainframe machine could accomplish a couple of decades ago is now


within the grasp of personal computers. Furthermore, advances in computer software make it feasible to analyze massive amounts of data that
could not previously be handled. Algorithms have also been developed
precisely to address the issues of extracting information from large databases. One tool that has emerged from this is data mining. Using such
techniques allow organizations to drill down and extract patterns and
trends that would otherwise be difficult to detect.
The Ability to Incorporate Data/Information
on a Dynamic Basis for Decision Making
Decision making based on a static set of data is a thing of the past. With
data being updated frequently and made available rapidly, it is prudent to
exploit new data to revise existing information. Advances in information
technology have made it possible to make information available in real
time. This can be used to satisfy customer needs and improve customer
satisfaction, which is vital to achieving the strategic goals of the organization. Consider, for example, the airline industry, a major service industry
today. Although on-time arrival is an attribute of customer satisfaction, a
related measure could be the time spent on board the aircraft prior to takeoff. On the basis of real-time information, if there is an existing backlog of
flights waiting for take-off, it might be possible to delay the boarding time
so as to improve this dimension of performance.
The Ability to Manage Globally Dispersed Operations
Economic necessities and shifts in demand patterns have caused organizations to become global. Companies may have suppliers and vendors in one region, manufacturers in another, and customers dispersed
across multiple regions. In the past, multinational companies with locations in various continents were somewhat self-contained. A given location would have all the necessary capabilities and resources to complete
required product transformations. This could be, for example, the entire
processing of the product from raw materials to the finished product, or,
if just producing a subcomponent. In each case, however, all necessary
equipment and human resources would be available at a particular plant.
As the location and quality of workforce talent have changed substantially and countries have more aggressively pursued foreign investment,
geographical boundaries have changed. A medical services company processing X-rays may now obtain X-rays from customers in one country,
have the results transcribed in another, and have the report ready for the
customer the following day. This necessitates the ability to coordinate the
various internal and outsourced activities in real time. Data transmission

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via Internet or cables has made this feasible, enabling the secure and efficient transmission of large volumes of data. It has also had an impact on
the degree to which outsourcing firms can take advantage of and assist in
the strategic delineation of core and peripheral services for service organizations. For example, the medical services company may have found it
effective and profitable to outsource the transcription part of the process.
The reduction in technical labor costs to perform this part of the process
may have more than outweighed the costs associated with data transmission and outsourcing needed to have this completed at a vendor organization. Transcription is thus no longer a core service of the organization.
Although this service still needs to be completed, the company no longer
needs to retain technical talent and equipment for this task, as it is cost effective to outsource it. In a way, this also impacts the strategic focus of the
organization and the quality initiatives that must be adopted to achieve
customer satisfaction. For core services, for example, the medical services
company processing X-rays may need to develop a set of goals to ensure
the quality of the X-rays taken. In contrast, for support services, a set of
quality objectives that focus on the reduction of transcription errors may
be appropriate. Both, however, will be necessary to provide overall satisfaction to the customer, the patient in this situation.
The Ability to Manage Geographically Dispersed Customers
and Their Dynamic Needs
To expand market share, corporations have, where feasible, had to
seek customers that are not necessarily in the same geographical vicinity
as the companys physical location. This requires customer information
that may span the globe. Furthermore, customer needs may vary by geographic location. For instance, a company selling soft drinks globally may
determine that customers in one country prefer a certain flavor compared
to those in another country who have a different preference. The company
will thus need to obtain aggregate data on a timely basis by country/region, yet determine forecast demand using other demographic information. Such collection of data and analyses can be supported by advances
in information technology.
Holistic Approach to Satisfying the Customer
Customer satisfaction will always be a key driver in maintaining and
improving a firms market share. Based on the core values of the organization, customer needs that can be met must be delineated. This will in
turn drive the mission and the strategic plan. Further, the core values will
shape the implementation of the quality initiatives based on the organizations core competencies.

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Meet Product Life Cycle Needs


For manufacturing organizations, only the quality of the delivered
product has in the past been considered. In this new era, however, satisfaction of customer needs will extend beyond the sale of the product
alone. Not only does the customer want a quality product, they will increasingly expect adequate service for the product, as appropriate, over
the life of the product. A segment of this need is satisfied through the use
of warranties offered at the time of sale of the product. A common practice at present is the use of optional, extended warranties that cover, for
example, a longer time period or amount of use, prior to expiration of
the initial warranty. Examples of products for which these are common
include home appliances such as washing machines, dryers, and refrigerators. What is also emerging is the concept of providing service during
the operating life of a product based on its prevailing condition. Consider,
for example, an automobile. Technology currently exists that enables the
manufacturer to obtain real-time data on the functional status of the automobile using wireless sensors. Using this data, the manufacturer may be
able to determine the performance of the engine, and if necessary, send
a message to the owner indicating that the car be brought in for service.
Such actions will rectify a potential problem prior to a failure. It will also
excite the customer, who now has greater confidence in the operation of
the vehicle, and that the integrity of the vehicle is being monitored based
on real-time operating conditions. Hence, even manufacturing organizations will have to incorporate a broader concept of what it means to satisfy the customer. This will impact the strategic plan and corresponding
quality initiatives.

Flexibility and Agility to Address the Dynamic Needs of the Customer


As discussed previously, customer needs not only change on a dynamic basis but also vary based on societal preferences and cultural
norms. Whereas customers in the United States demand left-hand-drive
automobiles, those in certain countries in Europe and elsewhere require
right-hand-drive vehicles. Depending on the degree to which a given
manufacturing/assembly plant satisfies demand for automobiles in different markets, there must be adequate flexibility to make the necessary
changes so that the appropriate mix and volume of products is produced.
This flexibility affects not only tooling and equipment but also employee
training and qualifications. Quality management practices and standards
may also vary since automobiles in one country may be subject to different
standards than those in others. If separate facilities were to be used to produce automobiles for different country markets, some of the complexities
relating to quality management practices could be avoided. Nevertheless,

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at the corporate level of the organization, adequate planning must take


place to ensure that the challenges of variety and complexity of products
demanded are met. It should also be noted that even for customers within
a region or country, the choice of product features and options demanded
could be numerous. The ability to handle customization to customerspecific needs will continue to be a key factor for successful organizations.
The quality management function must incorporate adequate steps, from
planning to the implementation phase, to ensure that an adequate structure is in place to meet the variety in customer requirements.
Also of importance is the speed with which the company is able to meet
the variety and complexity of customer needs. Being able to respond to
customer demand by reducing lead time for the product does not necessarily imply increased responsiveness to changing market needs. A
company can, for example, reduce lead time for a specific product by
increasing the use of overtime. In contrast, a change in customer needs
that involves adding a new option to an existing product may require design changes, tooling and equipment changes, as well as process-routing
changes. How quickly the company can make the transformations necessary to meet changing customer needs is a measure of its responsiveness
or agility. Quality management practices must ensure that the lead time
to meet changing customer requirements is as short as possible. Even if a
company is able to meet the diversity of customer needs, if they cannot
do so within a time span that the customer expects, a loss in market share
could result. One means by which lead time can be reduced is to have parallel lines of operation/assembly available. However, this will result in
an increase in capital expenditures for machines and equipment. It may
also necessitate the use of overtime or the hiring of temporary employers,
thereby increasing operational costs. Management will have to balance
the added costs against the benefits of increased customer retention and/
or growth in market share that results from the superior lead time relative
to that of competitors.
Meet the Needs of Other Constituencies in
Order to Effectively Meet Customer Needs
Meeting customer needs requires effective and efficient processes. In a
manufacturing setting, this implies having adequate equipment and machinery, a qualified labor force, and an effective management system of
which the quality management is a subsystem. Exploiting technological
advances by using up-to-date equipment and machines can help keep the
company up with if not get ahead of its competitors. The quality management team will, however, need to consider the pros and cons of using the
latest technology. Whereas fixed costs for equipment may rise, variable
costs may fall, which will necessitate a new evaluation of the break-even

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quantity and cost. Moreover, the impact of learning effects as well as the
need to integrate new technologies will need to be considered.
Another constituency that needs to be considered is the employees of
the organization. A motivated workforce is the foundation to a quality
product/service. Accordingly, it is imperative for the quality management
function to give appropriate attention to the morale and motivation of
employees. In this context, extrinsic and intrinsic rewards exist. Merit increases in salary, awards for meritorious service, recognition among peers
for innovative contributions, and public recognition in the organization
and community are some means by which rewards can be given. Based
on Maslows hierarchy of needs, once basic needs and safety needs have
been satisfied, the focal point should be on meeting needs related to selfesteem and self-actualization.8
Organizations must also strive to retain productive employees, doing
so through the creation of appropriate promotion and recognition policies. They will have to examine what attributes are valued in employees.
Does the organization seek only technical competency or also the ability
of employees to work with others? What importance does innovativeness
play? Does it value the ability of an individual who goes beyond his/
her prescribed responsibilities? Answers to these questions will define a
core set of values that must be conveyed to the employees and rewarded
accordingly.
Shareholders represent another constituency, and will have certain expectations regarding an organizations performance. Effective execution
of the quality policy will ensure the production/delivery of a quality
product/service. This will influence the ability of the firm to maximize
revenue at the lowest feasible cost, which will in turn influence the rate
of return on investment that is of concern to shareholders. It should be
recognized, however, that the quality management policy has to be implemented in harmony with other corporate strategies. The integration of
corporate strategies at the top management level is critical to the ability of
the organization to achieve its mission.
Responsibilities of the 21st-Century Organization
Successful organizations in the current business environment will continue to encounter a set of unique challenges that will require the integration of several objectives. To stay in business, the organization must of
course generate an acceptable level of profit and return on investment.
However, the unique circumstances under which they operate may subject them to additional pressures, for example, those tied to corporate
and social responsibility. Hence, they may have objectives that are seemingly in conflict with each other. If the overall corporate strategy integrates these various objectives, and, based on this, an appropriate quality

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management policy is formulated, it will create a unified road map for the
company. The role of top management will be to create this unified mission and strategic plan, and achieve their acceptance by all entities in the
organization. We now discuss some of the unique responsibilities of the
modern organization.
Creation of an Appropriate Organization Culture
The organizational culture is the heart and soul of the company. It represents the values of the corporation and should convey to all stakeholders
the behavior patterns expected. Although it may not be feasible to display
this in a written form, it is still a representation of the management style,
and implicitly conveys to employees the environment that prevails within
the organization. In some sense, it also represents the unwritten policies of
the companyhow information is transmitted back and forth within the
various layers of management, and how input from employees is valued.
The organizational culture represents an excellent avenue using which
senior management can create a bond with employees. Making employees
feel that they are an integral part of the organization improves morale and
motivation. Promotion of a spirit of teamwork and of the importance of
cross-functional teams for problem solving is an important outcome of the
culture. In todays organizations in which tasks are spread across multiple
locations and among vendors with different specialties, feasible solutions
may require the coordination of several units, both inside and outside
the organization. The development of a culture that embraces the concept of an extended system incorporating vendors and suppliers as part
of the organizational team, will promote the creation and adoption of new
strategies for problem solving. As described previously, information flow
and exchange has to be managed in a dynamic and global manner. An organizational framework that adopts this reality will be an ingredient for
success.
Acceptance of Corporate Responsibilities
The acceptance of as well as accountability for certain corporate responsibilities are realities for organizations today. One often debated responsibility relates to financial issues. After the debacle of organizations such as
Enron and WorldCom during the period 20002002, the Sarbanes-Oxley
Act was enacted by the U.S. federal government.9 Although the act itself
requires that the chief executive officer approve and accept responsibility
for financial statements, organizations need to look beyond merely formal
signature authority. Operational policies that impact quality management
goals and objectives should be formulated and implemented so that various units within the organization are aware of which elements contribute

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positively to profitability and which do not. Such transparency will promote a comprehensive approach to identifying where effectiveness or
efficiency needs to be improved. Hence, it becomes an organizationwide responsibility to achieve goals and objectives, and when they are not
achieved, divisive finger-pointing or the taking of short cuts is avoided.
In a sense, the prevailing organizational culture should promote such
cohesiveness.
Another dimension of corporate responsibility deals with the professional development of employees and associates. If the organization values
its employees, it should support their growth and development. Employees motivation is influenced by the manner in which they are treated by
the company. Particularly during difficult financial times, if employees
believe that the organization is genuinely concerned about their wellbeing, it will improve morale and performance. Organizations can provide
training programs not only to improve employees existing knowledge
and skills, but also to provide job enrichment or diversification. Moreover,
a participative environment in which management and employees work
together for the common good can have a positive effect.
Corporations also have a responsibility to the local communities in
which they operate. The local community is part of the extended system of
the organization, and employees are part of the local community. If the educational and cultural needs of employees and their family members are
satisfied, the workforce will be inspired and motivated. Helping to create
and maintain a good school system for the children of employees as well
as the community at large is one way by which an organization can fulfill
their responsibility. Providing adequate recreational facilities is another.
Within the organization, providing daycare, medical, or fitness facilities
for employees, or enabling employees to work from home where feasible,
are additional options. In general, offering benefits that reflect quality-oflife issues can remove significant burdens for employees. Employees often
consider these benefits quite attractive relative to financial compensation.
Social Responsibility with Respect to Resource Consumption
With population growth across the globe, demand for products and
services continue to grow. In addition, economic growth has fuelled an
expansion of the middle class in many countries, further increasing demand for products and related services. This has in turn had a impact
on demand for natural resources, the supply of which is in many cases
limited. Demand for energy is of particular concern. Energy can be produced from fossil fuels, extracted fuels such as those required for nuclear
energy, or through sustainable sources such as solar power, wind power,
tidal power, or hydropower. With the limited availability of fossil fuels,
the creation of which takes many years, it becomes the responsibility of

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organizations to limit their consumption to the extent feasible. If cost were


the only criterion used in selecting an energy resource, fossil fuels would
typically be chosen. However, socially responsible organizations that consider the long-term impact on society as a whole may opt instead for sustainable energy sources. These organizations may include the well-being
of mankind in their vision, and may choose a path that is not necessarily
the most cost efficient in the short run.
Effectively Managing Supply and Demand Side
Companies must effectively manage both the supply and demand of
products and services, rather than focus on one dimension alone. Consider first the supply side. With the increased and varied needs of customers, an organizations core capabilities may not enable it to satisfy all
customer needs. In such cases, the company may elect to outsource some
production that is outside its core capabilities. Selecting the right vendor,
treating the vendor as part of the organizations extended process, and
thus having to understand and possibly influence the vendors quality
policy become relevant issues. Following the sale of the product, the provision of service may also be part of customer requirements. In this case,
an organization may choose to outsource the service function to a vendor
with the requisite expertise. By engaging third parties, a company may
be able to effectively meet both the product and service needs of the customer within the constraints of its own resource capabilities. Such arrangements may also create an advantage over competitors who may not have
the expertise to satisfy all customer needs. Consider, for example, major
banks and financial institutions, such as Bank of America, that offer credit
cards to their customers. Such institutions may outsource the processing
of credit card purchases, preparation of monthly statements, and followup on customer inquiries to organization such as Total Systems Services,
Inc. Total Systems Services, for example, offers a full line of credit card
support services, which include processing card applications, producing
and mailing cards, authorizing certain credit related services, providing
customer service support, as well as offering merchant support services.
Thus, Bank of America can ensure that service needs are met even though
they themselves may not have the required expertise.
Diversification is another approach to managing the supply side. Research and development activities may identify product markets related
to those that a company already serves that the company could venture
into with reasonable infusion of resources. Although a cost/benefit analyses should always be performed for such new ventures, expanding into
new markets offers a possible means to balancing swings in product demand. A company that is well diversified is in a better position to manage

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overall profitability when there is a drop in demand for one product than
a company that is not. For example, consider a company that makes both
electric and gas generators. If demand for gas generators were to drop due
to an increase in gas prices, the companys profitability position might not
suffer if the company were able to respond to demand for other types of
generators for which demand may increase.
Another option is an acquisition/merger. If the company being considered for acquisition is in the same industry, the acquisition may lead to an
increase in capacity for the acquiring organization. The acquired company
may also have the capability to offer distinct product features, an expertise that the acquiring company may not have. Acquisition may thus offer
the ability to meet increased product demand or product variety in an efficient manner.
On the demand side, managing the needs and expectations of the customer is the major concern. The importance of meeting the dynamic needs
of the customer on a real-time basis was described earlier in the chapter. Here, we address means of managing the demand side. Several parameters related to demand are under the control of an organization, for
example, price, and the availability and scope of warranties and service
contracts. Price will be influenced by several factors, one of which is the
unit cost of production. If some aspects of production are outsourced, effective management of processes through the extended system will provide a means for cost control. In order to be competitive, price will also be
influenced by the prices of competitors products. Differences in quality
may make it possible for the company to set a higher price relative to that
of competitors. As part of satisfying the overall needs of the customer, a
warranty and/or service contract may also be included in the product/
service bundle offered. An assessment of opportunities and threats relative to competitors will provide insight into selecting parameters of these
offerings. The importance of a competitive offering of price, warranty, and
service contract should not be overlooked as this can influence overall
market share.
DISCUSSIONS AND CONCLUSIONS
The previous sections have presented some of the unique challenges
that organizations today face. Issues and approaches that impact the formulation of a corporate strategy and thus the strategy of the quality function have been discussed. The essence of the discussion is that there needs
to be a dynamic link between the formulation and implementation of a
quality strategy as they may need to be revised based on updated information. With increasing global competition and rapidly changing tastes,
needs, and desires of consumers, organizations are being forced to adapt

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strategies ever more rapidly to changing circumstances. In this section, we


summarize some of the concepts discussed earlier and offer guidelines for
companies that may lead to action items, the specifics of which may vary
by the nature, size, and scope of the product or service. The section also
suggests some pitfalls to avoid.
Proactive versus Reactive Role of Top Management
The traditional model of strategy development and implementation
that prevails in organizations is a strategic plan that sets goals and objectives; action plans are then devised for implementation. Following implementation, measures are obtained of the degree to which customer needs
and wants are met, and depending on the unmet needs, a feedback loop is
created, which may lead to the modification of the existing goals and objectives. This represents a reactive approach by top management.
Given the pressure to reduce lead times for delivering products or services, a feedback loop that merely reacts to consumer needs may no longer be effective. Instead, organizations must increasingly think ahead and
anticipate future customer needs. Planning for products or services to
meet these needs will enable an organization to leapfrog its competitors.
For example, consider the iPhone and iPad. Although personal computers have become ubiquitous in U.S. households, there is still a pent-up
need for greater mobility with regard to the real-time accessing of information. Though the desktop computer has greater computing power, the
average consumer is not necessarily interested in carrying out extensive
computing calculations that require significant computing power or using
application software. Instead, they seek access to real-time information
through the Web with the mobility to do so from anywhere at any time.
The physical dimensions of the product as well as wireless connectivity
thus become important features. Given their ability to respond to these
emerging customer needs, the two cited products have been able to capture significant market.
Forecasting future needs and wants of the customer is not an easy
task. The data needed to do so is not typically obtained from routine
customer surveys. However, a well-designed survey may ask questions
about not only the degree of satisfaction associated with current product offerings but also desirable product features and attributes. Further,
thought-provoking questions that capture unmet needs could be included.
Excitement needs of the consumer are not easily identifiable. It is not
uncommon for customers to recognize them only when they see how a
product or service meets them. The vision of marketing personnel who
analyze data on customer tastes and preferences and use this to anticipate
future needs is thus important. Product-design engineers then have the
task of creating products that accurately reflect these needs.

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Obsolescence due to technological advancement is another issue to be


considered by management. Such advances may require completely overhauling a products design to incorporate the latest technology. In this
context, other questions that will need to be examined include whether it
will be necessary to redesign processes to create the newly designed product, if the current equipment is adequate, should more sophisticated machinery with better tolerances be utilized, and what additional technical
capabilities are necessary of operating personnel. Again, addressing these
issues in a proactive rather than a reactive manner will assist management
in building and implementing cost-effective processes that allow the organization to respond quickly to a changing marketplace.
The use of product diversification as a path to increasing market share
has been discussed previously. However, adequate research is necessary
to identify specific new products or to incorporate new features into existing products. This again requires the accurate and timely forecasting of
future or unmet needs and preferences of consumers. Incorrect decisions
regarding future product mix may result in resource reallocation decisions
that sway an organization to the brink of failure. The strategy process
should consider consumer trends and relative competition. In the event
that an organizations core competencies cannot address future consumer
needs at a level that meets or exceeds that of competitors, senior management will have to consider other alternatives.

Linkage of the Quality Function with the


Overall Strategic Function
Product and service quality is an integral element of the overall strategic development process, and also influences the setting of goals and
objectives in the implementation phase. Accordingly, the organizational
structure must allow for the effective formulation and execution of quality strategies in a manner that is consistent with and integrated into overall company strategies. Given the importance of the quality function, its
representation at the senior management level is crucial. It is essential that
through participation in the strategic mission-setting process, input from
the quality function is incorporated. Similarly, the impact of various organizational entities, functions, and processes on the accomplishment of
the quality functions objectives should be examined. This requires the
acceptance of a philosophy that everyone has a role in the production
of a quality product or the delivery of a quality service. It is not enough
to simply display the quality motto or the quality mission in prominent
places. It must be voluntarily embraced by everyone. When employees are
convinced of the importance of the quality function and its role in creating better products or services, acceptance of the quality philosophy will

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follow and be sustainable. Thus, in addition to creating an organizational


structure that embraces the quality function, a formidable task exists in effectively communicating that quality is the responsibility of everyone in
the organization.
It is imperative to recognize that lip service from top management on
the importance of the quality function is insufficient. Unless management
truly embraces a commitment to quality and makes it a priority to ensure
it is similarly embraced throughout the organization, efforts to build a culture of improvement will not work. It may be necessary for management
to hold sessions with employees to communicate the importance of each
persons role in fulfilling the quality mission. Employees in a line organization who have responsibility for only a part of the overall process may
have to be educated about how each part of the process plays an important role in delivering quality in the finished product. As employees begin
to visualize this connection, they will develop a sense of participation and
involvement in serving the quality mission of the company. The deeper
this goes, the greater will be the effort employees are willing to make in
producing a quality product.
Top management may also need to create certain operational policies to
support the realization of quality objectives. Bonuses or incentives for producing defect-free products that require no rework or involve no scrap, is
one approach. Employees will be motivated to achieve quality in the processes under their jurisdiction as they realize the impact of their work on
subsequent process steps. Adoption of such a policy may also promote
teamwork since employees in each operating unit will come to realize that
overall product quality is a function of the operational quality of every
subprocess. An organization in which all employees pursue a common
goal as opposed to myopically suboptimizing based on the needs of an individual department or unit can be referred to as a motivated organization. It is known that in such motivated organizations, employees from
individual subprocesses may voluntarily try to assist those at other subprocesses since they care about finished product quality. Achieving this,
however, will require ensuring that everyone in the organization is adequately exposed to the organizations mission and strategic plans, and
the role of each of the respective units in supporting them. General Electric, for example, requires all new hires, regardless of position, to undergo
training and exposure to the organizations plans and objectives.
The importance of the quality function in the context of the overall strategic plan can also be conveyed through the acceptance of a do it right the
first time philosophy. The focus should be on defect prevention rather
than defect detection. Such an approach has several implications. From
an operational cost perspective, the production of defective products increases rework and scrap costs, and thus increases the unit production

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cost of acceptable products. This either cuts into profit margins or necessitates higher prices, which may have an adverse effect on sales volume.
Either way, the result to stakeholders more broadly is that competitiveness
is compromised, which may negatively impact the rate of return on investment, employment levels, and growth opportunities. Again, although
the implications are clear, everyone in the organization must be convinced
of the importance of such an approach.
Defect prevention can also be viewed from the perspective of its impact on available capacity. The production of scrap or items that must be
reworked implies a need for additional capacity to meet the same demand
requirements. Given capacity constraints, this will have an impact on the
ability to meet demand in a timely manner. When sufficient capacity is
not available, it may force an organization to utilize overtime to increase
output. The availability of equipment and personnel on an overtime basis
will have to be explored and its cost feasibility determined. If the use of
overtime is not feasible or cost effective, other options such as outsourcing
may need to be explored, and issues associated with managing the quality of outsourced processes addressed. Conversely, producing defect-free
products may cause an increase in available capacity. With rework and
scrap eliminated, the time and effort spent on those will not only be freed
up, capacity will be made available in a timely manner.
The choice of appropriate metrics for assessing performance toward
meeting both company and associated quality function goals is an important issue. The metrics selected must not only directly reflect the goals,
they must also be measurable, for without measurement and monitoring,
it is not possible to track the progress toward goal attainment. Further, a
distinction must be made between short-term and long-term measures.
Consider, for example, the rate of return on investment. This is typically
a long-term measure that reflects the magnitude of investments made in
equipment/machinery and the life of the equipment. For equipment that
lasts 15 to 20 years, an adequate rate of return may not be realized if the
entire cost of the equipment is depreciated in only one or two years. In
contrast, unit product cost is influenced by direct costs that may include
material and direct labor costs, overhead costs that may include administrative and maintenance costs, and selling costs that may include marketing and related costs. Some of these costs such as direct labor and material
costs may be influenced by short-term decisions, whereas others may be
impacted more by decisions with long-term implications.
Utilization of Organizational Strengths
Senior management plays a pivotal role in establishing a corporate strategy that will address the needs of various stakeholders of the

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organization. Organizations with the ability to accurately analyze current


trends and incorporate them in creating implementation plans will be at a
competitive advantage. An important factor in this context is the organizations maturity with respect to a particular product or market. Whether
the company is at the market entry stage for an already established product or is already an established competitor will be a key question to be addressed. Similarly, answers to questions about the amount and nature of
competition, existing product mix, balance of products in the conception
versus the maturity phase, and future diversification plans will influence
the corporate strategy and the associated quality function strategy and
initiatives.
It is essential that an organization take into account not only its core
competencies but also the relative competitive position of the company in
establishing strategy. Both of these factors will influence which functions
the company will conduct in-house and those that it will outsource. The
selection of corporate goals and quality initiatives will thus be impacted
by such decisions. Related to this is the reality that product quality is influenced by the quality level of each of the units in the supply chain, and
typically, the weakest link in the supply chain determines quality at the
end-user level. It thus becomes top managements responsibility to coordinate quality throughout the supply chain. In many instances, product
safety concerns mean that rigorous monitoring of quality is not only critical but also mandatory for all steps in the supply chain. An example of this
is the pharmaceutical industry. This places greater pressure on management to ensure that appropriate checks and balances are in place to monitor quality for each supplier as well as to institute sound manufacturing
practices throughout the supply chain.
In summary, the importance of the quality strategy can be captured
with a simple message. The quest for quality is a never-ending process.
Although perfection is a goal, improvement is always a possibility.

NOTES
1. Deming, W. Edwards. Quality, Productivity, and Competitive Position. Cambridge, MA: Center for Advanced Engineering Study, Massachusetts Institute of
Technology, 1982. Deming, W. Edwards. Out of the Crisis. Cambridge, MA: Center
for Advanced Engineering Study, Massachusetts Institute of Technology, 1986.
2. Crosby, Philip B. Quality Is Free. New York: McGraw-Hill, 1979.
3. Juran, Joseph M. Juran on Planning for Quality. New York: The Free Press,
1988. Juran, Joseph M. Jurans Quality Control Handbook. New York: McGraw-Hill,
1988.
4. Mitra, Amitava. Fundamentals of Quality Control and Improvement, 3rd ed.
Hoboken, NJ: Wiley, 2008.
5. Crosby, Philip B. Quality Is Free. New York: McGraw-Hill, 1979.

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213

6. Ibid.
7. Cohen, L. Quality Functional Deployment: How to Make QFD Work for You.
Reading, MA: Addison-Wesley, 1995.
8. Maslow, Abraham H. A Theory of Human Motivation, Psychological Review 50(4): 370396, 1943.
9. Sarbanes-Oxley Act, Public Law 107-204, 116 Stat. 745, U.S. Federal Law,
July 30, 2002.

Chapter 10

Innovation
Laura Birou,
William Christensen, and
Alison Wall

INTRODUCTION
What if Harry Potter ran General Electric? This is not just an interesting
thought, but the title of a book.1 Imagine the advantage a company would
have if it were run by people who could do magic, magic that would create innovative processes, products, and services. Indeed, businesses and
business leaders that are able to successfully and repeatedly introduce innovative products are sometimes referred to as wizards. Such a group
of modern wizards might include people such as Apples Steve Jobs, GEs
Jack Welch, and the founder and namesake of Walt Disney. One source of
innovation magic is technology. As noted by Arthur C. Clarke, Any sufficiently advanced technology is indistinguishable from magic.2 However,
focusing on technology alone as a source of innovation is shortsighted
because technology is transient but human need is not, and, innovation is
worthless if it doesnt add value by satisfying human needs.3 Steve Jobs,
referred to as the Wizard of Oz,4 quoted former Apple CEO John Scully
as saying, He ( Jobs) was selling magic, and everyone else was selling
technology. We thus need to better understand innovation and what
makes it happen in order to establish organizational environments that

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nurture it and allow businesses to compete in an rapidly changing global


business arena.
The purpose of this chapter is to explore innovation, what forms it takes,
what types of environments nurture it, how it is related to value creation,
and the role it plays in business strategy. Innovation is the ability to develop and successfully introduce new products and processes.5 It helps
drive a virtuous cycle of increasing value and competitive advantage that
is central to effective business strategy (Figure 10.1). Although an organization or an entrepreneur can enter the cycle at any point, since people generally think before they act, we believe that most organizations that enter
the cycle will do so purposefully and incorporate it as part of their strategic
planning process. From strategy emerge plans and objectives that create
and maintain an environment in which innovation is nourished. The specific innovations that result are then vetted, and those that create customer
value represent the master key to opening the door to sustainable competitive advantage (SCA), the ultimate objective of all business strategy.6
Figure 10.1
Innovation and Strategy

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INNOVATION AND STRATEGY


Virtually any attempt to distill strategy to its core ends up focusing on
SCA because SCA is the fundamental objective of virtually all business
strategy. Indeed, the fundamental reason why innovation is so sought
after and valued is because we recognize the innate connection between
value-adding innovation and SCA, as measured by long-term profitability, especially in hypercompetitive global markets.7 Specifically, the objective of strategy is to achieve and sustain competitive advantage. This
occurs when organizations are able to consistently deliver superior value
to their customers more efficiently and effectively than their competitors.
Innovation is the magic that creates this superior value not only in products themselves, but also throughout entire value/supply chains. Central
to this model is a focus on customers and their perceptions of value, both
tangible and intangible.8
Innovation adds little to an organization unless it contributes to the creation and delivery of customer value by satisfying a customers needs. Indeed, customer orientation and innovation are the two most important
success factors of a new product.9 But what is value? It is simple enough to
define value as the perception that something is worth having, but when
one considers the power of value, one begins to understand its magic. Consumers intuitively recognize the power of value as they are motivated to
give their business to organizations that they feel deliver superior value.
Sometimes perceptions of value are not even conscious and may be more
associated with intangible attributes than with tangible product features.
Nevertheless, perceptions of value drive consumers to action, and provide
advantage and profitability for those wizards capable of harnessing innovation. However, this reality seems to elude some business organizations that
give in to the enticements of short-term profitability or other distractions,
usually to the detriment of customer value and their own SCA. Most businesses would prefer to avoid risk and stick with known technologies, rather
than take the chance of having an unsuccessful new product.10 However,
when customers perceive they will receive superior value, they are willing
to seek out corresponding products and even pay more for them.11 For example, consider the offering of iPod software as a free app for the iPhone when
the latter was introduced. A product that many people already owned suddenly became a bonus feature on a product they wanted, allowing them to
use one device for what used to require two.12 Conversely, when the perception of value is weak, so are the supplying organizations chances of survival.
Coca-Colas ingredients are virtually the same as those of store brand sodas,
yet the cost savings from the latter are not of sufficient value for many people
to purchase the cheaper product, thereby giving Coca-Cola a source of SCA.
Innovation in creating, producing, and delivering customer value also
provides businesses with their greatest opportunities for differentiation.

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Innovation throughout a value chain creates unique value propositions.


From a high-level perspective, innovation contributes to SCA as organizations build and maintain value-adding capabilities, resources, and
combinations thereof. An organizations capabilities and resources can
be tangible or intangible, and consist of people, practices, processes, culture, leadership, philosophy, and other assets. These include unique tacit
knowledge, skills, brands, location, patents, and management practices.
Tacit knowledge differs from explicit knowledge in that it is experiential, practical, and skill based. It is also difficult to imitate, thus providing opportunities for differentiation and competitive advantage.13 Tacit
knowledge includes practical skills and experience held by individuals
and which reside within organizational processes and practices. In contrast, explicit knowledge can be defined simply as any knowledge that
can be put in written form. As such, explicit knowledge is easy to copy
and imitate.
It is important to understand and recognize the distinction between
tacit and explicit knowledge within organizations because it is tacit rather
than explicit knowledge from which emerges innovative ideas, products, services, and processes.14 In addition to it being unique and difficult
to copy or imitate, different tacit knowledge, skills, capabilities, and resources can be combined in unique ways.15 It is most often combinations
of skills, rather than any one skill or capability, that create value-adding
innovations that are difficult to copy or imitate, thus providing excellent
foundations upon which to build SCA.16
To better understand how unique combinations of resources and capabilities can drive SCA, consider the competition between chefs that occurs in a kitchen setting as seen in reality shows such as Top Chef, Iron
Chef, or Hells Kitchen. Chefs may be constrained by having the same resources (e.g., ingredients and equipment), working in the same physical
setting, and having the same amount of time in which to create various
dishes. In essence, the environment is controlled so that the only remaining source of potential advantage and differentiation is the tacit knowledge skills and capabilities of the individual chefs. Just as it is the superior
tacit knowledge skills and capabilities of winning chefs that allows them
to successfully innovate, add value, and win the competition, it is the tacit
knowledge skills and capabilities (and combinations thereof ) that allow
business organizations to successfully innovate in their respective domains and establish SCA.
INNOVATE OR DIE
Having become accustomed to rapid change and constant innovation,
customers are increasingly demanding new products and services that
deliver more value, quality, and reliability. Even in products that have

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changed little over time, customers expect additional value in terms of


increased quality and service. Ongoing advances in technology-based
products and services drive down the length of product life cycles, forcing
firms to accelerate new product development (NPD) cycles while simultaneously improving the effectiveness of those processes. This trend can be
illustrated by the fact that in 1990, on average, companies generated close
to 40 percent of sales from products that were less than five years old.17 In
contrast, by 2010 as much as 40 percent of revenues in a number of industries came from products introduced the previous year.18 Apple in particular reported that 60 percent of its sales came from products that were less
than three years old.19
In addition to simply keeping up with new technologies and knowledge, history suggests that businesses that are first to market or first
movers (FM) are generally able to capture around 50 percent of initial
market share, the so called pioneering advantage.20 Research also shows
that speed to market is even more important than cost or budget considerations. For example, firms that introduced high-tech products that were
six months past the projected release date but still within budget realized
a 33 percent decrease in expected profits over the first five years. Conversely, firms that introduced products on time but as much as 50 percent
over budget suffered only a 4 percent reduction in profits over the first
five years.21 Firms with shorter NPD cycles also demonstrated better performance than those with longer NPD cycles.22
Innovation in management and manufacturing processes is also critical in creating and maintaining competitive advantage. According to John
Kao, We all have a tendency to look for creativity in products and forget
about its importance in processes, practices, and perceptions. Such myopia can lead only to disaster. No business today can afford to neglect the
need for continual renewal of its marketing, its recruiting, its accounting,
its planning process, and so on.23 A number of trends continue to elevate the importance of internal process innovation in providing opportunities to create SCA. One of these is the increasing reliance on outside
suppliers for products and services that contribute significant value to
an organizations offerings. This trend means that suppliers are increasingly becoming major sources of product differentiation. As more knowledge lies outside of the firm, management of outsourcing relationships
has provided a major opportunity for innovation and value creation, as
well as an increasing risk for value deterioration if the wrong suppliers
are chosen and/or the relationships mismanaged.24 Organizations that are
able to manage outside relationships and obtain special or exclusive access to supplier-based innovations create substantial advantage for themselves. For example, when Boeing Corporation developed the Boeing 787
Dreamliner, which has become the fastest-selling commercial airplane in
aviation history, they incorporated the knowledge and resources of over

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50 partners in the product development process.25 In John Kaos creativity


audit, presented later in this chapter, he specifically calls for the identification of the source of creativity as either insiders or outsiders, and
for credit to be given where credit is due in order to foster that source of
creativity.26
The increasing rate of technology dispersion globally also means that
firms are less and less able to obtain or maintain unique technologybased value. Moreover, the industry in which an organization competes
can place limits on the ability to achieve SCA through technology, and a
focus on achieving only breakthrough technological innovations can result in missing out on smaller incremental innovations or losing sight of
what customers really want.27 In some industries such as the tire and dry
cleaning industries, there is little room for differentiation in basic products or services. The only means for innovation and creating unique value
is often via innovative processes and unique combinations of products
and services that synergistically enhance customer value. Innovation in
these industries is more often the result of how products are delivered and
packaged than unique aspects of the products or services themselves. Regardless of how innovations are achieved, one thing remains certain: the
mantra innovate or die is quickly becoming the norm and a key strategic focus.
THE INNOVATIVE ENVIRONMENT
Many factors contribute to creating an organizational environment that
effectively supports innovation and creativity. We address only a few key
factors that we believe have the greatest effect on innovation. Besides the
positive effect that each contributes individually, synergies may result
from them being present together. As factors are combined, they lead to
the creation of environments or cultures of innovation that are unique to
firms, and become more valuable together than any one is on its own.28
Organizational Culture
It has long been observed that organizational culture or environment
is a key contributor to innovation,29 and that failing to create the right
environments is a critical barrier to effective innovation.30 A mediocre company may have a strong but rigid culture transmitted by a fearbased boss, or wishy-washy culture promulgated by a leader with no firm
business or moral vision. An excellent organization is one in which the
founders build on a strong vision to take active steps to create an atmosphere in which innovation can prosper.31 Organizations are the result
of a group or groups of people working toward a common goal, and creativity and innovation are the result of interactions between individuals

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and a particular situation.32 It is important to understand the difference


between innovation and creativity. Creativity is the individual-level generation of new ideas whereas innovation is the method through which creative ideas evolve into something of value.33 If individuals perceive that
their environment encourages and rewards creativity, they will engage in
more creative behaviors that lead to organizational level innovations.34 A
key difference between creativity and innovation is that innovation is only
beneficial to the extent that it adds perceived value to a product or service,
whereas creativity is the result of, and results in, intrinsic motivation and
innovation. Creativity can be beneficial in and of itself simply by generating new approaches to a situation. Innovations must, however, result in
distinct, observable, and consistent addition of value. If innovation is the
goal and creativity is the avenue, how can an organization create an environment that can transform creative ideas into successful innovations?
Tacit Knowledge, Resources, and Capabilities
According to Ikujiro Nonaka, there are two basic routes to obtaining
tacit knowledge.35 One is through association with someone else who
possesses the desired tacit knowledgeakin to a master/apprentice relationshipwhereby there are opportunities for instruction, observation,
mimicry, feedback, and practice. The second starts with explicit knowledge (e.g., written instructions) that is slowly transformed into tacit
knowledge through a process akin to trial and error and repeated selfdirected practice. This route is less efficient and occurs more slowly than
the first, but may be the only route available if a relationship with the tacit
knowledge holder is not possible. Applying Nonakas logic, we can conclude that chefs obtain their tacit knowledge, skills, and abilities either
by learning them from an experienced chef, through trial and error, or by
some combination of the two. However, although this explains how they
acquire their tacit knowledge, it does not explain why one chef is able to
achieve a competitive advantage over others. The explanation for this can
be found in the innate abilities of the individuals and the innovation environment, which includes its structure and leadership, in which they have
nurtured their skills.36
Organizational Knowledge, Capabilities, and Resources
Further adding to the complexities of organizational innovation is the
fact that innovation and tacit knowledge reside not just within individuals
but within groups of individuals and even organizational cognitive structures. Research in organizational knowledge and learning suggests that
organizations learn and can possess and use knowledge, including tacit
knowledge.37 While the knowledge may reside in individuals, it combines

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to form organizational knowledge, which resides in organizational processes, practices, culture, and norms.38 Therefore, in addition to having
an innovative chef, one can also have an innovative cooking staff. Just
as chefs can use their tacit knowledge skills and capabilities in their culinary creations, so can an organization use its individual and group tacit
knowledge and corresponding skills and capabilities to create products,
services, and processes that deliver superior customer value.
Failure to Succeed
The key to developing skills and capabilities based on tacit knowledge
is practice. This is true for both individuals and organizations. While understanding about the innovation process continues to evolve, one thing
that is well understood is that the development, improvement, and refinement of skills and capabilities, including those related to innovation,
requires consistent and ongoing practice. This has been referred to as
routinization.39 Although seemingly obvious, the inextricable connection between practice and skill development has profound implications
for individuals and organizations. The relationship between practice and
tacit knowledge brings to light the most significant barrier preventing individuals and organizations from achieving superior skills based on tacit
knowledgeskills cannot be honed without practice, and practice cannot
be performed without error and failure.
Despite this truism, most individuals and organizations are at least
error adverse, if not intolerant of failure. A few organizations have embraced the fact that skills and capabilities along with the resulting innovation cannot occur without error. They are also finding ways to not only
tolerate but also embrace failure because they understand that without
error there is no learning, and thus no innovation and creation.40 For example, in a video entitled Failure: The Secret to Success, Honda extols failure
as a necessary precursor to success.41 In fact, recognizing that tacit knowledge, innovation, and competitive advantage cannot be obtained without
failure or error, they claim to happily embrace failure. Another example is
the award-winning global design firm IDEO, which has gone so far as to
adopt the motto fail soon to succeed soon.
What happens when error is forbidden, punished, or deemed unacceptable? Most individuals would likely want to give up whatever creative endeavor they are pursuing. If forced to continue, they would likely proceed
with extreme caution, avoiding anything innovative or risky, and resisting
any significant challenge or opportunity. It is easy to suggest that allowing
mistakes sounds great in theory but real businesses cannot afford to make
mistakes or to let employees take risks. No doubt, Honda, IDEO, and
other businesses are not embracing error and failure for its own sake or allowing it to adversely affect their overall financial success. It is natural for

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any person or organization to seek to avoid costly mistakes. The solution


therefore, although as varied as the organization, rests on having some
basic tools that can be used to create a balance that nurtures an innovative
environment, allowing failures that lead to success, while simultaneously
discouraging costly errors. Among these tools are Nonakas tacit-to-tacit
learning model (part of the SECI [Socialization, Externalization, Combination, Internalization] model), which encourages intense association between people with tacit knowledge and those who want to learn skills
based on this. Under the guidance of a mentor or master, individuals can
learn skills based on tacit knowledge while practicing under the watchful
eye of an expert who is prepared to intervene before costly errors occur.
Other tools include simulation, role playing, and other opportunities for
socialization between the haves and have-nots of tacit knowledge. Given
whats at stake, no less than the life blood of innovation, finding ways to
provide opportunities for employees to practice so that they can acquire
new, value-adding skills deserves more attention than it usually gets.
Managing Organizational Innovation
Within an organization, leveraging tacit knowledge becomes complex
because even though organizations can learn and possess knowledge,
knowledge ultimately resides in individuals. Organizational tacit knowledge capabilities are thus made up of groups of individuals, their skills
derived from tacit knowledge, and the interaction of resulting capabilities through various processes and interactions.42 These interactions naturally create new knowledge and thus skills and capabilities that, although
sometimes difficult to manage and even identify, are often unique to an
organization and difficult for competitors to copy or imitate. It is this that
makes it possible for organizations such as Toyota and Dell to offer factory tours and have their processes and practices described in articles, yet
retain their unique and effective competitive advantages.
Innovation and Customer Value
Although innovation is at the heart of competitive advantage, not all
tacit knowledge leads to innovation or the creation of customer value or
SCA. It is value that is created for and delivered to customers that generates profits, but profitability alone, particularly in the short run, is not
necessarily a good indicator of customer value or SCA. A chef might think
theyve created a culinary masterpiece and the chef might indeed be talented, but if they fail to attract and retain customers, no advantage exists.
Individuals and organizations must therefore leverage tacit knowledge to
identify and develop skills that create innovations valued by their customers. This is the essence of strategic innovation, the creation of value that

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customers value beyond the cost to create that value. The process of strategic innovation begins with identifying customer needs, and ends with
creating and applying tacit knowledge to meet those needs efficiently and
effectively.
Structure and Resources
Innovation tends to thrive in the absence of structure, and inappropriate
(i.e., rigid/hierarchical) structures have been shown to inhibit innovation.
On the other hand, structures that facilitate and encourage cooperation,
communication, and integration contribute positively in nurturing innovative environments.43 Cooperation serves to diffuse valuable knowledge
and information, and to leverage the knowledge possessed by individuals.
Communication facilitates cooperation by providing pathways by which
knowledge and information flows between individuals. Integration provides structures, including physical proximity, that facilitate cooperation
between individuals and groups that might not otherwise cooperate. The
antithesis of these positive pathways and structures are rigid organization structures that restrict knowledge sharing across intra and interorganizational boundaries. These are sometimes referred to as silos, and often
lead to over-the-wall processes characterized by discrete, disconnected
activity rather than more continuous, cooperative activity that transcends
organizational boundaries. Managers must be sensitive to both formal
and informal structures and pathways and how they either promote or
impede knowledge sharing and innovation.
The lack of resources or an inability to access needed resources can also
be highly detrimental to the creation and cultivation of innovative environments.44 The development and testing of new ideas always requires
resources, certainly of time, and usually of material and money as well.
When those resources are restrained or slow to materialize, the motivation and energy driving a new idea dries up or is redirected toward other
pursuits. No organization has unlimited resources with which to nurture
innovation, but every organization, even those that are severely resource
constrained, can effectively leverage existing resources by sharing them
across functions and groups.45 This is akin to a typical retail auto parts inventory system. No individual store carries a full inventory, but by sharing inventory across regional stores, inventory availability is increased and
most customer demands can be satisfied within 24 hours. To be effective,
these systems require accurate inventory records and must be supported
by good logistics systems. Similarly, an accurate inventory of resources
across an entire organization or even an interorganizational network, combined with processes that facilitate the effective allocation and movement
of resources to the right people at the right place at the right time, can go
a long way toward nurturing innovation even when resources are limited.

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Communication
Effective organizational communication has been shown to contribute
to innovative environments in terms of more effective problem solving,
reduced development times, increased flexibility, better cooperation between individuals and groups, heightened initiative and commitment,
and increased sensitivity to customers and markets.46 Likewise, communication failures lead to poor performance in terms of cost increases and
budget overruns, time delays, and poor quality and morale.47 Having the
right information at the right place and time adds value by contributing
to time and place utility.
In the book What Happy Companies Know, one chapter focuses on fostering innovation.48 One of the mantras offered is the team that sits together
invents together, and communicates the importance of co-location in fostering communication and the cross-pollination of ideas. Similarly, the
Obeya approach or large room process utilized by Toyota is based on
the notion that close proximity spurs informality and interaction, which
spurs innovation, particularly among people in different fields or areas
of expertise.49 Jack Welch, the former CEO of General Electric, is quoted
as supporting this approach, Co-location is the ultimate boundaryless
behavior and is as unsophisticated as can be . . . one room, one coffeepot,
one team, one shared mission.50 Effective communication has thus been
called superglue #1 in the development and maintenance of effective relationships and innovative environments.51

Leadership
As exemplified by Phil McKinney, the innovation wizard and vice president of Hewlett Packard, innovative environments are generally best served
by collaborative leadership styles. Since every factor of an innovation environment hinges on management support, it can be argued that supportive
leadership is the most important factor in innovation. In his Seven Immutable Laws of Innovation, McKinney ranks the law of leadership as law
number one in creating an innovative environment. This law states, Executive level support (Board, CEO and his/her direct reports) is critical for
an organization that wants to have innovation at its core. Leadership means
talking-the-talk AND walking-the-walk. It means committing (and protecting) resources (time, money, people, equipment) for innovation. How much
time does the executive team as a group and individually spend working
on innovation? Listening to status reports from others doesnt count.52 It is
interesting to note that the second law, the law of culture, also contains an
element of leadership, as do laws four (the law of patience), six (the law of
big hairy aggressive goalsBHAGs), and seven (the law of execution). The
other laws are the laws of resources (3) and process (5).

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225

One example of an innovation culture that reflects the law of BHAG is


Honda Corporations philosophy of kick the ladder out, or creating innovation environments in which there are high expectations, a culture of no
going back.53 Hondas approach is to assign aggressive/difficult projects
to autonomous teams and establish a serious expectation of success. Although failure would not likely lead to termination of employment, there
is a cultural stigma associated with these BHAG projects. Those invited
to participate in them are honored by the trust placed in them, and those
who succeed become heroes within their organizations. Using BHAG in
innovation is different from traditional stretch goals in that a BHAG approach creates a serious expectation of success even though the goals are
ambitious, whereas stretch goals are typically more of a wish without the
serious expectations or consequences of BHAGs.

WHAT TO DO AND WHAT NOT TO DO


With innovation it often seems that the harder one tries to grasp it the
more it slips through the fingers. Since many of the attributes of innovation seems ethereal, we have focused more on how to nurture innovation
and less on what the mystery that seems to surround it really is and how
it is created. Although we may not know precisely how to create an innovative enterprise, there are several clues about the motivation that drives
innovation and the types of skills most likely to produce it.54 As discussed
earlier, tacit knowledge is the type of knowledge most likely to produce
innovation. Rudimentary skills based on tacit knowledge may be acquired
through incentive systems that employ traditional Skinnerian rewards or
punishments. However, social science research has repeatedly shown that
anything requiring the use of cognitive skills (and certainly innovation requires the use of cognitive skills) cannot be accomplished using Skinnerian incentives whether negative or positive.55 In other words, incentives
(i.e., rewards) and disincentives (i.e., punishment) are not only ineffective
in nurturing innovation, they are also often counterproductive. Systems
that allow maximum autonomy or choice, that provide opportunities for
learning and mastery, and that instill a sense of meaningful purpose are
more effective in tapping the powerful intrinsic motivation that drives innovation.56 Organizations that can develop such systems are more likely
to be successful in creating and developing skills and capabilities based on
tacit knowledge than those that do not. It is no coincidence that the same
environments and processes that encourage the development of tacit
knowledge also encourage innovation and creativity. A person or group
of people free to experiment, given opportunities to learn and practice,
and instilled with a sense of purpose, is more likely to produce innovative results and get intrinsic satisfaction in doing so than someone in a

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Strategic Management in the 21st Century

more constrained environment who is denied training, and is robbed of


the satisfaction that should be associated with work well done.57
Having identified key success factors for developing a culture of innovation, a logical question is, How do we start? As in all strategic planning processes, situational analysis provides a starting point and helps to
identify the data necessary to conduct a gap analysis. One tool to accomplish this that fits with the concept of innovation is the creativity audit.58
The audit contains eight steps that reflect an organizations history and
culture with respect to creative endeavors, and provides a tool that an organization can use to catalog its innovative identity.

The Creativity Audit59


1. Bare Facts
a. What is the asset value of your creative capabilities (special equipment, people, architecture)?
b. What proportion of your revenue comes from products less than
one year old? Less than five years old?
c. Assess your creative productivity. What percentage of the last few
years creativity initiatives have turned into actual product? Into
actual improvements in business processes? Into useful changes
or reinforcements of the company culture?
d. Inventory, if possible, a half a dozen diverse creative initiatives
your company, your division, or your teamwhichever is appropriatehas taken recently.
2. Credit Due
a. Who brought those initiatives to public awareness or discussion:
an insider or outsider?
b. Who seconded them?
c. Who carried those initiatives to the next step, the next level, etc.,
all the way to realization?
d. What conversations were key to this process?
3. Occasion: Under what circumstances did those initiatives arise?
a.
b.
c.
d.

Did they arise out of nowhere?


Were they in response to specific challenges? If so, whose?
Were they in response to benchmarking the competition?
Did they arise in response to an emergency, necessity, or other
unforeseen event?
e. Where they the result of a well-considered corporate design to
encourage or import such initiatives?

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4. Design: If you believe that a company-wide creativity system stimulated a particular initiative, can you isolate the elements of the system that played a role?
a. Search and employ elements (recruitment, mergers, acquisitions,
consultants, etc.)?
b. Architectural elements (special work spaces, social spaces,
etc.)?
c. Cultural elements specifically descriptive and supportive of creativity?
d. Pedagogical elements (on-site training, sabbaticals, mind-clearing
exercises, etc.)?
e. Carrots and sticks (bonuses, peer pressure, status, rewards, etc.)?
f. Technological elements (information networks, communications
systems, gene-splicing tools, etc.)?
g. Leadership elements (interventions by the CEO et al.)?
h. Financial elements (investment in idea generation capabilities,
slack money)?
5. Tracking
a. Map the progress of a sample of creative initiatives from the idea
to unofficial project to official project, thence to active source of
company value.
b. Pay particular attention to the systemic barriers, checkpoints,
obstacles, friction points, and so on, noting whether the course of
action is appropriately flexible, or dysfunctionally sclerotic.
c. Be alert, also, to human factors ( jealousy and enthusiasm, alertness and ignorance, leadership support, etc.) that may stall or
smooth the progress of the initiative.
6. Benchmarking
a. How much do you know about the procedures and cultures of
your competitors? Of notably creative corporations?
b. How much do you know about the most creative company in
your industry?
c. How do you foster company-wide awareness of new developments in your industry? Trade shows? Newsletters? Conferences?
Customers? Creator networks?
d. Have you, in your investigations and research into the activities
of the competition, found clues to your own sources of future
competitiveness?
e. What hard-to-copy capabilities do you have in place that allow
your company to create distinctively, continuously, and effectively?

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7. People
a. Do you know who the top creative talents in your business are,
and what motivates them?
b. What is your track record in finding, attracting, developing, and
retaining talent?
c. Specifically, how many key creative talents did you lose in the
past 12 months and what are you doing to replace them?
d. Whos in charge of recruitment? Is it just human resources?
e. Do your reinventing processes lead to a desired level of diversity
and divergence of opinions, and inclusion of new voices?
f. What, if anything, is lacking in your recruitment processes, and
how and when do you plan to rectify those problems?
8. Creative Capital
a. What systems are in place for taking stock of your creative capacities and performance?
b. What systems are in place for generating creative ideas?
c. What systems are in place to stockpile and protect such ideas?
d. What systems are in place to realize such ideas?
e. What systems are in place to reward such ideas?

LOOKING BEYOND
As Robert Grudin stated in the book The Grace of Great Things: Creativity
and Innovation, Creativity and innovation are concepts so dear to modern culture that their very mention excites immediate approval. . . . Yet
we have shown comparatively little curiosity about the birth and growth
of innovationthe ways in which creative impulse develops into pathfinding achievement.60 Perhaps the reason we have been so nonchalant
about innovation is because we have, at least until recently, enjoyed having so much of it. Although the psychological and other esoteric aspects
of innovation and creativity are outside the scope of this chapter, we acknowledge that innovation and creativity are inextricably tied to every
aspect of our existence, our minds (conscious and subconscious), our bodies, our governments and cultures, and everything else that affects our
state of being. As Grudin states, creativity and freedom are the most precious freedom[s] of all, the liberty implicit in the creation of ideas and
new forms.61 His book courageously explores every path and topic in the
quest for a true understanding of the sources of innovation and creativity,
even daring to venture into the subconscious. In the end, he suggests that
innovation and creativity can best be nurtured by cultivating a combination of habits and attitudes that form a mental innovation environment or
what he calls a garden of the mind.

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Philosophers and thinkers have long recognized the complex nature


of innovation and its inextricable connection to every part of our beings,
as illustrated by Lorenzo de Medici (14491492), an Italian statesman,
who, upon being chided by a friend for sleeping a little late, said, what
I have dreamed in one hour is worth more than what you have done in
four.62 As organizations work to create and maintain cultures and environments that foster innovation, they should not only consider traditional
approaches but also broaden their thinking to consider all aspects of their
employees lives and environment. Some of the most innovative organizations of our day seem to be doing just that. For example, Google describes
their culture as we still maintain a small company feel. At lunchtime, almost everyone eats in the office caf, sitting at whatever table has an opening and enjoying conversations with Googlers from different teams. Our
commitment to innovation depends on everyone being comfortable sharing ideas and opinions. Every employee is a hands-on contributor, and
everyone wears several hats. Because we believe that each Googler is an
equally important part of our success, no one hesitates to pose questions
directly to Larry (Page) or Sergey (Brin) . . . or spike a volleyball across the
net at a corporate officer. . . . We are aggressively inclusive in our hiring,
and we favor ability over experience . . . [we] share a commitment to creating search perfection and have a great time doing it.63 This description
of Googles culture suggests that the company understands and appreciates the garden of mind concept suggested by Grudin and has established an environment and culture that nurtures innovation and creativity
by paying attention to a wide spectrum of variables that affect the lives of
their employees, not just salary and benefits.
NOTES
1. Morris, T. (2006). If Harry Potter Ran General Electric. New York: Doubleday
Broadway Publishing Group.
2. Clarke, A. C. (1984). Profiles of the Future: An Inquiry into the Limits of the Possible. New York: Holt, Rinehart, and Winston.
3. Levitt, T. (2004). Marketing Myopia. Harvard Business Review, 82 (7/8),
138149.
4. Phawker (2011, October 5). RIP: Steve Jobs, Wizard of Oz, Dead at 56. http://
www.phawker.com/2011/10/05/rip-steve-jobs-wizard-of-oz-is-dead/.
5. Azadegan, A., and Dooley, K. J. (2010). Supplier Innovativeness, Organizational Learning Styles, and Manufacturer Performance: An Empirical Assessment.
Journal of Operations Management, 28, 488505.
6. Gumusluoglu, L., and Ilsev, A. (2009). Transformational Leadership, Creativity, and Organizational Innovation. Journal of Business Research, 62, 461473.
7. Chen, J., Damanpour, F., and Reilly, R. R. (2010). Understanding Antecedents
of New Product Development Speed: A Meta-Analysis. Journal of Operations Management, 28 (1), 1733.

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8. Mishra, A. A., and Shah, R. (2009). In Union Lies Strength: Collaborative


Competence in New Product Development and Its Performance Effects. Journal of
Operations Management, 27 (4), 324338. Hilletofth, P., Ericcson, D., and Lumsden, K.
(2010). Coordinating New Product Development and Supply Chain Management.
International Journal of Value Chain Management, 4 (1), 170192.
9. Hilletofth, Ericcson, and Lumsden (2010).
10. Lane, J. A., Boehm, B., Bolas, M., Madni, A., and Turner, R. (2010). Critical Success Factors for Rapid, Innovative Solutions. In J. Munch, Y. Yang, and W.
Schafer (Eds.), International Conference on Software Processing (pp. 5261). Berlin and
Heidelberg: Springer-Verlag.
11. Ganesh, J., Arnold, M. J., and Reynolds, K. E. (2000). Understanding the
Customer Base of Service Providers: An Examination of the Differences between
Switchers and Stayers. Journal of Marketing, 64, 6587.
12. Deutschman, A. (2011, September 21). Exit the King: How Did Steve Jobs
Become a Wizard among Muggles? And What Will Apple Do without Its Willful
Inspiration at the Helm? Retrieved November 22, 2011, from Newsweek: The Daily
Beast: http://www.thedailybeast.com/newsweek/2011/08/28/steve-jobs-amer
ican-genius.print.html.
13. Kuwada, K. (1998, NovemberDecember). Strategic Learning: The Continuous Side of Discontinuous Change. Organization Science, 9 (6), 719736.
14. Birou, L. (2006). Relational Supply Chain: From Arms length to Alliances
and Joint Ventures, the Future of Supply Chain Relationships. In J. Cavinato (Ed.),
Supply Chain Management Handbook (pp. 289310). New York: McGraw-Hill.
15. Mishra and Shah (2009).
16. Craighead, C. W., Hult, G. T., and Ketchen Jr., D. J. (2009). The Effects of Innovation-Cost Strategy, Knowledge, and Action in the Supply Chain on Firm Performance. Journal of Operations Management, 27, 405421.
17. Welter, T. (1989, February 20). Product Development: Design Inspiration.
Industry Week, 238 (4).1
18. Hilletofth, Ericcson, and Lumsden (2010).
19. Dediu, H., 2011. ASY MCO. Retrieved September 15, 2011, from http://
www.asymco.com/2010/10/19/60-percent-of-apples-sales-are-from-productsthat-did-not-exist-three-years-ago.
20. Duffy, J., and Kelly, J. (1989, November). United Front Is Faster. Management
Today, 131134.
21. Gupta, A., and Wilemon, D. (1990). Accelerating the Development of Technology-Based New Products. California Management Review, 32 (2), 2444.
22. Swink, M., and Song, M. (2007). Effects of Marketing-Manufacturing Integration on New Product Development Time and Competitive Advantage. Journal
of Operations Management, 25 (1), 203217.
23. Kao, John (1996), Jamming the Art and Discipline of Business Creativity. New
York: HarperCollins, p. 23.
24. Azadeganand Dooley (2010).
25. Mishraand Shah, (2009).
26. Kao (1996), p. 24.
27. Treacy, M. (2004). Innovation as a Last Resort. Harvard Business Review, 82
(7/8), 2930.
28. Mishra and Shah (2009).

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29. Knight, K. E. (1967). A Descriptive Model of the Intra-Firm Innovation Process. Journal of Business, 40 (4), 478496.
30. Tushman, Michael L. (1988). Managing Communication Networks in R&D
Laboratories. In Michael L. Tushman and William L. Moore (Eds.), Readings in the
Management of Innovation (pp. 261274). 2Ballinger, 1988.
31. Baker, Dan, Greenberg, Cathy, and Hemingway, Collins (2006), What Happy
Companies Know: How the New Science of Happiness Can Change Your Company for the
Better. Upper Saddle River, NJ: Pearson Prentice Hall, p. 149.
32. Hunter, S. T., Bedell, K. E., and Mumford, M. D. (2007). Climate for Creativity: A Quantitative Review. Creativity Research Journal, 19 (1), 6990.
33. Rasuzada, F., and Dackert, I. (2009). Organizational Creativity and Innovation in Relation to Psychological Well-Being and Organizational Factors. Creativity
Research Journal, 21 (2), 191198.
34. Gumusluoglu and Ilsev (2009).
35. Nonaka, I., and Takeuchi, H. (1995). The Knowledge-Creating Company: How
Japanese Companies Create the Dynamics of Innovation. New York: Oxford University Press.
36. Hunter, Bedell, and Mumford (2007).
37. Azadegan, and Dooley (2010).
38. Gumusluoglu and Ilsev (2009).
39. Nonaka and Takeuchi (1995).
40. Rasuzada and Dackert (2009).
41. Honda Motor Company. (n.d.). Failure: The Secret of Success. Retrieved
September 23, 2011, from YouTube: http://www.youtube.com/watch?v=iJAq6
drKKzE.
42. Hunter, Bedell, and Mumford (2007).
43. Ibid.
44. Gumusluoglu and Ilsev (2009).
45. Mishra and Shah (2009).
46. Takeuchi, H., and Nonaka, I. (1986). The New New Product Development
Game. Harvard Business Review, 64 (1), 137146.
47. Tushman (1988).
48. Baker, Greenberg, and Hemingway (2006).
49. Ibid.
50. Ibid. pp. 155156.
51. Wachs, K. M. (2002). Relationships for Dummies. New York: Wiley.
52. McKinney, P. (2011, August 22). The 7 Immutable Laws of Innovation
Follow Them or Risk the Consequences. http://philmckinney.com/archives/
2011/08/the-7-immutable-laws-of-innovation-%E2%80%93-follow-them-or-riskthe-consequences.html.
53. Honda Motor Company. (n.d.). Kick Out the Ladder. Retrieved September 20, 2011, from YouTube: http://www.youtube.com/watch?v=wIjBHHAHwBE.
54. Gumusluoglu and Ilsev (2009).
55. Kohn, A. (1999). Punished by Rewards. Boston, MA: Houghton Mifflin.
56. Hunter, Bedell, and Mumford (2007).
57. Gumusluoglu and Ilsev (2009); Hunter, Bedell, and Mumford (2007).
58. Kao (1996), pp. 2429.
59. Ibid.

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60. Grudin, R. (1990). The Grace of Great Things. New York: Ticknor & Fields.
61. Ibid.
62. Hare, C. (1908). Courts and Camps of the Italian Renaissance. London and New
York: Harper & Brothers.
63. Google. (2011). The Google Culture. Retrieved November 4, 2011, from
http://www.google.com/about/corporate/company/culture.html.

Chapter 11

Organizational Culture, Performance,


and Competitive Advantage:
What Next?
Bianca Jochimsen and
Nancy K. Napier

For over 20 years, beginning in the late 1970s and early 1980s, the topic
of organizational culture has been a key area of interest for managers and
scholars worldwide.1 Much of the literature has focused on defining the
term organizational culture,2 and its relationship to an organizations
performance3 and competitive advantage.4 In particular, research has examined its importance, its links with other variables that may influence
performance, and how managers can use corporate culture to create and
build successful organizations. In this chapter, we present an overview of
selected past research on organizational culture and how it is viewed as a
contributor to performance and competitive advantage. We also identify
selected areas where existing research has not been fully pursued, for example, how to sustain culture over time, and offer observations on promising directions for future research. Building upon these observations, we
offer a simple framework that categorizes ways that organizational culture
and performance or competitive advantage may be related and that may
suggest new areas for research. In this discussion, we seek to contribute

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to managements comprehension and awareness of organizational culture


as a source of competitive advantage, while acknowledging that links between culture and advantage may sometimes appear to be loose.
WHAT IS ORGANIZATIONAL CULTURE?
During the last few decades of research on organizational culture, one
avenue of inquiry has been the development of a concrete definition of organizational culture, its characteristics, and its development and application in organizations. As might be expected, many different definitions of
culture and its influence in an organizational environment have emerged.5
Specifically, organizational culture has been defined as a complex set of
values, beliefs, assumptions and symbols that define the way in which a
firm conducts its business,6 a multidimensional control system to measure behaviors,7 and a pattern of shared and stable beliefs which develop within an organization over time.8 These definitions imply that an
organizations culture is a unique phenomenon with multiple layers, and
can help frame an organization in specific ways. Although initially looking at culture as a set of shared meanings, scholars subsequently began
to understand it had multiple levels. Schein discussed three levels of organizational culture: artifacts and creations, values, and basic assumptions.9
Although the three levels have specific characteristics that make them visible (e.g., technology) or invisible (e.g., assumptions and values) to organizational members or outsiders, all three levels need to be shared by
members to create an organizational culture. Scheins initial model was
modified by other scholars such as Hatch, who added another key level,
symbols.10 Fiol further delineated culture as an unobservable (culture,
norms) system of meaning.11 These changes and additions over time are
important as they further develop the ideas and models underlying culture, making them more adaptable and suggesting how the various levels of culture are linked. For example, the establishment of culture can be
viewed as manifesting, realizing, symbolizing, and interpreting the four
levels of artifacts/creations, basic assumptions, values, and symbols.12
These four factors could be set within an organization in a proactive or
a reactive way. In other words, management could set and reinforce the
key factors or the factors could develop on their own, almost organically,
with little direct guidance from management. Regardless of how the elements come into play, only when they become recognizable values can
they be internalized by members and become part of the organizations
foundation.
Other early research focused on external adaptation or ways to define and describe the types of organizational governance reflected in culture. Based on their observations of Japanese firms, Wilkins and Ouchi
characterized culture in terms of clans, bureaucracies, or markets.13 They

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235

argued that the clan culture, which they considered most likely to be associated with high levels of organizational performance, demonstrates
goal congruence, shared social knowledge through a long history, collective member interaction, and high loyalty to the organization. In contrast,
bureaucracy cultures are the simplest form of organizational governance
and operate merely through a sharing of certain social understandings.
They described market cultures as representing a more advanced form
of corporate governance since members share a more specific common
understanding about the organization, such as competition, prices, and
ideas. Other scholars have argued that organizational culture is an important factor in governing how members of an organization interact with
each other within and outside of the organization, and that those interactions and behaviors result in the organizations identity.14
Culture has long been considered to be a variable that is a key to establishing a competitive advantage,15 and intuitively, this would suggest
that it could have an influence on organizational performance.16 However,
research is inconclusive on the questions of if and how management can
actively influence the development and implementation of culture to improve the overall economic and financial performance of the organization.17 A deeper understanding how culture develops is thus critical in
determining whether and how it may relate to performance and competitive advantage.
DEVELOPMENT OF ORGANIZATIONAL CULTURE
Just as there are many different definitions of corporate culture, the research literature offers different processes that organizations have used in
the development of culture. For instance, Wilkins and Ouchi argued that
four factors (goal congruence, shared social knowledge, collective member
interaction, absence of institutional alternatives) influenced the development of clan cultures and contributed to the formation of a common social understanding within an organization that would be passed along to
future employees. Conversely, an organization with high employee turnover or that lacked stable membership or a shared corporate history, may
be unable to sustain a social understanding over time. Other scholars have
identified internal factors that contribute to the development of culture.
OReilly described the development as a process with four mechanisms
that ultimately lead to employee commitment and an organizational culture.18 First, an organization that asks for and requires participation from
its employees will involve them and make them feel valued. Additionally, management must take symbolic actions to support the development
of a strong organizational culture. Such clear, visible actions include,
for example, modeling the values that are important (e.g., integrity, transparency, respect for others), and in turn spread and reinforce the cultural

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values within the organization. Third, information shared within the organization (as well as outside the organization), whether it is from employees or from management, needs to be consistent, thereby reducing
the potential for contradiction or ambiguity. Finally, a comprehensive reward system needs to focus on the right mix of money, recognition, and
approval to keep employees motivated.
Wilkins and Ouchi and OReilly presented two examples of the ways
in which scholars view the development and implementation of culture.
Whereas Wilkins and Ouchi described more basic influences based mostly
on their definition of the clan culture, OReilly focused in more depth
on internal factors such as management and communication, rewards,
and employee beliefs and attitudes. Other scholars have also identified
a firms history and heritage as important19 and have pointed out that a
shared mindset is crucial in developing the organizational culture.20 Additionally, management practices can have an important influence on culture
development and sustainability. Although managements beliefs, values,
and propositions are essential,21 these need to be consistent and encourage
leadership at all levels of the organization.22 Only if employees are empowered will organizational norms and values be shared within the organization, and in communication with people outside the organization. The
empowerment of employees is particularly important since management
needs to ensure that they are not the only ones spreading and reinforcing
the organizational culture but that employees also exhibit and convey the
shared set of practices and beliefs.23 Human resource practices thus also
need to support the spread of culture within an organization.24 During the
hiring process, for example, the opportunity exists not only for applicants
to learn about the hiring organizations culture and to decide whether it is
consistent with their values and needs but for the interviewer to make the
same assessment of the candidate. By exhibiting and spreading the culture
at different organizational levels, a shared mindset grows, which further
cements culture development. Management must, however, demonstrate
a capacity for change within the organization to leave room for modification of the culture and to ensure it is aligned with the business mission
and strategy.
WHAT MAKES STRONG ORGANIZATIONAL CULTURES?
Whenever scholars discuss links between organizational culture and financial performance or competitive advantage, the notion of strong cultures emerges. Though the relationship between culture and performance
has been analyzed and interpreted in different ways,25 a strong organizational culture has often been considered to be related to improvements in
performance26 and organizational effectiveness.27 Whereas some scholars
argue that a strong culture is predictive of short-term future company

Organizational Culture, Performance, and Competitive Advantage

237

performance,28 others link it to overall growth rather than to profitability29 or long-term performance.30 Strong culture has also been associated
with the demise of companies and entire industries.31 Some have argued
that organizational culture could be a driving force behind continued
success in American businesses,32 extending the influence of culture beyond individual firms to an industry context. Much of the research findings come from an era (19801990s) when Japanese firms were dominant
(and hence a lot of research hailed their approaches to culture) and U.S.
firms were becoming stronger.33 Since then, however, the performance of
Japanese firms has fallen. Does this perhaps signal a different relationship
between performance and culture?
Since strong cultures were traditionally seen as influencing organizational performance, the concept of strong culture is relevant to any discussion about culture. So what are the characteristics of a strong culture
and how has it been defined by scholars? Just as there are a variety of
definitions for organizational culture, scholars have proposed different
definitions of strong cultures and their attributes. Strong culture has been
identified as stable and more intense,34 homogenous,35 and coherent.36 They have also been associated with wide consensus, for example,
norms and values that are widely shared among employees.37 Furthermore, strong cultures reflect an organizations sense of mission, longterm vision, and adaptability to change.38 Three key variables have been
identified as being potentially related to the overall strength of a culture:
who accepts the dominant value set, how strongly or deeply these values
are held by employees, and for how long the values have been dominant
within an organization.39
An example of a strong organizational culture that has led to continued success is that of Southwest Airlines. Southwest has consistently
outperformed its competitors by simultaneously keeping costs low and
customer and employee satisfaction high. This is due largely to its strong
organizational culture. This can be characterized as being informal or relaxed, and is manifested in terms of an enjoyable work environment. For
example, the CEO personally recognizes birthdays, births, and weddings
with cards and notes to make employees feel valued and acknowledged.
The core value underlying Southwests organizational culture is that employees are the number one priority, and this is the foundation for the airlines service model. The inference is that the strong organizational culture
is positively related to high work performance and that this represents a
competitive advantage the company has been able to maintain.
Research suggests that four conditions are necessary for any asset to
lead to superior and sustainable performance or a competitive advantage.40 To the extent that a strong corporate culture represents an asset,
culture must thus meet these conditions. First, the asset must be valuable,
meaning that it enables an organization to do things and behave in ways

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Strategic Management in the 21st Century

to add economic value to the firm.41 It must, in essence, be measurable


(e.g., in terms of sales or profits margins) or enable a firm to take advantage of an opportunity in the environment.42 Second, it must be rare in
that it has unique characteristics which are not common to other firms
in the marketplace.43 Third, it must be imperfectly imitable by competitors. In other words, whereas many elements of culture may be visible and
appear to be imitable (e.g., allowing dogs in the workplace seems to be an
increasing trend in the last five years according to many practitioner discussions of culture), it is the integration and combination of various factors that make up a culture that make it difficult to replicate. Thus, even if
the first two conditions can be satisfied (e.g., adding economic value and
being rare), they will not lead to sustainable competitive advantage and
superior performance if they are easily imitable and can be copied. A final
condition is that no perfect substitutes for the asset should exist, making it
even more difficult to imitate.44 Although the natural tendency may be to
notice visible artifacts or surface-level attributes of culture such as office
space and design (e.g., Googles bean bag chairs, IDEOs bicycles hanging from the ceiling), these may reflect but do not define an organizations
culture.
Other factors may support the sustainability of organizational culture
as a competitive advantage, such as geographic location45 or the extent to
which new employees capture and adapt to a culture, thereby ensuring its
continuation over the years even if management changes.46 From an internal standpoint, consistent values and methods of doing business, and
goal alignment across the organization enhances the likelihood of creating
a competitive advantage, as well as enhancing the visibility of the culture
among those outside the organization.47 The fact that scholars have voiced
different opinions and created a variety of models concerning the influence of strong culture on competitiveness demonstrates the importance
of the culture concept but also highlights the fact that it is not yet fully
understood.
EXISTING FRAMEWORKS
The review of selected research on organizational culture reveals many
common elements, variables, and implications. In addition to definitions
and descriptions of culture and its links to performance and competitive
advantage, the research provides useful conceptual frameworks and models. Whereas some scholars have developed models of the levels of organizational culture,48others have created models representing necessary
conditions to create a competitive advantage and high performance,49 or
implications of organizational culture. The latter cover a wide array of elements from shared history50 and joint experiences51 to management actions,52 leadership, and human resource practices.53 Common elements,

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239

however, include defining culture and its key dimensions.54 Most frameworks tend to focus on internal organizational factors associated with the
building or development of culture, including human resource practices,
top management practices, and the firms history and experiences. A few
consider external factors and relate these to achieving competitive advantage.55 The models generally suggest that organizations that encourage a
strong culture will tend to have strong performance. The implied mantra
is do the right thing and good results will be part of the outcome.
Among the most discussed variables in scholarly frameworks are management actions and behaviors and how they are related to organizational
culture and can ultimately lead to strong culture and success. Whereas Fiol
and OReilly stress that organizational culture is derived from management behavior patterns, actions, beliefs, propositions and values, Ulrich
and Lake focus on how human resource practices (set up by managers)
may influence internal aspects of organizational culture.56 They suggest
that leaders who inculcate a shared mindset within the organization and
encourage corresponding human resource practices may promote a capacity for change at all levels of the organization. This moves the discussion of
culture from development to long-term sustainability and management.
Both of these variables, management and human resource practices, are
internal factors related to organizational culture. As described by OReilly,
the norms and social realities implemented within the company, through
management and human resources, may relate to a companys strategy
and organizational commitment, which contribute to a sustainable competitive advantage.57 In his framework, OReilly states that organizational
commitment, comprising compliance, identification, and internalization,
need to be accepted by management and employees to encourage successful performance of a company. The multidimensional culture framework
by Marcoulides and Heck is less specific in stating what influences different factors of organizational culture.58 They suggest that five interrelated
variables may be associated with organizational performance: organizational structure and purpose/organizational values, which may influence
task organization, worker attitudes and organizational climate, which in
turn influence performance.
Although most of the frameworks focus on internal factors, Ulrich and
Lake also refer to external variables that may impact the possibility of creating a competitive advantage.59 They suggest that change and competition are two external factors that could potentially influence how and
when a competitive advantage emerges, implying that the road to competitive advantage is volatile and can be externally influenced. For example, significant recent changes within the mobile phone industry have
knocked Nokia, the early market leader, from its top position. Such shifts
in the competitive market place can delay or speed up the achieving of
competitive advantage by a given organization. The actions of competitors

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represent another factor that can change this timing, and suggests that a
strong internal culture alone does not necessarily lead to a competitive
advantage.
In summary, while the research covers a wide array of elements and
influences on organizational culture, it does not draw consistent or comprehensive connections with performance or the establishment of competitive advantage. Additionally, existing frameworks and models focus on
isolated dimensions of organizational culture rather than on combining
them to build a more complete picture of organizational culture.
WHATS MISSING?
The research on organizational culture started in earnest in the 1980s
and blossomed during the 1990s and 2000s. Recent literature, at least from
a scholarly perspective, has been less voluminous. Perhaps the notion of
culture as an influence on organizational performance is now so widely
accepted that there is little need for additional research. Earlier literature
suggests that at least conceptually, scholars assume a positive relationship
between organizational culture (especially if strong) and performance. Indeed, in a recent, albeit informal, survey of participants in an executive
MBA program with more than 300 combined years of managerial experience, none questioned the assumption of culture being critical and useful
as a way to create competitive advantage. Has it become so much a part of
management thinking that we understand all we need to? In an effort to
avoid complacency, should we not periodically ask if something is amiss
or perhaps missing? On (too) many occasions, research based upon a long
history of solid evidence has been questioned, and conclusions sometimes
overturned. From Copernicus quietly questioning the orbit of the earth to
Darwins challenge of human development to discoveries of new planets
and reclassification of known planets (e.g., Pluto), scientific research has a
tradition of reviewing what may or may not still hold validity.
In management, similar paradigm shifts may be less dramatic, yet questions about assumptions have emerged. Books and ideas from the 1980s
and 1990s caused shifts in thinking but some of their conclusions now
seem outdated. Ouchis Theory Z, which focused on building employee
consensus and involvement in organizations, offered what seemed at the
time to be views about motivation that took the business world by storm.60
Several consultant/researcher based books have also shaken long-held
beliefs or helped scholars and managers look at questions in new ways.
Peters and Watermans In Search of Excellence raised the question of why
some firms appear to perform well over time and others do not.61 Jim Collinss Good to Great took the question further, comparing firms in similar industries to identify characteristics that seemed to distinguish ones
that had become great from those that remained just good.62 Peter

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241

Drucker also questioned the ways managers operate and suggested alternate approaches or, at a minimum, that leaders ask different questions.63
Each posed what seemed to be simple questions and found sometimes
unexpected answers.
Although we would like to be able to follow in the footsteps of some
of these works, we do not presume to be asking or answering fundamental questions of management in this chapter. Our goal is not to challenge
the generally accepted assumption that culture and organizational performance are linked. Rather, our goal is to consider what might be missing in the literature or might be pursued in future research to strengthen
our understanding. As is likely common with any new research, those at
the forefront of early research on culture and performance seemed to be
certain of the links they found between the two variables. With more
research, however, scholars often become less definite,64 and as described
earlier, shifts have occurred in characterizing the dimensions of culture
or when it can be a source of advantage. In this section, we look at what
else might be useful to understand about the links among culture, performance, and competitive advantage. We suggest three areas that might be
examined more closely, and raise questions that could be pursued. First,
how does knowledge about links between culture and performance relate to non-Western (North American and European) contexts? What, for
example, does literature based on experience in Asia, Latin America, or
Africa reveal about the role of organizational culture on competitive advantage and performance, and is this the same as in the Western context?
Second, is it possible to have a strong, positive culture, yet poor performance? Conversely, can an organization have high performance yet poor
or negative culture? Under what conditions might these situations occur?
Finally, the literature focuses heavily on the importance of creating strong
culture, but there is less evidence or discussion of how to sustain this over
time. What mechanisms are needed and how might these vary across different types of organizations or sectors?
CULTURE AND PERFORMANCE IN AN
INTERNATIONAL CONTEXT
The literature on culture and organizational performance from an international perspective is deep in some areas but less so in others. Moreover, like much of the other literature on culture, it is somewhat dated.
Researchers from France and the United Kingdom have, for example,
found that the connection between culture and growth was stronger than
that between culture and performance.65 Researchers there also found that
leadership and culture are linked, certain types of leaders encouraging
different types of culture, and certain organizational cultures encouraging
leaders that support those cultures.66 Lee and Yu examined relationships

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between culture and organizational performance in Singaporean firms,


and found that industry sector may affect the types of cultures that emerge
(e.g., team oriented in hospitals, task oriented in insurance firms, and humanistic oriented in manufacturing firms).67 In addition, the strength of
the culture was positively related to performance in firms that were able
to adapt to changes in the environment.
Although researchers are urging more work to be done by indigenous scholars within developing or emerging economies, especially regions like Latin America, Africa, or South and Southeast Asia, less is still
known about culture in these parts of the world than in Western Europe
and North America. Further, although culture and performance have been
examined from the perspective of international management and multinational firms, they have received less attention from the perspective of local
firms in emerging economies. Given the growth of emerging economies,
more data that reflect companies from Asia, South Asia, and Latin America
should be available to examine. This opens the possibility of exploring entirely new dimensions of culture. For example, does indigenous culture in
areas such as East and Southeast Asia, where a strong Confucian influence
remains, influence the development of strong organizational cultures, and
how does this relate to performance? Many transition economies that are
moving from planned to market-based systems have now had 20 years of
(generally) open economic conditions. Yet in countries such as Vietnam,
where culture and a history of traditional patterns of behavior dominate
(e.g., hierarchy, being told versus taking initiative, jumping at opportunities regardless of their strategic value),68 organizational culture may
be hard to establish independently of the existing (strong) local culture.
Without further research, we have no clear sense of the issues and challenges; yet as firms operate globally, greater understanding will be useful.
In contrast to the relative dearth of research coming out of emerging
economies, there is quite a body of work on the impact of mergers/acquisitions on culture and performance, including some in an international
context.69 As international mergers and acquisitions have increased in the
last two decades, they have faced challenges of having to blend cultures,
and performance has not always been as hoped for. This should not, however, come as a surprise. A sizeable literature on mergers and acquisitions
suggests that even in domestic acquisitions and mergers, culture plays a
critical role in long-term success, which has traditionally been quite low.70
According to a survey of 200 top European executives, compatibility and
ability to integrate the new company was the most important success
factor, even more important than financial performance.71
One of the most studied failures in terms of cultures not merging was the
Daimler-Chrysler merger (which was revealed to be more an acquisition
of Chrysler, despite the public relations campaign to the contrary). Within
one year of the 1998 merger, only one-third of the Chrysler executives

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243

remained. Within two years, all the top U.S. executives had left, retired, or
were fired, and board size fell from 17 to 13, of which 8 were Germans and
only 5 were from the United States. Ultimately, Daimler sold Chrysler to
Cerberus Capital in 2007. A major reason for the failure according to both
scholars and executives who were willing to comment on it was that the
organizational cultures of the German Daimler and American Chrysler
were like oil and water, completely incompatible and unable to mesh. Like
many other such deals, cultural compatibility is critical but was (and continues to be) explored too lightly during the due diligence phase.72 This
case serves to illustrate the need for greater investigation into the role that
culture plays (or does not play) in supporting performance and competitive advantage in an international context.
MISMATCHES BETWEEN CULTURE AND PERFORMANCE
As discussed earlier, the research suggests that strong culture is linked
to high performance. But can organizations perform well when they do
not have what management scholars might consider to be a strong or positive culture, or conversely, can an organization have a strong culture yet
encounter employee turnover or poor performance? Under what conditions might these situations occur? One study did reveal that this is possible, and the one variable that seemed to help explain the difference was
whether firms had cultures that were appropriate for their industry sectors
and environments.73 Beyond that, we have little clear evidence or indication of the conditions under which these counterintuitive outcomes may
occur, whether it occurs in certain sectors, during certain points within
economic cycles, or in periods of political or technological instability or
other environmental states. Yet, it appears that such situations do occur, as
we discuss briefly in the following two examples.
High Performance, Unclear Culture
At a recent meeting of eight CEOs from a variety of industry sectors including sports, software, the arts, and government, one said that culture
is so important for his firm that if you look away for just a moment, it
can slip from your fingers. The others nodded in agreement and shared
stories about how they focused daily on making sure the message of culture was clear within their organizations. But what if it is not viewed as
being so critical? Can an organization with an unclear or weak culture
perform well? What if top management seems somewhat oblivious about
the role of culture and its importance? During the financial crisis of 2007
2009, several organizations experienced major declines in performance.
Discussion was rampant about whether the risk-taking cultures of investment banks led in part to the crisis, as described, for example, in Too Big to

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Fail.74 One bank that has received much attention over the years is Goldman Sachs. As far back as 1999, the book Long-Term Greedy characterized
some Goldman bankers in less than positive terms.75 Even during the crisis, however, the bank performed well compared to many of its peers. In a
2010 Charlie Rose show interview, Goldmans CEO Lloyd Blankfein was
asked what he thought had led to the behaviors that caused risky investments and decisions, where the callousness in the e-mails read before
a Congressional committee stemmed from, and whether it was a single
individual or if there was a culture of callousness. Blankfein waffled,
almost as though the idea of culture had not been something he had considered or focused on as a CEO, responding,
we have to be thoughtful about that [the culture] . . . I cant at this
point . . . I cant exclude [the culture] . . . there are 35,000 people at
the firm . . .
When asked what does contribute to Goldmans performance. Blankfeins response was that
we recruit and hire the best people and we retain them . . . because
we get people who are really interested in doing something that they
think is good for the public. . . . We get a kind of person who wants
to be influential . . . the people would like to do well for themselves
but at the height of their careers go into public service.
So just how important is a strong culture to performance? Other than
anecdotal evidence, we have little clear information about the extent to
which culture contributes to high performance or competitive advantage.
Strong Culture but Potential Turnover
One of the best-performing organizations in the United States, which
has over the last five years worked to build a culture of innovation, problem-solving mindset, accountability, and responsibility, has long attracted
excellent people. For entry-level positions, it consistently receives 100 applications per job opening. One middle manager at a different organization reported that seeing the CEO go on television five years ago to admit
that the organization had made a mistake was a trigger point for him.
That a senior manager would publicly apologize said to him that this
was a place with a culture of doing things right. He decided to leave
his existing employer and take a lower-level position at the organization in question just to be able to join an organization with a better culture. Since he switched organizations five years ago, he has moved back
up the ranks and continues to believe it was the best career decision he
ever made.

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When the CEO took over just five years ago, he realized the organization had what he called the cancer of complacency. It was a good organization and had been well run for 20 years by his predecessor; thus when
a crisis hit, the assumption was that one employee who did not follow policy was the cause for the mistake and should be fired. The CEO, however,
began looking in more depth and concluded that the culture needed to
change to one where the good enough attitude was unacceptable. Over
an 18-month period, the units supervisors developed three key pillars
that were a key to building and maintaining high performance and that
became the foundation for a culture of constant improvement over the
next several years. They included, for example, being sure that staff members were considered first in important decisions, and that the concerns of
the broader community in which the organization operated were also considered in the decision-making process. The culture has helped spread a
reputation among potential applicants as well as customers that this government agency is becoming the agency of choice when people need its
services. It has introduced several innovations that none of its peer institutions have adopted, saving several hundred thousand dollars annually.
Yet even this organization, with quantifiable benefits stemming from
an innovative culture and widely acknowledged positive and supportive
culture, found itself stymied within the last year. Circumstances beyond
its control led to a change in the market area it would cover. A peer organizations members began rumors that lower-level employees with short
tenure would lose their jobs and should jump ship to ensure they had
a job. Further, and especially irritating to senior management, was that
recruitment took place during work hours when employees of the two
organizations happened to meet on overlapping work or job sites. The result was that four employees did leave. The stated reason was that pension benefits at the competitor organization were better even though the
culture, which employees would experience every day, was not as strong.
So can culture be a competitive advantage? Anecdotal evidence suggests
that although it can, additional research is needed to better understand its
leverage and its effects and influence.
HOW TO SUSTAIN A CULTURE OVER TIME?
A third area where more research is needed is the sustainability of culture over time. Although existing literature discusses the elements of culture and how to create and build a culture, there is less discussion of how
to sustain a strong culture over time. Leaders of successful organizations
who recognize how organizational culture contributes to performance also
realize how fragile it can be. They also use quite different approaches to
sustaining and strengthening culture, depending upon the members of the
organization and where the organization is in its development. We present two short case studies of organizations that have each demonstrated

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several years of high performance and creativity to illustrate how some organizations seek to sustain culture. One case comes from a university athletic setting, many of whose organizational members are students (young)
and transient (25% turnover, new students each year). The second case is
of an organization founded 30 years ago but that has doubled in size over
a two-year period, making it harder for the founder/CEO (the original
creator of the culture) to touch each person individually.
The Test of Culture
Chris Petersen is the coach of the Boise State University football team.
He has been rated by different organizations as being one of the best
coaches in the United States for three years running, and his team consistently ends the season with a high ranking and increasing attention.
He places great emphasis on the crucial aspect of system or culture in
his program, choosing players and coaches largely on whether they are
OKGs or our kinda guy. This means players and coaches who in his
words are high output, low ego, and understand and are willing to put
in hard work and willing be part of a team. The system or culture focuses
on building integrity, good citizens, and being honest and transparent,
both for the coaching staff and players. His coaches seek recruits who are
great kids and good football players and who are also good students (he
claims that members of the football team have among the highest grade
point averages (GPA) of any athletes on campus). The program follows a
pyramid of success based upon a legendary basketball coachs ideas76
and includes basic values and expectations, ways to act, and specific goals
that the team and the program seeks to achieve in any given year (e.g.,
achieving a certain number of 3.0 GPAs within the team, winning an
end-of-season bowl game). Coaches talk about the culture and values
of the program, model what they mean in their interactions with players,
and seek other ways they can to highlight and reinforce their message.
One of the simplest ways they do this can be seen only behind the scenes,
away from journalists and crowds.
In the typically three- to four-hour-long evening meetings that coaches
hold after practice each day during the fall season, coaches review film
taken during practice and consider what plays they will put into the upcoming game. By the end of the evening meeting to discuss the offense,
only the key coaches remainthe offensive coordinator, assistant coordinator, and Coach Petersen, whose background is in offense. During one
meeting, a graduate assistant (GA) entered the room with a sheet of paper
that required the head coachs review and signature. To an outsider (a
professor) sitting in the room, the assumption was that the paper was a
listing of the GAs hours that the coach had to verify. Instead, the paper
was a test that players would take the next day on a few of the programs

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values. Each week, a test focuses on some aspect of part of the programs
core values, and as the semester progresses, the players have to know and
understand more about these values. Because the values and culture are
so important to the programs success, modeling behavior, instilling integrity in practice sessions and interactions with players, and even having
frequent short tests on the values all help sustain the culture. According
to Coach Petersen, by their third year in the program, players ace the tests
because they are steeped in and know the culture well, and the values become a part of how they operate.
Culture and Subculture
Healthwise is a not-for-profit international provider of online health
information and tools (it is, for example, a content provider for WebMD),
founded over 35 years ago by Don Kemper, who remains CEO. Building
and sustaining a culture focused on respect, inclusiveness, and transparency has been a hallmark of the organization since its beginning. It continues to be crucial to the six-person executive team, which spends at least
two hours a month discussing the organizations culture and how to preserve and nurture it even as the organization changes. Some key elements
of the culture involve a focus on getting the job done, not just spending
time, which provides flexibility in work hours and location for employees. Transparency of information encourages (perhaps more than some
would like) frequent meetings to ensure that everyone who needs to understands key issues. The culture is constantly discussed within the organization and modeled by managers. When deviations from it emerge,
people take the time to talk about how or whether certain actions enhance
or hurt the culture.
Job applicants (and aspirants who wish to apply for a job someday)
mention its culture as a major attraction. Senior managers say that depending on the position, the organization routinely receives 50500 applications. In 2010, for example, 120 people applied within 24 hours for a
receptionist. For all jobs, the interview/recruitment process is extensive,
comprehensive, and grueling for both recruiters and applicants. For those
who pass the initial screening, there is a phone interview followed by a
day of in-person interviews with three to four people in the functional
job area. The next step consists of a full day of interviews with 1012 individuals at all levels and several areas of the organization. If the applicant
makes it through this stage in the process, the final stage involves a case
study or assignment that replicates job tasks. The process itself conveys
much about what the organizations members consider important, and in
particular, the criticality of finding people who fit the organizations culture. The success rate is high, and turnover consists mainly of employees
who retire or move from the area. Rarely do people leave for other reasons.

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Nevertheless, as the organization grew beyond a tipping point of about


150 people,77 the CEO sensed changes, and the semiannual survey of employees revealed that several mentioned a decline in the Healthwise
culture. As Kemper investigated further, he realized that teams were developing their own (sub)cultures and employees were understandably
feeling closer to a team culture than to the culture of the organization as
a whole. In response, organization leaders began to urge team managers
to create subcultures that work for the teams, but with an understanding
that these cultures should mesh with the organizational culture but not be
dominated by it. Even more telling is the fact that when the surveys are
done, there are typically several pages of handwritten comments, both
positive and negative. To respond to the comments and to reinforce one
of the key elements of the Healthwise culture, transparency, the executive
team began holding regular fireside chats during the lunch period. During these chats, each executive with responsibility for an area that received
a negative comment responded to the comments. Specifically, what would
the organization do if action was possible, or if not, why was change not
possible. Again, the process helps to reinforce values of respect, inclusiveness, and transparency and communicates that any question or issue is
open for discussion. Employees may not always agree with decisions but
they will know why managers make them.
WHERE NEXT?
In this final section of the chapter, we propose ideas for possible research questions based both on existing research and on areas that could
generate new knowledge, particularly the link between culture and performance and the extent to which this link may hold. Although there has
been much research on the relationship between strong culture and high
levels of performance and some on the relationship between poor culture
and low performance, what about the other two combinations? In particular, under what circumstances might an organization have superior performance despite a poor or weak culture, and why might an organization
with a strong culture experience poor performance? Are these situations
characteristic of transitions (to low performance/weak culture or high
performance/strong culture) or are they positions worth examining and
understanding in and of themselves? Starting with the excellent firms
research of Peters and Waterman,78 we see evidence of how performance
changes over time. Many of the excellent companies with strong (at the
time) cultures no longer exist or can be considered to be exemplars of high
performers. This highlights the challenge of maintaining a strong culture
and raises two important questions: are cycles in the relationship between
culture and performance the norm and does culture shift during the cycle
and if so, what influences the shifts. Potentially more interesting is the
question of whether organizations can move themselves from one position

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to another if so desired. We raise these questions not because they are new
but because so little research has been done on them. An exception was
Kotter and Hesketts book Corporate Culture and Performance, in which they
analyzed and outlined several, at that point timely, examples to support
their hypothesis that there is a positive but weak correlation between corporate culture and performance.79 Indeed, they argued that the statement
strong cultures create excellent performance was questionable.
To better map the possible relationships between culture and performance, we use a 2 2 matrix (Figure 11.1) to illustrate the combinations of
performance (high, low) and culture (strong, weak). Each quadrant represents a position that an organization may find itself in. Based on the relationship between culture and performance described earlier we might
expect to find organizations in quadrants 1 and 4. Most literature would
suggest that quadrant 4 represents the most desirable scenario, but for
firms in this quadrant, is culture also a competitive advantage? In contrast, what are the implications for organizations that find themselves in
quadrant 1? And what is the significance of organizations in either of the
other two quadrants?

Figure 11.1
Positions for Organizations

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Kotter and Heskett noted that at the time of their study (19771988)
several companies fell into quadrants 2 and 3. They claimed that there
were several reasons for this. First, high performance in a weak culture
organization may result during and after an unrelated merger or acquisition that improves economic performance but does not generate a cohesive organizational culture, at least early in the arrangement. Another
reason is that that high-performing organizations may shift from having a
strong to a weak culture as a result of arrogance, bureaucratization, or
complacency, defined as the failure to adapt to change and the erosion
of the culture fit over time. The Ada County sheriffs office in Boise, Idaho,
provides a recent case of complacency and a weakened culture (quadrant
2), which ultimately allowed the most dangerous inmate in the jail to escape.80 Although many people chalked up the escape to poor security, the
sheriff on the other hand looked into the organizations culture and determined that the breach was more a result of a past culture of we are good
and theres no reason to change. As a result, he and his senior managers
initiated discussions that reviewed and dramatically changed the culture.
By asking what is the purpose of this organization, the agency developed three key values: safety of staff, security of the facility, and wellbeing of inmates. Having clarity in the organizations values now drives
the actions and decisions of every member of the organization. In addition,
and in part due to the willingness to question the organizations purpose
and operations, a more innovative climate is emerging, with members of
the organization trying out new ways of doing things within their units
(quadrant 4). As a result, the agency has become one that peers from the
rest of the country look to for new ideas.
If we look to a 30-year-old study as a source of possible research questions today, it is important to ask how well the observations from the study
have held up. How have the cultures and performance of the companies
fared over the last 20 years? Have there been shifts within the matrix? The
results are, perhaps, to be expected. Some of the high-performing organizations or organizations with strong cultures have either disappeared (e.g.,
H.F. Ahmanson) or lost significant market share (e.g., Hewlett-Packard),
or would no longer be considered strong performers today based on culture and financial performance. H.F. Ahmanson was a large savings and
loan association, also known under the name of one of its subsidiaries,
Home Savings of America. They had the highest corporate culture score
in their category but were classified as having relatively strong cultures
and relatively weak performance. However, the company was acquired
by Washington Mutual in 1998 and ceased to exist. One reason for their
acquisition might have been that despite their strong culture, the organization was not sustainable, absent strong financial performance. Similarly,
Hewlett-Packard had a high corporate culture score and a decent score
on performance. Over the years, however, the company went through

Organizational Culture, Performance, and Competitive Advantage

251

significant culture change stemming largely from the leaders shifting


focus (invention, then focus on the CEO during the Carly Fiorina years,
and severe cost cutting during the Mark Hurd era) and performance declines. Recently, performance has been mixed, with some improvement,
but even more recently it has become obvious what happens as a result of
erratic strategic decisions (and another new CEO).
The questions proposed here highlight the fact that there has not been a
comparable analysis of organizations and their performance and cultural
strength since the early 1990s, making it difficult to use recent examples
to illustrate shifts within the matrix. Although the matrix offers an outline
based on where most of the research on organizational culture has been
conducted, it is not comprehensive enough to serve as a new model. It can,
however, be used as a starting point to analyze important aspects in the research process. Although Kotter and Hesketts corporate examples might
be a little outdated, the results of their study are still relevant today and
can be used as a starting point in developing a new framework on organizational culture. Newer and more up-to-date research on todays top and
low performers can also contribute to updating and developing a theory
of organizational culture and the importance of organizational culture for
success. Research topics follow cycles of being more in or out of fashion;
organizational culture was a major focus for 20+ years and, as mentioned
earlier, may be so ingrained in the managerial thinking that it demands
less attention. But perhaps because of its deep-seated and long-term existence, it makes sense to revisit its role.

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77. Malcom Gladwell, The Tipping Point: How Little Things Can Make a Big Difference (New York: Little, Brown and Company, 2005).
78. Peters and Waterman, 1982.
79. Kotter and Heskett, 21.
80. Gary Raney and J. A. Schwarz, Turnaround in a Good Jail. American Jails
21, no. 6 (2008): 6165.

Chapter 12

The Emergence of Business Ethics


Krishna S. Dhir

Hlsmann described a free market system as a system of social cooperation based on the respect of private property rights.1 Adam Smith described the private acquisition of goods and their truck and barter for
other goods, to be part of the range of natural liberty, and John Locke
claimed that the right to property requires no justification because it is
rooted in the self-evident, axiomatic right to freedom.2 In a market system
that is entirely free, each individual who engaged in any business transaction would be free to utilize his own intellectual and material properties,
along with his own physical and intellectual capacities. Free competition
in the business environment would also constrain the individual from
using the properties and capacities of another. However, within the limits of using ones own properties and capabilities, each individual would
be free to deploy any set of precepts to their conduct. Not only would the
individual be in a position to define their own ethical system, they could
enforce the system by making it a prerequisite for a business transaction,
demanding its respect as a precondition for cooperating with others. Business ethics emerges from a system of beliefs and values held by individuals. Each individual engaging in a business transaction has an expectation
of conduct on the part of the other individual participating in the transaction that is acceptable to them, per their own ethical system. Business ethics thus arises from the expectation of others.

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A business transaction involves a minimum of two individuals, and


as a result of the transaction, property changes hands. The buyer seeks to
purchase factors of production such as raw materials, tools, or services,
from the seller, whereas the seller seeks to sell goods or services to the
buyer. If each individual adheres rigidly to an ethical system related to
their property and abilities, and to the precepts of conduct that are entirely distinct and differentiated from those of the other, a transaction is
not likely to materialize. The individual buying the good or service expects that the asset or service acquired will become their property, which
may then be enjoyed in whatever manner they choose, even as they expect
the seller to give up the right to do the same. The seller expects to be adequately compensated through the acquisition of assets of value deemed
by them to be of at least equal value to that of the asset being sold. Each
expects that the transaction will be based on free will exercised by each
party, without coercion. To form a basis for a transaction to occur, a set
of precepts must therefore emerge based on elements of the respective
ethical systems that they share, which adequately recognizes the property rights and respects the ethical system of the other. As stated by Hlsmann, By the very nature of their activities, businessmen are inclined
to consciously endorse the legitimacy of private property as an ethical
postulate . . . there prevails in business communities a tendency for the
spontaneous ( freely chosen) convergence of all persons toward such an
ethics.3 It is implied that no institutionalized moral authority is required
to bring about such a convergence.
It could be argued that in seeking increased economic value, business encourages greed and deviation from ethical conduct. Business
thrives at the expense of its competitors and that it therefore does not encourage . . . a spirit of cooperation.4 However, Hlsmann counters this
argument noting that as long as private property rights are respected,
competition cannot come at anybodys expense in the sense that it destroys physical property.5 Competition may indeed result in the reduction of the market value of goods or services, but as a result of market
forces, and not by coercion or violence to individual rights. An individual
in a competitive situation may come to realize that a collaborative strategy, one that pools complimentary resources and the abilities of two or
more individuals to address a competitive challenge, might bring about
improved outcomes in the marketplace. A group of individuals might,
therefore, come together to form an organization that realizes synergy and
efficiency. Others, too, may choose to interact with this organization to realize benefits. As was the case with the interaction between a buyer and
a seller, an individual collaborating with members of their own organization would seek in such interaction a system of ethics and behavior that
is consistent with ones own precepts. Each member of the organization
would expect that the conduct of the organization as a whole is based on

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free will exercised by each of its members without coercion. A common set
of precepts, shared by the individuals, has to emerge through collaboration between the organizational members and based on shared elements
of their respective ethical systems, that adequately recognizes the property rights of the other and respects their ethical system, for a transaction
to occur. This common set of precepts becomes the foundation for corporate ethics. The ethics of collaboration emerges from the recognition that
an organizations pursuit of a common mission and set of goals requires
adherence to a shared ethical system. Once again, corporate ethics arises
from the expectation of others.
Corporate ethics may be further shaped by the expectation of external
stakeholders of a business organization. Hlsmann goes so far as to assert
that the spontaneous convergence of interacting parties toward a common
ethics creates opportunities for virtues such as honesty and justice.6 Indeed, having recognized a modern corporation as a legal entity, society
expects it to be socially responsible. Hawtrey and Dullard state that, in
the eyes of . . . the community at large, the corporate sector should be intentional and collegial about virtue.7 According to Novak, a great moral
responsibility is inherent in the existence of corporations.8 Despite this, a
litany of corporate scandals have been observed through much of the history of the institution of corporations.
In the aftermath of the Enron debacle in January 2002, the Business
Week/Harris poll revealed that only 33 percent of individuals living in the
United States believed that large companies had ethical business practices, and just 26 percent believed that they were straightforward and honest in their dealings with consumers and employees.9 The situation has
not improved since then. In December 2010, a new Harris poll found that
the oil, pharmaceutical, health insurance, and tobacco industries, as well
as the telecommunications and automobile industries, were deemed least
likely to be honest and trustworthy. Oil companies were trusted by only
4 percent of those polled, and tobacco companies by a dismal 2 percent.
The telecommunications and managed-care industries were least trusted
to handle personally identified information.10
THE OCCURRENCE OF CORPORATE SCANDALS
Public trust in corporations has been severely compromised even
though over 90 percent of Fortune 500 companies have ethical codes of
conduct reminding their employees and stakeholders of their shared beliefs and values, and indicating the responsibilities and behaviors expected
of them by their respective employers.11 Widespread declaration of codes
of conduct by corporations imply that corporate managers are aware of
appropriate ethical behavior and societal expectations. Even though trust
is an essential element of business transactions, ethical breach of trust is a

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commonplace phenomenon, seen worldwide. Failure on the part of corporate executives to meet their responsibilities to stakeholders suggests a
lack of understanding of the gravity of the situation. As stated by Dhir, It
is imperative that executives in industry and corporationssenior executives in particulartake to heart the lessons learned from recent corporate
scandals of unprecedented scale and audacity. On these executives lies
greater responsibility today than ever before to meet societal expectations
of ethical conduct.12 Corporate greed and managerial self-interest have
manifested in major scandals, bringing highly regarded companies to disrepute. A few cases are described to provide a sense of the audacity and
scale of these scandals.
Enron, a global company in the business of trading and marketing natural gas and electric power, disguised debts from failed projects through
accounting loopholes and questionable reporting. Their purpose was to
mislead investors and unethically project the company as one that held
great promise. Through the 1990s, Enron stock price increased by 311 percent to give the company a market capitalization of $63.4 billion, six times
its book value!13 However, a whistleblower, Sherron S. Watkins, Enrons
vice president for corporate development, exposed Enrons corporate culture of fraud, and the house of cards came crumbling down.14 Investors
lost nearly $90 billion when Enron stock prices dropped from about $90
per share to about $1 per share through 2001.15 Ultimately, Enron declared
bankruptcy and ceased to exist.
The scandal raised questions about the role played by Enrons audit
and accounting partner, the erstwhile highly reputable Arthur Andersen.
The colossal failure of Arthur Andersens auditors to appropriately report
on Enron destroyed its reputation and led to its dissolution. Arthur Andersen was charged with and found guilty of obstruction of justice for
destroying records after investigations into Enron had begun.16 The scandal also raised questions about the appropriateness of allowing auditors
to also serve as consultants to their audit clients. Calls were made for the
regulation of large accounting firms. It was argued that Arthur Andersen
was at best lax in auditing Enron because it got larger fees from consulting for Enron than auditing the companys books.17
Enrons bankruptcy was the largest corporate bankruptcy in U.S. history, until WorldCom broke the record the following year. The WorldCom scandal was also rooted in accounting irregularities. The companys
growth had been sustained through mergers and acquisitions. When
WorldCom merged with MCI Communications in 1998, the $37 billion
merger was the largest ever in the United States. In 2000, when the telecommunications industry experienced a downturn, WorldCom CEO Bernard Ebbers was under pressure to cover margin calls on his WorldCom
stock that he had used to finance other businesses. He took loans in excess
of $400 million from WorldCom to cover the calls, putting the company

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under further pressure. Under the direction of Ebbers and other officers,
the company deployed fraudulent accounting practices to underreport
costs and inflate revenues, thereby hiding declining earnings and projecting a false picture of growth and profitability. Subsequent investigation
revealed that the value of WorldComs total assets had been inflated by
around $11 billion.18 In 2005, Ebbers was sentenced to 25 years in prison
for securities fraud, conspiracy and filing false documents with regulators.19 In his 2012 State of the Union address, President Barack Obama
called on the U.S. Congress to toughen the laws against securities fraud
and to strengthen the ability of the Securities and Exchange Commission
to punish Wall Street firms that repeatedly violate antifraud statutes.20
Examples of large-scale corporate scandals are not isolated to the
United States. Based in Switzerland, Asea Brown Broveri (ABB) describes
itself as a global leader in power and automation technologies that enable utility and industry customers to improve their performance while
lowering environmental impact.21 It was created through a giant merger
of companies in the Swiss-German and Swedish heavy industry sectors
in 1988. Its market capitalization soared eightfold and was valued at $25
billion by February 2000. However, the company turned out not to be the
earnings juggernaut it was made out to be. Just a year later, it was discovered that about 28 percent of reported net income between 1998 and 2000
was actually from nonoperating sources such as property and business
disposals. This was not an isolated incident. It came to light in 2002 that
the erstwhile CEO, Percy Barnevik, had been paid an undisclosed severance package of $78 million without the knowledge of ABBs board of
directors.22 In 2007, ABB admitted to have violated the U.S. Foreign Corrupt Practices Acts ( FCPA) antibribery law with questionable payments
in Asia, South America, and Europe (with a particular focus on Italy).23
In India, the Satyam Computer Services scandal became public in January 2009 when Satyams chairman, Ramalinga Raju, admitted that the
corporate accounts had been falsified. With that admission, $2 billion of
wealth belonging to 300,000 shareholders was eroded in a single week.
The scandal also marked a failure of Price Waterhouse Cooperss auditors
as a number of financial irregularities were discovered. For instance, Satyams actual number of employees was found to be around 40,000, not the
previously reported figure of 53,000. Mr. Raju was allegedly withdrawing
200 million Indian rupees (approximately $4 million) every month to pay
the 13,000 nonexistent employees.24 Satyam came to be known as Indias
own Enron scandal.
The scale of some of the scandals is difficult to fathom. The 2008 bankruptcy filing of Lehman Brothers was the largest ever in the United States.
At the time, Lehman Brothers held $613 billion in assets, and when it
failed, the whole world stopped lending money. In December 2010, Ernst
& Young was charged with assisting Lehman Brothers commit massive

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accounting fraud.25 To put the numbers in context, in 2010, the total value
of exports of U.S. goods to Europe amounted to about $240 billion. With
the value of corresponding imports of $319 billion, the United States recorded a deficit in trade with Europe of only about $80 billion.26
Wal-Mart is the United States largest corporation, employing about
1.3 million employees. Nobel Laureate Paul Krugman noted in 2006 that
on average, Wal-Marts nonsupervisory employees were paid a meager
$18,000 per annum. In contrast, its chairman, H. Lee Scott, was paid a salary of almost $23 million. Krugman observed that the past decade or so
has seen a massive transfer of wealth from the middle class to the wealthiest.27 Admittedly, debate continues on whether disparities resulting from
the dynamics of the marketplace should be regarded as scandalous. Unfortunately, however, unethical practices have contributed significantly to
the transfer of wealth lamented by Krugman. The cases described above
barely scratch the surface of the scandals of our times. The actual list of
scandals of the past decade or so is astonishingly long. Some of the more
notable cases include those of
AIGimproperly bolstered reserves and allegedly violated insurance accounting rules
American Airlinesdeferred maintenance of aircrafts
AOL Time Warnerfraudulently inflated revenues by more than $1
billion between 2000 and 2002
BAE Systems (United Kingdom)caught in bribery scandal pertaining to contracts in Saudi Arabia
Bristol-Myersaccounting irregularities
Clearstreaminvolved in financial scandal in Luxembourg
Deutsche Bank (Germany)caught in spying scandal
Exxonoverreporting oil reserves
General Electriccharged with inflating earnings in 2002 and 2003
to beat expectations and mislead investors
Goldman Sachscharged with fraud in April 2010 for marketing
subprime mortgages, admitting to offering complex debt to clients
while betting against their ability to repay
Halliburtonovercharged for government contracts
Lockheedcharged with bribery in Germany, Japan, and the Netherlands
Parmalat (Italy)cited in Europe for accounting and mutual fund
fraud
Phar-Morallegedly lied to the shareholders

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261

Royal Dutch Shell (the Netherlands)overstated oil reserves


Saab Aerospace (Sweden)charged in 2011 with bribing South African officials over sale of jet fighters for which it blamed its collaborator, BAE28
Siemens (Germany)engaged in corruption and bribery of Greek
government officials during the 2004 Athens Summer Olympics
Socit Gnrale ( France)derivatives trading that caused multibillion euro losses
Tyco Internationalexecutive theft
Union Carbideendangered the community and caused deaths and
injuries in Bhopal, India
Xeroxaccounting irregularities, which also brought its auditor,
KPMG, under scrutiny
It is evident that corporate scandals have not been limited to any specific region of the world. As noted by Swedens anticorruption chief, Christer van der Kwast, You hear people say that corruption is something they
have in Africa, in South America, in Asia, but corruption takes two sides
to happen.29 These scandals attest to the continued and widespread lack
of top management commitment to ethical practices across the globe. It is
thus important to understand how the ethical behavior of key officers in
corporations can be managed. Why do corporate scandals occur, and why
are they so widespread? To answer this question, one must first comprehend the complexity of a modern corporation.

EVOLUTION OF THE BUSINESS ORGANIZATION


Hawtrey and Dullard provide a brief account of how the legal basis of
the modern corporation developed.30 The genesis of the modern corporation can be traced back to the Romans, who in the ninth and tenth centuries formed organizations known as societas maris (maritime firms).31
They had a structure to this organization, a socius stans or partner on land,
and a socius tractor or partner at sea. Hawtrey and Dullard recognize this
structure as an early origin of the division between capital and labor.32
Angell and Ames described how this form found subsequent favor in
France and England.33 Pollock and Maitland similarly described the development of the royal charter of incorporation.34 These charters were
the devices through which the Crown, or a countrys monarch, granted
considerable powers of self-governance to the church and boroughs (administrative territories) through the 15th century. By the 16th century, the
instrument of royal charter was being deployed in a business context to
raise capital for mercantile trade and to create infrastructure for public

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goods such as turnpikes, canals, and railroads. The purpose of these developments was to provide organizations a degree of independence from
the Crown in terms of rights of perpetual succession, ownership, and selfgovernance.35 Today, the process of applying for incorporation of a company in the United States and Canada results in the issuance of a written
document by the state, referred to as the corporate charter, through which
the society recognizes the company as a legal entity. This document is also
known as the certificate of incorporation or the articles of incorporation.
The 17th and 18th centuries witnessed a financial revolution that
brought rapid growth to joint-stock companies, banking, insurance, and
the first active stock market in Amsterdam.36 The emergence of the stock
market had a dramatic effect on business. It made it possible for anonymous buyers and sellers, who did not participate directly in business operations or corporate governance, to transfer shares of the company from
one party to another. By the time the Industrial Revolution occurred, the
distinction between public and private interests was already clear. By
the late 19th century, business organizations were greatly affected by the
spectacular emergence of mechanization and large-scale manufacturing.
After the severe depression of 1873, the nature of business changed from
a focus on light to heavy industry. To accommodate mass production and
associated economies of scale, organizations became large. Mass production also led to the significant expansion of consumption, and business
organizations diversified from manufacturing into marketing, financing,
and other essential business functions. As vertically integrated companies
grew in size and complexity, the need for specialized expertise and administrative structures also became evident.37
As firms became too large for one person to manage, the owner brought
in additional individuals into management. Although these individuals
specialized in various business functions, management of the organization remained centralized. The legal structure of firms also went through
a transformation. Businesses increasingly preferred becoming incorporated over functioning as partnerships. Incorporation provided the benefits of limited liability to individual owners who could sell or transfer
shares to others without disturbing the business operation. As stated by
Dhir, Mergers and acquisitions followed. Single-product, single-function
firms evolved into multiproduct, multifunction businesses.38 Acquisitions were no longer constrained by industrial boundaries. Companies
that manufactured electric machinery diversified into appliances, automobile manufacturers began producing refrigerators, and meat packers
used their by-products to manufacture soap. The management of diversified organizations required changes in the manner in which organizations
were managed. Through the 1920s, companies such as DuPont, General
Motors, Sears Roebuck, and Standard Oil were among the pioneers who
decentralized their respective organizations.39 To ensure adaptability and

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263

agility, managerial responsibilities were differentiated and distributed


throughout the organization.
SEPARATION OF OWNERSHIP AND CONTROL
The advent of the stock market and the large-scale exchange of shares
brought new complexities to corporate organizations. For example, in
1711, the South Sea Company, a British joint-stock company, came into
existence. It assumed Englands debt that had resulted from the War of
Spanish Succession. In return, it was given a monopoly to trade in Spains
South American colonies. There was great speculation about the value of
the company, and this speculation ultimately resulted in an economic bubble, the South Sea Bubble of 1720, which caused financial ruin for many.
To control such speculation, the Parliament of Great Britain enacted the
Bubble Act of 1720, forbidding all joint-stock companies not authorized by
a royal charter. Throughout this process of corporate evolution, the nature
of management shifted from a fellowship of personal acquaintances to
that of an impersonal collective.40 As ownership became increasingly distributed and diffused through shares changing hands in the stock market,
the ownership and control of companies became separated. Logistics considerations made it challenging for shareholders to deal directly with the
intricate decisions involved in operating a multiproduct, multifunction,
mass-production-based business operation. The inability of one person
or shareholders to manage a complex organization gave rise to specialists. Capital budgeting, marketing, labor and personnel relations, production, engineering, and a number of other functions required the skills
of specialists. With this division of labor, the decision-making authority
became vested increasingly in career executives, professionals who had
well-honed skills, but little ownership stake in the companies they managed. Diffused ownership was no longer in control, and the executives became arbitrators for the collective enterprise, allocating priorities among
management, shareholders, creditors, suppliers, employees, competitors,
consumers, regulators, and other interested segments of the society, such
as local, regional, national, and international communities. This resulted
in the broadening of corporate motivations and objectives.41
The issue of ethical dilemma is compounded by the separation of ownership and control. This separation creates an agency relationship that
emerges when one or more persons, the principal(s), hire another person
or persons, the agent(s), to perform a service.42 The principal(s) hire the
agent(s) for their specialized competencies, and delegate decision-making
responsibilities to them for which the agents are compensated in some
manner. The agency relationship that exists between shareholders and
corporate executives can be problematic. In modern, publicly traded corporations, the ownership of shares is highly diffused and shareholders

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Strategic Management in the 21st Century

have limited direct control. As a result, problems may emerge due to the
divergence of interests of shareholders and executives. Goals pursued by
the agents may conflict with those desired by the principals. For example,
shareholders may be willing to assume significant risk to seek maximum
returns for their investment within a reasonable period of time. In contrast, agents may implement strategic decisions that maximize their personal welfare and minimize their personal risk, thereby enhancing their
job security and compensation and protecting their reputation. The divergence of interests gives rise to managerial opportunism on the part of
agents that can involve guile or cunning or deceitful behavior. It is difficult for principals to predict agents behavior in advance or even to monitor it past the corporate veil.43 The ever-increasing scale of scandals being
witnessed and the unending waves of shameful malfeasance and larceny
attest to the prevalence of managerial opportunism.
While criticizing corporate executives for not fulfilling their responsibilities to their stakeholders, many have also called for an increased emphasis on education regarding ethics in our institutions of learning. There
is a need to build among corporate managers the capacity to resist the
temptation to engage in unethical behavior. The Association to Advance
Collegiate Schools of Business (AACSB International) acknowledges that
In addition to providing a return to owners, business is charged with
other straightforward tasksacting lawfully, producing safe products
and services at costs commensurate with quality, paying taxes, creating
opportunities for wealth creation through jobs and investments, commercializing new technologies, and minimizing negative social and environmental impacts.44 In reality, the straightforward tasks listed in
this quote seem anything but straightforward or easy. Adequacy of return to owners is assessed not merely in terms of the magnitude of return,
but also in terms of the time taken to generate it. Immediacy is emphasized by shareholders and other stakeholders, but again, the perception
of adequacy arises from the expectations of others. In most cultures and
in particular those observed in the Western world, the lack of early and
attractive returns threatens the job security of corporate leadership. Yet,
other considerations, such as producing safe products, enhancing quality, creating wealth, commercializing new technologies, and minimizing
adverse social and environmental impact may demand time or require
reduced pace of activity.45 There are a number of sources that give rise
to the constraints of time. For example, corporations compete with each
other in the market place to meet the needs and demands of their consumers, and other stakeholders, in a timely manner. If a corporation fails to
do so, its competitors step in before it can and the need for its efforts disappears, compromising the opportunities for its executives to meet their
responsibilities across the board.46 Indeed, an ethical dilemma is characterized by the need to (1) choose between equally desirable or equally

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265

unsatisfactory alternatives, (2) assign different or competing priorities and


responsibilities to alternatives, or (3) solve a problem that has no satisfactory solution. The dilemma may emanate from the decision makers
system of values, principles, or sense of duty, and may be exacerbated by
uncertainties of outcome or consequences resulting from the choice, assignment, or solution.47
EMERGENCE OF CORPORATE AGGRESSION
In an economy in which a planning period of a mere three months can
be described as the short term, and the long term may not exceed a
year or two, corporate leadership can perceive a threat to their job security
on an ongoing basis. To cope with the pressures of time, the metaphor of
war is often applied to describe the mode of corporate operations.48 Murphy observed that As a matter of social practice, the reality of conflict resolution in the United States today is largely a violent one.49 In the last two
decades in particular, Americans have demonstrated an increased reliance
on violence as a method of resolving conflict. This is true not only in terms
of military intervention in political crises, butperhaps especiallyin
terms of . . . the reality of everyday life. Today, expediency and efficiency
are typical and universal measures of effectiveness and success. Davis and
Meyer described how three factors, speed, connectivity, and intangibles,
drive the increasing rate of change in the economy.50 In a fast-changing
milieu, where time is deemed to be a scarce resource, the pressure of expediency and efficiency do not allow time for the acquisition of knowledge,
education of those involved or affected, or application of wisdom. The
language deployed by corporations when communicating about strategic issues is often one of linguistic violence, wherein the message is often
twisted to perpetuate unjust influence over stakeholders. For example, the
description of a product may overemphasize its positive functional qualities, and mask the unwanted or even harmful effects of its use. Consider
the case of toothpastes. They often use abrasive materials to scrub plaque
off the teeth. Softened silica, chalk, and baking soda are some of the substances used for this purpose, often in combination. However, during the
20th century, the addition of pumice to the toothpaste was not unknown.
Dental products that used pumice would promise white teeth and sex
appeal to the user, without reference to the harm done to teeth through
the loss of dental enamel.51
Bureaucratic organizations are designed to deal with change with maximum efficiency, and systems are designed to overcome delays. The human
fallibility of the individual is overcome through dehumanized processes.
The metaphor of war describes competition as the enemy. The implications for corporate communications, in terms of its mode and content, are
profound. Dehumanization can lead to aggressiveness.52 Aggressiveness

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occurs because dehumanization makes the universal norm against harming other human beings seem irrelevant. If the other is less than human,
the norm does not apply.53 Coercive strategies are frequently implemented to bring about desired outcomes even as corporations take pains
to articulate and communicate their visions of the future and their missions within society. Corporations seek to control and manipulate, or at
least influence, the cognitive domain of their stakeholders so as to enhance
their image and be deemed reputable as quickly as possible.54 However,
there remains a gap between corporate rhetoric and the reality of executive behavior. The gap generates skepticism and distrust by consumers
toward the corporations. This causes much of the corporate effort to boost
reputation to become counterproductive.55 The recent corporate scandals
mentioned earlier attest to the continued and widespread lack of top management commitment and communication skills as major challenges to
corporate social responsibility.
In an adversarial mode of interaction, corporations have an advantage over consumers. Vendel suggested that in the emerging knowledge
economy, the evaluation of product quality prior to its purchase is vague
and partial.56 He cites software companies, investment bankers, and management consultants as examples wherein the significance of reputation
derives from the fact that it is difficult for customers to observe or evaluate the quality of products before purchase since production takes place
only after purchase. He explains that There is . . . asymmetry in information between customers and software companies concerning the actual
expertise possessed by the software companies employees. Customers, thus, have imperfect information about software companies abilities to handle and fashion the information technology so that it fulfills
their information-processing needs. With the stakeholders already at a
disadvantage, corporate advertisement is often viewed as a coercive and
sometimes even violent form of persuasion designed to promote the objectives of the corporation. The objective of its rhetoric seems designed to
overcome resistance by consumers or other stakeholders. Impersonal and
anonymous, it promotes bureaucratic predictability.57 Yet it is expected
that in the marketplace, as in any public realm, one shares words and
deeds, thus contributing [ones] share of action and thought to the fabric of human affairs . . . where issues are decided in a way worthy of free
[people]: by persuasion and words, not by violence.58
EXTRINSIC AND INTRINSIC VIRTUE
Some scholars have expressed faith in extrinsic virtue derived from the
market for corporate control. Manne argued that if an agent reneges on its
duty to pursue the goals and interests of the principal, corporate performance will be compromised and stock price will drop.59 This will create

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an opportunity for a third party that recognizes the potential of the underperforming corporation to bid for its control and replace its management.
Manne described the market for corporate control as a mechanism that
promotes responsive corporate behavior. Easterbrook and Fishel agreed,
believing that market forces impose checks on self-interest run amuck by
promoting competition among management specialists, thus protecting
public interest.60 Werner, too, endorses this view stating that the share
market . . . operates as the external adjunct of the corporations internal
governance structure.61
Other scholars have expressed skepticism about the extrinsic virtue of
corporations responding to the market system. The scandalous behavior
of corporate executives demonstrates the ineffectiveness of the market as
a punitive mechanism for corporate control.62 These scholars argue that
even if the market were to prove useful as a disciplinary system to discourage inappropriate behavior, it does not promote any particular vision
of corporate virtue.63 Moreover, it offers no guidance for socially responsible behavior. They argue that a vision of virtuous corporate behavior must
emerge from within the corporation. Hawtrey and Dullard argued that
just as one or two individuals can have an adverse impact on society or an
organization, a single individual acting virtuously can make a positive
difference for good.64 The recent history of whistleblowing attests to this
possibility, as illustrated by the case of Jeffrey Wigand, former vice president of research and development at Brown & Williamson (see below),
and Sherron S. Watkins, former vice president of corporate development
at Enron.65 Hawtrey and Dullard called for a theology of corporate virtue
to address conflicts of interest in boardrooms. They are not alone in making such a call.66 Their arguments suggest that to search for a virtuous
corporation, one must search for virtuous executives in the corporation.
These calls are based on the assumption that being human entails living
in community and developing certain virtues or skills required for a humane life with others.67 Through the experience of living in a community,
human reason arrives at core virtues of humanity, truthfulness, compassion, loyalty, and justice. Why is it, then, that public trust in corporations
is at an all-time low despite over 90 percent of Fortune 500 companies articulating and publicizing the ethical codes to be complied with by their
employees and other stakeholders?
DECODING THE ETHICAL COMPLEXITIES
Stephen V. Arbogast examined the nature of corporate corruption and
the process through which it resists ethical decision making through indepth analysis of what transpired at Enron.68 He examined the sequence
of events and developments through a series of cases, successfully tracing the mechanisms of corporate corruption and the dynamics of ethical

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issues through their evolutionary path within a single firm. This approach
to the study of corporate ethics differs from the conventional approach,
which attempts to analyze and evaluate ethical issues arising from individual decisions examined in isolation, and removed from the dynamics
of sequential decisions. The conventional approach fails to capture the nuances that accompany the process of one decision leading to the next, and
in which the ethical issues emerging through subsequent decisions become reality only because of prior decisions. In most business schools, to
teach the nuances of ethics, students are presented with a narrative case,
and warned in advance of the presence of an ethical dilemma. This approach is characterized as quandary ethics.69 In reality, however, decision makers are not forewarned that their decision-making prowess will
be tested. Decision makers identify problems, formulate solutions, and
implement plans, while performing under varying degrees of stress, engaging in concomitant sets of activities, and interacting with others, all
under time constraints. This suggests that the primary model for exposing
students to ethical dilemmas lacks a fundamental relationship with reality, and as such, this may impact the effectiveness of how ethics is taught
to future business decision makers. Moreover, if virtuous decision making is desirable, then perhaps the existing models, however taught, are
inadequate in helping students to reach virtuous conclusions. Generally
speaking, the broad ramifications of business ethics are too complex to be
adequately analyzed through the study of a single corporation. However,
as noted by Dhir, Arbogast has demonstrated that exploration in decision
making, within a single firm such as Enron, offers a variety of case studies
of both (1) those decision makers who chose the slippery path for personal
gain at the expense of others, and (2) those who chose to resist violations
of ethical standards even to the extent of blowing the whistle on their own
employers at great risk to themselves.70 Arbogast investigated the key
moments defining the evolution of what is now referred to as the Enron
scandal. His analyses brought into focus the inter-woven connections between various issues.71 Arbogast traced this evolution through the development of a total of 17 case analyses. The striking feature of these cases is
that, when taken in their chronological sequence, they demonstrate how
issues in subsequent cases would not have existed if the issues in preceding cases had been handled ethically. It is rare to find pedagogical materials on corporate ethics where sequentially emerging issues have been
treated as a chain of cause-effect relationship. This approach of analyzing
a range of issues, as developed by Arbogast, yields a process of decoding the complexities of ethical situations in a comprehensive and cohesive
manner.72
The ethicality of a decision is difficult to analyze precisely because such
quality is not always explicit. One cannot necessarily determine a decision
to be either entirely ethical or entirely unethical. Ethicality depends on the

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expectations of external agencies, such as the society or the stakeholders,


whereas the process of making decisions draws heavily from the decision
makers personal philosophy, or beliefs and values. The course of action
chosen emerges from the trade-offs deployed by the decision maker. In
order to keep their executives on track, consistent with declared codes
of ethics and adopted norms, corporations often develop control standards and operating procedures to which the executives must subscribe.
Expediency, or worse, ill intent, may tempt executives to suspend these
standards, even temporarily, with the dangerous consequence of heading
down a slippery path. Dhir states, Ethical problems usually evolve over
time, with step-by-step violations of standards, even minor oversights, resulting in escalating severity of the departure from control standards, and
a loss of cultural, procedural, and legal checks and balances.73 Minor violations of standards may initiate an accepted practice of making temporary or short-lived exceptions to the rules, which over time might become
the defining culture of expediency, even touted as pragmatism, and loss
of sensitivity to the underlying principles. The lesson of the Enron experience is that minor exceptions allow for subsequent developments that
would not have been seen had the exceptions not been entertained. These
developments, in turn, may snowball into further developments, in gross
violation of not only the prescribed standards, but also of societal expectations. In the case of Enron, this culture resulted in a major scandal and
corporate disaster.
The lessons to be learned through the study of the Enron scandal are
inadequately treated in the pedagogical literature. This inadequacy is inherent in an approach that relies on stand-alone case studies to provide
the student with a feel for nuances involved in ethical management of corporations. Stand-alone cases do not adequately capture the full range of
interrelated issues that arise from temporary, but deliberate, violation of
ethical standards to facilitate implementation of decisions. They are inadequate for the task of communicating the milieu in which such temporary
violations exist or the impact they make on the organizational culture. If
pedagogical materials are developed consisting of case studies, all drawn
from the same corporation and each dealing with issues emerging from
ethical lapses described in the previous case, student learning could be
greatly enhanced. With such materials to learn from, students could effectively acquire insights into the dynamics of the decision process and
emerging culture that facilitates ethical violations. This is what Arbogast
did with his study of the Enron scandal.74
If the managers of a corporate organization are ethical individuals, one
might expect that the conduct of that corporation would be ethical. However, this assumption does not bear out as being true. Organizational
designs, processes, and procedures are developed for efficient flow of
information and accomplishment of tasks. Human beings perform the

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functions that link one process to another. However, the lesser the dependence on human judgment, the greater is the efficiency of the flow
of information and work. Corporations seek to overcome inefficiencies
associated with human fallibility. We see this principle at its best when
robots replace humans as links between processes. Dhir states, Dehumanization can lead to insensitivity towards those who are affected by
corporate decision making, especially if the affected individuals are far
removed and out of sight. Even ethical individuals need to be educated
and trained to handle organizational dynamics, and specifically to deal
with the complex nature of ethical dilemmas that confront them in their
corporate lives.75
Even the education of an individual in ethical decision making does
not necessarily solve the problem of promoting corporate ethics. Often the
curriculum on business ethics is developed from a top management perspective. Many times, however, managers coping with the consequences
of unethical decisions are at the middle management level. It is no accident that 16 out of the 17 Enron cases developed by Arbogast address
the challenges faced by middle or lower-level managers. They reveal how
the culture of the company was influenced by the hierarchical seniority of
those willing to make ethical compromises. It becomes difficult for managers who are lower in the organizational hierarchy to challenge the ethicality of decisions made by their superiors.76
To understand the inherent complexities in ethical decision making, Arbogast has developed a role-playing approach to analysis. He asks those
who would resist corporate corruption (or those learning how to become
ethical decision makers) from within the corporate organization to devise
a statement describing the key issue as clearly as possible. This sheds light
on the ethical dimension of the issue. He then asks the resistors (or the students of ethical decision making) to highlight those exceptional attributes
of the issue that differentiate it from the many day-to-day problems that
fall in the gray area of routine decision making. In the process of doing so,
the resistors (students) find themselves articulating the ethical outcome
that would be acceptable to them. In doing this, they define the boundary
condition that becomes the basis of evaluating their alternatives.77 They
are then asked to identify likely consequences of their resistance to the unethical aspects of the issue. They examine the potential consequences of
their resistance being unsuccessful, and whether the outcomes would be
acceptable if the worst-case scenario was to occur. However, at this stage,
Arbogast requires that the resistors not consider the mitigation of their
personal risk. They are asked to factor in their own personal risk only in
the last step of the analysis.78
Arbogast next asks resistors to formulate alternatives that do not violate the boundary conditions identified earlier, rendering the problematic unethical action unnecessary. The resistors are now asked to deploy

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this alternative plan of action to exploit opportunities to demonstrate the


flaws and excessive risks associated with the unethical options they are resisting.79 They are now ready to be challenged to develop a tactical plan
of resistance. The goal at this stage would usually be to seek a decision
that favors a specific ethical plan of action. However, at times, the goal
might be to minimize the risk or contain the damage wrought by deviations from the control standards. In the last step of the analysis, the resistors are urged to describe the worst-case scenarios. They are then required
to develop feasible actions that would render the worst-case scenarios unlikely to occur. These actions may require the resistors to seek allies, especially if the stakes are high. An alternative would be for them to seek
a transfer with their corporation. Of course, they might even consider resigning from the corporation all together.80
THE NATURE OF VIRTUOUS CORPORATE BEHAVIOR
Contemporary discussion of ethical decision making has been dominated by (1) the deontological approach that studies decision-making
behavior in terms of binding obligations, as in duty, (2) the utilitarian approach, which examines decisions in terms of the importance of utility
over beauty or other considerations, or (3) the teleological approach that
looks at the quality of the consequences of decisions. Ethical behavior,
however, focuses on the question What and how should I do the right
thing? Epstein offered a detailed review of the development of business
ethics and corporate social policy.81 However, Dhir reported that in the
evolving literature on ethical decision making one can discern emergent
interest in virtuous decision-making behavior as well.82 Virtuous behavior is discernible in its focus on the quality of individual or corporate character.83 It is demonstrated by the courage to act in protecting the rights and
welfare of others even with incomplete information about the potentially
significant cost to oneself.84 Courage is an essential element in virtuous behavior. The cost to the decision maker can be exorbitant and unmitigated.
Cuff provided a review of the works of philosophers, psychologists, and
theologians on the role of courage in decision making in the face of threats
to ones well-being.85 Virtuous behavior focuses on the question, How
should I be a better individual, a better decision maker? As discussed by
Dhir, ethical behavior need not necessarily be virtuous or courageous.86
It may very well be motivated by self-interest in cases where the welfare
of others and self-interest coincide. An ethical action does not necessarily
demand courage. Indeed, even unethical behavior may be courageous,
requiring the individual to face up to imminent danger, as would be the
case if one was to steal or commit fraud in spite of the prospect of being
incarcerated. Virtuous behavior, however, is unique in that it is both ethical and courageous.

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Virtuous decision making is evident when an agent attempts to ameliorate a special class of ethical dilemma. These dilemmas are characterized by following attributes: (1) a situation emerges that presents an agent
with a conflict between alternative courses of action, (2) urgent action is
demanded of an agent that cannot be postponed, and (3) the situation
requiring action is encountered unexpectedly, without foreknowledge of
the emergent situation. The emergent situation is not of the agents making, and at least one of the courses of action benefits the agents personal
interests, often with relatively low associated costs or risks borne by the
agent. In contrast, other courses of action are in the interest of others, often
with relatively high associated costs or risks borne by the agent. The timing of decision making may be awkward or inconvenient in that it allows
little, if any, time for study and research, consultation with experts, or detailed analysis. As is the case with any decision-making process, virtuous
decision making in the corporate setting requires that the agent make an
informed choice. Nevertheless, information is incomplete. Although insufficient time is available for the agent to research the situation, it is evident that certain alternatives may have different consequences for others,
and some would potentially yield significant benefits to others. To be virtuous, the agent must first recognize the dilemma, that is, the agent must
recognize that (1) there are conflicting obligations to be met, and (2) there
is no solution that would satisfy all the demands of the situation. Knowledge is a prerequisite for virtuous decision making. Through knowledge,
the agent must seek wisdom, or understanding or deep insight. A virtuous
decision maker must minimize the costs to stakeholders and maximize
their benefits, even at great cost to themselves.87
Consider the example of Dr. Jeffrey Wigand, vice president of research
and development at Brown & Williamson from 1989 to 1993. Just 10
months into his employment with the company, he realized that he had a
dilemma. His employers were claiming that their tobacco-based products
were safe for consumption, but since he had a confidentiality agreement,
he could not speak up about his doubts about these claims. He described
his dilemma as follows: I realized after ten months with the company
that I had made a mistake. I was making a lot of money. I had a wife, and
two daughters, one of whom required extensive medical coverage, and I
wasnt ready at that time to bring the wrath of the tobacco industry on my
family and me. So I looked the other way until laboratory testing showed a
controversial pipe tobacco additive, called Coumarin, to be a lung-specific
carcinogen in mice and rats.88 Finally, in 1993, troubled by the addictive
nature of the additive and its potentially harmful effects on unsuspecting consumers, Wigand took issue with his employers over the continued
use of coumarin in pipe tobacco. They fired him. When, during a 1994
congressional hearing, the CEOs of seven major tobacco companies swore
that nicotine was not addictive, Wigand decided to expose the perjury. He

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273

broke the confidentiality agreement with his former employers and appeared on the news show 60 Minutes in 1996 to report that Brown & Williamson was aware of the addictive nature of nicotine. He also described
how he and his family were being harassed with death threats. Initially,
CBS, the television network that airs the show, shelved the interview, fearing a lawsuit from Brown & Williamson. Wigand paid a heavy personal
price in terms of the breakdown of his marriage and financial insecurity.
However, the interview was subsequently aired, and Brown & Williamson
sued Wigand for breach of confidentiality. In 1997, Liggett Group broke
rank with the larger tobacco giants and came clean. With the subsequent
settlement between the tobacco industry and the states, Brown & Williamsons suit against Wigand was dropped the same year.89
In the context of the virtual decision-making paradigm described
above, Wigand recognized that he had a dilemma in terms of the conflicting demands of (1) his personal well-being, security of his family, and
continuity of his career, and (2) obligations to others, including (a) his
confidentiality agreement with Brown & Williamson, and (b) obligations
to society in terms of savings human lives and protecting human health.
Dr. Wigand had faced the alternatives of relative safety by complying
with the agreement he had with his employer and the grave danger to his
well-being by talking to the news media. The situation was urgent since
consumers were being put in danger. Dr. Wigand opted to protect human
life over his own welfare. He was a trained researcher with specialized
scientific knowledge that helped him make a decision. His insight into
the nature of the dilemma guided his choice. He took on huge personal
risk to safeguard tobacco consumers and incurred significant personal
costs, despite the uncertainty surrounding the outcome of decision. As
a scientist-executive, he exhibited behavior that had all the hallmarks of
virtuous decision making: defiance, strength, courage, and honor.90 The
case of Sherron Watkins at Enron offers a similar illustration of such virtuous decision making.91
Examples also exist of corporations dealing with ethical dilemmas as a
matter of policy. For example, corporations have recalled products from
the marketplace in the interests of society at large.92 The recall by Johnson & Johnson in 1982 of packages of Tylenol that may have been tampered with is an example of corporate decisions exhibiting uncommon
virtue. Johnson & Johnson withdrew the suspect product even though
they were not necessarily liable for the consequences of it remaining in the
marketplace. Corporate executives took actions that did not necessarily
fulfill their obligations to the full spectrum of their stockholders, employees, and other parties. However, they acted to protect human welfare and
save lives, even though the cost of doing so could have been enormous to
the company. They chose to fulfill their obligation of social responsibility
at the expense of their own corporate interest, and resolved the dilemma

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effectively. The Washington Post reported, Johnson & Johnson has efficiently demonstrated how a major business ought to handle a disaster.
From the day the deaths were linked to the poisoned Tylenol . . . Johnson
& Johnson has succeeded in portraying itself to the public as a company
willing to do whats right regardless of cost.93 Not only did Johnson &
Johnson emerge stronger, they demonstrated their deep knowledge and
research strength by revolutionizing packaging technology for pharmaceuticals, cosmetics, and food products.
SUMMARY
This chapter has explored the emergence of business ethics from the exercise of individual beliefs and values in the marketplace. It examined ethics from the perspective of the degree of respect an individual has for the
natural right of others to own private property. It explained the prevalence
of corporate scandals in the context of the separation of the ownership of
the corporation from its control, and the divergence of the interests of the
shareholders from those of managers. It also explored why this separation
gives rise to corporate aggression. The chapter also introduced virtuous
decision making as a special case of ethical decision making, a virtuous
decision or action being not only ethical but also courageous. Enlightened
wisdom facilitates decision-making processes. Knowledge is thus a prerequisite for both ethical and virtuous decision making. When faced with
ethical dilemmas, there is often no time for research. Knowledge must
thus be acquired through the ingrained conditioning of the individual
through education, experience, training, and development.
NOTES
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Index

Accenture, 9
Activity complementarity (defined),
28
Adidas, 109
Africa, 242
AIG corporate scandal, 260
Alliance business outcomes (in strategic alliances), 24
Alliance capability (core competence): alliance experience, 3738;
alliance management skill, 3840;
identification of opportunities,
4041
Alliance competitive advantages
(defined), 24
Alliance relationship phase (in strategic alliances), 2526
Altintig, Z. Ayca, 99
American Airlines, corporate scandal, 260
Ames, Samuel, 261
Analyzer (in Miles-Snow typology
of defender, prospector, analyzer,
reactor), 15253
Angell, Joseph Kinnicut, 261
Ansoff, I., 71, 77
Ansoffs typology of growth strategies, 72

Antibribery laws, 259


AOL Time Warner, corporate scandal, 260
Apple: early struggles of, 8; innovative success of, 5, 7; iPad tablet development, 10; iPad tablet
devices, 10, 208; iPhone, 113, 208,
216; market acceptance of products, 1112; modern wizards at,
214; partnerships with innovative suppliers, 135; phone application downloads, 114; product sales
cycles, 221; website downloads,
113
Arbogast, Stephen V., 26771
Arthur Andersen accounting firm,
258
Asea Brown Broveri (ABB), 259
Association to Advance Collegiate
Schools of Business (AACSB International), 264
Atari, 104
AT&T, 57
Attention-based view (ABV) of the
firm, 8788
Automobile industry: company alliances, 32; 1970s industry disruption, 1023

280
Automobile industry, competitive
evolution example, 1058; marginorientation era (1895-1908), 105;
margin-volume-differentiation
equilibrium era (1925-1974), 106;
post-equilibrium era, 1078;
volume-orientation era
(1908-1925), 1056
BAE Systems (UK), corporate scandal, 260
Baker, M., 164, 165
Barnes & Noble, 154
Barnevik, Percy, 259
Barry, C., 165
Berkshire Hathaway, 6
Beta use stock market indices, 17475
BHAGs (big hairy aggressive goals),
22425
Big Three U.S carmakers, 1067. See
also Chrysler automobiles; Ford
Motor Company; General Motors
Biotechnology sector, 27, 37, 4041
Blackhurst, R., 100
Blankfein, Lloyd, 244
Blouin, J., 170
Bodie, Z., 183
Boeing Corporation, 5, 1617, 42, 183,
21819
Boulding, W., 4
Boyer, Kenneth, 129
Branding: global branding confusion, 109
Brin, Sergey, 229
Bristol-Myers, corporate scandal, 260
Bruner, R., 173
Budweiser, 109
Buffett, Warren, 6
Burgelman, R. A., 79, 8384
Busch, Adolphus, 98
Business ethics, 25574; business
organization evolution, 26163;
corporate scandals, 18182, 25761,
266, 274; decoding of ethical complexities, 26771; emergence of
corporate aggression, 265; extrinsic and intrinsic virtue, 26667;
factors shaping, 258; occurrence of

Index
corporate scandals, 25761; separation of ownership and control,
26365; virtuous corporate behavior, 27174
Business strategies, in strategic
human resource management,
15154; typology of cost leadership, differentiation, focus, 15354;
typology of defender, prospector,
analyzer, reactor, 15153
Business Week (BW), 12526
Business Week/Harris poll (2002, 2010),
258
BYD Auto (China), 108
Capital asset pricing model (CAPM),
161, 17374
Capital structure policy: business
cycles, macroeconomic conditions
and, 16768; and firm characteristics, 16667; and market timing,
16465
Capital structure theory: financial
distress and trade-off theory, 163;
Miller and Modigliani (M&M)
theory, 16263; pecking-order theory, 16364
Cargill-Dow strategic alliance, 29
Census Bureau: U.S. capital expenditure data, 171
Chapter 11 bankruptcy protection,
179
Chen, H., 168
Chery Auto (China), 108
China: automobile industry, 1078;
entrepreneurial tradition in, 33;
Mattel outsourcing issues, 123;
trade liberalization by, 102
Christen, M., 4
Chrysler automobiles, 1067
Ciba-Geigy, 40
Cisco, 53, 60
Clarke, Arthur C., 214
Clearstream, corporate scandal, 260
Coca-Cola Company, 102, 216
Collaborative attractiveness
(defined), 28
Collins, Jim, 240

Index
Colt, Samuel, 98
Commitment variable (in strategic
alliances), 25
Communication: role in innovation,
224
Competitive evolution, strategic
modes interactions (marketing
strategy), 97104; breakdown in
profitability, 9899; destabilization
from globalization, 1023; environmental influences, 100101;
evolutionary equilibrium, 99100;
future directions in a global environment, 10810; future global
partnerships, 11014; patterns in
a global context, 1034; political
barrier changes, political accommodations, 1012; U.S. automobile
industry example, 1058
Competitive imitation, 45, 12, 14, 16,
20; decision making by firms for
pursuing, 45; generic risks of, 14;
industry context, 1617; new offerings halo effect and, 12
Competitive implications of innovation and imitation, 1719
Competitive pressures, in mergers
and acquisition, 6061
Complexity factor, in industry environment (in mergers and acquisition), 52
Congress (U.S.): outsourcing concerns, 124; securities fraud concerns, 259; tobacco issues, 27273
Control determinants, of ICVs, 8284
Cooperative/relational norms (in
strategic alliances), 25, 35
Coors, 109
Core, J., 170
Corning, 37, 3940
Corporate aggression, 26566, 274
Corporate Culture and Performance
(Kotter and Heskett), 249
Corporate ethics. See Business ethics
Corporate financial strategy, 15985;
beta use stock market indices, 17475;
capital asset pricing model, 161,
17374; capital structure, historical

281
stock, operating performance,
16566; capital structure and firm
characteristics, 16667; capital
structure policy, business cycles,
macroeconomic conditions, 16768;
capital structure policy and behavioral influences, 16869; capital
structure policy and market timing, 16465; CEOs and, 161, 169;
CFOs and, 164, 175; cost-benefit
analysis identification of optimal
capital structure, 17071; cost of
capital, 171, 173, 184; earnings per
share, 164; estimating costs and
benefits of debt, 16970; financial flexibility, financing tools,
160, 17780; implication of leases
on, 160, 17881; inertia theory
(Welch), 166; leases, 162, 17781;
market risk premium, 17577;
market-to-book ratios, 164; peckingorder theory, 16364, 165; pensions, 160, 18283, 185; recent academic findings, 16469; Special
Purpose Entities, 160, 162, 178,
18182; textbook capital structure
theory, 16264; trade-off theories,
163, 16769; weighted average cost of
capital, 16163, 171, 173, 17677, 183
Corporate greed, 258
Corporate scandals, 18182, 25761,
266, 274
Cost-benefit analysis identification of
optimal capital structure, 17071
Cost leadership strategy (in Porters
typology of cost leadership, differentiation, focus), 153
Covin, J. G., 77
Creativity Audit (innovation tool)
steps: bare facts, 226; benchmarking, 227; creative capital, 228;
credit due, 226; design, 227; occasion, 226; people, 228; tracking, 227
Crosby, Philip B., 19192
Cross-border (international) alliances,
2829
Culture and performance: analysis
of relationship between, 23637,

282

Index

241, 249; high performance,


unclear culture mismatch, 24344;
international context of, 24143;
links between, 241; strong culture, potential turnover mismatch,
24445
Customer interests, in mergers and
acquisition, 5758
Customer satisfaction, holistic
approaches, 200203; flexibility,
agility in addressing customer
needs, 2012; meeting needs of
other constituencies to meet customer needs, 2023; meeting product life cycle needs, 201

acquisition and, 49; new business


identification matrix, 78; related
diversification, 71. See also Internal
corporate ventures
Dobbs, R., 175
Dow Jones index, 183
Dow Jones News Service (DJNS),
12526
Drucker, Peter, 24041
Dukane Corporation, 8081
Dullard, Stuart, 258, 261, 267
Du Pont, 183, 263
Dynamism factor, in industry environment (in mergers and acquisition), 52

Daewoo Matiz, 111


Dai, Y., 7
Daihatsu, 111
Daimler-Chrysler merger, 24243
da Silveira, Giovani, 132
Davis, Gerald F., 133
Davis, S., 265
Deal structuring phase, in mergers
and acquisition, 5051
Debt, estimating costs and benefits:
cost of suboptimal capital structure, 170; costs of debt, 170; tax
shield value, 16970
Defender (in Miles-Snow typology
of defender, prospector, analyzer,
reactor), 15152
Defined contribution plans, 182
Del Campo, J., 175
Dell, 222
Deming, W. Edwards, 19192, 194
Deutsche Bank (Germany), corporate
scandal, 260
Devaraj, Sarva, 132
Dhir, Krishna S., 258, 263, 26870
Disney (Walt Disney) Company, 75, 214
Diversification via internal corporate
venturing, 7188; Ansoffs typology of growth strategies, 72; economic motivations, 7274; firm
level diversity, 7475; history and
current trends, 7677; managerial motives, 7576; mergers and

Eades, K., 173


Earnings per share (EPS), 164
Easterbrook, F., 267
East Germany, 102
Eastman Kodak, 183
Ebbers, Bernard, 25960
EBM. See Evidence-based
management
Economic motivation for diversification, 7274
Electronic Data Systems, 9
Eli Lilly, 37
Eli Lilly, Office of Alliance Management, 26
Ellison, Larry, 60
Employee interests, in mergers and
acquisition, 5860
Employers Accounting for Defined Benefit Pension and Other Postretirement
Plans (FASB statement no. 158),
18283
Employment: BHAG projects and,
225; corporate executive risks,
76; firm survival influences and,
76; high-performance work systems and, 15556; influences of
outsourcing, 12324; stakeholders and, 211; virtuous corporate
behavior and, 272
Enron Corporation, 204, 258, 267, 270
Enterprise information technology
(IT) outsourcing, 9

Index
Entrepreneurial islands, in internal
corporate ventures, 84
Environmental incentives, in strategic alliances, 36
Environmental influences, in competitive evolution, 100101
Ericsson, 109
Ethics. See Business ethics, emergence
of
European Union (EU), 57, 102
Event-study methodology, 125
Evidence-based management (EBM),
140
Experiential (iterative) learning
model (Kolb), 4950
Exxon Mobil, 75
Failure: The Secret to Success video
(Honda), 221
Federal Aviation Authority (FAA), 81
Federal Trade Commission (FTC), 57
Fernandez, P., 175
Fiat, 111
Financial Accounting Standards
Board (FASB), 178, 18183
Financial distress costs and trade-off
theory, 163
Fiol, Marlene C., 239
Fiorina, Carly, 251
Firm level diversification, 7475
First moves marketing, 218
Fishel, D., 267
Flannery, M., 166
Ford, Henry, 98, 1056
Ford Motor Company, 1067, 111,
192
Foreign Corrupt Practices Act
(FCPA), 259
Fortune 500 industrial companies,
7677, 79
401k plans, 182
Free trade theory, 124
Friendly acquisitions, in mergers and
acquisition, 5354
General Electric (GE), 6, 12, 214, 224
General Motors (GM), 263; alliances of, 34; joint ventures of, 111;

283
lawsuit against Chery, 111; MVD
era (mid-1920s), 106
Germany: Deutsche Bank spying
scandal, 260; Lockheed bribery
scandal, 260; post-WW II division,
102; Siemens corruption scandal,
261
Gillette Safety Razor Company, 102
Global Aeronautica (GA), 42
Globalization: competitive destabilization and, 1023; complexities in global partnering, 10910;
influence of technology, 115; partnerships of the future, 111; and
patterns of competitive evolution,
1034, 1089
Goldman Sachs, 244, 260
Gomes-Casseres, Ben, 32
Good to Great (Collins), 240
Google, 229, 238
Governance of strategic alliances,
3135; contracts and contractual
dependence, 3133; cooperative
(relational) norms, 3435; noncontractual mutual dependence,
33; opportunity costs, 3334; real
costs, 33
The Grace of Great Things: Creativity
and Innovation (Grudin), 228
Graham, J., 16971, 173, 180
Great Wall Motor (China), 108, 111
Growth strategies, Ansoffs typology
of, 72
Grudin, Robert, 22829
Guay, W., 170
Hackbarth, D., 168
Halliburton, corporate scandal, 260
Hamel, G., 77
Harley-Davidson Motor Company,
15
Harris, R., 173
Hart-Scott-Rodino (HSR) Antitrust
Improvements Act (1976), 57
Harvey, C., 173
Hawtrey, Kim, 258, 261, 267
Hayes, Robert, 129
Healthwise, 24748

284
Heck, Ronald H., 239
Heineken, 109
Hells Kitchen reality show, 217
Henderson, D., 99, 100
Heskett, James L., 24950
Hewlett-Packard (HP), 3738, 25051
Hewlett Packard Personal Systems
Division Asia-Pacific (PSDA), 126
Higgins, R., 173
High-performance work systems
(HPWSs), 15556
Honda Corporation, 109, 111, 225
Horizontal alignment, in strategic
human resource management,
14243
Houghton, James R., 32
Hounshell, David A., 98
Hovakimian, A., 165
Hovakimian, G., 165
Hlsmann, Guido, 25758
Hurd, Mark, 251
Hyundai, 109
IBM, 58; alliance with Toshiba, 3637;
enterprise information technology, 37
IBM enterprise information technology (IT), 89
ICVs. See Internal corporate ventures
IDEO global design firm, 221, 238
Imitation decision making, 56, 1314
Implementation phase, in mergers
and acquisition, 6162
Incremental innovations: baking soda
in toothpaste example, 9; information communication by, 10; market
expectations and, 1314; outcomes
of imitation of, 19; signaling theory
and, 45, 14; sustainable competitive advantage and, 219
India: labor costs vs. U.S. labor costs,
122; Satyam Computer Services,
259; wage increase data, 127
Industrial organization (IO) economics perspective, of strategic management theory, 144, 145, 147,
155
Industrial Revolution (U.S.), 262

Index
Industry environment factors, in
mergers and acquisition, 5253
Inertia theory (Welch), 166
Information asymmetry, 6
Information technology (IT): ability
to incorporate data, information
for decision making, 199; ability to
manage geographically dispersed
customers, 200; ability to manage
globally dispersed options, 199200;
corporate aggression and, 267;
enterprise information technology,
89; infrastructures, 9; short-term
vs. long-term planning decisions,
19799; strategic plans influenced
by, 191; 21st century explosion in,
197200
Innovation, 320, 21429; business
management decisions and, 74;
competitive implications, 1719;
corporate innovation strategy,
77; Creativity Audit, 22628; differentiation strategies based on,
154, 21617; dos and donts of,
22528; employee rewards for, 203;
employee role behaviors and, 141,
146; incremental innovations, 45,
14; industry context, 1617; innovative history, 1112; kitchen reality show examples, 217; market
competency, 1213; new product
development cycles, 21819; organizational level, 5, 1113; and outsourcing, 131, 134; potential future
developments, 22829; product,
organizational-level signal interactions, 1316; product-level innovativeness, 811, 203; prospectors
role in, 152; relationship with critical performance outcomes, 4; signaling theory and, 4, 67; signal
interpretation and, 5, 79, 1314,
1617; strategic alliances and, 40,
43, 133; and strategy, 215, 21617;
sustainable competitive advantage and, 21519, 222; tacit vs.
explicit knowledge and, 217. See
also Apple; Boeing Corporation;

Index
Disney (Walt Disney) Company;
Ford Motor Company; Internal
corporate ventures; McDonald
brothers
Innovative environments, contributing factors, 219; effective communication, 224; failure to succeed,
22122; individual-level creativity, 220; managing organizational
innovation, 222; organizational
culture, 21920; organizational
knowledge, resources, capabilities,
22021; role of leadership, 22425;
structure and resources, 223; tacit
knowledge, resources, capabilities, 220; valuation of customers,
22223
Innovators dilemma (Christensen), 74
In Search of Excellence (Peters and
Waterman), 240
Integration management, in mergers
and acquisition, 6263
Integration planning phase, in mergers and acquisition, 5556, 58, 61,
64
Intelligence, actionable, 4
Interimistic alliances: demand-based
rapid formation of, 27; described,
24, 2627; relational development
in, 3537
Internal corporate ventures (ICVs):
described, 7778; future directions, 8688; incidence of failure
(studies), 79; leveraging in, 8081;
motives for, 8081; operational
relatedness in, 8384; organization
contexts of, 7980; parent-venture
product similarity, 8586; performance measures, 8182; position
and control as performance determinants, 8284. See also Diversification via internal corporate
venturing
International (cross-border) alliances,
2829
International Harvester,
110

285
Internet: data transmission capabilities, 199200; influence on outsourcing, 122; and information
relevance decisions, 19798; and
interimistic alliances, 27; and strategic alliances, 30; WiMAX, PCTEL
and, 73
iPad tablet devices, 10, 208
iPhone, 113, 208, 216
Iron Chef reality show, 217
Isuzu, 111
Jackson, Susan E., 141
Japan: organizational culture of,
23435, 237
Jiang, B., 175
Jin, L., 183
Jobs, Steve, 21415
Juran, Joseph M., 191
Kao, John, 21819
Kayhan, A., 16667
Kemper, Don, 24748
Kitchen reality shows, 217
K-Mart, 14
Kolb, David, 4950
Koller, T., 175
Korajczyk, R., 167
Kotter, John P., 24950
Krishnan, V., 180
Krugman, Paul, 260
Kuratko, D. F., 77
Lake, Dale, 239
Land Rover, 109
Lange, D., 7
Latin America, 242
Leadership: role in innovation,
22425
Leases: capital leases, 178; implications on corporate financial strategy, 18081; operating leases,
17778, 17980; raising capital
using, 162; synthetic leases, 180
Lee, P. M., 7
Lee, Siew K., 24142
Lego, 109
Lehman Brothers, 25960

286
Leland, Henry, 98
Lemmon, M., 180
Lengnick-Hall, Cynthia A., 141
Lengnick-Hall, Mark L., 141
Leveraging, in internal corporate
ventures, 8081
Levy, A., 167
LG, 109
Locke, John, 255
Lockheed, corporate scandal, 260
Long-Term Greedy (Lindskoog), 244
Lopez de Arriortua, Jose Ignacio, 34
Macintosh product platform, 8
MacMillan, I. C., 79
Mahindra & Mahindra, 110
Maitland, Frederic W., 261
Malmendier, U., 168
Managerial motives, for diversification, 7576
M&A. See Mergers and acquisition (M&A) integration, phased
approach
M&M theory. See Miller and Modigliani (M&M) theory
Mann, S. C., 165
Manne, H., 26667
Marcoulides, George A., 239
Margin-orientation era, automobile
industry (1895-1908), 105
Margin-oriented (MO) business, 96
Margin-volume-differentiation equilibrium era, automobile industry
(1925-1974), 106
Margin-volume-differentiation
(MVD) strategy, 95
Market competency: defined, 12; firm
reputation and, 1213; incremental
innovation and, 14; operationalization of, 21; product innovation imitation and, 5; research findings, 15;
signal quality and, 13, 15, 1718
Market focus strategy (in Porters
typology of cost leadership, differentiation, focus), 154
Marketing strategy, 95116; competitive evolution, strategic
mode interactions, 97104; global

Index
branding confusion, 109; growth
of railroad networks, 98, 101,
113; margin-oriented businesses,
96; mass marketing, 9699; mass
production and, 9698; strategic
market orientation, 9597; VMD
strategy, 97; volume-oriented strategy, 96100, 1028, 11011
Market risk premium, 161
Market-to-book ratios, 164
Mascot Systems Ltd., 126
Mass marketing, 9699
Mass production, 9698, 262,
26566
Mattel toy company, 123
Mazda, 111
McDermott, Christopher, 129
McDonald brothers, 98
McGrath, R. G., 79
MCI Communications, 259
McKinney, Phil, 224
McKinsey Consulting, 32
Medici, Lorenzo de, 229
Mergers and acquisition (M&A) integration, phased approach, 4866;
competitive pressures, 6061; continuing adaptation, 63; customer
interests, 5758; employee interests, 5860; experiential learning
model, 4950; friendly acquisition
characteristics, 5354; goal establishment, 56, 59; implementation,
6162; implications for management theory, practice, 6466;
integration management, 6263;
integration planning phase, 5556,
58, 61, 64; leadership continuity
(top management), 5960; method
of payment, 5455; middle management continuity, 60; prudent
planning, 61; regulatory review
process, 5657; resource combinations, 5152; stakeholder prioritization, 56; target environments,
5253; target selection, deal structuring phase, 5051, 64; top management continuity, 5960
Merton, R., 183

Index
Method of payment, in mergers and
acquisition, 5455
Meyer, C., 265
Miao, J., 168
Microsoft Corporation: competitive
evolution example, 104; interimistic alliances of, 27, 36; Office Suite
development, 8; WebTV alliance,
36
Mihov, V. T., 165
Miles, Raymond E., 15153
Miles-Snow typology of defender,
prospector, analyzer, reactor,
151
Miller, Merton, 160, 16263
Miller and Modigliani (M&M) theory,
16263
Mitsubishi, 111
Mobile phone ownership growth,
11214
MO business. See Margin-oriented
(MO) business
Model-T (Ford), 1056
Modigliani, Franco, 160, 16263
Montgomery Ward catalog, 101
Morellec, E., 168
Morris, M. H., 77
Motorola, 109
Moyer, R., 180
Munificence factor, in industry environment (in mergers and acquisition), 52
Murphy, S. M., 265
MVD strategy. See Margin-volumedifferentiation (MVD) strategy
National Association of Software and
Service Companies, 122
New product development (ND)
cycles, 21819
New York composite (stock) index,
161
Nike Corporation, 5
Nintendo, 104
Nissan, 109, 111
Nokia, 109, 23940
Nonaka, Ikujuro, 220, 222
Noninterimistic alliances, 36

287
Novak, Michael, 258
Novartis, 40
Obama, Barack, 259
Off-balance sheet financing tools, 160
Offshoring: decline in the value of,
12729; sample announcements,
126. See also Outsourcing
Ohmae, Kenichi, 32
Operational relatedness, in internal
corporate ventures, 8384
Oracle, 60
OReilly, Charles, 236, 239
Organizational culture(s): in Ada
County (Idaho) sheriffs office,
250; cohesion promotion by, 205;
creation of, 204; defined, 23435;
development of, 23536; as example
of intangible resources, 24; existing
frameworks, 23840; at Ford Motor
Company, 192; four factors of, 234;
at Google, 238; growth of strength
of, 23638; human resource support
needs, 236; at IDEO, 238; in innovative environments, 21920; international context, 24143; international
context of culture and performance,
24143; in Japan, 23435, 237; links
between culture and performance,
241; mismatches between culture
and performance, 24345; missing
components, 24041; need for parent organization-vendor compatibility, 194; research on, 240; role of
CEOs, 24346, 248; strategies for
sustaining, 24548; strong culture
(defined), 237; subcultures, 24748;
tests of, 24647. See also Culture and
performance
Organizational level innovation and
imitation strategy, 5, 1113; historical background, 1112; market
competency, 1213
Organizational reputation, 7, 12
Organization contexts of ICVs, 7980
Ouchi, William G., 23435, 240
Outsourcing, 12134; alignment benefits, 12930; alignment of priorities,

288
activities, performance, 13233; by
Boeing, 42; competitive priorities
and, 13132; cost-related drivers
of, 131; decision-making factors,
122; goals of, 121; if IT, by IBM, 9;
impact on shareholder value,
12529; and innovation, 131, 134;
and interimistic alliances, 2627;
of internal business functions,
12223; as make or buy decision,
122; manufacturing implications
of alignment, 134; risk factors,
12324; and strategic alliances, 24;
strategies for success, 12935
Page, Larry, 229
Parent-venture product similarity (in
ICVs), 8586
Parmalat (Italy), corporate scandal,
260
PCTEL, 73
Pecking-order theory, 16364, 165
Pensions, 160, 18283, 185
Performance Food Group, 171, 172
Performance measures, of ICVs,
8182
Peters, Thomas J., 248
Petersen, Chris, 24647
Phar-Mor, corporate scandal, 260
Phillips Oral Healthcare, 9
Pisano, Gary, 144
Political barriers, and marketing
strategies, 1012
Pollock, Frederick, 261
Porter, Michael, 10, 77, 144; typology
of cost leadership, differentiation,
focus, 15354
Position determinants, of ICVs, 8284
Post-equilibrium era, automobile
industry, 1078
Price Waterhouse Cooper auditors,
259
PR Newswire (PR), 12526
Production differentiation strategy
(in Porters typology of cost leadership, differentiation, focus), 154
Product-level innovativeness, 811,
1314

Index
Profit performance (defined), 24
Projected benefit obligations (PBOs),
183
Promus Hotel Corp. (PRH), 126
Prospector (in Miles-Snow typology
of defender, prospector, analyzer,
reactor), 152
Pyramid of success program, 246
Quality function in 21st century organizations: acceptance of corporate
responsibilities, 2045; alignment,
performance and, 133; creation of
appropriate organization culture,
204; distinguishing features of the
role of, 196; effectively managing
supply and demand side, 2067;
enhancement strategies, 154; holistic approaches to customer satisfaction, 200203; initiatives in
organizations, 195; linkage with
overall strategic function, 20911;
and outsourcing, 131; proactive
vs. reactive role of management,
2089; responsibilities of the 21st
century organization, 2037; role
of, 193; SHRM and, 14041; social
responsibility with respect to
resource consumption, 2056; 20th
century philosophies of, 19192,
194; utilization of organizational
strengths, 21112. See also Information technology (IT)
Quality is Job 1 slogan (Ford Motor
Company), 192
Railroad networks, 98, 101, 113
Raju, Ramalinga, 259
Rangan, K., 166
Reactors (in Miles-Snow typology
of defender, prospector, analyzer,
reactor), 153
Regulatory review process, in mergers and acquisition, 5657
Reputation (organizational reputation) research, 7
Resource-based view (RBV) of the
firm: description, 141; 1980s rise of,

Index
144; strategic management theory
and, 14344
Resources combinations, in mergers
and acquisition, 5152
Resources complementarity, in strategic alliances, 30
Resources in strategic alliances, 24
Resource transferability (defined), 28
Ring, Peter Smith, 111
Risk-free rate, 17374
Robb, A., 169
Robinson, D., 169
Roche, 40
Rodriguez, M., 165
Royal Dutch Shell (Netherlands), corporate scandal, 261
Ruback, R., 165
SAAB, 109
Saab Aerospace (Sweden), corporate
scandal, 261
Samsung, 109
Samuelson, Paul, 124
Sandoz, 40
San Pietro, Joe, 42
Sarbanes-Oxley Act, 204
Satyam Computer Services, 259
SCB Computer Technology, Inc.
(SCBI), 126
Schallheim, J., 180
Scherer, Frederick M., 101
Schroeder, Roger G., 132
Schuler, Randall S., 141
Scott, H. Lee, 260
Scott, W. Richard, 133
Scully, John, 214
Sears, Richard, 98
Sears, Roebuck and Co. catalog, 101
Sears Roebuck, 263
SECI (Socialization, Externalization,
Combination, Internalization)
model, 222
Securities and Exchange Commission, 178
Sega, 104
Shareholder value, impacts of outsourcing on, 12529; decline
in value of offshoring, 12728;

289
onshore vs. offshore comparison,
127; sample announcements, 126
Sheth, Jagdish N., 99
Shuen, Amy, 144
Siemens (Germany), corporate scandal, 261
Signaling interpretation, 78; as
guide for imitation decision making, 5; imitation decisions and, 13;
market contexts for, 1617; prescriptive suggestions for, 1314;
product-level innovation and, 89
Signaling theory, 4, 67; application
determination, 10; described, 6;
product-level innovation and, 8;
underlying assumptions, 67
Singer, Isaac, 98
Singer Manufacturing Company, 98
Sisodia, Rajendra S., 99
Six Flags, 171, 172
Smith, Adam, 255
Snow, Charles C., 15153
Socit Gnrale (France), corporate
scandal, 261
Sonicare toothbrush, 9
Sony, 104
South Asia, 242
Southeast Asia, 242
S&P 500 index, 161
Special Purpose Entities (SPEs), 160,
162, 178, 18182; accounting guidelines for, 18182; Enrons creation
of, 178; implication of, on corporate financial strategy, 182; use
of, for raising capital, 162. See also
Variable interest entities
Spence, M, 6
Standard Oil, 263
Strategic alliances, 2344; alliance
capability as core competence,
3741; benefits of, 23; challenges
of, 4143; complexity of, 41; contracts/contractual dependence in,
3133; control, oversight issues,
4143; cooperative/relational
norms in, 3435; cross-border
(international) alliances, 2829;
defined, 23, 24; governance of,

290
3135; identifying, securing opportunities, 4041; innovation and,
40, 43, 133; interimistic alliances,
24, 2627, 3537; noncontractual
mutual dependence in, 33; noninterimistic alliances, 36; opportunities created by, 148; opportunity
costs in, 3334; real costs in, 33;
resource-based motivations for
engaging in, 2931; resources in, 24
Strategic human resource management (SHRM), 13956; business
strategies, 15154; description,
13940; facilitation of EBM by,
140; high-performance work systems, 15556; horizontal alignment, 14243; HR strategy and
vertical alignment, 14142; human
resource practices, 15455; latticed
HR strategies: vertical, horizontal
alignments, 14951; resource-based
view of, 141; strategic management
relation to, 14041; and strategic
management theory, 14348; top
management team and, 141, 144,
146, 14851, 15556
Strategic management of quality,
191212
Strategic management theory:
agency/transactions cost perspective, 14647; dynamic capabilities
perspective, 143, 148; framework
for selecting theories, 145; industrial organization economics perspective, 144, 145, 147, 155; RBV
of the firm and, 14344; strategic
group process perspective, 145,
14748, 155; strategic leadership
perspective, 143
Strategic management theory and
SHRM, 14348
Strategic market orientation, 9597
Strong organizational cultures, 237
Stuck in the middle strategy (in
Porters typology of cost leadership, differentiation, focus), 154
Subaru, 109
Sun Microsystems, 60

Index
Sustainable competitive advantage
(SCA), 21519, 22223
Suzuki, 111
Tacit-to-tacit learning model (of Nonaka), 222
Target environments, in mergers and
acquisition, 5253
Target selection phase, of mergers
and acquisition, 5051
Tate, G., 168
Taurins, S., 8081
Technology: benefits of vertical integration, 75; biotechnology sector,
27, 37, 4041; complexity of licensing agreements, 24; consumer
demands for, 115; high-tech targeted acquisitions, 49; impact of
global dispersion, 219; influences
on competition, 100; information
technology outsourcing, 89; innovations of Apple, 7, 214; as innovative magic, 214; interimistic
alliances in, 2627, 37; Miles and
Snows typology and, 151, 152; new
product development advances,
218; and offshore-outsourcing decisions, 122; rapid obsolescence and
upgrading, 209; real-time data technology, 201; revolution in information technology, 191, 197200;
strategic partnerships and, 110
Teece, David J., 144
Tehranian, H., 165
Textron, 183
Theory Z (Ouchi), 240
3M Corporation, 11, 81
Tidd, J., 8081
Titman, S., 16667
T-Mobile, 57
Too Big to Fail (Stern and Feldman),
24344
Top Chef reality show, 217
Top management teams (TMTs), 141,
144, 146, 14851, 15556
Total Systems Services Inc., 204
Toyota, 109, 111, 222
Trade-off theories, 163, 16769

Index

291

Trust variable (in strategic alliances),


25
Tyco International, corporate scandal, 261
Typology of cost leadership, differentiation, focus (Porter), 15354
Typology of defender, prospector,
analyzer, reactor (Miles and Snow),
15153

Volume-margin-differentiation
(VMD) strategy, 97
Volume-orientation era, automobile
industry (1908-1925), 1056
Volume-oriented (VO) strategy,
9697, 96100, 1028, 11011
Volvo, 109
VO strategy. See Volume-oriented
(VO) strategy

UAL Corp., 179


Ulrich, David, 239
Union Carbide, corporate scandal,
261
United States (U.S.): anti-bribery
laws, 259; beliefs about business
ethics, 258; Big Three U.S carmakers, 1067; breweries (1870), 101;
incorporation process, 262; Industrial Revolution, 262; labor costs
vs. India labor costs, 122; mergers
and acquisition transaction laws,
57; outsourcing by U.S. firms,
12122; outsourcing employment
issues, 124; outsourcing survey,
132; volume orientation competitive benefits, 9899
US Airways Group Inc., 179
U.S. Department of Justice (DOJ), 57
Uslay, Can, 99

WACC. See Weighted average cost of


capital
Wachovia Capital Markets, 42
Walgreen Co. drugstore chain,
179
Wall Street Journal, 125
Wal-Mart Stores, 12, 260
Ward, Adolphus Montgomery, 98
Washington Mutual, 250
Waterman, Robert H., 248
Watkins, Sherron S., 258
Wealth-management industry, global,
17
WebMD, 247
WebTV: alliance with Microsoft, 36
Weighted average cost of capital
(WACC), 16163, 171, 173, 17677,
183
Welch, I., 166
Welch, Jack, 214, 224
Werner, W., 267
West Germany, 102
What Happy Companies Know (Baker,
Greenberg, Hemingway), 224
Wheelwright, S., 129
Wigand, Jeffrey, 267
Wilkins, Alan L., 23435
WiMAX, 73
Winn-Dixie Stores, Inc., 180
Winsor, Robert D., 99
WorldCom, 204, 25960
Wurgler, J., 164, 165

Valikangas, L., 79
Value-creation potential, of strategic
alliances, 2930
Van Binsbergen, J., 17071
Van der Kwast, Christer, 261
Van de Ven, Andrew, 111
Variable interest entities (VIEs), 182
Vendel, M. T., 266
Venkataraman, S., 79
Ventana Research, 159
Vertical alignment and HR strategy
(in SHRM), 14142
Vertical integration, 4243, 75
Vietnam, 242
VMD strategy. See Volume-margindifferentiation (VMD) strategy
Volkswagen, 111

Xerox, corporate scandal, 261


Yan, J., 168
Yang, J., 17071
Yu, Kelvin, 24142

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Strategic Management
in the 21st Century

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Strategic Management
in the 21st Century
Volume 3:
Theories of Strategic Management

Timothy J. Wilkinson, Editor

Copyright 2013 by ABC-CLIO, LLC


All rights reserved. No part of this publication may be reproduced, stored in
a retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording, or otherwise, except for the inclusion
of brief quotations in a review, without prior permission in writing from the
publisher.
Library of Congress Cataloging-in-Publication Data
Wilkinson, Timothy J.
Strategic management in the 21st century / Timothy J. Wilkinson and Vijay R.
Kannan, editors.
v. cm.
v. 1. The Operational environment v. 2. Corporate strategy v. 3. Theories
of strategic management.
Includes index.
ISBN 978-0-313-39741-7 (hbk. : 3 vol. set : alk. paper) ISBN 978-0-313-39742-4
(ebook) 1. Strategic planning. 2. Strategic alliances (Business).
3. Management. I. Title.
HD30.28.W524 2013
658.4'012dc23
2012041185
ISBN: 978-0-313-39741-7
EISBN: 978-0-313-39742-4
17

16

15

14

13

This book is also available on the World Wide Web as an eBook.


Visit www.abc-clio.com for details.
Praeger
An Imprint of ABC-CLIO, LLC
ABC-CLIO, LLC
130 Cremona Drive, P.O. Box 1911
Santa Barbara, California 93116-1911
This book is printed on acid-free paper
Manufactured in the United States of America

Contents

PART I: HISTORICAL
DEVELOPMENT AND OVERVIEW
OF STRATEGY THEORY
1. Major Theories of Business Strategy
Dawn Keig and Lance Eliot Brouthers
2. Early Concepts of Strategy
Marc D. Sollosy
3. Dealing with Complexities: The Role of
Management Frameworks
Andreas Schotter

3
25

39

PART II: STRATEGY THEORIES


4. Transaction Cost Economics
Jennifer Leonard
5. Resources and Dynamic Capabilities:
The Foundations of Competitive Advantage
Mary B. Teagarden and Andreas Schotter
6. Options and Strategic Management
Edward Levitas and Matthias Bollmus

65

91
108

vi

Contents

7. Managing Organizational Trust in the 21st Century:


A Pragmatic Approach to Trust Development,
Maintenance, and Repair
Edward C. Tomlinson, Andrew Schnackenberg,
and Emily Amdurer

126

8. Hypercompetition in the 21st Century:


A Look Back and a Look Forward
Robert R. Wiggins and Frances H. Fabian

147

9. Strategy and Entrepreneurship


A Discussion of Strategic Entrepreneurs
Franco Gandol

171

10. The Competitive Advantage of Strategic


Alliances: Companies Profiting from Partnerships
with Competing and Noncompeting Companies
George Nakos

196

11. Strategic Integrity Management


as a Dynamic Capability
Michael Fuerst and Andreas Schotter

214

12. Strategic Value Management: A New


Generation of Strategic Management Thinking
Juan Pablo Stegmann

237

About the Editors and Contributors

269

Index

281

Part 1

Historical Development and


Overview of Strategy Theory

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Chapter 1

Major Theories of Business Strategy


Dawn Keig and
Lance Eliot Brouthers

INTRODUCTION
Why Study Theories of Business Strategy?
The relationship between the academic theories underlying various
business strategies and the associated choices businesses make in pursuit of particular strategies can often be unclear. Across diverse scientific
and behavioral disciplines, theory helps us understand the why behind
phenomena in our world, the causal relationships influencing these phenomena, and the systematic reasons for a particular occurrence.1 In
studying firm dynamics, theory explains why particular ways of thinking or acting within and between organizations may exist.
Alternatively, business strategy represents a what, identifying both
what a firm chooses to do (and not to do) as well as what cohesive and
unique organizational approach will position themselves competitively
within their chosen markets.2 Underlying the multitude of business
strategy development approaches, schools of thought, and techniques
are a variety of business strategy theories that continue to evolve over
time. Theories of business strategy, therefore, can help link the why and
what of strategic approaches by explaining development of, and relationships between, major schools of theoretical thought. Understanding

Strategic Management in the 21st Century

the underlying theory linking particular strategic concepts may generate a deeper understanding of and appreciation for their applicability in
modern businesses.
It may also be useful to clarify how theories of business strategy
and more general theories of the firm are related, but are distinct theoretical groups. Theories of the firm seek to explain why businesses exist
in the first place by examining underlying economic and managerial
motivations and associated market behaviors.3 Some theories of the firm
have grown out of an economic tradition and its associated rational
actor assumptions, such as transaction cost economics and agency theory. Other theories of the firm are more behaviorally oriented, based on
real (not necessarily rational) individuals. The research traditions supporting the various general theories of the firm provided the different
frames of reference from which particular theories of business strategy
have emerged.
The purpose of this chapter is twofold. First, we introduce some of
the most influential theories of business strategy. Second, we trace their
intellectual development within the strategic literature.
A Framework for Major Theories of Business Strategy
To aid in understanding the emergence and development of some of
the most important theories of business strategy, the following framework is proposed. As Table 1.1 illustrates, individual theories of business strategy have been categorized into four dominant theoretical
paradigms: product-market-based perspectives, industry-based theories,
resource-based theories, and competition-based theories. To a large extent the categories and corresponding theories complement one another.
They are presented in a generally chronological fashion, recognizing
that the introduction and development of the various theoretical groups
and the theories within each group overlap and in many cases development remains ongoing. We begin by introducing product-market-based
perspectives on business strategy, which present typologies of product
and market selection as a basis for competitive success. We then proceed
to industry-based theories, which position industry factors as the primary
determinant of superior firm performance. Resource-based theories emphasize leverage of unique firm internal resources for competitive advantage. The final theoretical category presented is the competition-based
theories, which highlight the importance of the interplay between firm
and competitors, actions, and reactions.
It should be stressed that the theories selected are a representative
sampling of key theories of business strategy but in no way should be
construed to be an exhaustive list. The same can be said for the key
thought leaders and selected literature cited throughout. Each theory

Major Theories of Business Strategy

Table 1.1
Framework of Selected Major Theories of Business Strategy
Product-Market
Based Views

Industry-Based
Foundations

Resource-Based
Theory

Competition-Based
Theory

Product-market
growth matrix

Competitive forces

Resource-based
view

Strategic conflict

Three-dimensional
market view

Generic competitive
strategies

Knowledge-based
view

Competitive dynamics

Miles and Snow


typology

Dynamic
capabilities

highlighted has played an important role in the strategic literature and


evolution of strategic thought, but there are many others to be considered comprehensively. The categories and theories presented serve as
an introduction to some of the major theoretical underpinnings of business strategy as it has developed over the past several decades and prepare the reader for deeper understanding of business strategy theory.
PRODUCT-MARKETBASED VIEWS OF BUSINESS STRATEGY
Some of the earliest foundations of business strategy focused on the
intelligent selection of particular product-market combinations to fuel
economic growth and competitive success. Frameworks in this category primarily take the form of typologies that position strategy as
being driven by a series of choices regarding specific products and
markets. Some of the key business strategies in this category include
the Ansoff product-market growth matrix, Abells three-dimensional
conceptualization of product market, and the Miles and Snow strategic organization typology. There is a rich history here, and the models
selected are but a representative sampling of the evolution of thought
regarding strategic product and market selection.
The Product-Market Growth Matrix
Key Thought Leader: H. Igor Ansoff, 1957
Although growth is a prominent and often primary assumption
in modern business strategy, growth in response to competition was
just emerging as a topic of consideration for businesses in prior generations. The Ansoff product-market growth matrix represents both an
early theoretical approach and an applied business strategy tool.4
Ansoff introduced the matrix as a means of clarifying and differentiating true diversification strategies from other product-market-related

Strategic Management in the 21st Century

expansion decisions a firm may make. One of the attractive aspects


(and also limitations) of Ansoffs matrix is its simplicity. Ansoff conceptualized growth decisions as being a function of expanding either new or
existing products within new or existing markets. The resulting 2 2 grid
highlights four basic strategic options:
Market penetration. Growing the sale of existing products within existing markets represents a market penetration strategy. This growth
can be fueled either by selling more of the same product to existing customers or by winning new customers within the same market. As markets saturate, the viability of market penetration as a
growth strategy diminishes, and the other product-market strategies become more important.
Product development. The sale of new products to customers within
existing markets is a product development strategy. New products
may be developed and delivered by the rm itself or the rm may
pursue product development by partnering with or acquiring other
rms. Product development strategies can provide strong leverage
of current capabilities and market positions.
Market development. When firms have strong product lines, they
often pursue market development strategies to identify new markets
within which to sell those products. Generally the products themselves will be enhanced or modied in such a way that they can
suit the new market(s). The challenge for the rm is being able to
successfully attract and adapt to new market segments.
Diversication. Ansoffs 1957 article on diversication strategies
originally introduced the product-market growth matrix. Ansoff
pointed out that diversication typically represents the riskiest
of all of the strategic quadrants because it involves infusing new
products into new markets, requiring both product- and marketrelated skills, experience, and capabilities that the rm may not
adequately possess.
Ansoff emphasized that a company will choose various combinations
of the product-market strategies (not just one). Each strategy represents an
opportunity to leverage and grow upon past successes.
Three-Dimensional View of Product-Market Decisions
Key Thought Leader: Derek Abell, 1980
Numerous other typologies that expanded upon the simplified Ansoff 2 2 matrix have been introduced in the strategic management
literature over time. One example proposed by Abell expanded on An-

Major Theories of Business Strategy

soffs original conceptualization of market and mission by representing


product-market decisions as a three-dimensional construct.5
Like Ansoffs matrix, Abells typology characterizes strategic choices
as expanding either new or existing business. However, rather than
utilizing only product and market dimensions, Abell proposed three
distinct dimensions to be considered: customer groups served, customer
functions served, and technology employed. Each of these dimensions
represents a distinct area of potential growth. Customer groups served
relates most closely to the traditional understanding of customer
and is focused on diffusion and adoption of a product to new customer
groups. Abell recognized that the same customer group can have very
different functional needs and expectations. Thus, the customer functions served dimension represents a distinct product-market expansion
opportunity for firms. And technology employed considers the development and availability of alternative technologies that can potentially
substitute for or extend the existing technologies.
The resulting 2 2 2 three-dimensional model offers firms eight
distinct possible strategic options for growing existing or expanding
into new domains. For example, a firm may choose to address a new
customer function for its existing customers employing existing technology. Or the firm may employ new technology to meet an existing
customer groups existing functional needs. The differentiation between customer group, function, and technology offers a broader set
of options to consider than the more simplistic product-market grid.
Miles and Snow Typology
Key Thought Leaders: Raymond Miles and Charles Snow, 1978
Another extremely well-known product-market view of business
strategy was developed by Miles and Snow6 and identified four major
strategic types of organizations: defenders, prospectors, analyzers, and reactors. Miles and Snow observed that every organization tends to predominantly fit into one of these four classifications and contend that
understanding these categorical profiles can shed insight into how organizations are structured and the patterns by which they adapt to their
competitive environments over time.
A defender strategy is focused on stability of an existing core set of
products served to a relatively narrow set of markets. The defenders
priority is maintaining market strength and preventing competitors
from eroding their customer base, and therefore operational efficiency is
of critical importance to defenders. But the emphasis on stability means
that a defender organization may be seriously challenged when unpredictable changes, such as major shifts created by new technologies, are
introduced into the competitive environment.

Strategic Management in the 21st Century

Whereas the defender strategy is focused on maintaining stability, the


prospector strategy is characterized by maximizing flexibility. A prospector organization develops the skills and processes associated with innovation, the ability to continually identify, create, and leverage new
business opportunities. Prospectors are willing to forego operational efficiency, organizational stability, and even profit consistency in exchange
for an expertise and comfort with change.
Miles and Snow point out that when tomorrows environment is generally similar to todays, the defender strategy can have an advantage,
but the prospectors strong change orientation can be more effective
when tomorrows challenges are distinctly different from todays. For
this reason, many organizations pursue a hybrid approach and adopt an
analyzer strategy. Analyzer organizations attempt to balance the maintenance of a stable, core set of profit-maximizing products and customers
while simultaneously pursuing select new product-market opportunities. The concept of balance is important to the analyzer and represents
key trade-offs: the analyzer will never be as efficient as a pure defender,
or as innovative as a prospector. Establishing a viable balance is the primary challenge for organizations pursuing an analyzer strategy.
Whereas the other three organizational profiles in the Miles and Snow
typology represent proactive and deliberate business strategies, the reactor approach is characterized by instability and the general lack of
a consistent strategy, a series of reactive, ad hoc responses to external
events. Whether due to management failings to successfully articulate or
institutionalize a proactive strategy or due to lack of adequate response
to significant environmental changes in the market, the reactor strategy
is not seen as sustainable over the long term.
Limitations of Product-MarketBased Views of Business Strategy
Although the product-market-based business strategy views have
the benefit of being parsimoniousness, their very simplicity may also be
their primary limitation. The typologies provide a useful framework for
analysis, but they are not necessarily strongly theoretically grounded.
Good theory both explains causal relationships and provides predictive
insights,7 and these typologies are not predictive tools.
Subsequent research has sought to understand how product-market
typologies hold up under empirical scrutiny in determining specific
conditions under which particular product-market strategies may drive
superior performance. For example, Hambrick8 investigated whether
the different strategic types in the Miles and Snow typology were really
equally viable in different industries as Miles and Snow posit. He
found that the effectiveness of the strategic types was dependent on
both the nature of the environment (e.g., industry maturity, new product

Major Theories of Business Strategy

innovation rates) as well as the specific measures of performance that


the firm is targeting (e.g., ROI versus market share change). This led to
the insights that when ROI is the performance measure sought, prospectors in general are less effective than defenders, though in less mature
and less-innovative industries either a prospector or a defender organization is expected to perform better than an analyzer. However, if firms
wish to improve their market share in industries with high rates of new
product innovation, prospectors are expected to outperform defenders.
Research such as this helps emphasize that the industry characteristics
can have a significant impact on the effectiveness of a product-marketbased business strategy.
INDUSTRY-BASED FOUNDATIONS OF BUSINESS STRATEGY
Industry-based views of business strategy are among the best-known
theoretical contributions to the strategy literature, familiar to academics and practitioners alike thanks to the prominence of Harvard professor Michael Porter. Industry-based business strategy posits that there is
one best way to obtain and maintain competitive advantage in a given
industry, effectively positioning industry factors as the dominant determinant of superior firm performance. Each industry is structured in
such a way as to create particular barriers to entry and intensity of competition. This view is consistent with the traditional structure-conductperformance (S-C-P) paradigm from industrial organization, in which
the structure of an industry (e.g., concentration of competitors, barriers
to entry/exit or the extent of product standardization) determines the
nature of competition within the industry. Accordingly, a firms conduct
(e.g., pricing and production decisions, collusion activity) will seek to
leverage their relative power within that industry structure, ultimately
resulting in their level of performance (e.g., efficiency, profitability).
Therefore, according to the industry-based view, the focus of strategy
should be on industry-level factors. For instance strategy could focus
on analyzing and identifying industries that are structured attractively
for the firm. Or strategy could examine how to influence and/or alter the
industry structure to the firms continued advantage.
Competitive Forces
Key Thought Leader: Michael Porter, 1979
Porter promoted a process of analyzing industries based on five
forces that effectively describe each industrys basic competitive structure and subsequent attractiveness for a given firm: the bargaining power
of buyers, the bargaining power of suppliers, the threat of new entrants into
the industry, the threat of substitute products, and the resulting dynamics

10

Strategic Management in the 21st Century

of competitive rivalry among existing firms.9 The sum of these five forces
provides insights into the competitive intensity and associated opportunity inherent in that industry. A relatively lower collective strength
represents a greater opportunity for a firm to achieve long-term profitability. Porter emphasized that while all of the forces are important components of the total competitive picture, particular forces may be more
or less salient in one industry as compared to another. Key to a firms
success is the ability not only to accurately assess and deeply understand the nature, extent, and sources of the five forces in a given industry, but also to be in a position to leverage and influence the forces to the
firms advantage as well.
Different buyer groups exert different levels of influence on the overall profitability of an industry by demanding lower prices, preferential
terms, or increased quality of the sellers products and services. A particular buyer groups power is increased if they represent a relatively large
percentage of a sellers (or industrys) total sales, if there is evidence or
likelihood of the buyer being able to leverage backward integration to
obtain their goods, or if switching costs to move to another supplier are
low.
Similar in concept (though with opposite effect) to the buyers power,
suppliers can also exert their competitive influence by increasing prices
or decreasing product quality. A suppliers power is increased when
they are one of only a few supplier options, if they sell to a variety of
industries (so as to not be beholden to any one industry), or if a buyer
would experience significant switching costs to move to another supplier. It should also be noted that organized labor and government often
represent powerful supplier sources in many industries.
Industries that are characterized by high entry costs and other barriers to entry or profitability can discourage the introduction of new
competitors, thus strengthening the opportunity for incumbent firms.
Potential entrants consider many aspects of entry barriers when considering a move into the industry, including start-up capital requirements
and sources, probable competitive responses, impact of economies of
scale and experience curves, availability of distribution channels, relative importance of product differentiation for competitive success, potential switching costs, and impact of governmental regulation.
The availability of viable substitute products can be a powerful force
for a given industry, impacting the prices it can command and the associated quality and characteristics of the products it produces. The
power of substitute products produced by other industries is increased
when the price-performance improvements of the substitute product is
exceeding that of the industrys product, when buyer switching costs
are minimal, and when the substitute-producing industries are earning
higher profits (thus cushioning the impact of potential price reductions
on the substitute).

Major Theories of Business Strategy

11

The actions (and counteractions) of competitors within an industry represent a powerful and ongoing competitive force. Porter points out that
these dynamics may have a negative impact on the industry as a whole and
individual competitors (e.g., in the case of a price-slashing war) or may result in a positive impact on the overall industry (e.g., a flurry of matched
advertising attracts net new demand for the industrys products), thus benefiting all competitors. Some dynamics that tend to lead to decreased intraindustry rivalry include having a small number of competitors
(relative power patterns are better understood and more stable with fewer
competitors), rapid industry growth (everyone is expanding with the industry as opposed to at each others expense), higher switching costs,
and greater product differentiation (as opposed to commodity products).
Porters competitive forces model provides a framework upon which
firms can match their own strengths and weaknesses to the structure of an
industry of interest and effectively alter that structure over time by capitalizing on the weaker industry forces, increasing entry barriers, and managing the relative influence of buyers and suppliers.
Limitations of the Competitive Forces Model
Porters industry-based business strategy perspectives were revolutionary at the time and remain important components of strategic
thought today. However, although it is recognized that industry structure can be an important determinant of business success, it is not universally accepted as the major or necessarily primary determinant of
firm performance. For example, Rumelt found that firm-specific differences at the business unit level had a much larger and more stable effect
on firm performance than either industry- or corporate- (parent company) level effects.10 Other researchers have raised similar concerns regarding the true performance impact of industry-level factors11 and have
found at least equivalent support for the importance of firm-level factors.12 There is also the question of whether Porters five forces model
adequately identifies all of the important competitive forces related to a
firms environment. For instance, what about the impact of institutional
or regulatory forces on a firms strategic options and decisions?
Generic Competitive Strategies
Key Thought Leader: Michael Porter, 1980; George Day, 1990
Another Porter contribution to the industry-based theory of business
strategy is the concept of generic strategies.13 After analyzing and selecting
industries (and leveraging and altering their structure accordingly), firms
should choose one of three generic product strategies to obtain and maintain a sustainable competitive advantage: overall cost leadership, differentiation, or focus.

12

Strategic Management in the 21st Century

Through an overall cost leadership strategy the firms competitive


strength is based upon their ability to be the low-cost producer, subsequently underpricing the competition and enjoying higher relative returns. A low-cost producer leverages their high volume to effectively
reduce the impact of all of the five competitive forces. However, a cost
leadership strategy demands constant vigilance to maintaining operational efficiency and technological capabilities relative to the rest of the
industry.
A differentiation strategy can protect a firm from competitive forces
by distinguishing their products from those of competitors. Products
can be differentiated based on tangible attributes (quality, style) as well
as intangible attributes (status, brand). Because customers will pay a
premium for differentiated products, firms using a differentiation strategy may enjoy higher than average returns via a smaller relative market
share. As industries mature it may become more difficult to maintain
unique differentiation.
A third generic product strategy is to focus on a limited scope or segment of the market, intentionally pursuing low market share. Within
that narrow segment either a low cost or differentiation strategy can
then be applied, but with the recognition that this will not have an impact on the market as a whole.
Porter emphasizes that firms will be more successful relative to other
firms in their industry if they pursue just one of the three possible generic strategies, rather than diluting their organizational resources by
targeting multiple generic strategies, an undesirable state Porter refers
to as stuck in the middle.
Another similar generic product strategy classification scheme was
put forth by George Day,14 whose typology can be envisioned as a 2 2
matrix that examines two dimensions of potential generic product strategies: price and quality. A firm with higher prices with higher quality
(relative to other competitors) is considered to be using a premium strategy. Lower relative price/quality reflects an economy strategy. A superior
value strategy results from a relatively lower price/higher quality combination, and an inferior value strategy reflects a relatively higher price/
lower quality (e.g., as might be seen in the case of a monopolistic environment) than competitors. Days proposition is that the superior value
strategy is the dominant alternative and should therefore be the strategy
pursued by all.
Limitations of Generic Product Strategy Models
Similar to the objections to the product-market-based typologies,
questions regarding the usefulness of the simplistic generic product
strategy models have been issued. There may be more sophisticated

Major Theories of Business Strategy

13

contingent approaches to understanding and applying the generic strategies to be considered. For example, using Days classification scheme,
Brouthers et al. found that different product strategies work better in
different institutional markets, and firms that match strategy with institutional factors will achieve better performance.15
Taken as a whole, the industry-based views of business strategy
may underemphasize the competitive advantages inherent in the firms
unique resources and internal capabilities, instead assuming a degree of
homogeneity in firm resources. In the generalized industry-based strategic process, once an industry has been selected and entry strategy determined, it is assumed the firm can then acquire whatever additional
resources may be required to compete in that industry, an assumption
which the resource-based view (RBV) that follows has challenged.
RESOURCE-BASED THEORIES
OF BUSINESS STRATEGY
Resource-based business strategy theories provide an inside out approach to strategy formulation, emerging to help explain many of the
firm performance results that could not necessarily be traced to industrylevel factors proposed by industry-based theories. Resource-based theories promote development of business strategies that can leverage a firms
unique resources.
The Resource-Based View (RBV)
Key Thought Leaders: Birger Wernerfelt, 1984; Jay Barney, 1991
Although Birger Wernerfelt originally coined the term resource-based
view16 as a useful alternative to product-based strategic analysis, it was
Jay Barney who most fully developed and formalized RBV theory and
proposed its significance for business strategy.17
Firm resources are defined broadly in the RBV and include all physical resources, human resources, information resources, organizational
processes, and even organizational capital resources (internal and external relations) that can be leveraged by a firm for competitive advantage. Certain resources may represent unique firm strengths that can be
leveraged for competitive advantage. Two key assumptions underlying
the RBV are that resources are not homogeneous nor are they perfectly
mobile between firms in an industry (otherwise firm capabilities would
be equal and no one firm within an industry would achieve a competitive advantage over the others).
Four characteristics (the VRIN attributes) describing a firms resources are relevant to how they may result in a competitive advantage

14

Strategic Management in the 21st Century

or sustainable competitive advantage for the firm: valuable, rare, inimitable,


and nonsubstitutable.
To be relevant to competitive advantage, firm resources must be valuable, meaning they have power to create or leverage opportunities or minimize threats inherent in the firms operating environment.
Rarity speaks to the uniqueness of a firms resources. The more ubiquitous a given resource is throughout an industry, the less likely that resource is to provide any one firm with a competitive advantage.
Rare and valuable resources that are hard to imitate may enable a competitive advantage to not only be achieved, but also to be sustained over
longer periods of time. Some resources may be difficult for competitors to
imitate because the true nature of its link to potential competitive advantage is misdiagnosed or misunderstood, either by the competitor or even
by the firm itself, a condition referred to as causal ambiguity.
As with the other resource attributes the availability of viable substitutes for a given resource diminishes the likelihood that it will be able to
generate a competitive advantage for the firm.
Assuming that resources are heterogeneously distributed throughout
the firms in an industry and imperfectly mobile between firms, firms with
valuable and rare resources will achieve a competitive advantage. A sustainable competitive advantage can be achieved when the valuable and
rare resources can be protected from imitation and substitution
Limitations of the Resource-Based View
The consideration of the impact of resource availability and value on
firm competitive advantage emphasized by RBV has remained influential
within the strategic literature, but as a theoretical platform RBV has faced
many challenges, leading to a lively ongoing debate and continued refinement of RBV concepts, definitions, and applications.
One major area of controversy for RBV has been definitional problems in its conceptualization. Priem and Butler observed that because
valuable resources and competitive advantage are defined in the same terms,
a tautological problem exists within the originally conceived constructs,
which compromises RBVs falsifiability.18 The theoretical generalizability of RBV due to its emphasis on resource uniqueness has also been challenged,19 though as Levitas and Ndofor point out, more refinement of
operationalization approaches and empirical testing is required before
RBV is even ready for generalization.20
Perhaps the most significant criticism of RBV is that it is missing the
external market perspective. Just as proponents of RBV have criticized
the industry-based competitive advantage view for making restrictive assumptions regarding resources, RBV does exactly that regarding the product-market environment. Whereas the industry-based view

Major Theories of Business Strategy

15

assumes resource homogeneity and mobility among firms in the industry, RBV makes similar assumptions regarding demand. Because it is
actually the external market environment that ultimately determines
whether a particular resource is truly valuable, as the market changes,
so may the relative value of resources. To control for this, RBV makes the
implicit assumption of homogeneity and immobility of product markets
(unchanging demand).
But as Brouthers, Brouthers, and Werner point out in their examination of entry mode decisions, the relative nature of resource value may
be a critical consideration for firms operating in diverse institutional environments, such as in the international setting.21 Their empirical results
indicate that institutional influences, which may vary from country to
country, impact the value of the firms resource-based advantage on subsidiary performance, indicating that resource-based advantages are not
universal, but rather context specific. In many ways, RBV represents a
pendulum swing from the overly external view of industry-based theories to an overly internal one, a gap that some of the more integrating
theories of business strategy that follow have attempted to reconcile.
Knowledge-Based View (KBV)
Key Thought Leader: Robert Grant, 1996
Building upon RBV, the knowledge-based view of the firm highlights the strategic importance of a specific type of resource, knowledge.
Whereas RBV treats a wide variety of resource types in a generic fashion, KBV recognizes that knowledge is maintained by individuals, not
by organizations, and can take the form of either tacit or explicit knowledge. An individual develops tacit knowledge by action and experience.
Tacit knowledge is implicit in nature and operates on a subconscious
level within each individual, making it very difficult to articulate and
disseminate across the organization. In contrast, explicit knowledge represents information that can be articulated, documented, formalized, and
therefore systematically shared. Because all organizational knowledge
originates as tacit knowledge at some point and because tacit knowledge
is most inimitable and immobile, KBV recognizes tacit knowledge as the
primary strategic resource of the firm.22
Knowledge-based competence can stay with the firm, and accordingly, a firm can create a competitive advantage by coordinating, aggregating, and integrating the specialized knowledge that its individual
employees develop. This coordination of specialized knowledge can
take place via rules and directives, sequencing, routines, and group problem
solving and decision making.
Formalizing the sharing of individual expert knowledge in the form of
written procedures can be an efficient approach. If production processes

16

Strategic Management in the 21st Century

allow it, it can be effective to build individual expert knowledge into the
process by sequencing and slotting each specialists contribution to the
production activities, eliminating the need for separate coordination and
communication to share knowledge. Routinizing a coordinated system
of multiple specialists performing complex individual tasks simultaneously can enable reliable, automated coordination of expert knowledge
with minimal supplementary communication. Sometimes the coordination of specialized knowledge cannot be accomplished without highinteraction group communication processes.
KBV also reinforces the importance of having a common base of
knowledge shared throughout the organization upon which the mechanisms for coordination of specialized knowledge described above can
successfully operate. Because individual employee knowledge is increasingly mobile, the processes for knowledge integration (e.g., crosstraining, job rotation) and associated attention to development of
common knowledge domains and practices is increasingly important.
The sustainability of a firms knowledge-based competitive advantage
is dependent on the inimitability and breadth of its knowledge integration across the organization
Limitations of the Knowledge-Based View
Eisenhardt and Santos23 summarize several challenges to the knowledge-based view of business strategy that have been issued by the research community. Recognizing that individuals learning processes
are impacted by their sense of self as well as their organizational context, KBV could be strengthened by developing closer ties to organizational learning theory and social identity theory. It is also questionable
whether knowledge can truly be a firms most strategic resource without considering whether the knowledge is actually used or just retained
within individuals. In todays highly dynamic environment, the organizations ability to manage change may be an even more important resource than knowledge.
Dynamic Capabilities
Key Thought Leaders: David Teece, Gary Pisano, Amy Shuen, 1997
Although not necessarily explicitly emphasized as such, the dynamic
capabilities perspective is essentially an extension of the resource-based
view. Although RBV recognizes the strategic advantages that the leverage
of valuable, rare, inimitable, and nonsubstitutable resources can offer a
firm, RBV does not directly address the competitive implications of market changes as they relate to an organizations ability to adapt their resources and competencies to a rapidly changing environment.24

Major Theories of Business Strategy

17

Dynamic capabilities is proposed as a strategic framework to help explain the competitive advantages associated with firms abilities to continually develop and adapt their competencies in anticipation of and
response to environmental change.25 As the name implies, the focus is
on the dynamic nature of the external environment, in contrast to RBVs
more static view of resources. Capabilities are not synonymous with resources. Rather, capabilities represent a firms unique ability or capacity
to identify distinct internal and external competencies and subsequently
coordinate, reorganize, and reshape them as environmental changes dictate or allow.
This adaptive capability is developed and refined within organizational processes and ways of working over periods of time. Therefore
dynamic capabilities do not represent a type of resource that can be externally acquired and directly infused into an organization. Dynamic
capabilities evolve uniquely within each firm and for that reason can
become a source of a sustainable competitive advantage. Dynamic capabilities may also help the firm establish a series of temporary competitive
advantages as firms respond to successive changes in a highly volatile
environment.26
Limitations of the Dynamic Capabilities View
Since its introduction into the strategic literature, the dynamic capabilities concept has generated a steady stream of theoretical and empirical
research attention that has served to continue its evolution resulting in
a refined understanding of knowledge sourcing (how managers identify
valuable knowledge needs and opportunities) and knowledge transfer
(from both external and internal sources). However, a formal theory
of dynamic capabilities is still forthcoming, as researchers grapple with
clarifying the definitions (expanding and refining what we mean by capability), context (what kinds of environments are best suited to leveraging dynamic capabilities?), mechanisms (what processes are most
effective for communicating and codifying relevant knowledge?), and
expected outcomes (relationships to performance) associated with dynamic capabilities through further empirical testing.27
COMPETITION-BASED THEORIES OF BUSINESS STRATEGY
Although the industry-based view of business strategy emphasizes
the importance of industry structure and RBV emphasizes the value of
firm resources for competitive advantage, it is also recognized that the
decisions a firm makes in terms of its actions and reactions in relation to
its competitors in a market is a major determinant of firm performance.
The competition-based theories of business strategy emerged to fill this

18

Strategic Management in the 21st Century

gap and ensure attention to the dynamics of competition between rivals.


It is important to emphasize that the need for firms to think strategically
is driven by the existence of competition. If there is no competition, there
is no need to make strategy a priority. Firms that hold monopolistic positions within their industries do not face competition and therefore have
little need for thinking strategically.
Bruce Henderson, founder of Boston Computer Group, points out
that competition existed long before strategy28 as he draws an analogy
between business competition and competition between biological organisms. He observes that according to Gauses principle of competitive
exclusion, two animals of the same species attempting to live together
within the same environment will not survive. This competitive reality
in biology drives differentiation of species, and the same dynamic occurs in business competition.
Strategic Conflict
Key Thought Leader: Carl Shapiro, 1989
One competition-based theory of business strategy is strategic conflict. The strategic conflict approach complements Porters strategies in
that it recognizes the ability a firm has to manipulate its market environment, thus improving its competitive outlook.29 Utilizing a game theoretic foundation, strategic conflict can help firms identify and pursue a
preferred position within their industry. As firms take action, they also
anticipate what action they believe their rivals will take. Some of the potential strategic moves Shapiro highlights include investment in physical capital, investment in intangible assets (e.g., R&D), strategic control
of information (impacting rival firms beliefs about market conditions),
horizontal mergers, product standardization (e.g., in highly networked
industries), and strategic contracting.
Teece et al. point out that the relevance of applying strategic conflicts
gaming concepts can be context specific.30 For example, a firm that overwhelmingly dominates a given industry may not need to be as attentive
to rival firms activities as a firm in an industry where the competitive advantages are more subtle or evenly dispersed, further reinforcing the principle that the need for strategy is driven by the existence of
competition.
Competitive Dynamics Theory
Key Thought Leaders: Ken Smith,Walter Ferrier, Hermann Ndofor, 2001
Competitive dynamics theory helps explain the interaction and impact
of firm actions and competitor reactions in a given industry.31 Action can

Major Theories of Business Strategy

19

relate to any observable decision made by a firm for the purpose of defending their current competitive position or attempting to gain a new
competitive position. Examples of actions may include making price
changes, initiating special marketing activities, introducing new products,
or withdrawing from a market. Reactions represent the corresponding response taken by a rival firm.
The competitive dynamics model looks at both the firm initiating
a competitive move as well as the reacting rival firm. Several characteristics of the initiating firms action are considered by the competitor before formulating a response. First, the magnitude of the action is assessed.
For example, an action that required significant financial investment or
resources would be considered high magnitude and warrant more competitive attention. Second, the scope of the action is relevant. An action
that has an impact on multiple competitors is more potentially threatening than an action that has an impact on only one competitor firm. Third,
the type of action (tactical/temporary versus more strategic) is considered.
Several attributes of responders reaction are also relative to the competitive dynamics, including the likelihood of a response (if the attack is
substantial, the likelihood is higher) as well as the frequency and timing
of the response. The longer the time lag between action and response,
the greater the advantage to the initiator, also known as a first-mover
advantage. In addition to the attributes of the actor/action and reactor/
response, the characteristics of the industry itself also impact the competitive dynamics model. For instance, a high rate of industry growth
can reduce competitive interactions, as the growing demand minimizes
the need for individual firms to jockey for position. Likewise, a more
concentrated market with a smaller number of competitors leads to more
collusion and less competitive activity. An industry with high entry barriers limits the number of new entrants that incumbent firms need to be
considered with.
CONCLUSION
Future Directions in Business Strategy Theoretical Development
As the survey of major theories summarized in this chapter illustrates,
there is an incredibly wide variety of theoretical approaches to business
strategy development that have emerged over the past several decades.
There is no one best theory of business strategy. Each theory presented
has its own frame of reference, its own view of the firm and its environment, and its own set of assumptions, mechanisms, and explanations for
firm-level strategic dynamics. Each has its own proponents, challenges
(and challengers), and research agenda.
In general, the product-market-based views of business strategy provide parsimonious typologies for analyzing possible product and

20

Strategic Management in the 21st Century

market positions that are easy to apply and understand, but they are not
strongly theoretically grounded and may have limited applicability at
the corporate level. The industry-based strategic approaches helped raise
awareness of establishing competitive advantage within a particular industry, a perspective that may remain particularly relevant for entrepreneurial decisions. But the assumption that there is one best industry
position to be pursued combined with the lack of inclusion of firm resources and internal workings may limit its applicability, particularly as
we move from manufacturing-centric to knowledge-centric paradigms.
Although RBV emphasizes the importance of internal capabilities, its
weaknesses include a lack of consideration of the external market environment as well as possible tautological, operationalization, and testing gaps. And though competition-based theories of business strategy are
particularly relevant as competition is fueled by the pressures associated with todays shrinking and rapidly changing markets, care needs
to be taken that business strategy is not reduced to a series of moves and
countermoves.
Although it seems difficult to imagine, there was a time in the not-toodistant past where there was not yet a need for strategy. But in todays
highly competitive and complex business environment, businesses need
guidance more than ever to help them understand which strategic approaches can help them compete most effectively. Thus, the research attention in support of refining and expanding approaches business strategy is
expected to continue to accelerate. But rather than focusing on the development of new theories of business strategy or pitting theories against
each other to determine which one may be best, the emphasis at this
stage in the life cycle of strategy research should be on the integration of
and empirical testing of existing theory.
Managerial Implications
Business leaders may not necessarily directly or deliberately rely
on theory in identifying and implementing strategies for their firms.
Many may believe that theories are useful for academic exercises only.
But many of the strategic frameworks, tools, and techniques that they employ as practitioners have been grounded in the theoretical approaches
discussed within this chapter. For instance, IBMs transformation from a
technology/hardware company to a broad-based global solutions firm
is an excellent example of how a dynamic capabilities approach can help
a firm adapt its core competencies to a rapidly changing environment.32
Likewise, the pharmaceutical industry and the strategic resource value
of patents as firm sustainable competitive advantages provide a relevant context for understanding RBV. Competitive dynamics can be seen

Major Theories of Business Strategy

21

where there are widespread industry paradigm changes and shrinking


markets, such as in the airline industry.
Thus, as we just illustrated, although it is often unknowingly and indirect, strategic managers depend upon the foundations laid by theories of
business strategy. It has been said that Nothing is as practical as a good
theory.33 Managerial understanding of and appreciation for the theoretical traditions underlying applied practices in setting strategy can further
enhance the value of business research and its practical relevance to the
business community.

NOTES
1. R. I. Sutton and B. M. Staw, What theory is not, Administrative Science
Quarterly 40, no. 3 (1995).
2. M. E. Porter, What is strategy? Harvard Business Review 74, no. 6 (1996).
3. A. Seth and H. Thomas, Theories of the firm: Implications for strategy
research, Journal of Management Studies 31, no. 2 (1994).
4. H. I. Ansoff, Strategies for diversification, Harvard Business Review 35,
no. 5 (1957).
5. D. F. Abell, Defining the business: The starting point of strategic planning
(Englewood Cliffs, NJ: Prentice-Hall, 1980).
6. R. E. Miles et al., Organizational strategy, structure, and process, Academy
of Management Review 3, no. 3 (1978).
7. C. M. Christensen and M. E. Raynor, Why hard-nosed executives should
care about management theory, Harvard Business Review 81, no. 9 (2003).
8. D. C. Hambrick, Some tests of the effectiveness and functional attributes of
Miles and Snows strategic types, Academy of Management Journal 26, no. 1 (1983).
9. M. E. Porter, How competitive forces shape strategy, Harvard Business Review 57, no. 2 (1979).
10. R. P. Rumelt, How much does industry matter? Strategic Management
Journal 12, no. 3 (1991).
11. R. Schmalensee, Do markets differ much? The American Economic Review
75, no. 3 (1985).
12. G. S. Hansen and B. Wernerfelt, Determinants of firm performance: The
relative importance of economic and organizational factors, Strategic Management
Journal 10, no. 5 (1989).
13. M. E. Porter, Competitive strategy: Techniques for analyzing industries and companies (New York: Free Press, 1980).
14. G. S. Day, Market driven strategy (New York: Free Press, 1990).
15. L. E. Brouthers, E. ODonnell, and J. Hadjimarcou, Generic product strategies for emerging market exports into Triad nation markets: A mimetic isomorphism approach, Journal of Management Studies 42, no. 1 (2005).
16. B. Wernerfelt, A resource-based view of the firm, Strategic Management
Journal 5, no. 2 (1984).

22

Strategic Management in the 21st Century

17. J. B. Barney, Firm resources and sustained competitive advantage, Journal


of Management 17, no. 1 (1991).
18. R. L. Priem and J. E. Butler, Is the resource-based view a useful perspective for strategic management research? Academy of Management Review 26, no. 1
(2001).
19. M. Gibbert, Generalizing about uniqueness: An essay on an apparent paradox in the resource-based view, Journal of Management Inquiry 15, no. 2 (2006).
20. E. Levitas and H. A. Ndofor, What to do with the resource-based view,
Journal of Management Inquiry 15, no. 2 (2006).
21. K. D. Brouthers, L. E. Brouthers, and S. Werner, Resource-based advantages in an international context, Journal of Management 34, no. 2 (2008).
22. K. M. Eisenhardt and F. M. Santos, Knowledge-based view: A new theory
of strategy, in Handbook of Strategy and Management, ed. A. Pettigrew, H. Thomas,
and R. Whittington (London: Sage, 2002).
23. Ibid.
24. K. M. Eisenhardt and J. A. Martin, Dynamic capabilities: What are they?
Strategic Management Journal 21, no. 1011 (2000).
25. D. J. Teece, G. Pisano, and A. Shuen, Dynamic capabilities and strategic
management, Strategic Management Journal 18, no. 7 (1997).
26. I. Barreto, Dynamic capabilities: A review of past research and an agenda
for the future, Journal of Management 36, no. 1 (2010).
27. Ibid.
28. B. D. Henderson, The origin of strategy, Harvard Business Review 67, no.
6 (1989).
29. C. Shapiro, The theory of business strategy, The RAND Journal of Economics 20, no. 1 (1989).
30. Teece, Pisano, and Shuen, Dynamic capabilities and strategic management.
31. K. G. Smith, W. J. Ferrier, and H. Ndofor, Competitive dynamics research:
Critique and future directions, in Handbook of Strategic Management, ed. M. Hitt,
R. E. Freeman, and J. Harrison (London: Blackwell, 2001).
32. J. B. Harreld, C. A. O Reilly, and M. L. Tushman, Dynamic capabilities at
IBM: Driving strategy into action, California Management Review 49, no. 4 (2007).
33. K. Lewin, The research center for group dynamics at Massachusetts Institute of Technology, Sociometry 8, no. 2 (1945).

REFERENCES
Abell, D. F. Defining the Business: The Starting Point of Strategic Planning. Englewood
Cliffs, NJ: Prentice-Hall, 1980.
Ansoff, H. I. Strategies for Diversification. Harvard Business Review 35, no. 5
(1957): 11324.
Barney, J. B. Firm Resources and Sustained Competitive Advantage. Journal of
Management 17, no. 1 (1991): 99120.
Barreto, I. Dynamic Capabilities: A Review of Past Research and an Agenda for
the Future. Journal of Management 36, no. 1 (2010): 256.
Brouthers, K. D., L. E. Brouthers, and S. Werner. Resource-Based Advantages in
an International Context. Journal of Management 34, no. 2 (2008): 189.

Major Theories of Business Strategy

23

Brouthers, L. E., E. ODonnell, and J. Hadjimarcou. Generic Product Strategies for


Emerging Market Exports into Triad Nation Markets: A Mimetic Isomorphism Approach. Journal of Management Studies 42, no. 1 (2005): 22545.
Christensen, C. M., and M. E. Raynor. Why Hard-Nosed Executives Should Care
About Management Theory. Harvard Business Review 81, no. 9 (2003):
6675.
Day, G. S. Market Driven Strategy. New York: Free Press, 1990.
Eisenhardt, K. M., and J. A. Martin. Dynamic Capabilities: What Are They? Strategic Management Journal 21, no. 1011 (2000): 110521.
Eisenhardt, K. M., and F. M. Santos. Knowledge-Based View: A New Theory of
Strategy. Handbook of Strategy and Management (2002): 13964.
Gibbert, M. Generalizing About Uniqueness: An Essay on an Apparent Paradox in the Resource-Based View. Journal of Management Inquiry 15, no. 2
(2006): 124.
Hambrick, D. C. Some Tests of the Effectiveness and Functional Attributes of
Miles and Snows Strategic Types. Academy of Management Journal 26, no.
1 (1983): 526.
Hansen, G. S., and B. Wernerfelt. Determinants of Firm Performance: The Relative
Importance of Economic and Organizational Factors. Strategic Management
Journal 10, no. 5 (1989): 399411.
Harreld, J. B., C. A. O Reilly, and M. L. Tushman. Dynamic Capabilities at IBM:
Driving Strategy into Action. California Management Review 49, no. 4 (2007):
21.
Henderson, B. D. The Origin of Strategy. Harvard Business Review 67, no. 6 (1989):
13943.
Levitas, E., and H. A. Ndofor. What to Do with the Resource-Based View. Journal
of Management Inquiry 15, no. 2 (2006): 135.
Lewin, K. The Research Center for Group Dynamics at Massachusetts Institute of
Technology. Sociometry 8, no. 2 (1945): 12636.
Miles, R. E., C. C. Snow, A. D. Meyer, and H. J. Coleman Jr. Organizational
Strategy, Structure, and Process. Academy of Management Review 3, no. 3
(1978): 54662.
Porter, M. E. Competitive Strategy: Techniques for Analyzing Industries and Companies.
New York: Free Press, 1980.
Porter, M. E. How Competitive Forces Shape Strategy. Harvard Business Review
57, no. 2 (1979): 13745.
Porter, M. E. What Is Strategy? Harvard Business Review 74, no. 6 (1996): 6178.
Priem, R. L., and J. E. Butler. Is the Resource-Based View a Useful Perspective for
Strategic Management Research? Academy of Management Review 26, no. 1
(2001): 2240.
Rumelt, R. P. How Much Does Industry Matter? Strategic Management Journal 12,
no. 3 (1991): 16785.
Schmalensee, R. Do Markets Differ Much? The American Economic Review 75,
no. 3 (1985): 34151.
Seth, A., and H. Thomas. Theories of the Firm: Implications for Strategy Research. Journal of Management Studies 31, no. 2 (1994): 16592.
Shapiro, C. The Theory of Business Strategy. The RAND Journal of Economics 20,
no. 1 (1989): 12537.

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Strategic Management in the 21st Century

Smith, K. G., W. J. Ferrier, and H. Ndofor. Competitive Dynamics Research:


Critique and Future Directions. In Handbook of Strategic Management, edited by M. Hitt, R. E. Freeman and J. Harrison. 31561. London: Blackwell,
2001.
Sutton, R. I., and B. M. Staw. What Theory Is Not. Administrative Science Quarterly
40, no. 3 (1995).
Teece, D. J., G. Pisano, and A. Shuen. Dynamic Capabilities and Strategic Management. Strategic Management Journal 18, no. 7 (1997): 50933.
Wernerfelt, B. A Resource-Based View of the Firm. Strategic Management Journal
5, no. 2 (1984): 17180.

Chapter 2

Early Concepts of Strategy


Marc D. Sollosy

INTRODUCTION
Organizations do not exist in a vacuum. They exist in the environment
to supply goods and services as needed by the environment. They draw
input from the environment. In this simple systems framework, the success
of organizations depends on how efficiently and effectively organizations
align their resources and capabilities with the external demands that stem
from the environment. Organizations that provide the integrating mechanism by scanning the internal environment and external environment are
successful, and others are not. This is much easier said than done. The
integrating mechanism is provided by strategic management. Instead of
looking at various functional departments independently, managers need
to coordinate and integrate all functional areas intelligently, lest the organizations consist of only disjointed pieces. Managers need to craft strategies (formulation) and execute these strategies (implementation) in
organizations that are able to beat competition and outsmart rivals.
Corporate history is full of both success stories as well as failures. Success
stories include companies such as Amazon.com, eBay, Google, Wal-Mart,
ZDell, Microsoft, Southwest Airlines, and Nucor Steel. Companies that
struggled to withstand the competition include K-Mart, US Airways,
United Airlines, Gateway, Costco, and Target. Some companies achieve
success even in a turbulent environment, whereas some others struggle

26

Strategic Management in the 21st Century

for existence. For example, even in the middle of the financial meltdown,
Wal-Mart was able to maintain profitability and also expand.
Wal-Mart: A Classic Success Story
Since its founding in 1962, Wal-Mart has become the worlds biggest
retailor. Sam Waltons entrepreneurial strategy of everyday low prices
captured the imagination of millions of customers worldwide. The financial meltdown did not deter Wal-Marts profitability. For instance,
Wal-Mart had 7,600 stores in 2007, which employed 1.9 million employees
worldwide. In 2011, it had 8,900 units in 15 different countries with sales of
over $419 billion and 2 million employees. Undoubtedly, Wal-Mart ranked
first among retailers in Fortune magazines most admired companies surveyed in 2010. There are several reasons for the success of Wal-Mart. The
first reason is its focus on small towns instead of the urban and suburban locations that its rivals (Target, Costco, and K-Mart) concentrated on.
Second, Wal-Mart became the low-cost provider by sophisticated logistics
management, better human resource management practices, and by minimizing inventories. Efficient distribution enabled Wal-Mart to cut down
costs significantly and achieve above-average returns. Sam Waltons basic
philosophy of giving respect to employees brought loyalty to the organization. Sometime around 1991, Wal-Mart started penetrating into the
global market by first stepping into Mexico and gradually into China.
Though some of its international operations failed (e.g., in South Korea
and Germany), Wal-Mart continued to expand by exploring new markets.
Polaroid: A Classic Case of Strategic Failure
Edwin Land, a visionary and strong entrepreneur, started the Polaroid
company in 1937. The company was known for its polarized sunglasses,
Polavision movie system, and instant cameras. The company enjoyed a
reputation as the international consumers electronics and instant camera company till 1979. Polaroid introduced digital cameras in 1996 but
failed to attract customers. Polavision failed because of competition from
videotape-based systems that captured the market at that time. One of the
strategic blunders Polaroid committed was in its forecasting of the market
for instant cameras. After the introduction of instant cameras the demand
went down and the companys share price dropped significantly from $60
in 1978 to $20 in 1979. Some of the notable failures of Polaroid were its
technology and its marketing. Unable to sustain continuous losses, Polaroid filed for bankruptcy in 2001. The downfall of Polaroid was attributed
to the failure of senior managers to forecast the effects of digital cameras
on its business. The monumental mistakes committed by Polaroid became
the strengths for the competing firm, Eastman Kodak, which entered the

Early Concepts of Strategy

27

photography market in 1976. Kodak was able to outsmart Polaroid and


establish itself as the market leader. Eastman Kodak enjoyed wonderful
market share until the invasion of Fuji, which challenged Kodaks dominance in the market in 1991.
History is replete with such success stories as well as failures. As of
today, Google is enjoying the hallmark of being the number one search
engine. The question is: how are some companies able to sustain their
competitive abilities over time whereas others fail to do so? The answer
lies in successful strategic management.
STRATEGY AND STRATEGIC MANAGEMENT
The word strategy is a catchphrase in the current corporate lexicon.
Strategy is a plan or ploy to achieve competitive advantage and outwit
an intelligent opponent. It may involve decisions about which industry to
enter into, which product to manufacture, which service to render, where
to diversify, when to cut down production, and when to expand and when
to downsize. Strategy is not just evaluating various alternatives and selecting the one that is best. Rather, it encompasses the analysis of the impact
of all the alternatives and then selects the most cost-effective combinations
of inputs. Strategy is not a one-shot deal, but is rather an ongoing process. Companies continuously engage in crafting and implementing strategies to create value for the stakeholders by enhancing customer value. A
strategy is aimed at integrating an organizations goals, policies, and action into a cohesive whole. Organizations are able to marshal and utilize
the resources through a well-formulated strategy, and create a position in
the market by taking into account environmental factors, including their
competitors. Three important questions that need to be answered are:
(1) where are we now, (2) where do we want to go, and (3) how are we
going to get there. The first question requires scanning the internal environment and the competitive positioning of the company in the industry. The
answer to the second question deals with setting goals (both short term
and long term) for the organization. The third question deals with articulating strategies to reach the goals.
Strategic management deals with formulating and implementing the
strategies an organization undertakes in order to attain and sustain competitive advantage. This is easier said than done. In this highly volatile and competitive environment, organizations create value and secure above-average
returns only when they successfully craft strategies and implement them.
Strategic management is the process of aligning the organizations internal resources and strengths with the opportunities and threats stemming
from environment. Organizations that facilitate the fit between resources
and capabilities and environmental demands become successful. In the
absence of carefully crafted strategies, organizations remain a collection of

28

Strategic Management in the 21st Century

disjointed pieces, departments, and functional areas, and become directionless. Before formulating the strategies, top management need to evaluate the internal environment and identify the strengths and weaknesses,
and evaluate the external environment to identify the opportunities and
threats. This is what is known as SWOT (strengths, weaknesses, opportunities, and threats) analysis. Conducting SWOT analysis is an initial
starting point of strategic management. Based on these, companies evolve
strategies. Following the 2 2 matrix, these strategies can be labeled as
shown in Figure 2.1.
Strategic Decisions
Top management team members are responsible for making strategic decisions that provide overall direction to organizations. Strategic decisions are different from routine decisions in that they are complex,
vague, nonroutine, and do not have set precedents. These decisions have
organization-wide ramifications. Strategic decisions require commitment of resources, and most of the time these decisions are irreversible
in nature. A wrong strategic decision may prove to be costly to the firm
and therefore the top management team invests considerable time and
energy in making these decisions. Examples include decisions involving
Figure 2.1
Company Strategies

Early Concepts of Strategy

29

diversification, introduction of new product or service, downsizing, expanding the plant or starting up new production facilities, strategic alliances, and joint ventures.
Strategic Managers
An organization cannot function without general managers and functional managers. From the viewpoint of strategic management, the general
managers who are at the helm of the organization are called corporatelevel managers (consisting of CEO, board of directors, and other members
of top management team). The corporate-level managers are responsible
for crafting and executing the strategies that provide overall direction to
an organization. These managers determine what business to conduct or
service to render, and allocate resources accordingly. These managers provide leadership to the organization.
Every organization has division heads, called business-level managers.
These managers translate the corporate strategies into their individual
business units. Every organization consists of several small business units
(called self-contained divisions) that provide a product or service. The
business units work in coordination with other business units in sharing
the scarce resources and capabilities.
Last, functional-level managers are responsible for coordinating the activities in their respective functional areas such as finance, marketing, production, purchasing, and research and development. The functional managers
play a strategic role in aligning functional objectives with the overall goals
of the organization. They are responsible for the performance of their functional areas, and must provide valuable information to the corporate-level
managers in setting strategic goals and in evaluating performance.
THE EVOLUTION OF STRATEGIC MANAGEMENT
In late 500 bc, Sun Tzu authored a book called The Art of War, which
contains 13 chapters that focus on military strategies and tactics. According to Sun Tzu, the positioning of an army was important and while doing
so one should take into account the physical environment and subjective
beliefs of ones opponents on the field. He emphasized the importance
of responding quickly to the environment in order to appropriately meet
changing conditions. In a static environment, planning works successfully, but in a dynamic and changing environment plans rarely work.
Strategic management slowly blossomed into a distinct and important
discipline over a five-decade period. During the 1950s it was in the embryonic stage, where the focus of the top management team was on budgetary planning and controls and key concepts revolved around financial
control. To achieve control over the budgeting, management made use

30

Strategic Management in the 21st Century

of accounting tools such as capital budgeting and financial planning. At


this time companies achieved competitive advantage through coordination and control of budgetary systems. During the 1960s through 1970s,
management teams started focusing on corporate planning. Most companies initiated corporate planning departments to plan for growth and diversification and used forecasting as the primary tool to visualize growth.
Companies embarking on growth attempted to seek opportunities for diversification. By the 1970s, strategic management started evolving on a
more serious note, extending beyond the budgetary planning and control,
and corporate planning, to include positioning companies in relation to
competitors. Corporations tried to jockey for power and focused on selecting particular market segments and positioning for leadership. During this period, companies analyzed industry to determine attractiveness
in terms of entry barriers, available suppliers, and potential buyers. Companies attempted to diversify and expand through entry into the global
arena during this period. To align structure with strategy, companies
started slowly moving toward hybrid and matrix structures. By the late
1980s through 1990s, the growth of strategic management as a separate
discipline started taking its own shape. This can be seen in terms of companies attempting to secure competitive advantage. The key concepts of
the companies concerned the sources of sustained competitive advantage
(i.e., ways and means of gaining success over potential rivals). Table 2.1
captures the timeline of evolution of strategic management.
In the early stages of development, strategic management concepts revolved around microeconomics. As the theory of firm addresses the question of why firms exist and what determines their scale and scope,1 other
theories also revolved around this basic theme. The initial answer was in
terms of the neoclassical theory of perfect competition that considers the
firm as a combiner of inputs to produce desired outputs. Firms aim at
achieving the least among the cost combinations of inputs in the production process, equating the marginal cost to the marginal revenue to determine the level of output that maximizes profit. The inherent and highly
restrictive assumptions are that resources are perfectly mobile and the
buyers and sellers have all necessary information. Most importantly, firms
are small in size and produce single products, and hence all firms are assumed to be identical. The firms size is determined by technological and
managerial factors.
Gradually, researchers realized that these highly restrictive assumptions
may not be applicable in real life. Some degree of monopoly power exists
in industry. The firms that have monopoly power are capable of restraining output to maximize their profits. When power gets diluted, which can
be seen in terms of low industry concentration, firms compete for market
share and engage in different strategies depending on the context and purpose. The industry structure (called structure) as determined by the number

Table 2.1
The Evolution of Strategic Management
Time Period

Focus

500 BC

The ancient Chinese book titled The Art of War authored by Sun
Tzu mentioned some of the important concepts of strategy. The
book contains 13 chapters especially with regard to waging war, how
to use strategic power, how to have military combat, the ways of
maneuvering the army, and so forth.

1800s

Tactics and strategies applied to war situations. Tactics involve


the use of armed forces in the engagement and strategy is the use
of engagements for the objects of war (Carl von Clausewitz).

1920s1950s

Strategic planning was the main focus. Alfred Sloan of General Motors
mentioned development of strategic plan based on its strengths and
weaknesses.
Chester Barnard of New Jersey Bell in 1930 emphasized the importance
of strategic factors and organizational personal action to deal with
competition.
During World War II (1940s) the Allied nations emphasized strategic
thinking and use of some strategic planning tools for allocating the
scarce resources.

1950s1960s

Main issues of companies comprise budgetary planning and control.


Companies focused on meticulous financial controls and used capital
budgeting and financial planning as the tools to achieve the budgetary
goals. Top management teams were actively involved in working between
functional departments to achieve coordination with regard to budgets.

1960s1970s

For the first time, the managers brought the concept of corporate
planning to the forefront. Companies created separate corporate
planning departments that were entrusted with the task of using
sophisticated forecasting techniques and plan growth and
diversification.

1970s1980s

Corporations attempted to jockey for power and the main focus


of the firms was positioning in the global market. Market segmentation, securing brand loyalty, and industry analysis were the key
components during this phase. Companies moved away from the
traditional functional structures to organic and hybrid structures
such as matrix and project structures to position their organizations
in global arena.

1980s1990s

From embryonic stage, strategic management slowly progressed to


identify the reasons why some companies outperform others.The focus
shifted to securing competitive advantage and the strategic management
scholars attempted to find the antecedents of sustained competitive
(continued)

32

Strategic Management in the 21st Century

Table 2.1 (continued)


Time Period

Focus
advantage. Industry analysis and resource-based view dominated the
field during this phase. Corporate restructuring, outsourcing, and
reengineering were some of the organizational implications. Resource
acquisition, capability building, and moving into attractive industry
were the chief strategies the companies were engaged in.

1990s2000s

Sustained competitive advantage were the unifying theme of the


corporations. Strategic alliances such as joint ventures, mergers, and
acquisitions ruled the strategic management during this phase. A new
shape of competition took place in terms of cooperative strategies.
Virtual organizations were developed and size was no longer an issue
here. Strategic innovation and survival with cooperation were chief
characteristics during this stage.

20002010

This decade was characterized by volatile business environment


characterized by recession, occasional disturbances in financial sector,
and financial meltdown throughout the world. Emerging Third World
economies paved way for new strategies for the corporations.
Finding new and unexplored international markets and outsourcing
to cut down growing overheads were the hallmarks of the strategies.
However, success to most of the organizations was short lived and
companies resort to both proactive and reactive strategies to survive
and maintain sustained competitive advantage.

of buyers and sellers, entry barriers, product differentiation, and proportion of fixed to variable costs sets the tone for the strategy (called conduct),
which may be seen in advertisement wars and price wars between firms.
Performance is a close combination of these forces structure conduct.
Therefore, subsequent scholars (e.g., Bain 1954) in strategic management
focused on examining the structure-conduct-performance relationship.
The first and foremost scholar who brought recognition to strategic
management as a separate discipline was Chandler after he wrote the
book titled Strategy and Structure in 1962. Chandler explained how giant
corporations (such as General Motors, Standard Oil, and DuPont) have
grown over the years in such a way that senior managers had to direct
their energies to make long-term decisions and move away from daily
routine decisions. He was the first to label a formal termstrategyfor
these long-term plans. The term actually was derived from the Greek
word strategos (which means art of the general).
Following Chandler, corporations resorted to making use of long-range
planning in their strategic decision-making agendas. The main focus was
to examine budgetary proposals in light of the past data on expenditures.
Chandler also argued that organizations need to change their structure to

Early Concepts of Strategy

33

follow the changes in strategy. Firms gradually moved to organic structures (from traditional functional structures), which were centered on
work teams and groups to enhance productivity and performance.
Almost at the same time, Schumpeter (1950) argued that firms should
try to capture the market by innovation and make rivals positions vulnerable. He was of the view that competition over innovation would be more
effective than the price competition. It is important to note that firms seeking radical innovation eventually enjoy monopoly power. But a significant
point is that this radical innovation is often risky and the financial commitments involved in innovation may prohibit firms from venturing to
implement the innovation. In the process of innovation, firms are engaged
in creative destruction.
It is also important to take note of Ronald Coases notion of the costs
of negotiating contracts for the factors of production. Based on Coases
framework, Williamson elaborately explained the transaction cost economics (TCE) as relevant to strategic management. Most importantly,
firms avoid the costs of transactions through price mechanisms. The transaction cost approach is very much relevant under the conditions where
the potential for opportunistic behavior by the members in the transaction is very high. Williamson emphasizes the existence of three conditions
for this opportunistic behavior: asset specificity, a small number of people
involved in transactions, and imperfect information. Early in the 1980s,
some other scholars, such as Klein and Leffler, extended the framework
of Williamson by stating that existence of opportunistic potential is not
adequate for deriving monopoly power. It is likely that both the parties
may engage in cooperative relationships to avoid diseconomies stemming
from the mutual exploitation.
As history reveals, firms moved away from simple long-range planning
to craft and implement strategies to deal with the changing environment.
Until the 1970s, companies did not face challenges from global competition. Onset of technology paved the way for the Information Age and
most of the U.S. companies lost their ground to international firms. For
example, the automobile industry in United States experienced rapid decline in their market share due to intense competition from Japanese automobile companies.
EVOLUTION OF THEORIES IN STRATEGIC MANAGEMENT
Firms make strategic choices to outrun competitors. The essence of
strategic management is to (1) attain, and (2) sustain the competitive advantage. The key question encompassing strategic management is why
some firms achieve higher levels of performance. Strategic management
offers different perspectives for accounting performance differences between and among firms. Some view that a better-performing organization

34

Strategic Management in the 21st Century

may be in a better market position that is protected from its competitors.


Others view that organizations need to have unique capabilities and core
competencies to sustain competitive advantage. Other scholars argue that
to have sustained competitive advantage, firms need to occupy a powerful position in a network of organizations. Yet another perspective is that
firms need to align structure with strategies that fit well with the challenges offered by the market to sustain competitive advantage. Finally,
important work by Williamson proposes that the way to maintain competitive advantage is to minimize transaction costs.2
As we dig up history, various approaches to study strategy can be discussed under two broad streams of theories: competence-based theories
and game-based theories. Whereas competence-based theories take the
organization theory perspective and focus on the process, game-based
theories take the economic perspective and give importance to the governance perspective. Based on these theories, two broad perspectives
are followed: industry/organization perspective (called I/O model) and
resource-based perspective (called RBV model).
The concept of competence has gained currency in the recent past in
strategic management literature. Though some scholars contend that the
concept of competence has acquired a tautological reputation, David
Teece, Gary Pisano, and Amy Shuen argue that core competences are
derived by looking across the range of a firms (and its competitors)
products and services.3 Some examples include the following: IMBs
core competence is in integrated data processing and service, Eastman
Kodaks core competence lies in its imaging process, and Motorolas
core competence lies in its effective communication network. The basic
tenet is that a firms distinctive competence is a differentiated set of skills,
complementary assets, and organization routines, which together allow a
firm to coordinate a particular set of activities in a way that provides the
basic for competitive advantage in a particular market or markets.
Transaction Cost Economics
Based on the seminal work of Coase (1937), Williamson developed a
new theory in strategic management called transaction cost economics
(TCE). TCE describes the firm in organizational terms (i.e., governance
structure) and not in traditional microeconomics terms (i.e., production
function). The basic tenet of TCE is to economize on transaction costs and
mitigate the hazards that accrue due to opportunism. According to Williamson, whereas cognitive specialization is a means by which to economize, governance is the economizing response in the sense that it infuses
order in a relation where potential conflict threatens to undo or upset opportunities to realize mutual gains.4

Early Concepts of Strategy

35

Game Theory
When firms move from a monopoly situation to that of duopoly and
eventually oligopoly, application of game theory becomes very much relevant. Sometimes firms make strategic decisions in the absence of complete
information just by making assumptions about how other firms act and
react. Managers may systematically evaluate strategic alternatives and
spend enormous amounts of money that may result in huge dividends
depending on how other firms perceive the strategies employed by the
competing firms.
Agency Theory
According to the principle of hedonism, almost all individuals act in
accordance with self-interest by exerting minimum effort to extract maximum benefits. It is assumed that everyone is cognizant of the self-interest
motivations of others, and this gives platform for concerns about conflict
of interest. In the context of organizations, these conflicts are apparent between the principal who engages another individual called an agent, to
perform services on his/her behalf. Agency theory explains the relationship between the principal (the shareholders) and the agent (the CEO)
who has been engaged to make decisions on the principals behalf. Issues
may develop because the principal and agent, while working toward the
same goal, do not always share the same interests. The actions of agents
(called CEOs and top management team) may not necessarily be consistent with the interests of principal (stakeholders). Strategic management
therefore attempts to bring some governance mechanism through a board
of directors to see that agents will not take decisions in their self-interest.
The boards of directors will ensure that that the interests of both the principal and agents are aligned for the benefit of the organization. In this process some agency costs are involved, such as the principals monitoring of
expenditures and the agents bonding cost. Agency theory also explains
the reasons why agents will not be motivated to exert effort unless incentives are provided and some share in the value of the firm is negotiated by
the agents in the contract. Agency theory ties pay closely to performance.
Resource-Based View (RBV)
According to Barney, sustained competitive advantage largely depends on the resources (assets, capabilities, organizational processes,
firm attributes, information, and knowledge) a firm possesses. Although
a firms external environment is important, firm resources are far more
important than the environment in which the company operates. RBV is
based on two key assumptions, namely, resources are heterogeneously

36

Strategic Management in the 21st Century

distributed across all the firms, and the firm resources are largely immobile. Given these assumptions, a firm secures competitive advantage
if the resources possess the qualities of rarity, value, imperfect imitability, nonsubstitutability, and nontransferability. The proponents of RBV
argue that competing firms will not be able to imitate strategies based on
resources because there is causal ambiguity and social complexity associated with the relationship between these resource configurations and
sustained competitive advantage. RBV has gained wide currency in the
academic lexicon because its capability logic is very convincing in explaining why some firms achieve success despite the fact that they fall
under the industry that is not performing well. The core logic behind the
RBV is the capability logic that states that a firm can outperform rivals
only if it has a superior ability to acquire, develop, configure, and use the
resources to sustain its competitive advantage. The basic argument of the
RBV is that a firms competitiveness is a positive function of the resource
mobilization and capability building so that strategies are designed to
capitalize on the opportunities and mitigate threats stemming from the
environment. The way in which firms exploit and leverage internal abilities and resources is the key. Having superior resources is a necessary, but
not sufficient, condition. What is important is that the resources and competencies need to be protected from exploitation by competitors through
imitation and substitution.
Industrial Organization (IO) Theory
According to IO theory, industry forces in which a firm operates are
very important for the firm to maintain profitability. The industry attractiveness depends on the strength of the five forces: competition of firms
within the industry, bargaining power of buyers, bargaining power of
suppliers, threat of new entrants, and availability of substitute products.
The stronger the forces, the more unattractive the industry becomes. Analysis of these five forces is the key for a firm to see whether it can have an
edge over its competitors. IO theory places a premium on the environment
and is explicitly concerned with the opportunities and threats stemming
from the environment. Researchers who subscribe to the IO theory argue
that a firm should scan the external environment and focus on identifying and exploiting opportunities and neutralizing threats. However, it is
necessary to match the firms internal capabilities to exploit opportunities
and strengths, in order to mitigate the threats from environment. Strategic management researchers attempt to address the performance differences across firms in terms of two basic approaches: IO and resources.
As Montgomery contends, a portion of these differences may be due to
unique firm characteristics and actions; and another portion is due to the
conditions in their respective industries in which firms operate.5 Scholars

Early Concepts of Strategy

37

argue that industry effects explain far more variance than firm effects. The
debate is ongoing.
APPROACHES TO STRATEGIC MANAGEMENT:
HISTORY TO PRESENT
The history of strategic management reveals that for much of the 20th
century the dominant approach to strategy was the design approach, as
articulated by Alfred Chandler, where the emphasis was on the relationship
between strategy and structure. Chandler argued that strategy determines
the structure and the environment within which a firm operates. Big corporations such as General Motors, Du Pont, and Standard Oil followed the
design approach in the sense that changes in strategy necessitated changes
in the structure. A slight departure from the design approach was the levels approach of strategic management. Igor Ansoff, in 1965, argued that
it is important to think of strategy at various levels, such as the corporate
level, business level, functional level, and operational level. Corporate-level
strategies deal with what industry a firm should choose to operate and
which product/service it decides to manufacture or render. The businesslevel strategies deal with how to use that product/service effectively to
sustain competitive advantage. At the functional level, managers need to
set their departmental objectives and conduct operations.
During the 1970s, strategic management scholars focused on a new
approach called the positioning approach. Porter and his colleagues,
Lamb and Caves, argued that a firms profitability depends on the position it occupies in the industry. Positioning is dependent on five forces:
intensity of rivalry of firms in the industry, buyer power, supplier power,
new entrants, and substitute products. A firm can place itself in the industry in a comfortable position if the industry is characterized by high entry
barriers, weak bargaining power of buyers and suppliers, and weak substitute products. Firms may pursue low-cost leadership, differentiation,
and focus on strategies to gain sustained competitive advantage.
As a radical departure from the positioning approach during the 1990s,
RBV has come into vogue, and it emphasizes the importance of resources
and capabilities and core competencies of a firm in maintaining competitive advantage. The firms internal strengths are seen in terms of resources
and capabilities, which are the true sources of sustained competitive
advantage.
Although some strategic management scholars focused on industry analysis (e.g., Porter), some others stress the importance of resources and capabilities (e.g., Barney, Teece) as the means of securing competitive advantage;
many companies have emphasized team-based restructuring and have focused on outsourcing to cut down unnecessary overheads. By the beginning of the 2000s and through 2010, the main focus of organizations shifted

38

Strategic Management in the 21st Century

to cooperative behavior between firms and the related organizational implicationsalliances and networking. The Internet revolution has brought
a new type of competition through e-commerce, virtual organizations, and
reconciliation of size with flexibility and agility to deal with competition.
NOTES
1. Conner, K. R. (1991). A historical comparison of resource-based theory and
five schools of thought within industrial organization economics: Do we have a
new theory of the firm? Journal of Management, 17 (1), pp. 121154; Bain, J. S. (1954).
Economies of scale, concentration, and the condition of entry in twenty manufacturing industries, American Economic Review, 44, pp. 1539; Chandler, A. D.
Jr. (1962). Strategy and Structure, Cambridge: The MIT Press; Klien, B., & Leffler,
K. (1981). The role of market forces in assuring contractual performance, Journal
of Political Economy, 89, pp. 615641; Williamson, O. E. (1975). Markets and Hierarchies: Analysis and Antitrust Implications. New York: Free Press; Coase, R. H. (1952).
The nature of the firm. In G. J. Stigler & K. E. Boulding (Eds.), Readings in Price Theory, Chicago: Irwin, pp. 331351 (Reprinted from Econometrica, 1937, 4: 386405);
Schumpeter, J. A. (1950). Capitalism, Socialism and Democracy (3rd ed.). New York:
Harper & Row.
2. Lenz, R.T (1980). Environment, strategy, organization structure and performance: Patterns in one industry, Strategic Management Journal, 1, pp. 209226;
Barnett, W. P., & Burgelman, R. A. (1996). Evolutionary perspectives on strategy, Strategic Management Journal, 17, pp. 519; Porter, M. E. (1980). Competitive
Strategy. New York: Free Press; Barney, J. B. (1991). Firm resources and sustained
competitive advantage, Journal of Management, 17, pp. 99120; Wernerfelt, B.
(1984). A resource-based view of the firm, Strategic Management Journal, 5 (2),
pp. 171180.
3. Pfeffer, J., & Salancik, G. R. (1978). The External Control of Organizations.
New York: Harper & Row; Burt, R. S. (1992). Structural Holes. Cambridge, MA:
Harvard University Press; Scott, W. R. (1975). Organizational structure, Annual Review of Sociology, 1, pp. 120; Venkatraman, N., & Prescott. J. E. (1990).
Environment-strategy co-alignment: An empirical test of its performance implications, Strategic Management Journal, 11 (1), pp. 123; Williamson, O. E. (1991).
Strategizing, economizing, and economic organization, Strategic Management
Journal, Winter Special Issue, 12, pp. 7594; Saloner, G. (1991). Modeling, game
theory, and strategic management, Strategic Management Journal, Winter Special Issue, 12, pp. 119136; Dixit, A. K., & Nalebuff (1991). Thinking Strategically.
New York: Norton; Jensen, Michael C., & Meckling, William H. (1976). Theory of
the firm: Managerial behavior, agency costs and ownership structure, Journal of
Financial Economics, 3 (4), pp. 305360.
4. Williamson, O. E. (1999) Strategy research: Governance and competence perspectives, Strategic Management Journal, 20, pp. 10871108.
5. Montgomery, C. A. (1988). Guest editors introduction to the special issue on
research in the content on strategy, Strategic Management Journal, 9, pp. 38.

Chapter 3

Dealing with Complexities: The Role


of Management Frameworks
Andreas Schotter

INTRODUCTION
Dealing with complexities is one of the most critical management tasks
of the 21st century. Industry boundaries shift, globalization pressures
increase, and innovation cycles accelerate. Together with organizational
growth they raise complexity to almost unmanageable levels. In their
2007 Harvard Business Review article, David J. Snowden and Mary E.
Boone1 described the characteristics of complex systems that involve a
large number of interacting elements, most of which are nonlinear but
interconnected. The authors argue that in complex systems even minor
changes can produce disproportionately large consequences. In a recent
survey by McKinsey & Company2 that included 2,240 top executives
from corporations across a wide range of industries, who were asked
about the risks, challenges, and complexities, in the context of innovation and its commercialization, 35 percent of respondents stated that the
key challenges are aligning human and financial resources, 29 percent
stated the lack of formalized processes as the greatest risk, and 27 percent stated that dealing with complexities when gaining internal leadership alignment the most difficult task. The results of this survey reflect

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Strategic Management in the 21st Century

the pressing need for organizations to reduce complexity, to simplify the


task of management, and to organize the link between strategy development and strategy execution more effectively.
A solution to the problem is the implementation of a coherent management framework that on the one hand provides structure and guidance
toward execution for best performance and on the other hand allows for
the necessary flexibility in order to react effectively to environmental
dynamism.3 This then enables managers to swiftly adjust, develop, and
implement strategy4 as required. Christopher Ittner and David Larcker5
reported in their Harvard Business Review article on nonfinancial performance measures that companies that adopted enterprise performance
management systems gained up to three percent higher returns on assets and more than five percent higher returns on equity as compared to
those firms that do not use performance management systems.
In this chapter, the concept of management frameworks is being introduced. The discussion includes a series of specific examples that provide
solutions for particular elements of the strategic management process.
The majority of the chapter describes a management framework that
evolved from both rigorous academic research and applied best practices, which were deemed most encompassing and effective in solving
the organizational complexity quandary. We call this framework toward
performance excellence (TPE). TPE was developed when Jacques Kemp,
in his former role as senior executive for the Dutch multinational ING
Group, did not get the desired solutions from the application of existing
frameworks or from templates provided by some of the top-tier management consulting firms. TPE is likely the most comprehensive and most
practically applicable management framework today.
MANAGEMENT FRAMEWORKS OVERVIEW
When Lehman Brothers, one of the most respected banks on Wall
Street, filed for bankruptcy protection in September 2008 the global financial system went into a steep downward spiral in a matter of hours. The
recession that was triggered eliminated billions of dollars from bank and
businesses balance sheets and erased countless individual investors lifetime savings. Around the world tens of thousands of jobs disappeared in
just a few days.
The investigation into the causes of this event revealed that nobody
at Lehman Brothers or at the financial institutions who followed similar
trading practices had any understanding of the inherent risks that their
businesses faced. The Financial Times6 described the results of the congressional report following the Lehman collapse as shocking and stated that
the firm did not possess any real operational controls. This allowed too
many uncoordinated decisions and short cuts, which increased the actual

Dealing with Complexities

41

operating risks for Lehman Brothers exponentially. Not even the chief executive officer (CEO) at the time seemed to have any comprehension what
the financial position of the company actually was. Although the blame
was put on some top-level executives who, during the good days, seemed
to neglect due diligence, it also became apparent that the lack of consistent controls across the organization and an ineffective, if at all existing,
information system left the banks senior managers in the dark about the
actual financial health of the organization. In addition, management also
seemed to rely too much on reviewing past performance without a system
that would allow it to understand the future and the potential risks that
would be faced moving ahead.
When Toyotas chairman, Akio Toyoda, had to testify in spring 2010 in
front of the U.S. Senate about the recent wave of safety recalls of Toyota
vehicles, another apparent poster child of operational excellence showed
signs of serious organizational troubles. Over decades the global automotive industry had almost religiously adopted elements of the so-called
Toyota Way,7 a supposedly superior operational management and production process that, at its center, followed kaizen,8 the traditional Japanese method of continuous improvements. Over many years, Toyota led
consumer reports and public perception in the quality area. No other car
manufacturer had higher ratings in consumer reports and could stand up
stronger to the constant price and discount pressures in the cutthroat car
business that was plugged by oversupply.
However, the break and accelerator crises revealed that Toyota, over
time, had fallen victim to a strategy execution misalignment problem that
nobody at the firm expected. An inefficient internal communication process further clouded the assessment ability of Toyotas management.9 Although Toyota initially followed a clear differentiation strategy built on
quality leadership, the execution of this strategy deviated during the late
1990s when a series of senior management changes took place. Toyota
was then forcefully pursuing a volume leadership strategy that turned the
focus internally on cost reduction instead of quality. In addition, the rapid
internationalization that took place during that time and the never really
achieved implementation of global decision-making processes created
an ineffective one-way communication process at Toyota. Held back by
cultural differences and poor integration, reporting structures and managerial controls never caught up with the global expansion of Toyotas
vehicle manufacturing and sales. In the end, in Japan nobody really understood the seriousness of the break and accelerator issues that emerged
in North America. At the same time, management in the United States did
not know how to react since the decisions necessary for such an issue were
in the hands of managers at Toyotas corporate headquarters in Japan.
These managers either did not respond to enquiries and reports or assumed that everything was just fine. The Toyota case further highlights the

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Strategic Management in the 21st Century

potential dire consequences of misalignments between strategy and strategy execution. In general, effective coordination and control are difficult
to achieve in rapidly expanding organizations. This is particularly true for
centralized organizations with global reach but without functioning allencompassing management frameworks in place.
The two previous examples are by no means unique. Over the past few
years, billions of dollars have been erased from corporate balance sheets
around the world because of the abrupt adjustments needed as reaction to
the effects of the global financial crisis. Some of the most respected companies have fallen victim to external forces that they apparently did not
see coming. The question that always comes up in these situations is, were
the leaders just ignorant or, even worse, incompetent, or are large organizations simply too complex to be managed efficiently?
Today, the scale and scope of global businesses are very different as
compared to even a decade ago. The biggest issue, however, is that we
still try to manage organizations with the same methods and frameworks
we used 50 or even 100 years ago. If we take a closer look at most organizations today we see them compartmentalized and divided into departments, strategic business units, countries, or product clusters. This logic
follows the management model Alfred Sloan10 introduced with great success 100 years ago at General Motors to provide a spreading, misaligned,
and highly decentralized organization structure. The result was that the
company became the worlds largest carmaker for a period of 77 years.
Today, most businesses are still organized following to a certain extend
Sloans way, although business units, departments, and divisions often
turn into self-contained silos with little interaction with the rest of the organization. Some organizations try to break out of the inefficiencies by
restructuring themselves into so-called matrix organizations, with flat hierarchies and multiple reporting lines. However, if you talk to managers
who have experience with this kind of restructuring most will tell you
horror stories about inefficiencies, increased dysfunctional conflict, and
reduced employee satisfaction. Sy and DAnnunzio11 identified the most
critical challenges of matrix organizations, including structural form, misaligned goals, unclear roles and responsibilities, ambiguous authority,
lack of a matrix guardian, and too silo-focused employees. The biggest
problem with these often rushed initiatives is that whereas reporting lines
are redrawn and hierarchies reshuffled, new management tools are seldom provided and if they are being provided, they are shoehorned into an
organizational setting in disregard of the existing vital processes that are
essential for the individual organization.
Based on these issues, it comes as no surprise that companies spend
millions of dollars on structures and systems. IT infrastructures are carefully and constantly reengineered, and factories and plants are designed
and laid out in order to achieve maximum efficiency. Consulting firms

Dealing with Complexities

43

such as McKinsey & Company or Accenture earn hundreds of millions in


providing their expertise by deploying their latest frameworks. The reality is that management in todays complex organizations requires better
analytical tools to deal with complexity and not activities to reduce complexity. In fact, complexity can be valuable for organizations, especially
in high tech and service sectors. Strategically applied, complexity supports the protection of intellectual property (IP) in environments that do
not have the necessary institutional protection mechanisms to deal with
the risks of IP theft.12 Nevertheless, complexity should not impede the
flow of information that is critical to maintain complete and proper communication across all parts of the organization. Well-designed management frameworks are the tools to make complexity manageable.
SOME MANAGEMENT FRAMEWORKS
WORK BETTER THAN OTHERS
Most organizations use some sort of framework, though they are
usually specialized in nature and relate to explicit processes such as IT,
human resources, sales reporting, or supply chain management. Some
are high level, top management oriented, and are intended to be used by
the most senior executives exclusively. Other frameworks are more general in nature. The problem with most of these frameworks is the way
they connect or, more accurately, do not connect with each other. They
were usually designed by specialists for specialists, who often work in
very specific contexts while using different terminology as compared to
other members of the same organization. In addition, in global organizations it is not uncommon to find that some regions use one kind of system and other regions use other systems that do not connect well with
each other, if at all. In addition, cultural differences developed within
and from outside the organization might mean that reporting is done in
very different ways. In most companies, the only framework that usually connects different parts of the organization well in a consistent way
is the reporting of financial data. The finance department is sometimes
the only department that applies standardized spreadsheets for reporting and communicating data.
Specialized frameworks have their valid purpose but an organization
also needs an overarching management framework that encompasses
the whole organization, while addressing the management of environmental complexities. To illustrate this concept we draw an analogy with
architecture and the construction of a large building. Constructing a
building might require a wide range of specialized blueprints for highly
specific experts who only work on particular parts of the structure; however, there is only one overarching architectural master plan on which
each of these specialists work and from which individual interconnected

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Strategic Management in the 21st Century

elements are developed. In an organization, as well, there needs to be


one master plan that spans the whole organization and connects all the
elements. The point is that these individual elementslike the plumbing of a buildingare unable to function without all the other parts.
They need to be incorporated into a coherent structure in order to be
effective. Similar to a building, an organization consists of a number of
elements, including finance, sales and marketing, production, distribution, international, research and development, human resources, legal,
technical departments, and of course top management that form a functioning whole. The larger the organization, the more diverse and, often,
the more geographically spread out it is. Similar to the design of a building with different floors and utility lines that are well connected, an organization needs to ensure that its various layers are well connected and
that all functions and activities work together based on the same plans
and templates. Adopting a birds eye view, it is clear that management
should provide the connections between all the different parts of an organization. Hence, it is the responsibility of management to align all the
different parts and prevent them from pulling apart without either limiting their individual effectiveness or their proper functioning for the
overall organization.
Starting from the 1960s there was a proliferation of high-level strategic frameworks proposed including those of Michael Porter and Igor
Ansoff.13 The former is still widely cited as the underpinning for newer
framework variations. Many of these frameworks, however, are problematic because they focus purely on strategic intent and planning and
insufficiently address strategy execution and structural consistency.
Hence, critics such as Henry Mintzberg14 argue that those frameworks
do not reflect the reality of how business is being conducted in the real
world. The 1990s and 2000s saw the appearance of a large number of
specialized frameworks in areas such as marketing, finance, and operations. Advances in IT and the wide-ranging availability of high-speed
Internet at the global level led to the widespread adoption of enterprise
resources planning (ERP) solutions from the likes of SAP and Oracle.
This in turn affected organizational structures and often caused disconnections between the so-called hard processes that are more numbers
based and the soft processes that are more relationship based. Eventually, new general management frameworks emerged, including Kaplan
and Nortons balanced scorecard approach,15 which was later complemented with the strategy maps concept.16 Pryor, White, and Toombs17
developed the 5Ps model that fosters the alignment of an organizations
purpose, principles, processes, people, and performance. The 5Ps model
was targeted specifically at smaller businesses; hence it was kept fairly
simple. Another widely used concept was McKinseys 7S framework,18
aimed at describing and transforming an organization in a more holistic way in order to drive efficiencies. Finally, Accentures SAP-based

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45

advanced performance management solution represents a framework


that integrates an IT-driven enterprise resources management approach
and a managerial relationship approach.
There are many more frameworks available. Almost daily a new generic approach seems to emerge. Hence, it is impossible to address them
all in the context of this chapter. We acknowledge, however, that different managerial preferences make one or another framework more appealing to specific executives and their respective organizations. The
selection for this overview was of course biased, though it was based
on more than 20 years of executive experience and diligent academic
research that spans a period of more than six years. In the following
section, the underlying individual logics behind the four frameworks
selected for discussion will be introduced before we provide a more indepth look at the TPE framework.
MCKINSEY 7S MODEL
Prominent McKinsey & Company consultants Tom Peters and Robert Waterman in their book In Search of Excellence first introduced the
7S management framework in 1982.19 It since has become known as the
McKinsey 7S model because of its adoption as the management consultancys trademark management tool. The term 7S refers to the seven
elements that are linked together to form the overall framework. These
elements include an organizations (1) strategy, (2) structure, (3) systems, (4) staff, (5) skills, (6) style, and (7) shared values. When looking
at it from the top, the framework simulates an interconnected molecule
with the shared values at its center and the six other elements forming
an interlinked hexagon around it. The main premise of the framework
is the total interconnectedness of the seven elements and that management needs to take all elements into account simultaneously, regardless
of whether they are hard elements, such as structure, or soft elements,
such as style. The ultimate goal is internal organizational alignment.20
The framework can be applied to specific teams, departments, or to the
organization as a whole. It is particularly useful for merger or acquisition integration processes.
Hard elements are easier to define and influence than soft elements.
Strategy statements, organizational structures, and IT systems are all
hard elements. Soft elements, on the other hand, can be more difficult
to grasp, are less tangible, and are more affected by organizational culture. They include shared values, skills, style, and staff. According to Peters and Waterman,21 soft elements are as important as hard elements in
order to achieve superior performance.
Strategy and structure are self-explanatory; hence they will not be further described here. Systems, in the context of the 7S framework, refer
to organizational processes and routines. Style refers to the leadership

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Strategic Management in the 21st Century

style of top management. Staff measures the overall quality of employees and their general capabilities, whereas skills refer to their actual expert competencies. Shared values represent organizational culture and
the general work ethic of the members of an organization. The central
positioning of shared values emphasizes that they are directly connected
with the functioning of all the other elements.22
The application of the 7S framework is based on a two-step mapping
approach. The first step is used for an assessment of the actual configuration of the elements and the second step is used to describe the intended ideal configuration. The 7S framework is helpful in evaluating
the wider reaching impact and interrelatedness of change processes in
organizations.23
The main limitation of the 7S model is its lack of specific drivers or
measurement categories. Although the seven core elements provide a
high-level framing and the central notion of shared values connects the
soft with the hard elements well, it is difficult to identify the most critical
subelements for each category or to aggregate them into a cohesive measurement. This means, if one category is rather weakly developed, alignment between an existing and an intended model might be presumed
but in reality there could still be important elements that are not aligned
because they were not considered in the first place. Hence, a detailed
case study and very deep insights into the organization and its processes
are crucial preliminary requirements for making the application of the
7S model work. This, however, does not happen often and especially not
from the inside. Daily tasks and routines take priority over in-depth internal assessment chores. A further concern is that the connection with
the external environment of the organization is completely missing from
the 7S framework.
THE 5PS MODEL BY PRYOR, WHITE, AND TOOMBS
Mildred Golden Pryor, Chris White, and Leslie Toombs24 developed
the 5Ps model as a tool for small business owners to monitor long-term
organizational survival and success. Pryor et al., at the time, deemed it
necessary to develop a simple tool for smaller businesses for strategic direction and for the strategy execution. They called this element of their
framework (1) purpose. The other four elements of the 5Ps are (2) principles, (3) processes, (4) people, and (5) performance.25
In the 5Ps model purpose drives structure, which in turn is defined by
principles and processes. Structure then drives the behaviors of people,
which lead to improved performance. Through feedback loops all three
levels reconnect individually with purpose and guide the improvement
processes in an organization.26 Pryor et al. specifically mentioned that
metrics and measurements are vital to track status and to gauge success

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47

toward performance. However, the authors fall short of providing specific measurement tools. Pryor et al. also explicitly referred to alignment
but they do not specify how alignment should be achieved. In a recent
follow-up article Pryor et al. stated that: . . . they [small business owners]
may or may not understand how to convey those principles to their employees or how to align principles with the other elements of the 5Ps
Model.27
Using the 5Ps framework is considerably simpler than the McKinsey
7S framework, both because of the formers application simplification
and more so because of its straightforward linear design as compared to
the complexity that the multidimensional interconnectedness of the 7S
framework creates. The 5Ps framework could be developed step by step
and would still be useful even if only partly completed. Implementing
the 5Ps framework is considered to be less disruptive to daily business
activities, less resources demanding, and no general buy in by many different stakeholders would be required.
THE BALANCED SCORECARD AND STRATEGY MAPS
Robert Kaplan and David Norton first introduced the balanced scorecard as a stand-alone concept in 1992 in a Harvard Business Review article.28 The motivation behind the development of the balanced scorecard
approach was to provide a tool that would measure performance beyond traditional, purely financial, indicators. It was immediately appealing not only to those organizations that did not seek superior financial
performance as their primary objectives, such as not-for-profit organizations, but also to strategists who adopted the balanced scorecard for
measuring those managerial activities that could not directly be assessed
by reviewing financial balance sheets. The tools great initial success led
to the bestseller: The Balanced Scorecard: Translating Strategy into Action.29
The balanced scorecard filled a void30 that using financial measures
alone left when assessing competitive and corporate strategy. This included the strategic value of nonfinancial resources such as intellectual
capital. The balanced scorecard does not ignore the financials. Instead,
it adds three more dimensions to the strategy assessment and planning
processes, including customers, organizational processes, and learning
and growth. The explicit objective is to measure current performance
and also to evaluate how well the organization is actually positioned for
future performance.
According to Kaplan and Norton, the balanced scorecard provides
three main advantages. First, it allows managers to identify the key
focus areas that lead to superior results. Second, it supports the integration of organizational initiatives, including product or service quality, human resources activities, research and development, or other

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Strategic Management in the 21st Century

long-term activities. Third, it allows for breaking down the usually


higher-order strategy objectives into finer-grained measurable activities
that can then be attributed to individual departments and managers. For
example, investment in training might not lead directly to higher profits
but it might improve the skills of the customer service representatives,
which then will lead to higher levels of customer loyalty, which should
lead to more sales. Other examples include the measurement of the effectiveness of information technology, specific customer data, and market intelligence that is not publicly available as well as organizational
climate including innovation propensity, entrepreneurial spirit, employees conflict-and problem-solving attitudes, and the efficiency of organizational processes.31
It has to be pointed out that these measures are meant to complement
financial performance data and do not replace them. In fact, the authors
argue that in combination with (1) traditional financial measures (2) customer scores, (3) learning and growth scores, and (4) internal business
processes scores, the balanced scorecard approach further enables organizations to be more forward looking, which then leads to better risk
and cost-benefit assessments.32
At the time when Kaplan and Norton developed the balanced scorecard, more and more management literature started to look strongly at
the notion of customer focus. Hence, customer satisfaction became a hot
topic. Measures for customer-relevant performance included new customer acquisition rates, customer retentions, loyalty, defect and failure
rates, and relative market share. Depending on a firms strategic objectives, for example, product leadership (e.g., Mercedes, Intel), customer
intimacy (e.g., Starbucks), or operational excellence (e.g., Wal-Mart),
these measures would reflect how well it performed.
In the context of accelerated innovation cycles and technology change,
the concept of continuous learning is regarded as a critical capability for
organizations to achieve sustainable growth. Kaplan and Norton understood that measuring only the dollars spent on training would not measure successful learning.33 Therefore, in order to assess the effectiveness
of learning and growth activities, measures should include, for example,
aggregated scores for employee satisfaction, information system availability (e.g., intranet), propensity for information sharing, employees
willingness to excel, and the awareness of and willingness to support
strategy.34
Business processes are the fourth dimension included in the balanced
scorecard. Business process scores measure internal effectiveness, or how
well a business operates. There are two categories, including missionoriented processes that encompass production processes, product turnaround, and innovation effectiveness. These mission-oriented processes
are usually difficult to decouple or break down. Relevant measures have
to be carefully developed by those who actually run the processes. The

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49

second category consists of support processes that are easier to measure


because of their more repetitive characteristics.35
One reason that the balanced scorecard has been so successful from
the beginning is that it integrates the four basic perspectives into one
graphically easy-to-grasp framework. All dimensions are divided into
four main categories called: (1) objectives, (2) measures, (3) targets, and
(4) initiatives. For example, if the objective were expanding sales across
the product portfolio, the relevant measure would be the increase in the
number of products sold. The target would be set accordingly and specific initiatives to reach the objectives would be defined as, for example,
sales promotions that include the number of product bundles offered.
The business process category is particularly important. If developed
correctly, the measure can lead to identifying errors within the system
at more specific points rather than at the very end of the process only.
Kaplan and Norton argue that the balanced scorecard creates a doublelooped feedback system by not only measuring the effectiveness of the
process but by also measuring the effects of the processes on the overall
strategic outcome.36
Recently, the balanced scorecard evolved from a simple assessment
tool into a strategic management framework when the concept of strategy maps was added.37 Strategy maps enable companies to visualize
critical cause-and-effect relationships of the different individual scorecards of different departments or business units. Strategy maps show
how the different layers of an organization connect with each other and
how they influence overall performance. They also allow for the development of a fair reward system that is not only based on the achievement of individual targets but that also shows how a specific objective
supports, accelerates, or hinders overall strategy.
The introduction of strategy maps also revealed one of the biggest
reasons for criticism of the balanced scorecard approach, namely, poor
implementation design and implementation longevity.38 The most common complaints and application failures include too many or too few
measures, ambiguity concerning the real performance drivers, inappropriate/inconsistent or static weighting of the individual measures,
a lack of annual reviews of the relevance of individual measures, and,
most importantly, poor organizational design and the lack of structural
adjustment based on the initial scorecard outcomes. Kaplan and Norton
themselves listed the following eight main risks of the balanced scorecard approach, including insufficient top management commitment,
too few individuals involved, implementation of the scorecard at the
highest organizational level only, too lengthy development and implementation processes, making the scorecard only a one-time initiative,
implementing the scorecard as a systems project, inexperienced scorecard champions or consultants, and finally, using it only for compensation justification purposes.39

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Strategic Management in the 21st Century

ACCENTURES ADVANCED PERFORMANCE


MANAGEMENT SOLUTION
The Accenture advanced enterprise performance management solution (A-EPM) is in a certain way different from any other management frameworks. It is tightly integrated with one of the worlds leading
ERP software developed by the German information technology giant
SAP. A-EPM is intended to be a financial and commercial planning and
analysis tool that supports organizations in managing all aspects of the
business toward optimum performance.40 It encompasses the broader
planning and management aspects, including business intelligence,
overall data management, corporate governance, risk and compliance,
budgeting, forecasting, and general reporting.
At the heart of the A-EPM framework are the raw data that ERP software provides for process optimization. The Accenture framework component adds the strategic management angle to the SAP solution. The
goal is to allow firms to develop more advanced capabilities, to achieve
better insights, to improve managerial decision making, and to react
more quickly to changing market conditions based on computer science
analysis.41
Accenture and SAP have collaborated on the ERP system integration
for more than 30 years. Hence it comes as no surprise that the Accenture
A-EPM framework builds on the SAP solution. Considering that in 2008
alone, Accenture provided more than 1,400 organizations with SAP services,42 the A-EPM framework has the potential for considerably high
levels of adaptation. With A-EPM, Accenture aims to provide a solution
that goes beyond the analysis of purely quantitative measures by identifying critical nonfinancial drivers for high performance while integrating them into a self-managed ERP solution.
The A-EPM framework is built around the concept of business enablers that stand at the center of a circular process that begins with the
formulation of a firms business strategy. This then leads to the targetsetting process, followed by the definition of operating parameters, and
the monitoring dimensions for the actual operations. This then loops
back to the business strategy stage. The framework is intended to be
comprehensive by incorporating not only key performance metrics but
also by providing supporting tools that guide management behaviors
and organizational culture.
The enablers at the center of the system are solidly grounded in an
integrated information technology infrastructure. They include incentives and rewards, data structures and controls, standardized processes,
and leadership capabilities. The outer circle that is built around the enablers comprises the management processes and a so-called information
repository. The business strategy process starts with the refinement of

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51

the corporate vision and strategic objectives; then the key value drivers
are determined, followed by the success measures. When this process is
complete the target-setting stage begins. Here management assesses the
portfolio value, before specific targets for the previously identified measures are set. Finally, these targets are decomposed into lower-level metrics that cascade down throughout the organization. From the operating
component of the framework managers have to develop specific implementation proposals, including resource allocation along all planned activities. Then a first review component completes the operating phase,
which leads to the monitoring component of the framework. Here all
key measures are assessed based on tight integration with the SAP software. Executive management is then able to review performance and
develop further action plans, reallocate resources, and update forecasts,
which completes the circle.
The Accenture A-EPM framework is not without criticism. Although
Accenture has a long-standing reputation as a successful SAP implementation partner, there are often complaints about inexperienced consultants on the ground who are either not familiar enough with the details
of the complex SAP software or who do not understand the businesses
that they supposed to optimize.43 Committing to the implementation of
A-EPM also means that an organization should already have a functioning SAP ERP solution in place or that it is about to deploy one. This
comes with a substantial investment, often in the hundreds of thousands
if not millions of dollars. Hence it can only be practical for organizations
that have reached a certain size and that spread across business units
and/or regions.
THE TOWARD PERFORMANCE EXCELLENCE FRAMEWORK
So far we have learned that management frameworks should encompass the entire organization and all its processes. Frameworks should
guide the activities of departments, business units, and individual managers toward higher performance levels while not adding unnecessary
complexity. Management frameworks should be enabling mechanisms,
which add value to management by making managers better informed
and more effective. Too often, however, managers introduce a particular
management framework that is complex or does not have any bearing
on execution. The result is that top management, individual managers,
and the organization as a whole gradually become less efficient at managing time, resources, and costs.
In 2003, Jacques Kemp, then newly appointed CEO of ING Insurance
and Asset Management Asia-Pacific, faced a similar challenge. When
he took over from a predecessor who had just completed the acquisition of the Aetna Insurance business into ING, Kemp was tasked with

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Strategic Management in the 21st Century

integrating and improving the overall efficiency of the 14 Asian ING


country operations and the 10 regional functions located at ING Asias
headquarters in Hong Kong. The goal was to create synergies and to
eliminate misalignments across business units. Not satisfied with the
standard solutions that some of the even most renowned management
consulting firms provided, he developed his own management framework that he later labeled TPE.44 Once the TPE framework had been
rolled out and all business units and functions were using it as an active
management tool, clear progress could be noted in terms of efficiencies,
better audit reports, higher growth rates, and much higher satisfaction
scores among staff and customers.
For Kemp the overarching issue was the optimization of what he
called the management of management. He argued that many executives would define their top five priorities as, for example, customer
focus, superior operations, execution, market leadership, and employee
satisfaction but would not define these categories in a way that they
could be understood throughout the organization at every level. According to Kemp, in addition, often managers would fall short in creating
the appropriate organizational structures that would enable successful
strategy execution. Kemp argued that executives have to provide management with the right tools to get the job done. Kemp compared his
approach with how the Swedish furniture company IKEA had perfected
its do-it-yourself furniture assembly for consumers, which essentially
enables anybody to succeed in the building task, no matter how complex the overall piece may be. Kemp argued that IKEAs main added
value was to transform amateur carpenters (the IKEA customers) into
professional carpenters by giving them a complete, consistent, and comprehensive set of tools and templates. Based on this, Kemp saw his main
role as leader to make certain that his managers had effective tools in
order to become much more efficient at both the individual-level tasks
and the overall organizational coordination level.
The difference between TPE and the more theoretically derived frameworks developed by management consulting firms and academicians is
TPEs grounding in business realities that dynamically evolved based
on managing spatially dispersed business units and business functions.
TPE follows the logic that the development of management matrices and
key performance indices (KPIs) are fundamentally a team effort. Because
of the lack of team orientation in the development of the matrices, measurements, and KPIs, many of the competing frameworks miss the implicit details in the connections between planning, execution, feedback
and adjustment processes. The main use of a management framework
should be to enable management to execute the organizational mission
and vision effectively. The framework then becomes a structured and
coherent tool that acts as both a template for execution and for organizational alignment.

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53

TPE follows a predominantly linear sequential approach. It starts


with the clear setting of an organizations mission and vision (who and
what), and then moves on to internal and external analyses that form
the foundation for the business planning process. Traditional tools like
strength-weakness and opportunities-threats analysis (SWOT) are used
for data-analysis purposes. Based on these analyses, management should
decide how to compete from a business strategy perspective (e.g., low
cost versus differentiation or focused differentiation or focused differentiation). From here, the previously mentioned drivers are developed.
After describing the macro/micro market situation and trends, competitive analysis, and SWOT, we use the results as inputs for the business
planning process and the definition and operationalization of the performance drivers.
THE SIX PERFORMANCE DRIVERS
At the core of TPE are six drivers that bridge the distinctive levels of
an organization. These drivers and their respective subdrivers include
varying levels of granularity depending on the individual managerial needs of a firm. The drivers include an organizations (1) portfolio,
(2) marketing, (3) operations, (4) structure and processes, (5) financials,
and (6) reputation/governance. The six drivers are all connected with
inputs from the organizations vision/mission and strategy as well as
inputs/outputs related to reports from audits, planning, managerial objectives, KPIs, and communication/knowledge management. TPE
follows a specific sequence in order to guarantee overall alignment.
The six drivers help zero in on what has to be done. Figure 3.1 illustrates the overall framework and how the drivers align in a linear
fashion TPE.
The portfolio driver derives directly from the business vision and mission. It focuses on how the company wants to grow and how it will do so
(or indeed, in times of a downturn, how it will consolidate). Questions
that need to be addressed here are, for example, (1) What will we offer?
(2) Will we grow organically or through acquisition? (3) Will the company operate independently and vertically integrated or will we pursue
an agency or partnership model? (4) Will we manufacture/develop inhouse, or will we outsource?
The marketing driver focuses on customers, sales, and distribution. It
focuses on downstream activities and acts as a feedback tool for strategy
effectiveness. It most directly has an impact on and measures market
performance.
The organizational driver determines who will carry out all of the other
support tasks an organization has to complete on a daily basis and how
these tasks enable the core business functions. It informs management
on how the organization will be structured and what human resources

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Strategic Management in the 21st Century

Figure 3.1
Driver Framework

will be required. It also defines compensation and training requirements


and reporting lines.
The operational driver defines where operations should be located,
how the supply chain will be managed, what technology (including IT)
will be required to support operations, and what operational risk factors
need to be managed.
The reputational driver focuses on how the company will maintain its
reputation and its brand. It sets out the role to be played by corporate
communications, and also reminds everyone of legal issues and how
internal and external compliance will be enforced. This is critical since
reputational failures can threaten a companys chances of successfully
executing its strategy.
Finally, the financial driver focuses on corporate finance functions, including currency management, risk management, and the planning of
long- and short-term financial demands.
It is critical to understand that the drivers must follow the proposed
sequence in order to be meaningfully interconnected. If they do not follow the sequence alignment is likely not achievable. Each of the drivers
includes a predetermined set of subdrivers. For example, the subdrivers for marketing are customers, products, and distribution or sales, including channel planning. These subdrivers are fixed and should not
be changed once established. Their interdependencies are important

Dealing with Complexities

55

because they cascade down into specific objectives, including which


products we want/need, which customer segments, and which distribution channels. Based on these objectives specific KPIs will be established, such as the number of customers per segment (now and in
the future). The setting of the objectives and KPIs depend again on the
overall vision/mission and strategy.
THE SPIDER CHART
For defining the strategic position, direction, and implementation of
a company, the TPE framework includes a specific subdriver planning
tool called the strategy spider chart. Kemp developed the spider chart
based on a Bain & Company template. The spider chart contains five
strategic elements, each of which needs to be considered. The elements
are: (1) reach, (2) business, (3) products, (4) distribution, and (5) customers. For this short introduction, we take a look at the marketing spider
chart only.
The reach element (1) refers to an organizations activities across specific geographical markets, or alternatively, market segments. Critical
questions to be asked are: (1) In which countries/geographical markets
do we currently operate? (2) Where do we want to operate in the future
according to our strategic priorities? (3) Is there a strategic necessity to
expand into specific other markets, or is there a need to withdraw from
certain markets in order to reallocate resources including managerial
capacity?
The decision to expand or withdraw could be driven equally by opportunities or threats. For example, expanding into Africa could create
a long-term growth opportunity based on a potential first-mover advantage. Alternatively, it could tie up resources that would be needed
to be more competitive in existing markets, which could improve shortand medium-term firm competitiveness. Ultimately it is here where
managerial decisions are required. TPE helps the decision-making processes by making the effects transparent across all different levels of an
organization.
The business element (2) refers to the specific lines of business an organization currently engages in or should engage in according to its mission and vision. For example, a financial institution such as ING might
be in the businesses of savings, loans, insurance, pension plans, asset
management, and/or wealth management. Marks & Spencer is engaged
in food and clothing retailing. Some companies might focus tightly on
one industry and one line of business (e.g., McDonalds on fast-food restaurants); others might be widely diversified across many different segments, for example, like General Electric or Samsung. When considering
strategic direction, one should think about whether the company is in

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Strategic Management in the 21st Century

the right business areas to support its mission and vision and how the
business configuration supports or hinders the overall performance. The
business element is often overlooked in the strategy planning processes
because it is assumed that the company wants to continue with the businesses it operates. Divestment and investment decisions are then too
often made based on marginal contributions of the individual businesses
without considering the overall importance of the businesses relative to
the core activities of the firm. The business driver helps to establish strategic importance across different businesses within a firm.
The product element (3) follows logically. It refers to the range of products (for the purposes of this discussion, products also include services)
that a company offers. The key question here would be: do the specific
products meet the needs of customers today and in the future?
The distribution element (4) refers to the channels through which products are delivered to customers. For example, does the company sell directly to its customers, or does it use agents or other middlemen? Again
implicit in both, the product and the distribution elements is the need to
examine the status quo and determine whether the product offering and
the distribution system are configured effectively to meet customer needs
and to help the company to carry out its mission and vision.
Finally, the customer element (5) supports the need of a firm to evaluate
its existing customer base and to assess whether there are noncustomers
that should be reached. Also, the overall customer configuration must
be assessed in terms how a firm can utilize its customer base across all
different business units. Critical questions to be asked are: (1) Should we
have more customers or fewer? (2) Should we be looking at other groups
such as, for example, business customers versus consumers or other
demographics such as youth, women, and minorities? (3) Do we have
the right customers to help us fulfill our mission and vision?
Barwise and Meehan in their recent book, Beyond the Familiar: LongTerm Growth through Customer Focus and Innovation,45 illustrate how firms
often focus for years on customer segments that are actually not profitable. The TPE framework helps managers identify those segments and
enables the firm to move away from serving them and concentrate on
those customers that will generate higher levels of profitability. Figure
3.2 illustrates the marketing spider chart by using the example of ING
Insurance Asia-Pacific for the year 2006.
The spider chart is critical for making strategic priorities transparent.
During the research for this chapter we found that the use of the spider
chart created an important side effect. Not only did the charting exercise
establish clarity, transparency, and a sense of knowing why and how priorities are being set, it also reduced organizational conflict significantly.
By using the spider chart, every manager can clearly identify strategic

Dealing with Complexities

57

Figure 3.2
Marketing Spider Chart

priorities and align her/his actions accordingly. The spider chart forms
the basis for KPI development. Based on the strategic priorities, KPIs
would be derived logically at each specific level of granularity with a
natural alignment across all levels. It is here where the KPI scores are
all interconnected logically and coherently, though every individual
manager will be assessed based on departmental and individual performance measures that develop out of the subdrivers.
Although the description earlier is representative for the TPE marketing driver, every one of the six drivers has to have a specific subset of
performance elements, which need to be set by business unit managers
and should then be aligned with the involvement of functional managers and top management. Managing the six TPE drivers is key to achieving performance excellence. Ultimately, the task of management is to
respond to these drivers and create and execute strategies that take them
all into account. Once the TPE process has started, alignment is almost
inevitable due to the sequential nature of the framework. The relevant
cross-functional connections become transparent based on the interconnectedness of the business processes and functions. For example,
the global marketing manager naturally connects with the marketing

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Strategic Management in the 21st Century

managers in the individual countries and/or business units, yet the


country marketing manager connects with his/her country finance
manager locally. Business and task objectives get sorted horizontally
based on the level of granularity and also vertically based on functional
relatedness across levels. This way, a naturally working matrix structure
emerges based on connectedness and relevance and not based on hierarchy alone. From here management objectives, KPIs, communication,
knowledge management tools, proper pay for performance, and audit
tools assure that high levels of performance can be achieved. The results
from the audits then loop back into the external and internal analysis
and planning process.
Kemp developed TPE because he experienced firsthand that organizational functions often do not communicate well across static departmental lines. Sometimes functions are even at war with each other. The
alignment task becomes more critical when complexity increases because of across-industry reach and/or because of geographic reach. TPE
represents a fusion between decision tree and feedback loop, with the
objective of total alignment.
TPE IMPLEMENTATION
Implementing a management framework, as with any aspect of strategy, requires first that top management think carefully about what the
use of a framework is supposed to accomplish and how it should support the firms activities. Action plans must be developed for each business unit at all levels from the boardroom to research and development,
financial management, sourcing, manufacturing, and marketing and
sales. These action plans must be communicated and all those involved
need to be carefully briefed about their own roles and what is expected
of them. They must know exactly what is needed of them. A general instruction to just get on with it will not be enough. TPE helps managers
with the process of moving from mission to vision, then to strategic direction, then to strategic priorities, then to organizational settings, and
then to implementation. It is a process tool and does not set the strategy as such but rather directs its alignment, execution, and continuous
improvement. Because TPE is comprehensive, complete, and consistent
it assures that the execution process will not be incomplete or ambiguous. TPE does not create more bureaucracy, it only captures what management has already decided to execute. It becomes a living document
rather than a collection of disconnected scores that are threatened to lose
alignment over time. TPE does not eliminate creativity or flexibility. It
frees up time because it deliberately crosses boundaries. It shows where
organizational silos create inefficiencies and provides managers with the
opportunity to fix them.

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59

CONCLUSIONS
Today, organizations reach their limits based on their individual capacities in handling complexity. With complexity inefficiencies emerge, leading to suboptimal performance because the costs of these complexities are
often higher than the benefits of achieving scale economies. This is one
reason why global financial markets regularly apply discounts when valuing large diversified firms. In addition, because the global business environment is dynamic, rigid standards and inflexible solutions do not work.
Constant adaptability is therefore key, as are localized solutions, even for
globally operating companies. Yet, management frameworks often fall
short in handling these dynamics. The reason is that too often frameworks
either neglect execution or do not align the different elements of an organization in a cohesive but flexible way. When researching for this chapter,
we came across a multitude of frameworks that all could do parts of the
structuring job well. However, most of them fall short in terms of completeness and alignment or in terms of flexibility. Over time they loose
relevance, which leads to managerial frustration. The frameworks introduced in this chapter are all practical solutions to the problem, though
TPE represents the most applicable tool for the managing of managers
task. TPE focuses on the entire strategic management process and on all
connected business units and functions, both vertically and horizontally.
It creates alignment and action-ready templates that are easy to understand. The framework follows what Andrew MacLennan46 calls sequential thinking. It was developed along a dominant flow of logic though it
allows for adjustments and feedback in order to maintain relevance. The
advantage of TPE is that these changes immediately show their effects
across the entire matrix. Consequently, inefficiencies and structural issues
become obvious and trigger pertinent strategic adjustments instead of tactical actions that often result in even more inefficiencies and wasted management time. TPE can be applied to large and small organizations or, like
in the case of ING Asia-Pacific, to subunits only.
In this chapter, we provide only a brief overview of these frameworks
though the importance of using management frameworks should now be
obvious. Successful organizations use frameworks to handle complexities, not to eliminate them. Ultimately, being able to navigate dynamic
business environments better than the competition creates the opportunities to generate higher levels of sustainable performance excellence.
NOTES
1. Snowden, D. J. & Boone, M. E. 2007. Leaders Framework for Decision
Making. Harvard Business Review, 85(11) 6876.
2. IBM. 2010. Capitalizing on Complexity: Insights from the Global Executive Study.
Somers, NY: IBM Global Business Services.

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3. Drenvich, A. & Kriauciunas, A. P. 2011. Clarifying the Conditions and


Limits of the Contributions of Ordinary and Dynamic Capabilities to Relative
Firm Performance. Strategic Management Journal, 32(10): 254279.
4. Mintzberg, H. & Waters, J. A. 1985. Of Strategies, Deliberate and Emergent.
Strategic Management Journal, 6: 257272.
5. Ittner, C. D. & Larcker, D. F. 2003. Coming Up Short on Non-Financial
Performance Measurement. Harvard Business Review, 81(11): 8895.
6. The Financial Times. 2011. Lehman Analysis. http://www.ft.com/lehman.
Accessed February 14, 2011.
7. Liker, J. 2004. The Toyota Way. New York: McGraw Hill.
8. Laraia, A., Moody, P. & Hall, R. 1999. The Kaizen Blitz: Accelerating
Breakthroughs in Productivity and Performance. New York: John Wiley and Sons.
9. Greto, M., Schotter, A., & Teagarden, M. 2010. Toyota: The Breaks and Accelerator Crisis. Thunderbird Cases Series. Glendale, AZ: Thunderbird School of
Management.
10. Sloan, Alfred P. 1964. in McDonald, John, ed., My Years with General Motors.
Garden City, NY: Doubleday. Republished in 1990.
11. Sy, T., & DAnnunzio L. 2005. Challenges and Strategies of Matrix Organizations: Top-Level and Mid-Level Managers Perspectives, HR. Human Resource
Planning, 28(1): 1039.
12. Greto, M., Schotter, A., & Teagarden, M. 2010.
13. Ansoff, I. 1965. Corporate Strategy. London: McGraw-Hill.
14. Mintzberg, H. (1994, January-February). The Fall and Rise of Strategic
Planning. Harvard Business Review, 72(1): 107114.
15. Kaplan, R. & Norton, D. 1992. The Balanced ScorecardMeasures that
Drive Performance, Harvard Business Review, 70(1): 7179.
16. Kaplan, R. S. & Norton, D. P. 1996. Linking the Balanced Scorecard to Strategy. California Management Review 39(1): 5379.
17. Pryor, M. G., White, J. C., & Toombs, L. A. 1998. Strategic Quality Management: A Strategic, Systems Approach to Quality. Independence, KY: Thomson
Learning.
18. Rasiel, E. & Friga, P. N. 2001. The McKinsey Mind: Understanding and Implementing the Problem-Solving Tools and Management Techniques of the Worlds Top
Strategic Consulting Firm. New York: McGraw-Hill.
19. Peters, T. and Waterman, R. 1982. In Search of Excellence. New York, London:
Harper & Row.
20. Ibid.
21. Ibid.
22. Ibid.
23. http://www.mindtools.com/pages/article/newSTR_91.htm. Accessed
February 13, 2011.
24. Pryor, M. G., White, C. J., & Toombs, L. A. 1998.
25. Pryor, M. G., Anderson, D., Toombs, L. A., and Humphreys, J. H. 2007. Strategic Implementation as a Core Competency: The 5Ps model. Journal of Management Research, 7(1): 317.
26. Ibid.
27. Ibid.
28. Kaplan, R. & Norton, D. 1992. The Balanced ScorecardMeasures that
Drive Performance. Harvard Business Review, 70(1): 7179.

Dealing with Complexities

61

29. Kaplan, R. & Norton, D. 1996. The Balanced Scorecard: Translating Strategy
into Action. Boston: Harvard Business School Press.
30. Kaplan, R. & Norton, D. 2008. Mastering the Management System. Harvard
Business Review, 86(1): 6277.
31. Kaplan, R. & Norton, D. 2001. The Strategy Focused Organization. Boston:
Harvard Business School Press.
32. Kaplan, R. & Norton, D. 1996.
33. Kaplan, R. & Norton, D. 1992.
34. Coelho, A. 2003. Two Alternative Approaches to the Evaluation of Performance:
360-Degree Feedback and the Balanced Scorecard. London, ON: Ivey Management Services Case Series.
35. Ibid.
36. Kaplan, R. & Norton, D. 2001.
37. Kaplan, R. & Norton, D. 2000. Having Trouble with Your Strategy? Then
Map It. Harvard Business Review, 167176.
38. Coelho, A. 2003.
39. Kaplan, R. & Norton, D. 2001.
40. Accenture. 2011. Driving Broad Business Value through Advanced Enterprise Performance Management. http://www.accenture.com/us-en/Pages/ser
vice-advanced-enterprise-performance-management-summary.aspx. Accessed
February 14, 2011.
41. Accenture. 2009. Accenture Advanced Enterprise Performance Management Solution for SAP. PDF published online at http://www.accenture.com/
SiteCollectionDocuments/PDF/AEPM_for_SAP_Print_Brochure_FINAL_3309.
pdf. Accessed February 13, 2011.
42. SAP corporate website. 2011. SAP Partner Spotlight: Accenture. http://
www.sap.com/ecosystem/partners/spotlight/accenture/index.epx. Accessed
February 14, 2011.
43. Krangel, E. 2009. SAP: Clueless Consultants from Accenture and IBM
Giving Us a Bad Name (SAP). Business Insider. http://www.businessinsider.
com/2009/2/sap-clueless-consultants-from-accenture-and-ibm-giving-us-a-badname-sap. Accessed February 14, 2011.
44. White, R. & Schotter A. 2006. Jacques Kemp. Towards Performance Excellence.
London, ON: Ivey Management Services Case Series.
45. Barwise, P. & Meehan, S. 2011. Beyond the Familiar: Long-Term Growth through
Customer Focus and Innovation. San Francisco, CA: Jossey-Bass.
46. MacLennan, A. 2011. Strategy Execution: Translating Strategy into Action in
Complex Organizations. New York: Routledge.

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Part II

Strategy Theories

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Chapter 4

Transaction Cost Economics


Jennifer Leonard

INTRODUCTION
Transaction cost economics (also referred to as transaction cost theory of
the firm, transaction costs, TC or TCE) is the theory of firm governance
that specifically addresses the make or buy questionshould a firm internally make or externally buy (or some combination) a specific product,
input, or service.
TCE has been applied at all levels of business: industry, firm, and
group, and has been beneficial to questions pertaining to internal/external debt financing, distribution channel management, market entry decisions, and employee management and compensation issues. TCE works
for profit, social entrepreneurial ventures, nonprofit, and government entities as well.
A BRIEF HISTORY
To understand the history of transaction cost theory, one must first
understand some of the basic assumptions of the economic thinking of
the time. In the late 1930s and early 1940s, classical economics had three
basic assumptions: (1) markets are efficient; in other words, those who
could produce the goods most cheaply were doing so; (2) a firm or person will maximize a benefit while minimizing costs (called rational or

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economic man); and (3) decisions were made with a perfect knowledge of the marketseverything that one needed to know in order to
make the optimal decision was known.
Ronald Coase, a British born and educated economist, had a problem
with market efficiency: if markets are efficient, and the market is made of
individuals who all contracted with each otherwhy do firms exist? He
first asked this question in 19371 in his essay, The Nature of the Firm. As
a result of his research, Coase determined that transacting in the market
cost more than the simple price of the good or service; costs were created
when finding a trading partner, sharing and gathering information, and
bargaining. Therefore, by Coases reasoning, firms arise when it becomes
cheaper to create services or goods internally and to avoid these transaction costs. The introduction of inefficient markets was a significant
change to classical economic theory, and although Coase could not provide specifics as to what exactly the transaction costs were, the first step
had been taken, that is, the transaction cost paradigm was born.
In the late 1950s, Herbert Simonsociologist, psychologist, political
scientist, and economistwas ready to turn economic theory on its head
again. As a behavioral scientist, Simon theorized that rational man does
not exist, and that most decisions are based on satisficingor basing a decision on criteria that will satisfy the need, rather than optimize it.2 Simon
is also thought to have introduced bounded rationality, which is the idea
that ones choices are limited by the processing capability of the human
brain, the limitedness of information the human brain can store, and the
amount of time one has to make the decision.
Simon, along with his colleagues, Richard Cyert and James March,
at the Carnegie School, had a profound influence on others in the economics department. Later referred to as freshwater economics, this
new approach to macroeconomics stressed the dynamic and quantitative aspects of economic decision making. The Carnegie Experience
was one that emphasized cross-discipline study, and Oliver Williamson,
a doctoral student, took full advantage of the latest developments in
behavioral theory, game theory, and organization theory, as he studied
economics.3
In the yearly 1960s Williamson, a doctoral student at Carnegie-Mellon,
was asking the same types of questions Coase had posed 30 years earlier,
but found that classical economics provided no satisfactory answers. As
part of the training at Carnegie, Williamson (and all doctoral students)
was encouraged to pursue interdisciplinary answers to questions. Although Williamson did not doubt that market costs were important to the
answers, his cross-discipline training had him considering behavioral aspects as well as purely economic ones.
As Williamson states, What was especially distinctive about Carnegie
is the way that it combined organization theory with the contiguous social

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67

sciences. My understanding of and approach to the study of economic organization underwent a vast and permanent change in the process.4
Thus, it was that bounded rationality and opportunistic behavior were
introduced into Williamsons theory. The later additions of other behavioral aspects of organization and decision-making theories (such as
Cyert and Marchs work on search5), sociology (trust), and game theory
(conflict of interest) research rounded out the change from paradigm to
theoryTCE.
Since the 1970s when Williamson first introduced the basicand, at
the time, incompletetenets of TCE in his book Markets and Hierarchies,6
many theoretical and empirical studies have shown the strength and robustness of the theory as well as its practical applications ranging from
government to nonprofit, from large auto manufacturers to small family
owned businesses, from California to Hong Kong.
WHAT ARE TRANSACTION COSTS?
As Coase first suggested in 1937, every transaction made by a firm has a
cost.7 Williamson and others later determined that the costs may be external (market costs) or internal (bureaucracy costs).8 External costs can be in
the form of searching for a trading partner, negotiating contracts, making
sure those contracts are enforced, ensuring performance compliance, and
monitoring assets, the general market, and trading partners. Internal costs
may also be present, and are associated with negotiations between departments and/or management and employees, coordination of production or
services, compliance with standards, monitoring of activities and quality,
and enforcement of internal agreements. Because of the behavioral choices
that are made in assessing transaction costs, the costs are subjective rather
than objective.
The unit of analysis in transaction cost is the transaction itself, which
is defined as the transfer of goods or services between technologically
separable units.9 Understanding the assumptions and underlying factors
of how transaction costs come about may allow managers to minimize or
mitigate those factors. As with any theory, transaction cost has assumptions that are accepted as underlying truths and are taken for granted.
In the case of TCE, three basic assumptions are made: decision making
is based in bounded rationality, managers have differing risk preference,
and that people may be subject to opportunistic behavior. One of these
three must be present in order for a transaction cost to arise.
Bounded Rationality
Bounded rationality is, basically, the assumption that one does not
know everything one needs to know in order to make an optimal decision.

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Bounded rationality also encompasses satisficing (making a less than optimal decision as long as the estimated result is satisfactory) and using rules
of thumb when the number of choices is too large for the decision maker
to consider or when time to make the decision is short.
Williamson defines bounded rationality as feasible foresight, . . . the
capacity to look ahead, uncover possible hazards, and work out the ramifications, thereupon to incorporate hazard-mitigating mechanisms . . . 10
and behavior that is intendedly rational but only limitedly so; a condition of limited cognitive competence to receive, store, retrieve, and process information.11
The main effect of bounded rationality, according to transaction costs,
is that all complex contracts are unavoidably incomplete,12 because contracts must be created that not only cover what is, but everything that may
bean impossible task. Bounded rationalitys impact on transaction cost,
however, is limited to the complexity of the transaction. Bounded rationality has little effect on simple transactions, such as purchasing a stock
component or a product from a retail store, but can have a large bearing
on those transactions that require investments in specific assets or are rife
with uncertainty or the possibility that the trading partner will act in an
opportunistic way.
Example
The manager of the sales force at Aspinox, Bernadette Nolan, has decided to equip her sales representatives with smartphones so they can call
back to the office, offer quotes immediately, and have GPS capabilities.
Considering that Nokia Corporation alone has 120 smartphones aimed
specifically at the business market,13 choosing the optimal smartphone
could take weeks of research. Rather than use her scarce resources on researching the issue, Ms. Nolan chose to buy Nokia phones (because she
was familiar with the brand), and compared only the basic features she
needs, the year released, and the price. Additionally, once she chose a
model with which she was comfortable, she had to select a retailer. Google
lists nearly 50 retailers for Nokias 6600 model. Because of bounded rationality Ms. Nolan did not necessarily buy the phone with the optimal performance, best technology, lowest price, or greatest valueshe settled for
a phone and a seller that met her needsshe satisficed.
Opportunistic Behavior
The accepted definition of opportunistic behavior as it is applied to
transaction costs is self-interest seeking with guile.14 The important
thing to remember about opportunistic behavior is not that such behavior always exists, but that the possibility of opportunistic behavior is always

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69

present. Most people act honorably and do the right thing; some people
will do more than required; but there are always a few who are without
scruples, and will not act in the best interest of all parties to the transaction, but rather are acting with self-interest. Opportunist behavior is directly related to asset specificity: the more specific the assets, the more
likely opportunistic behavior will occur.
Example
Joshua Castle, CEO of Tris-plex, knows that the companys performance
is extremely below analysts predictions. He has convinced his CFO to use
some questionable accounting practices to artificially inflate the profits,
and thereby the stock prices. Joshua knows that an audit is scheduled to
begin in another month and that it will show the irregularities in the accounting records.
A week before the audit started, Joshua sold his stock, although he
was telling analysts, shareholders, and employees that Tris-plex was as
financially sound as ever. Just before the audit results were to be released,
Joshua left the country for Madagascar, which does not have an extradition treaty with the United States.
Most CEOs would never consider acting as Joshua Castle has. However, the opportunistic behavior construct only assumes that some partners
may act dishonorably, and precautions must be taken.
Risk Preference
Risk refers to the possibility of loss.15 Risk preferences, or how much
risk a person prefers to take come from a combination of situational (e.g.,
reference points, escalating commitment) and constant (e.g., organizational culture, national culture, disposition) factors. A manager may be
anywhere along a continuum that encompassed risk aversion (prefers
a smaller, but certain outcome), through risk neutrality (does not have
any preference), to risk seeking (prefers a lower expected payoff with the
hopes of a larger payoff ). Because of situational factors, a manager could
be strongly risk averse in one situation, but risk neutral in another.
Example
Aspinox is entering into a new agreement with Cansilware in which
Cansilware will act as a distributor of Aspinoxs product. Cansilware has
offered two options to Mark Harmony, the CEO of Aspinox. In the first,
Cansilware will pay a set amount for the product, resulting in a five percent profit margin for Aspinox. In the second option, Cansilware will
purchase more of the product, which will result in a three percent profit

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Strategic Management in the 21st Century

margin for Aspinox, but Cansilware will give Aspinox a small additional
percentage of the net sales price, which may provide Aspinox with a seven
percent profit margin. The sales of the product are unpredictable because
it is new on the market; however, Cansilware thinks the possibility of selling all of the products it buys is about 60 percent.
If Mark is risk averse, he will choose the first optionhe will be satisfied with the five percent because no risk is associated with the contract.
If Mark is risk seeking, he will choose the second option as a greater profit
(7%) is associated with the transaction. If Mark is risk neutral, he will have
no preference between the two options.
CRITICAL DIMENSIONS
In addition to basic assumptions, there are other critical dimensions to
the theory, that, when combined with the basic assumptions, are elemental to creating transaction costs.
Uncertainty
Uncertainty is the source of disturbances to which transactions are
subject,16 and is caused by bounded rationality and opportunistic behavior. Uncertainty may be economic in nature (e.g., will a particular commodity price rise or will demand for a specific service increase) or based
on partnership performance (e.g., will a trading partner deliver the goods
on time or will it renew the contract).
All transactions are prone to disturbances. However, when those disturbances occur frequently and are hard to predict, bounded rationality
makes it impossible to see all of the possible ramifications of a particular
choice. In and of itself, this may not be an issue, but when opportunistic
behavior is involved, the uncertainty causes transaction costs.
Risk and uncertainty must be distinguished from each other. Risk comes
about when a probability of losing can be calculated, whereas uncertainty
is the possibility of reward or loss that has no odds.17 Thus, risk is perceived by the decision maker, whereas uncertainty comes from outside.
Example
Aspinox buys its major component from a Japanese firm, Namlux. The
9.0 magnitude earthquake that occurred in March 2011 was the most powerful quake to strike Japan. The 1,589 earthquakes and aftershocks that
shook the island resulted in tsunami waves up to 133 feet that penetrated
nearly six miles inland. Located outside of funato, Namluxs building
was destroyed, as was the harbor it used to ship goods to the United States.
Although Aspinox and Namlux understood that the possibility of an
earthquake happening was good since major earthquakes and tsunamis

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71

had hit the port in 1896, 1933, and 1960, the location, timing, and power of
another earthquake was uncertain.18
This uncertainty increases transaction costs because secondary trading
partners with acceptable delivery schedules and assets must be found,
and complex contracts created between Aspinox and Namlux in order for
Aspinox to protect itself against the possibility of an earthquake delaying
the delivery of its major components for an unknown amount of time.
Transaction Frequency
The frequency with which trading partners interact can affect transaction costs in two ways: setup costs and reputation.19 Setup costs may be as
simple as writing a contract or as complex as hiring specialized employees or creating custom dies. In this case, something like economies of scale
occur. The more often two partners interact, the less setup expenses will
cost since they are spread over multiple transactions. So, the more often
transactions are made between two trading partners, the lower the associated transaction costs would be.
Trust is also an effect of frequent transacting, with reputation being
how others see the person or organization. The more often partners transact in an honorable manner, the more likely it is that trust and a good reputation will be built.
Example
Aspinox entered an agreement with Sollaz to supply a new component.
Sollaz was a relatively new firm, and had not yet established a reputation
in the industry. Sollaz was one of the few manufacturing firms, however,
that could provide the component Aspinox needed. Over the years, Aspinox placed many orders; made several changes to the component design;
and increased the number of components needed. The more often Aspinox and Sollaz did business, the less complex the contracts had to be, because Sollaz always performed to the contract specifications or beyond.
Thus, trust was built between the two firms because of the frequent transactions they had together. Sollaz also started building a good reputation
because of its performance with Aspinox and the few other firms with
which it dealt.
Asset Specificity
Of the three critical dimensions, asset specificity is the most important,
according to Williamson.20 Assets specificity refers to those assets that one
trading partner obtains in order to fulfill a contract, but would be difficult to use in any other transaction. Some examples of assets dedicated to
a specific contract are employees with special training, locations or plant

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Strategic Management in the 21st Century

sites, physical assets (such as dies or manufacturing equipment), process


knowledge, and brand-name capital. As can be seen, asset specificity may
take many forms.
Asset specificity, depending on its circumstances and the degree to
which the assets are nontransferable, may also bring about the fundamental transformation. When an organization is searching for a trading partner,
many potential partners may be available, all of which start on an equal
footing. However, when a single partner is selected, and a contract negotiated, it is possible that an investment in assets specific to the contract (i.e.,
the transaction) must be made. At that point, the fundamental transformation takes place. The winner of the contract is now more dependent on the
originating firm than before the assets were purchased. The originating
firm is also more dependent upon the trading partner, since that partner
now has specific assets that are needed to complete the contract. This mutual need is called bilateral dependency.21
Example
When Aspinox needed the component to make its product, it considered several manufacturing firms. None had the exact part Aspinox
needed, so all of the firms started negotiations from identical positions.
Ultimately, Sollaz offered the best price and delivery schedule, and Aspinox awarded the contract to Sollaz.
In order to fulfill the needs of Aspinox, Sollaz had to invest in some special machinery, metal dies, and employees. Although Sollaz could use the
machinery and employees (although less effectively) for other customers,
the dies were created specifically for the Aspinox account, and could not
be used elsewhere. At this point the fundamental transformation took place,
and Sollaz became more dependent on Aspinox to both fulfill the original
contract was well as to continue the association.
Aspinox is also more dependent on Sollaz, as it is now the only firm
that has the specialized people and equipment to create the component
Aspinox needs. The original contract and the need for and use of the specific assets have created a bilateral dependency.
In order to protect themselves, at least in the beginning of the relationship, both Aspinox and Sollaz must have complex agreements in place.
Eventually, as transactions become more frequent, the agreements will
become simpler, because Aspinox and Sollaz will build trust in each
other.
MODIFIERS
In addition to direct causes, several elements may either increase or decrease the effects of asset specificity, uncertainty, and frequency: bilateral

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73

dependency, small numbers exchange, information impactedness, and


asymmetries and trust.
Small Numbers Exchange
Small numbers exchange refers to the number of possible trading partners that already have transaction specific assets in place. When this number is small, fewer choices are available and the firm becomes dependent
on these few suppliers to fulfill its need. On the other hand, if there are
many possible partners, or highly specific assets are not required, the firm
has more choice of trading partners.22
Bilateral dependency is a form of small numbers exchange that reduces
the number of possible trading partners to one, once the fundamental transformation (or a large investment in transaction specific assets) takes place.
Example
As discussed earlier, no companies had the part that Aspinox needed.
Only a few were willing to make the investments needed to make the part,
so the number of choices Aspinox had were severely limited. When Sollaz
won the contract for the components, the small numbers exchange (or the
number of possible trading partners) was reduced to a single partner. At
this point, a bilateral dependency was created. Aspinox is solely dependent on Sollaz to create the part, and Sollaz is dependent on filling orders
from Aspinox in order to make the investment in the specialized and required equipment and employees payoff.
Information Asymmetry and Impactedness
Information asymmetry occurs when one party to the transaction has
a deeper knowledge than the other party,23 causing the costs of transacting in the market to increase because of bounded rationality. Information
impactedness is a function of information asymmetry, but includes an element of costliness; it is extremely or prohibitively expensive for the less
knowledgeable of the partners to gain the information needed to gain parity. Thus, information impactedness may increase the chance of the partner with knowledge to act in an opportunistic manner.24
Example
When Mark Harmony started Aspinox, he went to Maria Sanchez, a
lawyer specializing in business start-up and taxes. Mark knew some basics
from his time at business school, but not enough to feel confident with all
the decisions he would have to make. Maria, on the other hand, had been to

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Strategic Management in the 21st Century

law school, passed the state bar, and been in practice for many years. Consequently, Maria knew more about business law than Mark could hope to.
The difference in the levels of knowledge between Mark and Maria could
have allowed Maria to act opportunistically, perhaps by inserting herself as
a shareholder or otherwise acting for her own benefit rather than in Marks
best interest. For Mark to gain the same knowledge, he would have to, at a
minimum, attend law school. In order to bring parity, the costliness of the
information causes information impactedness. Trust played a part in the
transactionalthough Mark may not have known Maria personally before
she became his lawyer, he got several recommendations and understood
that Maria took her fiduciary duties seriously.
Trust and Reputation
Introduced into the TCE model by Chiles and McMackin in 1996,25 trust
is generally defined as increasing ones vulnerability to the risk of opportunistic behavior of ones transaction partner, whose behavior is not
under ones control in a situation in which the costs of violating the trust
are greater than the benefits of upholding the trust.26 In order for trust to
be present, risk must be present as well. If there is no risk, there is no reason to trust. Thus, the two constructs are totally interrelated. Trust inhibits
opportunistic behavior; mistrust, on the other hand, may increase the likelihood of opportunistic behavior.
Trust is generated through social norms (e.g., shared expectations, cultural norms, religious conventions) or through social embeddedness (i.e.,
situational trust). Frequency of exchange also has an impact on trust. The
more often two firms interact (assuming neither behaves opportunistically), the more likely it is for trust to develop between them. Trust also
indirectly has an impact on information asymmetries as it allows one partner to feel comfortable sharing information, assuming that its partner will
not use that information to act in an opportunistic way.
A firm that engages in trustworthy behavior (e.g., performs with honesty, reliability, quality) may gain a reputation for being trustworthy. Its
reputation, then, allows trust to develop more easily, despite asset specificity, transaction frequency, and the level of risk and risk preference.
Examples
Mark Harmony, CEO of Aspinox, has known Cindy Grey, CEO of Greybar, for many years. They attend the same church and are in the same social circle. Because Mark feels he knows Cindy, he does not hesitate to use
Greybar as a supplier without a detailed contract.
Mark has done business with Luke Wook, an independent contractor,
many times in the past. Luke has always performed to Marks satisfaction,

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75

so Mark trusts him to do the same in the future. He also feels he can trust
Lukes expertise and judgment; therefore the contract between them can
be less complex than might otherwise be the case.
Medmedia has been in business for many years. Mark calls several of
Medmedias current customers for referrals. He finds that all of the customers are very pleased with the services they received from Medmedia.
Mark also checks with the Better Business Bureau to see what complaints
have been filed against the company, but found none. A search on the
Internet showed Mark that Medmedia has consistently earned four- or
five-star ratings from its customers. All of these sources together indicated
that Medmedia has an excellent reputation. Although Mark does not have
personal experience with Medmedia, he feels he does not need a complex
contract based on Medmedias excellent reputation.
Market Power
Market power is a relatively new construct in the TCE, having been
proposed by Shervani, Frasier, and Challagalla in 2007.27 Market power is
defined as the ability to achieve a high level of influence or control on the
behavior of others in contact with it.28 Specifically, market power refers
to the firms market power with respect to its buyers. A few ways market
power is created are cases where a firm has a large market share; creates
(or carries) a brand that end customers strongly desire; or has products (or
services) that are highly differentiated. As costs (and their modifiers) are
transaction specific, it stands to reason, that a multiproduct firm may have
strong power in some markets, but weak power in others.
TCE would indicate that when the cost of transacting in the market becomes too high, an integrated (i.e., direct sales to its end users) marketing
channel will be used. On the other hand, one does not necessarily have to
lower costs, one may also maximize the transaction savings.29 Thus, the
ability of a firm to influence its trading partner due to the size and number
of its purchases reduces the costs through mitigating costs such as monitoring, incentives, and control issues.
Example
Through the years, Aspinox becomes a leader in its markets, thus gaining large market power. Cansilware has long been a primary distributor
for Aspinox, and has found that Aspinoxs products are in high demand,
and are making up a large portion of Cansilwares sales. The relationship
between Aspinox and Cansilware has become one where Aspinox has
power over Cansilware. Cansilware knows it must keep Aspinox happy,
so it will allow Aspinox to have access to information about end users, set
delivery schedules, and some say over the way products are displayed.

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HOW COSTS ARE CREATED


Transaction costs are not quantifiable per se, as they are created, in part,
by behavioral issues that are not measurable. The interaction of the assumptions (i.e., bounded rationality, risk preference, and opportunistic
behavior) and the critical dimensions (i.e., frequency of exchange, uncertainty, and asset specificity) create transaction costs, which may be market
or bureaucracy costs. The full model is shown in Figure 4.1.
Market costs are those costs that are created when a firm decides to
transact in the market, to procure the needed goods or services from outside the firm. Examples of market transactions would be a retailer purchasing materials from a wholesaler; a software company outsourcing
its call center; or a manufacturer obtaining components from another
manufacturer.
Whenever a transaction takes place, costs are created. Market costs are
those associated with searching for a trading partner; creating contracts
between the two trading partners; monitoring the trading partner; and
enforcing the contract if compliance becomes a problem.
Search
Finding a trading partner that can provide the needed goods and services (especially when specific assets are needed) and determining prices

Figure 4.1
Transaction Cost Model

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77

are both considered search costs.30 These costs may be the cost of information, learning, and time, among others. Nonmeasurable search costs may
also manifest as the cost of satisficing,31 due to incomplete searches (e.g.,
myopic and local search tactics).32
Search costs are created when opportunist behavior, bounded rationality, and asset specificity are combined. The inability to know how a potential trading partner will behave in a situation where bilateral dependency
caused by the need for specific assets requires that the firm investigate the
potential partner and gathering information can be costly.
Search costs may be lowered if the partners have transacted before
(transaction frequency) and/or trust has been built. Reputation may be
used as a substitute for trust, which also lowers transaction costs.

Contracting
Contracting costs consist of those costs associated with negotiating and
creating a contract for goods or services between the two trading partners. Such contracts may be complex or very simple in nature, but they are
never complete or fully comprehensive.33 When the contract is complex
in nature, the costs of creating such a contract are much higher than when
a simple contract is created. The most extensive (i.e., having the most constructs) of the costs associated with a transaction are those associated with
contracting.
Contracting costs may come about when uncertainty and bounded rationality is combined with opportunistic behavior. Because a manager
cannot know all there is to know about either the future or the possible
trading partner, a contract must be created, thus creating transaction costs.
Additionally, the more specific the assets needed to complete the transaction, the greater the risk of opportunist behavior, and the more complex
the contract must be.
Risk preference may impact the completeness of the contract: riskaverse managers will require contracts that are more complex, whereas
those who are risk seeking may require less complete contracting.
When few possible trading partners exist for a transaction, usually because of a need for transaction specific assets, contracting costs rise, because the transaction may be slanted to the benefit of the trading partner.
When the possible number of trading partners drops to one (this may
happen because of the fundamental transformation), a bilateral dependency may arise, where each firm feels it is held hostage by the other.
Complex contracts may arise in order for the firm to be protected against
uncertainty and opportunistic behavior by the other.
Information asymmetries and impactedness tend to favor one party in
a transaction over another. When combined with opportunistic behavior,

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Strategic Management in the 21st Century

contracts must be more complex in order to protect against one partner


using its knowledge to gain an advantage over the other.
The more often two partners work together, the more likely it is that
trust will build between them, as long as both behave honorably. In cases
of costs that arise from small number exchange and information asymmetryboth ultimately caused by opportunistic behaviortrust or reputation, if present, can reduce the cost of transacting.
Monitoring
Monitoring is the cost of observing and/or controlling the performance
of a trading partner.34 Monitoring may take the form of audits, quality
checks, computer system reporting, incentives, and so on.
Monitoring costs are created when bounded rationality, opportunistic behavior, and uncertainty are combined. Because a firm is unsure of
whether the trading partner will behave honorably and managers cannot know all they need to in order to assure that the contract is being
carried out as it should be, the need to monitor the trading partner is
created.
When asset specificity is high, the need to monitor is more intense,
causing higher transaction costs, whereas fewer specific assets decrease
the need to monitor and results in lower transaction costs.
Risk preference will impact transaction costs because a risk-averse
manager may feel the need to monitor the partner in order to reassure
himself of the partners behavior, whereas a risk-seeking manager may
not see the need. Thus, a firm with risk aversion will have higher transaction costs, whereas the risk seeking will have lower costs.
Because frequent transactions in which the partner behaves properly
may lead to trust, the more frequently the partners have traded, the lower
the need for monitoring. Reputation may act as a substitute for trust, also
lowering transaction costs.
A trading partners high market power may also impact transaction
costs because it creates a small numbers exchange when a trading partner is in a sellers position in the supply chain. The firm may feel it is in a
hostage position in such a situation and thus, feel less need to monitor
the partner. On the other hand, when the firm dominates market power,
the trading partner may be in the hostage position. In such situations, the
firm may not feel the need to monitor a supplier partner because it is important for the trading partner to maintain the relationship.
Information known to one partner may be costly to discover or to
transfer. Thus, it is possible that information asymmetry can increase
transaction costs if the firm decides that it is important to have the same
information the partner has, and that the information is available through
the monitoring function.

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79

Compliance
Compliance costs are those that arise when a trading partner does
not live up to the terms of the transaction (usually a contract) in terms of
quality, deadlines, or other specifications. Enforcement costs are the costs
of forcing a partner to comply with the terms of the transaction, proper
usage of property rights, and handling intellectual property rights appropriately. These costs may be court costs, costs of having an employee at the
partners location, mediation, and so on and may affect either the trading
party or the firm itself.35
Enforcement costs arise when uncertainty is combined with bounded
rationality because contracts cannot be fully comprehensive. When assets are specific to the transaction, trading partners are more likely to behave inappropriately. Although incomplete contacts may allow for some
adaptation that is beneficial to both parties, when a partner behaves opportunistically, the firm may have no recourse but to enforce the contact
through third-party intervention. Bounded rationality also affects enforcement costs when that third party must interpret the areas of the contract
that are incomplete.
One partner may comply with the contract, even to its detriment, because it hopes to have exchanges in the future that will bring greater benefits than noncompliance does. Thus, expectations of future exchange and
frequency of exchange may lower the costs of enforcement.
Information asymmetries, especially in the area of intellectual property,
can increase enforcement costs. Should either partner with proprietary or
protected knowledge find that the information has leaked, it may use selfprotecting measures to avoid completing the contract, thereby creating
higher enforcement costs.
Bureaucracy
Although transactions can take place in the market, transactions may
also take place in-house, or within a firm. These transactions are not
costless; however, the costs are different from those created in market
transactions.
Negotiating
Negotiating costs are those associated with employment contracts and
span of control (i.e., how much control one manager has.36
Negotiation costs come about when opportunistic behavior and information asymmetries or impactedness are combined. The future employee
may have knowledge that the firm does not and/or is costly for the firm
to obtain, such as knowledge of the going market rate, a criminal record,

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Strategic Management in the 21st Century

or ulterior motives for wanting the job. Because the employee may try to
take advantage of this situation, information costs or contract costs may
arise.
Subsequent negotiations, although subject to the same costs as initial
negotiations, must also take into account social comparison and envy,
which may result in an employee displaying opportunistic behavior in
order to equalize a perceived injustice.37
In either instance, asset specificity may have an impact on costs. An
employees specialized knowledge can increase negotiation costs, as the
negotiation process is lengthened and additional information gathered
about market rates, the specialty are, and best uses for the knowledge.
Trust, especially in subsequent negotiations, can also lower negotiation
costs; the longer the employee has worked for the firm (assuming it has
acted honorably), the most trust develops resulting in less complex negotiations and less time negotiating.
Coordination
Coordination costs encompass the costs of organizing division-todivision transfers (e.g., how many units of a specific component must be
created, how often services should be performed), technology transfer,
which employees and managers will be involved, and investment decisions, among others.38
A firm may not be able to determine the exact needs of each division
or business unit at any given time without extensive information. Coordinating products across divisions or departments such that warehousing
expenses are kept to a minimum requires information about raw goods
delivery, current stocks on hand, output requirements, and so on. Coordinating investments calls for the manager to estimate life of equipment,
changes in future technology, and other long-term needs that, by definition, cannot be known with any conviction.
When this bounded rationality is combined with uncertainty (e.g.,
equipment breakage, stock market crash, extreme weather), coordination
becomes difficult. Adding the possibility that one divisions manager or
employees may behave opportunistically for any number of reasons (e.g.,
politics, envy, power plays), the coordination between departments (both
products and investments), becomes costly.
Information asymmetry can increase coordination costs when one
division or manager has information that another does not, or that information is costly to obtain. The more information the firm has about
production schedules, equipment issues, raw material forecast (e.g.,
JIT systems), and technology changes, the lower the coordination costs
will be.

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81

Monitoring
Monitoring costs are those associated with productivity auditing, span
of control, reporting, information gathering, and otherwise making sure
that employees, managers, and divisions are behaving responsibly.39
Monitoring costs are created when uncertainty, bounded rationality, and
opportunistic behavior are combined. Because a manager cannot know
that employees or other divisions will behave in an honorable manner;
cannot know all that is needed to know about product schedules, raw materials delivery, and employee related issues (i.e., social comparisons and
envy); and cannot know about uncertainty (e.g., demand, weather, or performance of equipment), a large amount of information must be gathered.
The need to monitor becomes more extreme when asset specificity (e.g.,
specialized knowledge, equipment) is present, but lowers when fewer
dedicated assets are needed. When trust has developed between divisions, or managers and employees, the need for monitoring is reduced.
Information known to only one division, manager, or employee may be
costly to discover or to transfer to another. Information asymmetry can increase transaction costs if the manager decides that it is important to have
the same information as the employee or another division.
Enforcement
Internal compliance reflects the costs of auditing divisions, paying
high-productivity workers appropriately, quality assurance, and timeliness of service or component delivery. Enforcement costs are those associated with handling issues such as malingering, low productivity, and
mismanagement of divisions, and can range from disciplinary action to
firing.40
Compliance costs arise from the combination of bounded rationality and
opportunistic behavior. Because coordination, like contracts, may be incomplete and allow for some adaptation that is beneficial to both agents (i.e.,
managers, employees, divisions), when an agent behaves opportunistically,
the firm may have no recourse but to resort to some disciplinary action.41
An employee that has proprietary or protected knowledge may act opportunistically, assuming that the firm or division cannot run without
him, especially when that knowledge is specific to the transaction. The resultant information asymmetries may increase enforcement costs, because
the firm does not want to deal too harshly with the employee until the
knowledge has been transferred.
On the other hand, the employee may comply with the rules, even to
his disadvantage, because he hopes to have continued employment that
will bring greater benefits than noncompliance does. Should the employee
find that the specialized knowledge has been transferred or been used

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Strategic Management in the 21st Century

inappropriately, he may use self-protecting measures, thereby creating


higher enforcement costs.
How Governance Structure Is Chosen
TCE posits that three basic governance types exist for transacting:
market, hierarchy, and hybrid. The choice of governance structure is determined by the costs associated with a specific choice. The choice of governance structure is often referred to as the make or buy decision. The
main premise of TCE is that of the classic strategy-structure-performance
model. Therefore, one should:
align transactions, which differ in their attributes, with governance
structures, which differ in their costs and competencies, in a discriminating (mainly, transaction cost economizing) way.42
The following model, based on Williamson43 indicates which structure
is the most efficient given asset specificity and investment safeguards.
When assets are generic and no investment safeguards are needed,
transactions should be made in the free market, where simple contracts or
implied contracts exist and disputes are handled by the courts (A0;S0). In
the unrelieved hazard zone, where assets are generic, but minimal investment safeguard are needed, complex contracts are the norm (A0;S1).
Hybrid forms of governance (e.g., alliances, joint ventures, and long-term
contracts) become needed as assets become more specific and more safeguards are needed (A1;S1). At some point along the continuum, assets become so specific and the need for investment protection becomes so strong,
that the firm is compelled to bring the transaction in-house (An;Sn). To
recap, when investments in specific assets and the need for safeguards increases, the more important it is that the firm consider bringing the transaction in-house rather than use market governance.
Market
A market-governance structure simply means that one firm will purchase the needed goods or service from another firm. This transaction
may be as simple as purchasing a toothbrush from the grocery store or as
complex as having customized components built for an aircraft. A market
transaction is the buy choice and is associated with generating market
costs. Firms choose to transact in the market when market costs are lower
than bureaucracy costs.
The more generic the product or service the firm needs, the lower the
costs of transacting in the market are, and the higher the associated bureaucracy costs. Generally, the less specialized the assets needed to complete

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83

the transaction, the more likely it is that the firm will choose a marketgovernance structure. However, asset specificity, as discussed earlier, is
not the sole determinant of governance choice. Ultimately, however, when
market costs are lower than bureaucracy costs, the transaction should take
place in the market to obtain the most efficient strategic fit.44

Hierarchy
Hierarchical governance structures are those in which the production
or services are provided from within the organization. Hierarchy is the
make choice and is associated with created bureaucracy costs.
These transactions are generally complex in nation, and may require
that the firm develop new skills and other specialized assets. Although the
bureaucracy costs of the transaction will increase, the market costs become
nonexistent. Four major issues should be considered before choosing hierarchical governance: (1) asset specificity (the more specialized the asset,
the higher the need for in-house production); (2) contract complexity (the
more complex the contract needs to be, the higher the need for in-house
production); (3) uncertainty of any kind, be it volume, supplier, customer,
or technology (the more uncertain the situation surrounding the transaction, the higher the need for a hierarchical structure); and (4) exchange
frequency (the more often an exchange is made, the more likely it will
be less costly to perform within the firm). Asset specificity and contract
complexity are the more important areas of concern. Generally, however,
when overall bureaucracy costs become lower than the costs of transacting in the market, the transaction should take place in a hierarchy in order
to capitalize on the strategic fit.45
In situations where a hierarchical governance structure is needed, but
the firm does not have the ability to bring the transaction in-house for
lack of some resource (e.g., knowledge, plant, equipment, patent), the firm
may choose to vertically integrate (either backward or forward) in order
to obtain those resources.
Hierarchy should always be the last choice of the firm because markets
inherently have more incentives to perform at peak efficiency, whereas hierarchies have fewer incentives.

Hybrid
Hybrid forms of government are those that are neither pure market nor
pure hierarchy, such as joint ventures, partnerships, and alliances. Hybrid
governance structures fall between the two dichotomies of the make or
buy choice and are associated with producing both market and bureaucracy costs.

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Strategic Management in the 21st Century

A hybrid governance structure enjoys the benefits of lower costs than it


would if it contracted either in-house or in the market only. Pure market
transactions may be subject to small numbers exchange or bilateral dependency, making a hybrid form more efficient. Market costs of monitoring
and enforcing in-house transaction may become too high, also making a
hybrid form more efficient.

MANAGEMENT IMPLICATIONS
A theory that can explain why firms exist and what the optimal governance structure should be chosen in a given situation is terrific for academics; however, the theory should also provide guidance to managers
who are trying to make decisions.
Governance
Outsourcing
Outsourcing is generally considered to take place in an unassisted
market, as shown in Figure 4.2. If a firms market costs are lower than
its related bureaucracy costs, then outsourcing to the free market is the
appropriate response, given that appropriate contractual safeguards are
present.
When investment safeguards are not present (unrelieved hazard),
both market and bureaucracy costs must be taken into account in determining whether market failure exists. Contracts, which are by nature incomplete, must be complex and disputes will be handled by the court
system, raising market costs to the point where other options must be considered. A hybrid form of governance may be appropriate, or bringing the
production of the needed service or product in-house through vertical integration or diversification.46
Vertical Integration
Vertical integration was one of the first applications of TCE,47 and has
been shown to be a robust theory in this regard. The most important reason for a firm to integrate vertically is because the market is uncertain, has
too much risk, and is unpredictable. A market with few buyers and sellers,
frequent transactions, high assets specificity, as well as the standard issues
of bounded rationality and opportunism, may be considered a failed market. Alone, none of these characteristics is of particular concern; however,
when many are present the market has failed. When faced with a failed
market, the best choice of the firm is to integrate.48

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85

Figure 4.2
Strategy-Structure Performance Model

On the other hand, many firms choose vertical integration when it is


not necessary. Vertical integration should be an organizations last choice,
not its first
because internal organization always experiences a loss of incentive
intensity and added bureaucratic costs as compared with markets
and hybrids. If, therefore, there are not compensating gains (bilateral
or multilateral adaptability advantages), integration is the source of
cost without benefit. Firms that mindlessly integrate weaken themselves in relation to nonintegrated rivals.49
An expedient aid to determining if vertical integration may be appropriate was proposed by Stuckey and White,50 using transaction frequency
and asset specificity in which they council vertical integration only when
frequency is high and asset specificity is high as shown in Figure 4.3.
Although vertical integration should be a last resort, many firms ignore
the many quasi-integration options available to them.

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Strategic Management in the 21st Century

Figure 4.3
Asset Specificity and Transaction Frequency

Quasi-Integration
Strategic alliances and other quasi-integration options such as joint
ventures, partnerships, long-term contracts, and licensing are more adaptable than vertical integration. Quasi-integration mechanisms (often called
hybrid governance) protect against market failures that might otherwise indicate that vertical integration is appropriate, while proving some
major benefits. Joint ventures, partnerships, and long-term contracting,
for example, allow each firm to keep its own identity, thus avoiding antitrust issues; reduce information impactedness and asymmetries through
the sharing of technical or market specific knowledge; and reduce asset
specificity and opportunism through controlled ownership, to name but
a few.51
Thus, when vertical integration seems appropriate, quasi-integration
should be considered. However, when protection for innovations (e.g.,
patents, copyrights, trade secrets) is doubtful and complementary assets
are required or are highly specific, vertical integration may be the only
option.

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Related Diversification
The primary benefit derived from related diversification is that of economies of scope, which arises from synergy, shared resources, and knowhow.52 Given opportunistic behavior, information impactedness, and
bounded rationality, the need to share or jointly utilize inputs and the ability to coordinate and exchange synergy in the open market would create
contracts that are nearly impossible to create, enforce, and monitor. Thus,
in situations where assets are specific, resources are shared or jointly utilized, and knowledge is deep, related diversification would be indicated.
In other situations, one must consider both the market and bureaucracy
costs associated with a related diversification strategy. Although market
costs may be high, internal costs associated with asset specificity, monitoring, and scheduling are not free. If the internal costs related to diversification are lower than the costs of using the open market, or if market failure
exists, then diversification is the correct option for the firm.
Unrelated Diversification
Economies of internal capital markets are the primary benefit of choosing an unrelated diversification strategy. Economies of internal capital
markets arise when there is market failure, primarily caused by opportunism and information impactedness. External investors are separated from
control and ownership, allowing managers to act in their own interests
rather than those of the investors. Therefore, an unrelated diversification
strategy gives the firm the opportunity to be an internal investor, applying all of its control and monitoring functions to the capital investment,
ensuring efficient use of capital and allocation of resources, and oversight
of division to ensure efficiency and reducing slack more effectively than if
the divisions were stand alone business entities.53
Recap
What can TCE do for managers? First, it can be used in any make
or buy decision from a choice of vertically integrating or outsourcing to
using debt (market) or equity (hierarchy) financing. One of the nicest aspects of TCE, from a managerial point of view, is that it is simple and
straightforward: contracts can never be complete, so one must determine
what risks one willing to take knowing that people may behave opportunistically, and that ones investment in assets may be in jeopardy.
The main things to remember when making market/hybrid/hierarchy
decisions are:
1. Every investment should be subjected to the make or buy
question.

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Strategic Management in the 21st Century

2. Lack of present or future switching costs indicate a commodity good


or service, which should always be outsourced, providing viable
trading conditions exist.
3. Using a hierarchical governance structure should always be the last
choicenot the rst.
4. When the assets needed are specic to the transaction and the contract will be complex, hybrid governance should be considered
before hierarchy.
Second, TCE has been around for nearly a half century and is strongly
supported by empirical evidence at the industry, firm, and group levels as
valid. Managers will find that using the TCE analysis for make or buy
decisions will work well for churches, at all levels of governments, in airlines and the airline industry, for automobile manufacturers and the auto
industry, as well as for service industries and firms, and has even been
used to determine what sort of choices families make!
NOTES
1. Coase, Ronald H. The Nature of the Firm. Economica 4, no. 16 (1937):
386405.
2. Tadelis, Steven. Williamsons Contribution and Its Relevance to 21st Century Capitalism. California Management Review 52, no. 2 (Winter 2010): 159166.
3. Hardt, Lukasz. The History of Transaction Cost Economics and Its Recent
Developments. Erasmus Journal for Philosophy and Economics 2, no. 1 (Summer
2009): 2951.
4. Williamson, Oliver E. Examining Economic Organization through the
Lens of Contract. Industrial & Corporate Change 12, no. 4 (August 2003): 918.
5. Cyert, Richard, and James March. A Behavioral Theory of the Firm. Englewood Cliffs, NJ: Prentice-Hall, 1963.
6. Williamson, Oliver E. Markets and Hierarchies: Analysis and Antitrust Implications. New York/London: Free Press, 1975.
7. Coase, The Nature of the Firm.
8. Jones, Gareth R., and Charles W.L. Hill. Transaction Cost Analysis of
Strategy-Structure Choice. Strategic Management Journal 9, no. 2 (March/April
1988): 159172.
9. Tsang, Eric K. Behavioral Assumptions and Theory Development: The
Case of Transaction Cost Economics. Strategic Management Journal 27, no. 11 (November 2006): 9991011.
10. Williamson, Oliver E. The Economics of Governance. American Economic
Review 95, no. 2 (May 2005): 8.
11. Williamson, Oliver E. Transaction Cost Economics and Organization Theory. In Handbook of Economic Sociology, edited by N. Smeltzer and R. Swedberg,
101102. Princeton, NJ: Princeton University Press, 1994.
12. Williamson, The Economics of Governance, 8. Emphasis in the original.

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13. Nokia. en.wikipedia.org/wiki/List_of_Nokia_products (accessed January 20, 2012).


14. Williamson, Oliver E. Opportunism and its Critics. Managerial & Decision
Economics 14, no. 2 (March/April 1993): 97.
15. Yates, J. Frank, and Eric R. Stone. The Risk Construct. In Risk Taking Behavior, edited by J. Frank Yates, 4. New York: Wiley, 1992.
16. Williamson, Oliver E. The Theory of the Firm as Governance Structure:
From Choice to Contract. Journal of Economic Perspectives 16, no. 3 (Summer 2002):
175.
17. Knight, Frank H. Review of Melville J. Herskovits Economic Anthology. Journal of Political Economy 49 (April 1941): 247258.
18. Ofunato, Iwate. http://en.wikipedia.org/wiki/%C5%8Cfunato,_Iwate (accessed January 20 2012).
19. Williamson, The Economics of Governance, 118.
20. Ibid.
21. Williamson, Transaction Cost Economics and Organization Theory,
77107.
22. Ibid.
23. Arrow, Kenneth J. The Organization of Economic Activity. The Analysis
and Evaluation of Public Expenditure: The PPB System, Joint Economic Committee, Washington: 91st Congress, 1969, 5973.
24. Williamson, Oliver E. Markets and Hierarchies: Some Elementary Considerations. Organizational Forms and Internal Efficiency, 1973: 316325.
25. Chiles, Todd H., and John F. McMackin. Integrating Variable Risk Preferences, Trust, and Transaction Cost Economics. Academy of Management Review 21,
no. 1 (1996): 7399.
26. Ibid., 85.
27. Shervani, Tasaddiq A., Gary Frazier, and Goutam Challagalla. The Moderating Influence of Firm Market Power on the Transaction Cost Economic Model:
An Empirical Test in a Forward Channel Integration Context. Strategic Management Journal 28, no. 6 (2007): 635652.
28. Ibid., 639.
29. Geyskens, Inge, Jan-Benedict E. M. Steenkamp, and Nirmalya Kumar.
Make, Buy, or Ally: A Transaction Cost Theory Meta-Analysis. Academy of Management Journal 49, no. 3 (2006): 519543.
30. Coase, The Nature of the Firm.
31. Williamson, The Economics of Governance, 118.
32. Cyert and March, A Behavioral Theory of the Firm.
33. Williamson, Oliver E. The Vertical Integration of Production: Market Failure Considerations. American Economic Review, 1971: 112123.
34. Williamson, Oliver E. The Economic Institutions of Capitalism: Firms, Markets,
Relational. New York: Free Press, 1985.
35. Williamson, Markets and Hierarchies: Some Elementary Considerations.
36. Ibid.
37. Nickerson, Jack A., and Todd R. Zenger. Envy, Comparison Costs, and
the Economic Theory of the Firm. Strategic Management Journal 29, no. 13 (2008):
14291449.

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38. Williamson, Markets and Hierarchies: Some Elementary Considerations.


39. Ibid., 317.
40. Williamson, Oliver E. Economics and Organization: A Primer. California
Management Review 38, no. 2 (Winter 1996): 131146.
41. Nickerson and Zenger, Envy, Comparison Costs, and the Economic Theory of the Firm.
42. Williamson, Transaction Cost Economics and Organization Theory, 79.
43. Williamson, Oliver E. Strategizing, Economizing, and Economic Organizations. Strategic Management Journal 12 (Winter 1991): 7594.
44. Williamson, Oliver E. Economic Organization: A Case for Candor. Academy of Management Review 21, no. 1 (1996): 4857.
45. Ibid.
46. Williamson, Oliver E. The Economics of Organizations: The Transaction Cost Approach. The American Journal of Sociology 87, no. 3 (November 1981):
548577.
47. Teece, David J. Williamsons Impact on the Theory and Practice of Management. California Management Review 52, no. 2 (2010): 167176.
48. Shapiro, Carl. A Tribute to Oliver Williamson: Antitrust Economics. California Management Review 52, no. 2 (2010): 138146.
49. Williamson, Transaction Cost Economics and Organization Theory, 83.
50. Stuckey, John, and David White. When and When Not to Vertically Integrate. McKinsey Quarterly no. 3 (1993): 337.
51. John, George, and Barton A. Weitz. Forward Integration into Distribution:
An Empirical Test of Transaction Cost Analysis. Journal of Law, Economics, & Organizations (1988): 337355.
52. Kay, Neil M. The Emergent Firm: Knowledge, Ignorance and Surprise in Economic Organisation. New York: St. Martins Press, 1984.
53. Jones and Hill, Transaction Cost Analysis of Strategy-Structure Choice.

Chapter 5

Resources and Dynamic


Capabilities: The Foundations of
Competitive Advantage
Mary B. Teagarden and
Andreas Schotter

INTRODUCTION
The basic logic behind business strategy is the development of a competitive advantage in order to generate profits. Strategists focus on both
the formulation of strategy and the implementation of strategy. Both of
these activities depend on the fit between the competitive environment
a company faces and the resources at its disposal plus the way the organization configures these resources. Apple, Dell, and Lenovo compete in
the same industryinformation and communications technologyyet,
each creates value for customers and competitive advantage for themselves in different ways. Apple differentiates by focusing on creating
seamless integration of its computers and products in a service-rich customer experience. Lenovo focuses on providing standardized computers, and provides customer support through a network of retail outlets.
Dell takes yet another approach; they provide mass customized computers built using a large, but not infinite menu of options that can be

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configured to meet a wide range of customer needs that they support


with virtual online or call center service. These three competitors make
products that address similar customer needs but address these needs
with wide variations in how they make their computers and how they
serve their customers.
Organizations exist because they are a more efficient mode for executing certain transactions than individuals; hence they lead to greater profitmaking opportunities for groups than individuals would if they had to
interact independently in a market. In his classic essay titled An Inquiry
into the Nature and Causes of the Wealth of Nations written in 1776,
Adam Smith uses the example of the division of labor in a pin factory to
demonstrate this concept.1 Smith argues that one worker producing pins
might be able to produce 20 pins a day. On the other hand, were the work
organized with pin-making tasks broken down into coordinated steps,
10 specialized workers focusing on one or two steps each could produce
over 4,800 pins40 times the number of pins any individual could produce according to Smiths estimates.
The economic logic behind Smiths assertion is that the within firm
combination of different specializations leads to lower transaction costs.
Lower transaction costs in turn, lead to more efficient market interactions
that allow more resources to be available for allocation to the development and production of better or more products and services. From this
rather abstract perspective firms can be regarded as bundles of resources
that in combination create a specific competitive position for a firm in its
respective market. In our earlier example, Apple, Lenovo, and Dell each
configure different bundles of resources that result in different competitive positions in their markets. The important strategic questions for executives then become:
1. Why do customers buy our products or services?
2. How are we different from our competitors?
3. How can we bundle our resources in order to gain a market
advantage?
4. What are the key success factors that drive our competitiveness?
This line of strategic thinking is based on what strategy scholars call
the resource -based view of the firm, a strategic management perspective popularized by Jay Barney,2 although its roots go back to Wernerfelt.3
The resource-based view of the firm emphasizes the internal strengths
of an organization for building a competitive advantage.4 It is different
from the traditional industrial organizational economics perspective5
that postulates that a firms profit-maximizing abilities are largely determined by forces defined by the respective industry in which the firm

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exists. The resource-based view suggests that competitive advantage


can be achieved when a firm holds valuable resources that are (1) rare,
(2) difficult to imitate, (3) not substitutable, and (4) organized in ways
that allow them to be exploited. These key characteristics are commonly
expressed in an acronym, VRINO, based on the initials of the key characteristics: valuable, rare, inimitable, not substitutable, and organized to
be exploited.
Barney defined resources in a fairly general way and included all
fixed assets, capabilities, organizational processes, firm attributes, information, and other knowledge.6 Barneys model initially contained only
valuable, rare, and inimitable resources characteristics. It was later that
other scholars added the not substitutable and organized to be exploited
dimensions.7 VRINO resources can be many different tangible and intangible assets, including technology, machinery, talent, location, natural
resources, know-how in general and in specific in the form of patents,
brands, and much more. In the automotive industry, for example, engine
technology, design know-how, and market access based on a strong dealership network can all be VRINO resources depending on the individual
market characteristics. As illustrated in our earlier computer company
example, in a given industry competitive advantage can be achieved in
many different ways and there is not necessarily one best set of resources or one preferable combination of resources that leads to competitive advantage.
A form of chicken-and-egg debate persists in strategic management: The
resource-based view popularized by Barneys VRINO framework represents one perspective and industrial organization economics popularized by
Michael Porters five forces model8which suggests that the way firms
generate profits is mostly determined by the external environment and the
individual relative resource position a company enjoys rather than their
specific unique resource positionrepresents the other perspective.9 A
successful firm, according to the five forces model, is one that is able to execute the dominant strategic paradigm of its industry better than its competition. We will explain the different elements of the resource-based view
and the VRINO framework in more detail later.
In this chapter, we will also discuss dynamic capabilities, which is an
extension of the resource-based view.10 The dynamic capabilities perspective adds resource integration, resource building, and reconfiguration to
the framework. Here, dynamic represents the viewpoint that the external
environment constantly changes and organizations need to address the
change by developing specific but flexible resource management capabilities. The elementary idea behind dynamic capabilities is that a firm should
use competencies for developing short-term competitive positions, which
should then be developed into more sustainable, long-term competitive
advantages.

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THE FOUNDATIONS OF THE RESOURCE-BASED VIEW


In true academic tradition, Barneywho popularized the resourcebased view and the VRINO frameworkwas integrating and extending the work of other scholars. The resource-based view, often credited
to Barney, has its theoretical roots in Ricardian economics and Penrosian
economics.11 Penroses early work was intended to explain firm growth,
which is affected by the individual collection of the productive resources
of a firm. In contrast to earlier industry-based analyses, the resource-based
view attempts to explain firm heterogeneity or differences, and why some
firms achieve enduring superior performance when compared to their industry competitors.12
It was Wernerfelt in 1984 who originally developed and proposed the
resource-based view.13 Barney14 continued to build on Wernerfelts seminal work when he introduced the notion of strategic factor markets and
the role of expectations. The resource-based view was further developed
with the contributions of Rumelts15 concept of isolating mechanisms and
Dierickx and Cools notion of inimitability and its causes.16 Barney integrated these concepts into later versions of his original resource-based
view.17 From the perspective of the resource-based view, a firm can earn
sustainable profits if it meets two conditions: (1) it has unique superior
resources compared to the resources its competitors control; and (2) those
resources are protected by some kind of isolating mechanism that prevents their diffusion among competitors.
Barney18 argued that in order for a firm to transform a short-term competitive advantage into a sustained competitive advantage, a firms resources have to be heterogeneous in nature and restricted in terms of
mobility. Grant19 argued that in addition to those criteria identified by
Barney, levels of durability, transparency, transferability, and replicability
are also important determinants for sustainable competitive advantagecreating resources. If these conditions hold, a firms bundle of resources
can generate profits. Sustained advantage20 and sustainable advantage21
can be interpreted in the same way. Sustainability does not mean that advantages persist indefinitely, but that those advantages depend on the restriction against imitation or substitution.22
An excellent example from the computation industry demonstrates this point. Until the mid-1970sthe pre-personal computer era
engineers and scientists used slide rules to perform precise calculations.
Two companies, Sterling and Pickett, dominated the industry. Sterling
made a high-precision plastic slide rule that sold at a low price, about
$3affordable for high school students and home users. Sterlings superior precision plastic manufacturing capabilities afforded them a sustainable advantage in the mass computation market. Pickett, on the other
hand, made a high-precision steel slide rule that sold at a high price, about

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95

$50. Picketts superior precision steel manufacturing capabilities afforded


them a sustainable advantage in the corporate engineering computation
market. Together Pickett and Sterling dominated the slide rule industry
with more than 80 percent market share. Then in the 1970s, HP introduced
a handheld electronic calculator that revolutionized the computation
industry. When it was introduced, the HP calculator cost more than
$450, the monthly salary of a degreed industrial chemist. Within five
years, the HP calculator displaced slide rules with a price point that was
affordable for the mass market. The sustainable advantages enjoyed by
Sterling and Pickett evaporated. They were displaced by a superior substitute. The famous economist Schumpeter would have described this as
creative destruction.23
A firms strengths enable it to perform well. Pickett and Sterling had
manufacturing strengths. Within the slide rule industry, each had a competitive advantageone in precision plastic and one in precision steel
manufacturing. These competitive advantages influenced customers purchase decisions.24 It could even be argued that Pickett and Sterling had
sustainable competitive advantage because their competitive advantages
were difficult to imitate. The slide rule manufacturing core competencies25
and high-precision capabilities that each enjoyed were sustainable competitive advantages until HP changed the game. The relationship of these
concepts is presented in Figure 5.1.26
The resource-based view has been criticized for its all-inclusive definition of resources, its fixed viewpoints, and its disregard for environmental conditions.27 According to Miller28 as well as Priem and Butler,29 the
value of a resource depends on the respective product markets where a
company competes in. So even if a resource is valuable because it has a
low cost, is rare, and difficult to imitate, and not-substitutable, and organized to be exploited, the product market determines whether or not the
resource can maintain its value to generate a competitive advantage and
ultimately profits.
Consider the example of Thyssen-Henschel, the German company that
developed the first commercial magnetic train. Undoubtedly, the company had costly/valuable know-how that was rare, difficult to imitate, not
substitutable, and organized to be exploited. However, the market was
not willing to pay the additional costs for this technology, nor were customers willing to switch among different transportation modes.
Similar to the calculator example, markets and industrial structures
such as technology development may also influence the imitability and
substitution of certain resources.30 Therefore, whether or not a resource
is valuable is also largely determined by industry structures. From the
resource-based view, the relationship between industrial structures and
firm conduct depends on the possession of unique resources. Only particular firms can respond to specific environment changes through

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Figure 5.1
The Organization of Firm Resources (Adapted from Marino, 1996)

conceiving and implementing related strategies because they possess the


desired resources.31 HP had unique know-how that they could transform
into a computational device, the calculator that displaced slide rules. Further, the relationship between firm conduct and performance is contingent
on firms resources. For example, Hitt, Bierman, Shimizu, and Kochhar32
argued that whether geographical and service diversification lead to superior performance depends on whether the firm possesses superior human
resources.
THE VRINO FRAMEWORK
The business strategy process begins with a mission and a vision statement.33 The mission statement formulates what the basic premise of a
firm iswhy does the firm exist? For example, a pharmaceutical companys mission could be to save lives. The mission statement defines

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97

the overarching purpose. The vision statement then becomes more targeted. For example, We want to be the world leader in cancer research
and cancer drug sales. Once the mission and vision have been defined,
the business strategy process continues with the formulation of more specific objectives, followed by a detailed internal (firm specific) and external
(environmentally driven) analysis.34 Then different strategic alternatives
are developed. It is at this point in the business strategy process that the
resource-based view becomes important.
The VRINO framework is a useful analytic tool in the internal analysis
step and considers the value of certain resources for reaching the strategic
goals. VRINO defines a firms resource strengths and their competitive
potential. We will discuss each dimension below.
Valuable
It is important to determine if a certain resource is valuable. A valuable resource allows a firm to exploit market opportunities or to counter threats from products or services of their competitors. If a resource
provides one of these two utilities it should be deemed valuable to the
firm. The value of a certain resource and its capability also depends on the
industry in which a firm operates. The value proposition of a particular
resource is not universal and can become a liability in a different industry
or under changing conditions. For example, if you operate as an innovator with a lot of product engineering talent you are unlikely able to compete in an industry that competes on low cost instead of differentiation.
Your engineers may become a costly liability under the low-cost scenario
instead of a valuable resource under the differentiation scenario.35
A value chain analysis is critical for identifying those resources and capabilities that add either a profit-generating or a cost-reducing function to
a firms activities. It is also here where a firm should decide which of its
processes should better be kept in-house or outsourced. If an outsourcing
provider could potentially create more value or save cost over in-house
activities a specific resource would be considered a liability instead of a
valuable. Too often managers fail to deploy a very rigorous analytic regime to assess the value of resources or they fail to regularly reevaluate
the value proposition of their resources and capabilities. This is especially
true for those firms that do not compete on price. Outsourcing provides
the potential to free valuable financial resources or human resources that
in turn could be deployed in areas where they add relatively more value.36
Rarity
The next dimension of the VRINO analytic logic refers to the notion
of rarity. Rare resources are defined as being both short in supply and

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persistent over time in order to generate sustained competitive advantage.37 For example, silicon is a core resource for the semiconductor industry but it is abundantly available. Hence it is not deemed a VRINO
resource. However, having world-class engineerslike those employed
by Samsung, which is able to design thinner but larger and higher-quality
silicon waferscould increase the competiveness of a firm as compared
to its industry peers. Another example is Toyota, which has a valuable
resource in its hybrid electric-gasoline engine technology. However, if
Toyota were unable to secure enough lithium, a resource needed for its
batteries, the hybrid technology would not be a VRINO resource. Consequently, Toyota has invested substantially in silicon mining, despite being
primarily an automotive company. The goal is to maintain access and control over critical and rare resources in order to sustain a competitive advantage. Building competitive strategy on the access and control of a rare
resource is obviously a good strategy. However, if a firm has very strong
control over a resource, its competitors are likely to increase their R&D
activities in order to either imitate the resource as such or develop a substitute that replaces the resource.
Difficult to Imitate and Nonsubstitutable
Resources that are imperfectly imitable are valuable and have the potential to create a critical product or service advantage or a cost advantage
over a firms competitors.38 Firms with valuable and rare resources, which
are hard to imitate by other firms, can gain first-mover advantages within
their industry.39 Intel, for example, has enjoyed a first-mover advantage
more than once because of its rare fast R&D cycle time capability that
brought SRAM and DRAM integrated circuit technology, and brought microprocessors to market well ahead of the competition. The product could
be imitated, but it was much more difficult to replicate the R&D cycle time
capability.
A firm can either exploit a market opportunity or neutralize an external
threat by using its rare and valuable resources. When competitors identify a resource-based competitive advantage, they may respond in two
ways: First, they may choose to ignore it and continue to operate as usual
and focus more on competitive pricing. Alternatively, they may choose to
analyze (reverse engineer) and imitate (copy) the competitive resources of
its rival in order to reach competitive parity.40 However, sometimes it is
difficult for other firms to get access to or to imitate those resources. As a
result, innovative companies that implement strategies based on difficultto-imitate and nonsubstitutable resources can gain long-term competitive
advantage.41
In most cases imitation appears in two ways: direct duplication or substitution. Direct duplication has been a problem for Apple across their

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99

entire value chain. Apples extraordinary popularity has led to considerable counterfeiting or copying of their prototypes, products, know-how,
trade secrets, service model, and even store concepts.42 Apples products
are predominantly contract manufactured in China. Additionally, the
rising Chinese middle class makes the companys products very popular with local consumers. The strong interest of this consumer group to
show off with high-status consumer goods further spurs the activities of
counterfeiters.
Apple sells its products globally through company-owned retail stores,
online, and through value-added resellers. By the last quarter of 2010 they
had 233 retail stores in the United States and 84 internationallyincluding
two in Beijing and two in Shanghai with a third on the way.43 In September
2011, they opened their first retail store in Hong Kong. The Apple retail
store, a critical differentiator of the Apple experience, is being knocked off
in China. By late 2010 fake Apple stores outnumbered real ones and recently bloggers reported five new fake stores in Kunming, a southwestern
Chinese city with a population of more than 6.4 million. The fake stores
had Apples iconic look, logo, store layout, and employee apparel. Telltale signs identified the fakesincluding the words store, or in one case
Apple storebeside the white Apple logo in the window, something
Apple never does. According to some reports, staff members in these fake
stores believed they were working for Apple.
Chinese authorities acknowledged these fake stores and in the process
identified 22 fake Apple stores in total. Consequently, these stores were
prohibited from using Apple trademarks and symbols. However, only two
stores were closed, whereas the others simply changed their store names
but retained the Apple retail look and service model. It should come as
no surprise that almost all of the products sold in these fake Apple stores
are knockoffs, mostly sourced from Hong Kong.44 This problem has not
stopped at Chinas borders. Apple seized unauthorized iPod, iPhone, and
iPad knockoff accessories bearing the Apple logo for sale in the Chinatown section of Queens, New York.45 Although Apples is a dramatic case,
almost all innovation-driven firms face equally significant IP violation exposure in China and other locations around the world.
The cost of imitation is usually high for the following reasons: unique
historical conditions, patents, social complexity, and casual ambiguity.
Unique historical conditions often create distinct resources and efficiency
advantages for the incubator firm or first mover. Incubators are often advantaged by better access to rare resources and economies of scale. In addition, competitive advantage is frequently embedded in social structures
and interpersonal relationship and unique culture characteristics, which
create social complexity as a barrier to imitation. Casual ambiguity makes
it difficult for imitating firm to identify the specific critical competitive
advantage-creating factor of incubator firms. The would-be copycat

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simply cannot figure out what the target firm does or how they do it. Patents are legal barriers, which in a law enforcementefficient environment
are almost impossible to overcome.46 Once a firm has realized the value,
rarity, and low levels of inimitability of resources and capabilities, the next
step is to organize the company in a way to exploit these resources efficiently. If done right, the firm can enjoy a period of sustained competitive
advantage.
Organized to be Exploited
There are many components to the resources-organizing process. They
include, but are not limited to, the companys formal reporting structure,
management control systems, and compensation policies.47 Reporting
and control structures are both formal and informal and should be aimed
at aligning managerial conduct with a firms strategies.48 Resourcesorganizing capabilities are often referred to as complementary because
alone they do not provide much value.49 However, in combination with a
firms other resources and capabilities these complementary capabilities
can result in sustained competitive advantage. Without organizing capabilities even firms with valuable, rare, and costly to imitate resources can
suffer competitive disadvantages.
Applying the VRINO Framework
The VRINO framework can be used to evaluate the profit-generating
potential of a firms resources and capabilities. The easiest way of applying the VRINO framework is to go through each characteristic sequentially in order to assess the competitive and economic implications of the
firms resources, individually and in combination, with all its other resources and capabilities. If a resource is not valuable the company may
consider abandoning the resource because it may tie up capital or other
management time, which would create inefficiencies. Value here does not
refer to the actual price of the resource but to the value-creating notion
relative to the market. Often firms think they need to provide certain services or complementarities to customers that historically were important
for business but over time lost their value-creating function.
Next, if the resource is valuable but not rare it merely establishes competitive parity. A competitive parity means that the company is no better
or worse off than its competitors. Third, if a resource or capability is valuable and rare, but not costly to imitate, a firm has achieved a competitive
advantage and will temporarily achieve above-normal economic returns.
Often certain management practices show this characteristic. However,
because the resource or capability is not costly to imitate, other companies
will soon copy the resource or capability. Finally, the best-case scenario

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101

would be if a resource is valuable, rare, difficult to imitate, and costly to


organize. This resource would then become a source of a sustained competitive advantage. The O in the VRINO framework is of critical importance, because no matter how valuable, rare, or costly to imitate a resource
is, if it is not organized to be exploited then it will most likely become a
competitive disadvantage and end up hurting the firm financially.50
THE DYNAMIC CAPABILITIES PERSPECTIVE
The concept of dynamic capabilities emerged in response to some key
shortcomings of the resource-based view of the firm, which has been
criticized for ignoring factors surrounding resource development and
resource reconfiguring, instead assuming that resources simply exist.51
Based on this criticism the dynamic capabilities perspective has extended
the resource-based view with the notion of evolving capabilities. In contrast, the term ordinary capability refers to those capabilities that are
needed by a firm to simply conduct its normal business operations. They
are the standard routines that are not necessarily unique to the individual organizationfor example, the accounting system that keeps track of
revenue. Ordinary capabilities are not critical for developing a competitive advantage but for transforming VRINO resources into competitive
advantage. The dynamic capabilities perspective assumes that the market, the competitive environment, the technological environment, and
the cultural context constantly change and more importantly, that firms
that do not have the capabilities to adjust to these changes are vulnerable
to failure.
Some scholars define dynamic capabilities as the ability to integrate,
build, and reconfigure internal and external competencies to address
rapidly-changing environments.52 Through the development of capabilities based on sequences of path-dependent learning, a firm can stay ahead
of its competition and continue generating profits.53 Dynamic capabilities
include knowledge, learning, and absorptive capacity.54 In the context of
quickly changing environments, dynamic capabilities are simple, experiential, unstable processes that rely on quickly created new knowledge and
iterative execution to produce adaptive outcomes.55 The term dynamic56
stands for the ability to renew and realign competencies along the requirements of the changing business environment. Capabilities, on the other
hand, refer to the role of management in adapting, integrating, and reconfiguring the internal and external organizational expertise, resources,
and functional know-how of a firm to match the conditions of the changing environment. The units of analysis within dynamic capabilities are the
processes, positions, and paths of an organization.
From this perspective the dynamic capabilities notion seems logical, but in reality organizations by definition present some resistance

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Strategic Management in the 21st Century

to dynamism. This resistance is created by bounded rationality or the


limited bandwidth of firms and their managers in dealing with complexities, situational versus long-term decision-making preferences, organizational routines and processes, the level of specialization in a firm,
and the resistance against incurring costs for activities that have uncertain outcomes.57 Resistance can create competence traps. Consider cellphone manufacturer Nokia, for example; for many years the company
dominated the industry based on its superior product design and the
simplicity for performance of basic communication functions. When
smartphones emerged Nokia was slow in moving from a closed
productfocused strategy to an open utilityfocused strategy that would
better address the changing needs of the market. Nokia was relying too
much on its design capabilities and failed to see the need to acquire the
content integration and development competencies needed for success
in the smartphone market. In a way Nokias success decreased the willingness of the management to change.
The dynamic capabilities perspective expands the paradigm for explaining how competitive advantage is developed and sustained. Firms
resorting to resources-based strategies attempt to accumulate valuable
technology assets and employ an aggressive intellectual property development and protection position. However, winners in the global marketplace have been firms demonstrating timely responsiveness, and rapid
and flexible product innovation, along with the management capability
to effectively coordinate and redeploy internal and external competences.
The latter notion is what defines dynamic capabilities. It addresses the
constantly changing characteristics of the environment and it highlights
the key role of managers in appropriately adapting, integrating, and reconfiguring internal and external organizational abilities, competences,
and the use of specific resources.
Processes, positions, and paths are the underlying mechanism of dynamic capabilities.58 Processes refer to patterns of activities and learning
or how things are done in a firm. Positions refer to the current endowment
of technology, intellectual property, market share and customer base, external relations, and complementary assets. Paths refer to the availability
of strategic alternatives and their relative effects on increases or decreases
in returns or profits.
Only recently have researchers begun to focus on how firm-specific
dynamic capabilities are developed and on how ordinary capabilities
and resources are transformed to respond to changes in the business environment. The competitive advantage of an organization derives from
dynamic capabilities rooted in high-performance routines that are embedded in an organizations processes. The dynamic capabilities approach
provides an important complementary dimension to the resources-based
view perspective.

Resources and Dynamic Capabilities

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ROUTINES AND CAPABILITIES


Imagine a company that generates revenue by producing and selling
the same product or service, on the same scale and to the same set of clients repeatedly. The capabilities used in this process become routines.
Without them, the firm could not collect the revenues that allow it to acquire more inputs and repeat the process over and over again. In contrast,
capabilities that would change the product or service, the manufacturing process, the scale, or the composition of the client base are not routines. They fall into the dynamic capabilities domain; they also reflect the
VRINO notion described earlier.
Take, for example, innovation capabilities. By definition, innovation capabilities are not commonplace although some firms in industries with
rapid innovation cycles, such as Intel, and short product life cycles, such
as Apple, hold more of these capabilities than others. The traditional pharmaceutical industry is strongly based on a high level of R&D and innovation. Often market valuation for these pharmaceutical firms is based
on their product pipeline. However, these same firms struggle in environments with weak intellectual property protection, such as China. In
order to generate profits from their innovation positions in these markets
they need to create other capabilities, specifically alternative intellectual
property protection capabilities.59 Other examples are the capabilities that
support the selection and development of new outlets by leading retailer
Wal-Mart, or by Starbucks. Although the store development and design
as such is highly standardized and therefore routine, the site-selection
process and the ability to buy/lease the best location is not routine but
a unique dynamic capability; dynamic, because it changes depending on
the specific environmental context.
It is worth noting that dynamic capabilities are not synonymous with
flexibility or change. There are many ways to change. It is quite possible
to change without having dynamic capabilities. In organizations, change
is often triggered by either external shocks resulting from radically, unpredictable circumstances, or by internal effects, such as, for example, the appointment of a new CEO. In contrast to dynamic capabilities, these change
processes often occur due to simple events, whether it is because an external challenge arrives or because an autonomous decision to change is
made at a high level. Here, organizations might be pushed into a high
paced, contingent, opportunistic, and perhaps creative search for satisfactory alternatives that do not depend on dynamic capabilities and are
largely nonrepetitive.
The concept of dynamic capabilities is a helpful addition to the tool kit
of strategic analysis, but strategic analysis itself remains a matter of understanding how the idiosyncratic attributes of the individual organization
affect its prospects in a particular competitive context.

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NOTES
1. Smith, A. An Inquiry into the Nature and Causes of the Wealth of Nations. New
York: Oxford University Press, 1776.
2. Barney, J. B. Firm Resources and Sustained Competitive Advantage. Journal of Management 17:1 (1991): 99120.
3. Wernerfelt, B. A Resource-based View of the Firm. Strategic Management
Journal 5 (1984): 171180.
4. Mahoney, J. T. & Pandian, J. R. 1992. The Resource Based View within the
Conversation of Strategic Management. Strategic Management Journal 13:5 (1992):
363380.
5. Porter, M. E. Competitive Strategy: Techniques for Analyzing Industries and
Competitors. New York: Free Press, 1980; Caves, R. E. Industrial Organization,
Corporate Strategy and Structure. Journal of Economic Literature 18 (1980): 6492;
Silverman, B. Organizational Economics. In J.A.C. Baum (Ed.), Companion to Organizations. Oxford, UK: Blackwell Publishing, 2002, 233256.
6. Barney, J. B., 1991.
7. Dierickx, I. & Cool, K. Asset Stock Accumulation and Sustainability of
Competitive Advantage. Management Science 35:12 (1989): 15041511; Rumelt,
R. P. Towards a Strategic Theory of the Firm. In R. B. Lamb (Ed.), Competitive
Strategic Management. Upper Sadler River, NJ: Prentice Hall, 1984.
8. Porter, M. E. How Competitive Forces Shape Strategy. Harvard Business
Review 57:2 (1979a): 137145.
9. McGahan, A. M. & Porter, M. E. How Much Does Industry Matter, Really? Strategic Management Journal 18 (Summer Special Issue, 1997): 1530.
10. Teece, D. J. & Pisano, G. The Dynamic Capabilities of Firms. Industrial
and Corporate Change 3:3 (1994): 537556; Teece, D. J., Pisano G., & Shuen, A. Dynamic Capabilities and Strategic Management. Strategic Management Journal 18:7
(1997): 509533; Eisenhardt, K. M. & Martin, J. A. Dynamic Capabilities: What Are
They? Strategic Management Journal 21:8 (2000): 11051121.
11. Penrose, E. The Theory of the Growth of the Firm (Third Ed.). Oxford, UK: Oxford University Press, 1959; Ricardo, D. Principles of Political Economy and Taxation.
London, UK: J. Murray, 1817, 1965.
12. Peteraf, M. A. The Cornerstones of Competitive Advantage: A Resource
Based View. Strategic Management Journal 14 (1993): 179191; Barney, J. B. Is the
Resource Based View a Useful Perspective for Strategic Management Research?
Yes. Academy of Management Review 26:1 (2001): 4157.
13. Wernerfelt, B., 1984.
14. Barney, J. B. Strategic Factor Markets: Expectations, Luck, and Business
Strategy. Management Science 32:10 (1986a): 12311241; Barney, J. B. Organizational Culture: Can It Be a Source of Sustained Competitive Advantage? Academy
of Management Review 11:3 (1986b): 656665.
15. Rumelt, R. P., 1984.
16. Dierickx, I. & Cool, K., 1989.
17. Barney, J. B., 1991, 2001.
18. Barney, J. B., 1991.
19. Grant, R. M. The Resource-based Theory of Competitive Advantage. California Management Review 33:3 (1991): 114135.

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20. Barney, J. B., 1991.


21. Grant, R. M., 1991; Ghemawat, P. Sustainable Advantage. Harvard Business Review 64 (1986): 5358.
22. McGrath, R. G., MacMillan, I. C., & Venkataraman, S. Defining and developing a competence: A Strategic Process Paradigm. Strategic Management
Journal 16:4 (1995): 251275; Oliver, C. Sustainable Competitive Advantage: Combining Institutional and Resource Based Views. Strategic Management Journal 18
(1997): 697714.
23. Schumpeter, J. A. Theory of Economic Development. Cambridge, MA: Harvard
University Press, 1934.
24. Porter, M. E. Competitive Advantage: Creating and Sustaining Superior Performance. New York: Free Press, 1985.
25. Prahalad, C. K. & Hamel, G. The Core Competence of the Organization.
Harvard Business Review (May-June, 1990): 7990.
26. Marino, K. E. Developing Consensus on Firm Competencies and Capabilities. Academy of Management Executive 10:3 (1996): 4051.
27. Eisenhardt, K. M. & Martin, J. A. 2000; Priem, R. L. & Butler, J. E. Is the
Resource Based View a Useful Perspective for Strategic Management Research?
Academy of Management Review 26:1 (2001b): 2241; Teece, D. J., Pisano, G., &
Shuen, A. 1994; Miller, D. An Asymmetry-Based View of Competitive Advantage. Strategic Management Journal 24 (2003): 961976.
28. Miller, D., 2003.
29. Priem, R. L. & Butler, J. E. Tautology in the Resource Based View and the
Implications of Externally Determined Resource Value: Further Comments. Academy of Management Review 26:1 (2001a): 5766; Priem, R. L. & Butler, J. E., 2001b.
30. Eisenhardt, K. M. & Martin, J. A., 2000.
31. Barney, J. B., 1991; Barney, J. B., 2001.
32. Hitt, M. A., Bierman, L., Shimizu, K., & Kochhar, R. Direct and Moderating
effects of Human Capital on the Strategy and Performance in Professional Service
Firms: A Resource-Based Perspective. Academy of Management Journal 44 (2001):
1328.
33. Ansoff, H. I. Corporate Strategy: An Analytic Approach to Business Policy for
Growth and Expansion. New York: McGraw-Hill, 1965; Learned, E. P., Christensen,
C. R., Andrews, K. R., & Guth, W. Business Policy. Homewood, IL: Irwin, 1969.
34. Hofer, C. W. & Schendel, D. Strategy Formulation: Analytical Concepts.
St. Paul, MN: West, 1978.
35. Barney, J. B., 1991.
36. Teagarden, M. B., Meyer, J., & Jones, D. Knowledge Sharing among High
Tech MNCs in China and India: Invisible Barriers, Best Practices and Next Steps.
Organizational Dynamics 37:2 (2007): 190202; Stringfellow, A., Teagarden, M. B., &
Nie, W. Invisible Costs in Offshoring Service Work. Journal of Operations Management 26:2 (2008): 164179.
37. Barney, J. B. & Hesterly, W. S. Organizational Economics: Understanding
the Relationship between Organizations and Economic Analysis. In S. R. Clegg,
C. Hardy, & W. R. Nord (Eds.), Handbook of Organization Studies. Thousand Oaks,
CA: Sage, 1996, 115147.
38. Lippman, S. A. & Rumelt, R. P. Uncertain Imitability. Bell Journal of Economics 13:2 (1982): 418438.

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39. Lieberman, M. B. & Montgomery, D. B. 1988. First-Mover Advantages.


Strategic Management Journal 9: 4158; Lieberman, M. B. & Montgomery, D. B.
First-Mover (Dis)Advantages: Retrospective and Link with the Resource Based
View. Strategic Management Journal 19:12 (1988): 11111125.
40. Shenkar, O. Copycats. Boston: Harvard Business Press, 2010.
41. Hill, C.W.L. & Jones, G. R. Strategic Management: An Introduction. New
York: Houghton Mifflin, 1998.
42. Apple received widespread media attention from many public sources including: http://birdabroad.wordpress.com/2011/07/20/are-you-listening-stevejobs/; http://www.bbc.co.uk/news/technology-14273444; http://www.pcworld.
com/businesscenter/article/239196/wikileaks_cable_apple_slow_to_
counter_chinese_fakes.html; http://www.pcworld.com/printable/article/id,239
196/printable.html; http://www.pcworld.com/businesscenter/article/239196/
wikileaks_cable_apple_slow_to_counter_chinese_fakes.html; https://outlook.thun
derbird.edu/owa/redir.aspx?C=7dd5ac2c10d94cabb4737cf0e375f316&URL=http
%3a%2f%2fwww.macrumors.com%2f2011%2f09%2f09%2fapples-strict-securitymeasures-for-pre-release-hardware%2f; retrieved 9/2/2011. Our discussion is a
synthesis of this reporting.
43 . http://topics.nytimes.com/top/news/business/companies/apple_
computer_inc/index; retrieved 9/2/2011.
44. http://gizmodo.com/5832504/two-nyc-stores-selling-knock+off-applegadgets-are-under-attack-by-apple; retrieved 9/2/2011.
45 . http://www.reuters.com/article/2011/08/18/apple-knockoffs-idUSN1E77H1Y920110818; retrieved 9/2/2011.
46. Barney, J. B. & Hesterly, W. S., 1996.
47. Caves, R. E. Industrial Organization, Corporate Strategy and Structure.
Journal of Economic Literature 18 (1980): 6492; Chandler, A. Scale and Scope: The Dynamics of Industrial Capitalism. Cambridge, MA: Harvard University Press, 1990;
Chandler, A. D. Strategy and Structure: Chapters in the History of the Industrial Enterprise. Cambridge, MA: M.I.T. Press, 1962.
48. Pfeffer, J. & Salancik, G. R. The External Control of Organizations: A Resource
Dependence Perspective. New York: Harper & Row, 1978; Rumelt, R. Strategy, Structure, and Economic Performance. Boston: Harvard Business School, 1974, 1984.
49. Teece, D. J. Profiting from Technological Innovation: Implications for Integration, Collaboration, Licensing and Public Policy. Research Policy (1986):
285305; Teece, D. J. Competition, Cooperation and Innovation: Organizational
Arrangements for Regimes of Rapid Technological Progress. Journal of Economic
Behavior and Organization 18 (1992): 125.
50. Barney, J. B., & Hesterly, W. S. Strategic Management and Competitive Advantage: Concepts and Cases, 4th ed. Upper Saddle River, NJ: Pearson Prentice Hall, 2011.
51. Eisenhardt, K. M. & Martin, J. A., 2000.
52. Teece, D. J., Pisano, G., & Shuen, A., 1997; Dierickx, I. & Cool, K., 1989.
53. Dierickx, I. & Cool, K., 1989.
54. Teagarden, M. B., Meyer, J., & Jones, D. Knowledge Sharing among High
Tech MNCs in China and India: Invisible Barriers, Best Practices and Next Steps.
Organizational Dynamics 37:2 (2007): 190202; Stringfellow, A., Teagarden, M. B., &
Nie, W. Invisible Costs in Offshoring Service Work. Journal of Operations Management 26: 2 (2008): 164179.

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55. Eisenhardt, K. & Martin, J., 2000.


56. Teece, D. J., Pisano, G., & Shuen, A., 1997.
57. Simon, Herbert. Bounded Rationality and Organizational Learning. Organization Science 2:1 (1991): 125134.
58. Teece, D. J., Pisano, G., & Shuen, A., 1997.
59. Schotter, A. & Teagarden, M. B. A Dynamic Intellectual Property Protection Framework for China. In A. Gupta, T. Wakayama, & U. S. Rangan (Eds.),
Global Strategies for Emerging Markets. New York: John Wiley & Sons, 2011.

Chapter 6

Options and Strategic Management


Edward Levitas and
Matthias Bollmus

Many now accept the idea that a firms value can be decomposed into
two basic components: the value of cash flows from its current operations and the value of discretionary investment opportunities, or options, embedded in the firms resources. These options provide the firm
with flexibility to alter operations in the face of environmental change
or operational uncertainty, and can often form the basis for sustained
advantages. For example, owning a patent on a pharmaceutical technology, through granting its owner the legal right to exclude others use,
provides a firm with a number of exclusive options. These include the
unique ability to manufacture a product based on the underlying technology, the ability to license the technology to another entity, the ability
to further develop the technology into something more potentially valuable, the right to defer decision on the technology, and even the right to
abandon the technology.
The distinction between current cash flows and future options may
appear trivial but does have important implications for management
practice and strategy research. Most investments (e.g., the building or
expanding of research facilities; the marketing or promoting of a new
pharmaceutical) suffer from a degree of irreversibility, or the inability to
fully recover the investment if circumstances change. Uncertainty increases

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the possibility of failure since once ostensibly promising investments


may erode in value if conditions become unfavorable and irreversibility
precludes the recouping of investment. An option strategy of investment
can minimize potential loss by compelling iterative or incremental investment (when feasible) rather than committing unconditionally at the outset
to a project. Assuming that a project can be terminated after each stage,
incremental investing allows the firm to avoid committing the entire cost
of the project upfront, and permits gathering of information over time to
assess whether the next investment (and the entire project) remains feasible. In short, incremental investing allows for the cultivation of options.
In this chapter, we briefly review the real options literature as it applies to strategic management. We then discuss some implications for
option value and competitive advantage that have received relatively
little attention in the strategy literature.
BACKGROUND
Similar to financial options, real options give the technology owner
the right without any obligation to pursue a specific alternative. This real
options approach partitions firm or investment value into two components: the value of discounted cash flows from the firms existing activities and the value of options that the firm holds1

where Ci,t denotes the value of discounted cash flows from ongoing operations and Oi,t denotes the value of the firms options.
Simply put, options provide opportunities for discretionary investment, and thus, confer choice. This is a nontrivial issue with regard
to a firms strategizing since much of a firms strategy is emergent
managers cannot remain static on formulated strategies but must continually refine these in response to changing environmental conditions as well
as opportunities provided by a firms internal operations.2 Environmental
jolts may occur without warning and may make current resource utilizations obsolete. Firms hoping to withstand these jolts must have a repository of potential responses, or face the threat of failure. One should also
note that changes in environmental conditions may create opportunities for
prepared firms to enhance competitive positions as well. Firms that possess
wide arrays of valuable responses to environmental change have the greatest opportunity to gain in turbulent environments, and thus have greater
propensity to develop or maintain competitive advantages. This flexibility of response makes simple possession of an option valuable. Firms that
possess more discretionary alternatives will perform better in times of increased environmental volatility than will less prepared competitors.3

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The real options develop some stylized categories of real options,


most notably the following:
Growth, platform or learning options refer to opportunities to expand operations or enter new markets based on experience in utilizing a resource.4 For example, understanding therapeutic uses
for a drug compound after intense research scrutiny may provide
the owner with many options that were unanticipated or unrecognized at the beginning of experimentation. In some cases, newly
discovered uses prove more valuable than the originally identified
implementation (e.g., Pfizers Viagra, which was initially targeted
to treat types of arrhythmia until researchers identified efficacy in
a much more profitable impotence market). It is important to note
that experience often provides the platform for further exploration and knowledge acquisition.5 Apples knowledge developed
through its experience failing with Newton handheld computer
devices appears to be instrumental in its subsequent successful
introduction of iPod, iPhone, and iPad products.
Deferral options reflect abilities to delay decisions on investments
without prohibitive cost. An example of a deferral option is the
ability to delay commercialization of a product until greater understanding of consumer market conditions are gained.
Abandonment options provide the owner with the ability to terminate pursuit of an activity. The shuttering of a plant that no longer
produces with efficiencies desired by management is one example.
Switching options provide the ability to alter the inputs or outcomes
of an investment path with minimal cost (e.g., change inputs, move
to new output market, etc.). Soft-drink manufacturers exercised
their option to switch sweeteners when they replaced pure cane
sugar with the cheaper high-fructose corn syrup.
Generally, real options theorizing attempts to provide guidance on
managing the effects uncertainty and irreversibility (with some assumption of decision-maker rationality) have on investment value.6 We will
use the commonly employed oil field example to demonstrate.7 Assume
that during periods of wide fluctuations in oil prices (but with no clear
trend) a firm considers adding an oil field to its investment portfolio.
Outright purchase of the oil field entails considerable upside potential
given the possible rise in oil prices. Purchase, however, also entails considerable downside risk since oil prices may also decline.
Holding an option (i.e., the right without obligation) to purchase
the oil field alters the returns distribution in comparison to the opportunity to merely purchase the field. The option to purchase provides the

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option holder with the ability to defer decision until s/he can collect
more information about price trends (i.e., reduce uncertainty). If the
owner notes a clear upward trend in price, s/he may choose to exercise
the option by buying the oil field at the price specified in the option
contract, thereby benefiting from the options upside. S/he may also
own the right to sell the now more valuable option to another party.
However, if oil prices appear to be decreasing to the point where investment is unprofitable, the firm can simply choose not to exercise the
option to purchase the field, thereby limiting its downside. Therefore,
one witnesses an asymmetric return pattern from option possession
where upside potential is limited, among other things, by the maximum value of the underlying asset (e.g., the oil field in this case),
whereas a downside floor is limited to opportunity costs of option possession (assuming that the firm acts rationally and does not pursue
value decreasing options).
IRREVERSIBILITY
This example demonstrates the role irreversibility plays a role in real
options logic.8 Irreversibility refers to the inability to recover part or all
of an investment if conditions change. The oil field, for example, can be
considered at least partly irreversible since firms cannot recoup all of
the expenditures associated with field purchase should oil prices decline
below profitable levels. If ones investments were completely reversible,
one would not need to consider option investing since poor decisions
could be costlessly corrected. One should note that irreversibility will
vary by option. For example, a new alliance contract may be terminated
at minimal cost9 although failed entry into new markets can have devastating consequences for firms. Obviously, assessing degrees of irreversibility is essential for determining values of real options.
UNCERTAINTY
Uncertainty obviously plays an important role in determining the
value of the oil field option. Option management is unnecessary in the
absence of uncertainty since complete knowledge (and rationality) allows one to consistently select the optimal investment strategy. In the
presence of complete knowledge, one knows exactly what course to pursue. Obviously, such conditions are rarely met. Therefore, option values
often (but not always) increase with increasing uncertainty.10 In the case
of the oil field, an investor cannot easily recoup her/his loss if economic
conditions move downward (leading to declines in oil prices), or if
alternative means of energy production develop (leading to decline in
oil demand).

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We should note, however, that the effects of uncertainty on option


value are multifaceted. For example, some scholars11 distinguish between economic uncertainty (i.e., that which is due to general macroeconomic movements) and technical uncertainty (i.e., that which can
be reduced via experimentation), which demonstrate countervailing effects on investment decisions.12 For example, economic uncertainty reflected in highly volatile oil prices compels one to wait to invest (e.g.,
pursue development of an oil field) in order to gather more information
about long-term project profitability. Such uncertainty is exogenous
since firm actions can in no way reduce this uncertainty.13 In contrast,
technical uncertainty or the lack of understanding of how to effectively
extract the oil is endogenous (since firm activities can reduce it) to
the decision process and therefore can be reduced via investment. Iterative development (e.g., drilling a number of wells before deciding which to pursue for further oil extraction, using various drilling
technologies before deciding which is most effective) will inform the
firm of potential oil in the field, viability of extraction methods, etc. The
important point here is that whereas economic uncertainty in the real
options literature forestalls investment (e.g., wait and see how events
unfold), technical uncertainty compels (at least in a limited manner) investment (e.g., investment reveals more information on which to base
subsequent investment).
Furthermore, some research indicates that a single type of uncertainty can have a nonlinear effect on investment.14 For example, uncertainty may precipitate conditions where increases in (potential) returns
to a unit of investment exceed the cost of that unit. Such conditions can
occur when exogenous uncertainty creates considerable ignorance about
future business conditions and thus, provides considerable upside potential while depressing input prices.15 For example, consider a manufacturing firm in an industry facing considerable market uncertainty.
This uncertainty may lead to reduced input prices as producers curtail
further production. However, reduced production may also attract new
entrants into the industry. Some incumbents may be able to forestall
entry by investing in a new plant while offsetting some of this investment with lower input prices the industry.16 In such cases, uncertainty
about demand and potential entrant abilities may compel rather than
dissuade investment in the plant.
REAL OPTION VALUATION
Real option valuation techniques are often viewed as enhancements
to more traditional net present value (NPV) approaches.17 One of the
weaknesses of NPV approaches, similar to any forecasting method,
is that it requires relatively precise knowledge about the timing and

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amount of cash inflows and outflows associated with an investment,


and appropriate discount rates. Option values, on the other hand, impute uncertainty and the value of choice. Furthermore, and critically,
the discounted cash flow approach generally assumes that the manager does not change investment decisions and/or react to environmental changes over. The cash flows (both positive and negative) that were
forecasted before project pursuit generally remain unaltered even as
new information is uncovered.18 Similarly, the rate at which cash flows
are discounted should adequately reflect the risk of the investments
cash flows. If the risk of those cash flows varies throughout the project
(as they often do), the discount rate should reflect these changes. NPV
approaches fail in this regard.19
In addition, the discounted cash flow models do not adequately address the intrinsic value of investment opportunity. The intrinsic value, described as the difference between the actual value of an investment and
the market price of the investment, may result from embedded options
(which we will discuss in more detail later). As mentioned earlier, the traditional valuation methods value cash flows, and not the options that could
enable management to take corrective actions to improve the cash flows.
Based on these weaknesses of the traditional models to address the
value of real options, a new set of valuation methods specific to real options has emerged. Among those the Black-Scholes model20 is the most
prominent model. On a very basic level, this model essentially applies
the law of one price, which states that in efficient markets, all identical
goods must have the same value (or price) after, if applicable, exchange
rate are taken into consideration. The reason that markets are assumed
to be efficient is due to the concept of arbitrage; if prices for the same
good or service would be different in different markets, then an arbitrageur would purchase the asset in the cheaper market just to sell it in the
market in which the price is higher.
The difficulty is that most real options are not traded on a market
since they may be uniquely possessed by the firm (e.g., a firms ability to alter its own product mix, or to use established logistics and distribution systems to enter a new market). This creates the problem of
efficient valuation. To circumvent this problem, one could establish a
dynamic tracking portfolio that consists of investment opportunities
with the same, or very similar, payoffs than the firms option but comprising traded assets.
The law of one price then suggests that the option, though not traded,
ought to be valued the same as the portfolio of traded investment opportunities with the same payoff. Since those other investment opportunities are traded on efficient markets, their price ought to accurately
reflect their actual, true value. As a result, the price of a firms option is
derived off a comparable investment.

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ITERATIVE INVESTMENT AND COMMITMENT


Whereas many investment decisions are often framed as all-ornothing decisions (e.g., sell/keep a division; make/buy inputs), optionbased strategies emphasize the value of iterative investing (at least under
specific conditions) rather than committing unconditionally at the outset to a project.21 Assuming that a project can be iteratively planned so
that decisions to continue/terminate can be made after each stage, incremental investing allows the firm to avoid committing to the entire
cost of the project upfront (and thus subjecting a firm to significant exogenous uncertainty), and permits gathering of information over time
to assess whether the next investment (and the entire project) remains
feasible (i.e., allows the reduction of endogenous uncertainty).
To demonstrate, consider the example of pharmaceutical development. Drug development faces considerable uncertainty in terms of type
and magnitude. Endogenous uncertainty results from low probabilities
that the technology will be safe and effective in humans. Exogenous
uncertainty stems from, among other things, societal acceptability of a
treatment even if it is demonstrated to be therapeutically effective (witness, for example, the weak marketing efforts for many approved family
planning devices). In light of these uncertainties, managers must carefully manager their firms option chains. Instead of committing up
front to a single project (whose success may cost hundreds of millions
of dollars), options strategies often dictate small initial investments in a
variety of projects to assess feasibility before final commitment. If some
projects fail, these can be abandoned (or used as platforms to develop
other therapies). In contrast, managers can provide further incremental
funding for the pursuit of projects that demonstrate some efficacy in the
current stage. Mismanagement of option strategizing (e.g., overcommitting
to a project in times of uncertainty) can have drastic consequences. Committing to the of building a plant to manufacture a drug for clinical trials before assessing the efficacy of the drug in animal models, or before
assessing the degree to which the drug will be socially accepted subjects
the company to considerable risk of investment loss. Holding options
on land to build a plant, and simultaneously conducting background
research on contract manufacturers are ways of avoiding such commitment under uncertainty.

A PORTFOLIO OF OPTIONS VERSUS


AN OPTION ON A PORTFOLIO
The preceding text also alludes to the importance of distinguishing between holding a portfolio of options and holding an option on
a portfolio of assets.22 In short, research23 suggests that the former

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(i.e., holding a portfolio of options on multiple assets) is more valuable


than the latter (i.e., holding an option on a portfolio of assets). Basically,
holding a portfolio of options on multiple assets affords greater flexibility and thus provides a higher value than holding an option on a
portfolio of the same assets. The flexibility stems from the fact that the
holder of the option portfolio is able to exercise the option on each asset
individually whereas the holder of the option on the asset portfolio can
only purchase all the assets in the portfolio. This is especially important in the case of pharmaceuticals since, in many cases, the technology
simply does not work in practice as it did in testing (witness, for example, the efficacy of pharmaceutical candidates in animal models that is
not replicated in human subjects). In other cases, competing products
preempt the profitable commercial introduction of a technology. A deficiency in complimentary assets such as trained sales force, manufacturing capacities, or even a legal team needed to defend the legitimacy
of the patented technology may also reduce the commercial viability of
a technology. Thus, greater flexibility in terms of decisions with which
to confront contingencies is critical to vitality in technological dynamic
environments.
UNIQUE VALUE
One of the more important aspects of real options application to firm
strategy resides in the notion of unique value or that value idiosyncratically possessed by the firm.24 Often, due to idiosyncratic knowledge, one
firm will realize investment opportunities to which other firms are not
privy. We can refer back to the oil field example to demonstrate. Assume
two firms, firm A and firm B, are now considering an oil field purchase.
Firm A, an owner of multiple fields, has through its previous operational experience gained a substantial understanding of oil field operations. This internal knowledge helps reduce the risk of the investment
vis--vis firm B, and in turn would impact the value of this investment
opportunity to this specific firm. On the other hand, if company B has
some but limited experience on how to turn a newly purchased oil field
into corporate profits, then this option to purchase may be more risky
than As and thus affect the perceived value of this option. In short, due
to this knowledge asymmetry, firm A may realize greater value than
does firm B due to tacit knowledge.
Polanyis swimmer provides a descriptive example of the characteristics of tacit knowledge.25 The swimmer, by definition, possesses a
proficiency in the act of swimming. Yet, the task of swimming defies
description. Although proficient at performing consistently, the swimmer cannot articulate the method by which s/he accomplishes her/
his task nor can novices hope to acquire such knowledge through

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observation of the swimmer. Of course, swimming can be reduced to easily describable constituent acts. Physiology texts provide descriptions of
the mechanisms by which a swimmers lungs maintain buoyancy. Physics texts depict the mechanics necessary for the swimmer to accelerate and achieve a certain velocity. However, mere examination of these
texts is not sufficient to provide a novice with the knowledge of swimming. As Polanyi26 suggests, knowledge of the particulars does not confer knowledge of the larger activity. Very few novice swimmers, after
having been provided with instruction, master the skill without initial
failures. Rather, novices must transform a familiarity of constituent acts
(e.g., buoyancy regulation, aquatic locomotion) to an in-depth knowledge of the larger activity (i.e., swimming). In so doing, the novice must
coordinate knowledge so that constituent acts effectively perform in
unison. They must routinize the procedure. Thus, an individual can
learn to swim only by experience and experimentation.27
Similarly, the ability of a firm to perform skillful activities rests on
the tacit knowledge it possesses in the form of higher-order organizing capabilities.28 As is the case with a swimmer, firms are not endowed
with these capabilities but must acquire them over time.29 Capabilities
necessary for configuring resources can only be developed as a firm exploits resources and subsequently witnesses resource strengths and
weaknesses. As a result of such exploitation, the firm develops an indepth familiarity with resources that, like the act of swimming, can be
capitalized on but not fully codified. As experiences mount, the firm
gains a greater understanding of its resources. Accordingly, capability
development follows a path-dependent trajectory30 as capability acquisition is largely determined by the firms course through history. And,
for the most part, time compression diseconomies31 constrain potential
imitators in their attempts to acquire a firms entire tacit knowledge.
History not only furthers knowledge of resources but also serves to
decrease the costs of its internal transfer and creation. More than simply
a collection of individuals, the firm is defined by its network of social
interactions.32 As the firm proceeds through history, employees develop
a collective consciousness, or mind-set that is specific to that firm. One
aspect of this mind-set is a familiarity employees have with one another
as well as knowledge of the unwritten (i.e., tacit) rules and routines on
which a firms activities are based. Furthermore, a common language
or code emerges, which serves to economize on communication costs
by providing a single medium (i.e., free of parochial distortions) through
which disparate groups or functions (e.g., marketing, finance, operations) can communicate.
In addition, this collective mind-set fosters communication efficiency
by providing a lens through which organizational members view the
world. Although learning may take place in the mind of the individual,

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what each individual learns is very much a function of what his/her


peers (perceive to) know.33 Unwritten or tacit rules and routines dictate
to managers/employees what types of knowledge are considered useful
or valuable by the larger organization.34 Knowledge deemed unsuitable
is discarded. Accordingly, when confronted with voluminous amounts
of endogenously or exogenously derived knowledge, employees/
managers can recognize that knowledge which is deemed crucial to the
vitality of the firm (i.e., it fits with the existing mind-set of the firm).
In other words, tacit knowledge allows the organization to circumvent
the bounded rationality of individual employees.35
Consequently, organizational knowledge development is largely
localized as exploitation and search practices conform to historically
determined parameters.36 Firms tend to search (and will, generally, be
more successful in searching) for productive opportunities in local
areas, or areas that are closely related to their expertise. As noted, learning tends to be cumulative, and thus, local search may not only lead to
beneficial returns but may also provide the direction in which future
learning takes place.
In short, history may allow one firm to see opportunities that elude
its competitors.37 Such unique perspectives create asymmetries in the
options two firms may derive from the same resource. We turn to these
issues below.
ADDITIONAL UNIQUE OPPORTUNITY RECOGNITION
So far, we have devoted most of our discussion to single options provided by resources (e.g., to defer/not defer decision, to enter/not enter).
We now turn our attention to the more realistic context where resources
provide multiple choices to firms.38 One might imagine a situation where
one option, such as, for example, the option to delay a purchase, might
create several opportunities for management to take corrective actions.
Management might, for example, assess changes in variables such as
oil prices, environmental guidelines on drilling, technological advancements of drilling, increased willingness of investors to fund new projects, and so forth, which might lead to more accurate valuations. In that
case, the option might have also created opportunities for management
to positively act beyond the initially identified purchasing decision. Deferring purchase decisions, for example, may have provided the firm
with opportunities to further consider the appropriate mix of debt and
equity to finance the purchase of the oil field. As such, an option might
in reality create more than one opportunity for management to identify
new options.
Similarly, the option to delay the purchase of an oil field may also enable managers to reconsider and make changes to other projects. For

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example, the firm may consider the purchase of an oil field and also the
development of an alternative fuel source. The purchase of that alternative fuel project may be strongly dependent on future oil prices (as is the
oil field purchase); if oil prices decline, the development of the alternative
fuel source may be delayed because consumers are less willing to switch.
If oil prices increase, consumers are more likely to demand an alternative
fuel source. In this case, the option to wait and see before having to decide
whether to purchase the oil field might impact multiple projects.
Options on discovering additional options refer to what Geske39 labels compound options, or simply, options on options. Often, unique
knowledge provides the option to discover a multitude or cascade of
subsequent choices. The growth of Wal-Mart provides an example of
such an option cascade.40 Wal-Mart has operated in discount retailing for
over four decades, and in that time has expanded into pharmacy, financial services, toys, electronics, groceries, optometry, warehouse stores,
and so forth. The platform on which it based such expansion was itself built from the knowledge of operations it acquired over that period,
knowledge of (regional) buying habits of its current and future customers, as well as the ability to alter its knowledge/processes to changing
circumstances. In short, learning by Wal-Mart cascaded into a series of
subsequent opportunities. The initial option Sam Walton exercised to
open his first five and dime store now appears to be much more valuable than anyone originally anticipated. Often unique options translate
into value that is unanticipated by outsiders (and insiders). One important implication is that outsiders (including public equity markets)
are incapable of efficiently valuing or assessing the competitive threat
of option-producing companies.

UNIQUE DISCOUNT RATES


Traditional valuation methods such as NPV or internal rate of return
use discounted cash flows as the basis for their valuation of a cashproducing asset. Essential to these valuation methods is the market riskadjusted cost of capital rate r at which the cash flows are
discounted,

where CF is the net cash flow in each period, respectively, t is the time
period of the cash flow, i represents one of a sequence of cash flows
to the investment, and ICO represent the initial cash outlay (i.e., the

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initial cash investment to purchase the asset that will subsequently generate cash flows). Consequently, the interest (or hurdle) rate is negatively correlated to the NPV of the investment opportunity; an increase
in r will lower the NPV, and vice versa.
Real option strategy allows managers to exploit change. Therefore,
such strategies are meant to reduce investment risk in terms of the
discounted value of the asset; newly available information will help
managers identify advantages (or disadvantages) of a project and improve (or stabilize) cash flows. Effective implementation of option reasoning may also limit downside risks as iterative investment reduces
money at risk. Furthermore, flexibility recognition and unique knowledge will allow firms to more easily identify and pursue alternative
paths should the focal investment prove to be ineffective (e.g., Pfizers
entry into the male impotence market). Consequently, utilization of a
real option perspective should reduce the perceived risk (and attendant
discount rate) of the project. We would therefore expect to see lower
market riskadjusted cost of capital rates (discount rates) for firms that
effectively implement real options strategies. Due to its negative correlation with NPV, the lower interest rate will result in a higher discounted
value for a specific investment stream.
Therefore, in addition to the effect additional opportunity recognition (discussed in the preceding section) has on valuation, option savvy
companies should also uncover additional value due to reduced investment risk. Option recognition allows the identification of a series or
portfolio of opportunities over which to spread risk.41 It also allows for
the accrual of additional information with which to make investment
decisions.42 Accordingly, option cultivation entails reduced hurdle rates,
which in turn, elevate discounted cash flow values. Option-producing
firms should, therefore, realize additional value due to this reduced
perceived risk as well.
INPUT MARKET ADVANTAGES
As suggested, when a firm has the capability to create, recognize,
and/or value an option-producing investment, it might conclude that
the value for a needed input is lower than the market value of that input.
Theoretically, market values will reflect the value the average buyer
should place on that asset. Given the identification of unique option cascades, one firm may pay less per option than competing bidders (as
the cost of resource purchase is spread across the widely acknowledged
and those options uniquely acknowledged by the firm). If, for example, the cost of adding a geologist to help map and estimate the location and
size of an oil field is represented by his/her salary of $80,000 annually,
but a firm can utilize these geologist more effectively due to superior

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engineering, surveying, access to capital, and so forth, the $80,000 salary will represent a more valuable investment to that firm than to lessendowed competitors.
RISK ACCEPTANCE
When a firm has the luxury of having a certain amount of slack available, it may be more willing to take calculated risks. For example, a
firm with a very successful, revenue-producing product line might be
more willing to take some risks on a new, risky project than a firm that
doesnt have a guaranteed income from a successful product to fall
back on. In other words, if a firm knows that it could absorb losses without those affecting the business in the long term, it might change the
firms willingness to take risks on new products.
Real options are also assets, similar to the successful product, and as
such having options and knowing how to efficiently create and use options may change the firms willingness to take risks on other, more risky
options. For example, if a firm already owns several high-producing
oil fields, it may change its consideration of a new project with a
higher-than-usual risk. In other words, the ability and knowledge that
the firm knows how to efficiently use real options may have altered
its risk aversion, and the combination of the current assets of the firm
and the firms confidence in its own ability to manage real options may
alter the firms risk tolerance. The firm may feel like that it can take some
chances because it has a certain amount of slack resources (e.g., cash
from the revenue-producing asset, etc.) that will help absorb a negative
shock if the new venture doesnt work out.
Conversely, firms that are less confident about their ability to follow
a real optionsbased strategy may be less likely to take risks on projects that would require the efficient application of real options. In an
extreme example, this might lead to the already successful firm taking
more risks, and the less successful firm taking fewer risks. This in turn
may increase the already existing variance in performance between the
two companies.
PERCEIVED VALUE AND BENCHMARKING
Perceived value is often related to some sort of benchmark. For example, our own valuation of an asset is at least influenced by its market
value; the perceived value deviates from the market but it will at least
be influenced by how the market values the asset. We suggest that there
are other benchmarks that will play a role when setting the perceived
value of a real option. For example, it is possible that an asset becomes
more valuable to us just because our competition really wants it and

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therefore signals that their perceived value of the asset is high; the signal could, for example, be an increased purchase price bid by that competitor. Surely, the book value of an asset doesnt increase just because a
competitor wants it, but the market value is influenced. And is the market value not just a culmination of perceived values?
If we extend this concept of demand and supply, where more and
more entities perceived values might influence the market price of an
asset, which would create a bubble (as we have seen numerous times
between the tulip craze and the latest housing bubble), then the extension of this concept should also apply to option valuation. The perceived
values of options are influenced by valuations held by other market participants. If competitions value perceptions increase, so might our perceived value of that same option; this increase in valuation would then
not solely be based on rational behavior but also on the intricacies of the
relationship between the competitor and us. For example, if Google and
Microsoft would try to secure and option for the same asset, then their
rival relationship might influence their own internal (perceived) valuation of that option.
The realization that our own perceived value of an option is not just
endogenous to the firm, but is also influenced by outside forces (such
as the competitor) now opens this up for some gamesmanship. At one
point, a firm might not even really want to purchase the real option, but
continues to signal that it does just to increase the perceived value to the
competitors and hence drive up the price. As such, the concept of perceived value is closely related to firm strategy.
If we know that our competitors perceived value of an option increases upon our demonstration of interest, then this could result in a
bidding war (and escalation of commitment). For example, one might
observe this betting war with financial options when it comes to finding a new CEO for a firm, where usually the salary of these CEOs is
relatively low, but the amount of options might decide where the CEO
decides to go; thus, the firm with the highest option value becomes the
winner in the competition for the CEO.
One could imagine that the same concept can apply to real options;
two firms compete for the same resource and try to outbid each other,
where the resource is an option on a real asset. One might find similar
examples in professional sports, where not only salaries but also options are part of a players or coachs compensation package. The much
sought after no-trade clause, for example, is an option for the player (the
option to decline a trade), while teams often have the option to pick up
a players contract.
In addition, the external force influencing the perceived value of an option may come from a regulatory entity. If, for example, the government
sets new environmental standards pertaining to the extraction of oil, then a

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patent on a new technique to extract that oil might suddenly be perceived


as more highly valued. All of this may suggest that the perceived value of a
real option is influenced by exogenous forces.
To what degree is the perceived value of a real option driven by internal or external forces? This is an interesting question, and might depend on the specific situation, but in general one could imagine that it
may have something to do with the firms experience dealing with real
options. If, for example, a firm is relatively new to the concept of real options, then it might trust outside advice or guidance more than if it had
ample experience dealing with and valuing real options.
Also, the relative experience with real options, or lack thereof, might
also impact the efficiency with which real options are created, recognized, and used. As such, Kogut and Zander43 found that if options are
integrated, organizational routines and culture will adjust, raising the
cost of abandoning the option. Bower and Christiansen44 found that
when options are only used sporadically they will increase costs, pushing firms to kill them. In both cases it may be argued that a firms experience with options may influence their perceived value of the said
option.
CONCLUSION
Real options are a central topic in strategic management. With the advancement of technology and the increase in the scope of competition
(e.g., from global competitors), more and more firms may choose to employ any and all assets that could help improve the competitive position
the firm; real options are one of these assets.
Our discussion of real options has outlined its strategic importance
to management and has also shown several areas that remain uncertain and potentially underdeveloped within many firms. Although
some of those weaknesses could potentially be addressed quickly, others will take time (e.g., gaining experience working with real options).
We also discussed how several strategically important concepts, such
as irreversibility, risk, and uncertainty, converge at the topic of real
options.
Although real option valuation remains ambiguous to many firms,
hindering the advancement of the strategic implementation of real options because of an apparent lack of clarity, the potential upside of implementing real options into the firm merits a serious consideration of
the real option strategy.
NOTES
1. Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial
Economics, 5(2), 147175.

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2. Mintzberg, H. (1978). Patterns in strategy formation. Management Science,


24(9), 937948.
3. Bowman, E. H., & Hurry, D. (1993). Strategy through the option lens: An
integrated view of resource investments and the incremental-choice process.
Academy of Management Review, 18(4), 760782; Folta, T. B. (1998). Governance and
uncertainty: The tradeoff between administrative control and commitment. Strategic Management Journal, 19(11), 1007; McGrath, R. G. (1997). A real options logic
for initiating technology positioning investments. Academy of Management Review,
22(4), 974996.
4. Chang, S. J. (1995). International expansion strategy of Japanese firms: Capability building through sequential entry. Academy of Management Journal, 38(2),
383407; Kim, D., & Kogut, B. (1996). Technological platforms and diversification.
Organization Science, 7(3), 283301.
5. Cohen, W. M., & Levinthal, D. A. (1990). Absorptive capacity: A new perspective on learning and innovation. Administrative Science Quarterly, 35(1), 128
52; Penrose, E. T. (1959). The Theory of the Growth of the Firm. Oxford; New York:
Oxford University Press; Roberts, K., & Weitzman, M. L. (1981). Funding criteria for research, development, and exploration projects. Econometrica, 49(5),
12611288.
6. Dixit, A. K., & Pindyck, R. S. (1994). Investment under Uncertainty. Princeton,
NJ: Princeton University Press; McDonald, R. L., & Siegel, D. R. (1985). Investment
and the valuation of firms when there is an option to shut down. International
Economic Review, 26(2), 331349; Roberts, K., & Weitzman, M. L. (1981). Funding
criteria for research, development, and exploration projects. Econometrica, 49(5),
12611288.
7. Levitas, E., & Chi, T. (2010). A look at the value creation effects of patenting and capital investment through a real options lens: The moderating role of uncertainty. Strategic Entrepreneurship Journal, 4(3), 212233.
8. McDonald, R. L., & Siegel, D. R. (1985). Investment and the valuation of
firms when there is an option to shut down. International Economic Review, 26(2),
331349.
9. Chang, S. J. (1995). International expansion strategy of Japanese firms:
Capability building through sequential entry. Academy of Management Journal,
38(2), 383407; Chi, T. (2000). Option to acquire or divest a joint venture. Strategic
Management Journal, 21(6), 665687.
10. Dixit, A. K., & Pindyck, R. S. (1994). Investment under Uncertainty. Princeton,
NJ: Princeton University Press.
11. Ibid.
12. Folta, T. B. (1998). Governance and uncertainty: The tradeoff between
administrative control and commitment. Strategic Management Journal, 19(11), 1007.
13. Ibid.
14. Folta, T. B., & OBrien, J. P. (2004). Entry in the presence of dueling options.
Strategic Management Journal, 25(2), 121.
15. Abel, A. B. (1983). Optimal investment under uncertainty. The American
Economic Review, 73(1), 228233.
16. Kulatilaka, N., & Perotti, E. C. (1998). Strategic growth options. Management
Science, 44(8), 10211031.
17. Mun, J. (2002). Real Options Analysis Tools and Techniques for Valuing Strategic
Investments and Decisions. New York: John Wiley & Sons.

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18. Amram, M., & Kulatilaka, N. (1999). Real Options Managing Strategic Investment in an Uncertain World. Boston, MA: Harvard Business School Press.
19. Mun, J. (2002). Real Options Analysis Tools and Techniques for Valuing Strategic
Investments and Decisions. New York: John Wiley & Sons.
20. Black, F., & Scholes, M. (1973). The pricing of options and corporate liabilities. Journal of Political Economy, 81(3), 637654.
21. Roberts, K., & Weitzman, M. L. (1981). Funding criteria for research, development, and exploration projects. Econometrica, 49(5), 12611288.
22. Merton, R. C. (1973). Theory of rational option pricing. The Bell Journal of
Economics and Management Science, 4(1), 141183.
23. Chi, T. & E. Levitas. 2007. An examination of options embedded in a
firms patents: Value of dispersion in citations. In J. J. Reuer and T. W. Tong
(Eds.), Advances in Strategic Management (Real Options Theory). NY: Elsevier, v. 24:
404428.
24. Penrose, E. T. (1959). The Theory of the Growth of the Firm. Oxford; New York:
Oxford University Press.
25. Polanyi, M. (1962). Personal Knowledge: Towards a Postcritical Philosophy. London: Routledge & Kegan Paul.
26. Polanyi, M. (1966). The Tacit Dimension. Garden City, NY: Doubleday;
27. Polanyi, M. (1962). Personal Knowledge: Towards a Postcritical Philosophy. London: Routledge & Kegan Paul.
28. Kogut, B., & Zander, U. (1992). Knowledge of the firm, combinative capabilities, and the replication of technology. Organization Science, 3(3), 383397;
Kogut, B., & Zander, U. (1996). What firms do? Coordination, identity, and learning. Organization Science, 7(5), 502518; Nelson, R. R., & Winter, S. G. (1982). An
Evolutionary Theory of Economic Change. Cambridge, MA: Belknap Press of Harvard
University Press; Penrose, E. T. (1959). The Theory of the Growth of the Firm. Oxford;
New York: Oxford University Press; Teece, D. J. (1988). Technological change and
the nature of the firm. In G. Dosi (Ed.), Technical Change and Economic Theory. London: Pinter Publishers.
29. Nelson, R. R., & Winter, S. G. (1982). An Evolutionary Theory of Economic
Change. Cambridge, MA: Belknap Press of Harvard University Press; Penrose, E. T.
(1959). The Theory of the Growth of the Firm. Oxford; New York: Oxford University
Press; Teece, D. J. (1988). Technological change and the nature of the firm. In G.
Dosi (Ed.), Technical Change and Economic Theory. London: Pinter Publishers.
30. David, P. A. (2003). Clio and the economics of QWERTY. International Library of Critical Writings in Economics, 163, 607612.
31. Dierickx, I., & Cool, K. (1989). Asset stock accumulation and sustainability
of competitive advantage. Management Science, 35(12), 15041511.
32. Kogut, B., & Zander, U. (1992). Knowledge of the firm, combinative capabilities, and the replication of technology. Organization Science, 3(3), 383397;
Kogut, B., & Zander, U. (1996). What firms do? Coordination, identity, and learning. Organization Science, 7(5), 502518.
33. Simon, H. A. (1991). Bounded rationality and organizational learning. Organization Science, 2(1), 125134.
34. Kogut, B., & Zander, U. (1996). What firms do? Coordination, identity, and
learning. Organization Science, 7(5), 502518.

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35. Teece, D. J., Rumelt, R., Dosi, G., & Winter, S. (1994). Understanding corporate coherence: Theory and evidence. Journal of Economic Behavior and Organization,
23(1), 1.
36. Cyert, R. M., & March, J. G.,. (1963). A Behavioral Theory of the Firm. Englewood Cliffs, NJ: Prentice-Hall; Nelson, R. R., & Winter, S. G. (1982). An Evolutionary
Theory of Economic Change. Cambridge, MA: Belknap Press of Harvard University
Press; Penrose, E. T. (1959). The Theory of the Growth of the Firm. Oxford; New York:
Oxford University Press; Teece, D. J. (1988). Technological change and the nature
of the firm. In G. Dosi (Ed.), Technical Change and Economic Theory. London: Pinter
Publishers.
37. Penrose, E. T. (1959). The Theory of the Growth of the Firm. Oxford; New York:
Oxford University Press.
38. Ibid.
39. Geske, R. (1977). The valuation of corporate liabilities as compound options. Journal of Financial and Quantitative Analysis, 12(4), 541552.
40. Levitas, E., & Ndofor, H. (2006). What to do with the resource-based view.
Journal of Management Inquiry, 15(2), 135144.
41. Markowitz, H. (1952). Portfolio selection. Journal of Finance, 7(1), 7791.
42. Roberts, K., & Weitzman, M. L. (1981). Funding criteria for research, development, and exploration projects. Econometrica, 49(5), 12611288.
43. Kogut, B., & Zander, U. (1992). Knowledge of the firm, combinative capabilities, and the replication of technology. Organization Science, 3(3), 383397.
44. Bower, J. L., & Christensen, C. M. (1995). Disruptive technologies: Catching
the wave. Harvard Business Review, 73(1), 43.

Chapter 7

Managing Organizational Trust in the


21st Century: A Pragmatic Approach
to Trust Development, Maintenance,
and Repair
Edward C. Tomlinson,
Andrew Schnackenberg, and
Emily Amdurer

Trust is widely acknowledged to be critical for organizational effectiveness. Indeed, researchers have confirmed its role in predicting a wide
array of outcomes ranging from employee satisfaction, commitment, and
performance-related behaviors to team effectiveness and to organizationallevel operating metrics such as sales and profitability.1 The advantages
offered by trust are often understood as a product of favorable social exchanges in relationships with others.2 That is, voluntarily conferred social
resources by one party create a sense of obligation that invokes some form
of reciprocation by the other,3 thus engendering trust. Although trust can
be a useful tool in generating a competitive advantage4 (e.g., via reducing
the need for interfirm monitoring), the potential benefits it offers often
fail to materialize. It appears that trust is a commodity that organizations

Managing Organizational Trust in the 21st Century

127

often squander by neglecting to cultivate it among their stakeholders,


and/or acting in ways that damage trust.5 Recent surveys show that, in
general, trust in organizations is low and continues to erode over time.6
If trust can be harnessed as a resource to actually improve organizational
effectiveness, organizational leaders need practical guidance on how trust
can be developed, maintained, and repaired if damaged. We draw from
the academic research on trust in organizational settings to provide this
guidance. In order to accomplish this objective, we begin by providing a
research-based framework on the nature and determinants of trust. We
proceed to use this foundation to articulate how trust can be managed effectively in organizational settings.
OVERVIEW OF TRUST
Our analysis begins from the premise that one cannot successfully undertake a course of action intended to produce a given result until the criteria defining that result is clear. Because the term trust is common to
everyday language, individuals may presume to understand all that this
term connotes and yet use it in ways that significantly differ from how
others view the concept. Such a problem has even arisen among researchers in different academic disciplines who all use the term trust when referring to concepts that are actually distinct, such as cooperative behavior7
and goodwill.8 To ensure conceptual clarity, we define trust as the psychological state [of the trustor] comprising the intention to accept vulnerability based upon positive expectations of the intentions or behavior of
[a trustee].9 Because trust comprises a willingness by the trustor to be
vulnerable, it is distinct from, yet leads to, behaviors that involve actually
taking a risk in a relationship with a trustee.10 This distinction is important
because cooperation, for example, can arise in the absence of trust (e.g.,
when the trustor is not in a vulnerable position on an important issue11 or
when an individual is coerced into cooperating).
It is also important to distinguish between trust and factors that give
rise to trust. The question is, if trust is the willingness to be vulnerable
to another, what contributes to this willingness? We will identify and describe three primary factors: the trustworthiness of the trustee, the transparency that enables an assessment of the trustees trustworthiness, and
the emotional attachment between the trustor and trustee.
Trustworthiness
Simply stated, trust is placed in those who are deemed to be trustworthy. Accordingly, trustworthiness is focused on a rational evaluation of the
trustee, with particular emphasis on characteristics that contribute to the
trustors willingness to become vulnerable. These characteristics tend to

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be viewed as traits or attributes that typify ones behaviors and intentions.


Factors that contribute to ones image of trustworthiness can be parsimoniously summarized in terms of ability, benevolence, and integrity.12
Ability refers to that group of skills, competencies, and characteristics
that enable a party to have influence within some specific domain.13 In
other words, trustworthiness necessarily involves the capacity to honor
trust: the noblest intentions to honor trust fail to do so without the requisite ability. It is also critical to note that ability is specifically evaluated in
relation to a particular realm, because skill and competence in one domain
does not necessarily translate into others. For example, one might trust
her spouse (who is employed as an accountant) to correctly complete and
file the household tax return, but not to successfully prepare a large holiday meal for friends and family (given his limited culinary experience).
Finally, some types of abilities are malleable (such as skills that can be acquired and refined over time), whereas some are stable and resistant to
change (such as cognitive ability).14
Benevolence refers to the extent to which a trustee is believed to want
to do good to the trustor, aside from an egocentric profit motive.15 Such
discretionary behaviors speak to the trustees willingness to behave in a
trustworthy fashion. Benevolence is evaluated in relation to the specific
relationship between the trustor and trustee. Therefore, assessing benevolence is believed to be more easily accomplished in more developed relationships, as this involves an evaluation of the trustors orientation toward
the trustee in particular (which is not the case with ability). Demonstrating
a pattern of care, concern, and goodwill toward the trustor over time (especially when it comes at some cost to the trustee) are the hallmarks of benevolence. Once formed, perceptions of benevolence can be very resistant
to change.16 For example, in strong, well-developed relationships, perceptions of high benevolence can become so entrenched that trustors deny
any subsequent evidence of malfeasance.17 In the same way, once one is
regarded as having low benevolence, any subsequent behavior tends to
be viewed through a lens of suspicion.18 There is also some evidence that
trust erodes more rapidly when the reason for a trustees violation of trust
is an unwillingness (rather than inability) to honor trust.19
Integrity refers to the trustors assessment that the trustee adheres to a
set of principles that the trustor finds acceptable.20 Indicators of integrity
may include the degree to which the trustor treats others fairly, engages
in consistent and predictable behavior, and enacts behaviors that are consistent with espoused principles and values. Importantly, the trustors
acceptance is as critical as the trustees adherence. For example, the trustees adherence to espoused principles facilitates predictability, but might
show that the trustee is predictably selfish, and therefore does not necessarily contribute to trust. It is the adherence to principles the trustor accepts that facilitates the trustors confident positive expectations. As with

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129

benevolence, integrity also speaks to the trustees willingness to honor


trust. Because integrity is often perceived in reference to accepted principles and values, it tends to result in a holistic evaluation of the trustee.
That is, regardless of domain, and regardless of whether it occurs in the
trustors particular relationship with the trustee, integrity-relevant events
are salient and diagnostic. Much like perceptions of benevolence in an established relationship, integrity perceptions tend to be highly stable once
formed (unless there is overwhelming evidence to the contrary).21 For
example, trustees found to be dishonest on one occasion tend to be perceived as dishonest in general.22
Transparency
In recent years, increased attention has been paid to the topic of transparency.23 Most accounts of transparency define it as the inherent quality of information in communications such as employment contracts,
lease agreements, advertising materials, operating policies, e-mails, public disclosures, and other public documents.24 In this chapter, we define
transparency more comprehensively in terms of the degree to which communications are characterized by disclosure, clarity, and accuracy. Research suggests that higher levels of transparency correspond to higher
levels of organizational trust.25 Elaborating on this relationship, we contend that transparency relates to the formation of trust in two basic ways.
First, when a firm finds itself in the position of a trustee, transparency
signals to its partners and stakeholders a level of trustworthiness through
the forthright development of contracts and other documents. In other
words, firms trying to prove that they are trustworthy will increase their
openness in information flow. Second, when a firm takes the position of
a trustor, transparency allows it to more accurately assess the partners
trustworthiness. In this way transparency provides more information to
the trustor about the partners abilities, benevolence, and integrity.
Emotional Attachment
The previous sections on trustworthiness and transparency are predominantly grounded in a rational, cognitive approach. This overlooks
the reality that we often trust others (at least to some extent) because of
our positive feelings toward them. Especially in close and well-developed
relationships, parties often come to develop strong emotional bonds due
to their identification with each other. That is, they share common interests
and goals, they tend to react the same way in common situations, and they
espouse the same values and principles.26 Identification fosters a sense of
mutual caring and concern in the relationship. Clearly, this is more than
mere benevolence. Whereas benevolence indicates a unilateral perception

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of the trustees goodwill toward the trustor, emotional attachment engenders a mutually strong, positive emotional bond between the trustor and
the trustee. Although trust resulting from such a strong emotional attachment is relatively more uncommon (compared to trust due to more cognitive considerations), it can be particularly robust and resilient.27
PRACTICAL GUIDANCE
Now that we have discussed the factors that lead to trust, we proceed
to build on this foundation to develop an understanding of how organizations can use this knowledge in practical ways. Specifically, we focus on
how organizations can strategically capitalize on the development, maintenance, and (if needed) repair of trust. Furthermore, given that trust is a
feature of relationships, we will consider how organizations should approach development, maintenance, and repair in their roles as trustor and
trustee, respectively. That is, we propose that organizations should selectively and prudently manage who they trust under certain conditions, and
seek to garner the trust of key stakeholders (such as employees, customers, and alliance partners).
Trust Development
Trust development is the first phase in the trust relationship, and is
characterized by several inherent tensions. For one, both parties desire to
manage how they are being perceived. However, if the parties are too careful in managing their impressions, they might be perceived as concealing
their true nature and sabotage their own attempts to appear trustworthy.
In addition, both parties are acutely aware of their own vulnerability and
look for ways to minimize risk.28 Yet one party must risk engaging with
the other to initiate the relationship. In this section, we will explore how
organizations can work through these tensions and develop trust in both
roles (i.e., as the trustor and the trustee).
Organization as Trustor
Two key stakeholder groups with whom organizations enter into trusting relationships are employees and strategic partners. One specific case
where the organization and employees engage in trust initiation is during
the new-hire process. Organizations want to hire employees that they believe will carry out the mission of the organization. In order for organizations to rely on employees they need to see their employees as trustworthy.
Ideal candidates would be highly competent (ability), care for coworkers
and the general welfare of the organization (benevolence), and demonstrate adherence to the organizations values (integrity). Obtaining this

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information about future employees is rather difficult. Resumes and cover


letters offer initial data on ability (such as educational credentials, work
accomplishments, and skill certifications), yet are unable to depict how
applicants would behave at work on a daily basis. And although reference checks may reveal more information, many organizations have policies inhibiting the release of previous employment data. Organizations
have therefore turned to integrity tests to help cull dishonest applicants
from honest ones. Integrity tests are designed to evaluate applicants honesty, conscientiousness, dependability, and reliability. Studies have found
that these tests help predict employees likelihood of engaging in theft
and other counterproductive work behaviors.29 These tests clearly help
with initial assessments of applicants integrity. However, it is difficult for
selection tests to establish applicants benevolence since these perceptions
tend to develop over time.
Once new employees have been hired, organizations can continue to facilitate the trust-development process to ensure the trust they are extending to employees is wisely placed. In an effort to minimize risk, managers
often enact tight controls over employees to monitor and assess their actions. Overly restrictive monitoring limits the degree to which employees
can establish their trustworthiness, and even reduce their willingness to
be transparent. Although such controls may cut down on workplace inefficiencies, they may concurrently create distrust between employees and
the organization. Alternatively, firms might construct policies and procedures that boost employee trustworthiness without negative ramifications.
For instance, organizations can develop training programs that increase
employee skill sets,30 thereby raising employee ability. Additionally, ethics
training programs have been associated with enhanced employee integrity
(i.e., rejection of unethical decisions) in situations that tested ethical principles.31 These training programs serve as another filter in which the organization can evaluate and even enhance employee ability and integrity.
Strategic alliances also present the organization with critical decisions
to make in terms of whether and to what extent they should trust potential
partners. For strategic partnerships to work effectively, firms must make
decisions that mutually support the interests of both parties. This is especially difficult in the beginning of the relationship when both parties
are uncertain of how self-interested and opportunistic the other party will
be.32 Structural assurances have been identified as elements that help
establish higher levels of trust early in the relationship.33 These safeguards
include regulations, guarantees, and legal recourse. Regulations help by
assuring the trustor that there are reliable standards within and between
industries that companies obey. For example, a food wholesaler can feel
comfortable entering into a business relationship with a meat processing
plant because the plant obeys food safety codes set forth by the Food and
Drug Administration.

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Guarantees aid by reducing the amount of risk in the relationship; this


occurs when one or both of the parties have financial backing.34 For example, a bank that wants to invest with a new firm can more readily establish
an investing relationship if the new firm is backed by a guarantor. Such
security allows the bank to enter into the relationship at a faster pace and
reduced vulnerability.
Finally, legal recourse helps to initiate trust by ensuring the parties will
fulfill their responsibilities as stated in a contract. If either party breaks
the contract, the other party can take legal action to recoup the loss. In
addition to financial and legal repercussions, a breach can lead to social
consequences. For instance, an auto company that partners with a tire
manufacturer can depend on a contract that stipulates that the tire company will produce high-quality tires. If the tire company tries to cut costs
and produce tires with a rubber material that jeopardizes the safety of a
vehicle, the tire company will have to pay legal costs and risk negative reactions from the media and public at large. Because of these major costs to
the business, the auto company can rely on the tire company to uphold its
side of the contract.
Although these structural elements serve as aids for faster trust development, they do not convey trustworthiness and therefore cannot take the
place of trust. In fact, studies have found that the most successful partnerships do not rely on contracts and safeguards to reduce opportunism, but
instead depend on a trusting relationship.35 Specifically, entrepreneurial
firms that moved beyond contracts had increased confidence in their partners performance, greater ability to protect private information, more patience with adapting to necessary changes, and more resolve to not exploit
others.36
Thus, it is important for the trustor to seek out a partner that is known
for having a trustworthy reputation. The vast amount of information online can help companies easily vet firms that are recognized for having
high ability, benevolence, integrity, and transparency, as well as firms that
are notorious for having a lack of ability, benevolence, integrity, and transparency. Reports of product recalls are good indicators of a lack of ability. For instance, the 2007 recall of Fisher-Price toys appears to have been
caused by an oversight in their procedures to monitor manufacturing
partners. Although parent company Mattel apologized and rectified the
issue, Fisher-Prices reputation for producing quality toys was damaged
nonetheless.37 Lawsuits that have established the guilt of a defendant are
another signal of an untrustworthy partner. They can be indicators of failures of one or even all characteristics of trustworthiness. In the case of
Countrywide, allegations were made that the company intentionally concealed the risky nature of its deals from investors.38 The allegation that
Countrywide intentionally violated securities laws suggests the possibility of a breakdown of integrity, transparency, and benevolence. Fraudulent

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financial reporting signifies a lack of adherence to legal principles, inaccurate information, and harm to clients well-being.
Although trustors should vigilantly watch for (un)trustworthy behavior of potential partners, they should also search for indicators of transparency. Investigating the communication methods of potential partners can
glean a great deal of information. Companies should look for evidence of
transparency in communications.39 This can be done by evaluating public statements and language in product materials and internal documents
for clarity, accuracy, and disclosure. This type of inquiry can help companies make legitimate judgments of how transparent the potential partner
is likely to be.
Organization as Trustee
In the trustee role, the organization should take steps to demonstrate
trustworthiness to employees, customers, and partners. There are a few
tactics organizations can employ to help form these impressions. First,
organizations must ensure that they take steps to cultivate and communicate high ability in managing a successful enterprise. This entails both
managerial competence (making effective strategic decisions and managing relationships) and technical competence (producing high-quality
goods or services).40
Creating and enforcing structures that encourage fairness can demonstrate a companys integrity. If employees believe that the organization
has a fair performance management system (where employees are evaluated and rewarded on the basis of job-relevant criteria in a manner that ensures accuracy, consistency, and the suppression of bias), they will be more
likely to view the company as adhering to a set of admirable principles.
Investment in employee training programs is a strategy that organizations can employ to increase perceptions of benevolence. Specific policies such as tuition reimbursement illustrate that the company is willing
to devote its financial resources to advance employees knowledge and
improve their careers. Employees may interpret this investment as a sign
that the company cares about their personal development. This attribution is especially important because it can serve as a foundation for the development of positive emotional bonds between employees and the firm.
When employees feel as though they are being cared for they will likely
produce positive feelings toward the organization. To the extent that this
leads employees to feel a sense of identification with the organization (as
one that shares the same values and contributes to a mutually rewarding
relationship), a strong emotional attachment to the organization might be
formed.
When developing trust with strategic partners, the trustee has the responsibility of gaining the partners trust. Organizations can begin to do

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this by proactively communicating, taking measures to ensure equity,


and allowing for adaptation.41 Communication can serve two purposes in
trust building. First, it helps form a shared understanding of common values, which is a critical aspect of trust.42 Shared values help organizations
predict the other partys behaviors, which is important in minimizing risk.
Second, communication is essential in forming perceptions of transparency. A key aspect of transparency is disclosure. In order for both firms
to have an understanding of the others position, business dealings and
strategy, both firms need to disclose. It is especially important in the beginning of the relationship for the trustee to disclose information as that
will establish precedent for future information exchange.
Organizations in the trustee role can also ensure fairness in their relationships with partner firms, in order to convey their integrity. For example, they should work to increase perceptions of equity, which is a
crucial aspect of interfirm cooperation.43 Broadly speaking, equity refers
to a belief that the amount of outcomes should be commensurate with
the amount of inputs.44 Inequity between firms is associated with higher
levels of suspicion, which results in partner distrust.45 In addition, using
fair procedures to determine outcomes leads to greater cooperation46 and
profitability,47 as well as deeper commitments.48 It is important that the
trustee displays acts of fairness in the beginning of the relationship when
initial judgments are formed and when practices are instituted. In certain
situations, fair procedures may also indicate perceptions of transparency
and benevolence. Take for example a company that explicitly communicates how the distribution of profits will match invested resources. In this
example the outcome is commensurate with the inputs (integrity), there is
advance disclosure of information regarding a transaction (transparency),
and there is evidence that the trustee cares about the trustors interests by
rewarding their contributions (benevolence).
Trust development plays a critical role in effective relationships. During
this phase, the organization should take specific steps to help form positive experiences with stakeholder groups. As the trustor, the organization
should look for employees with integrity and create structures that increase their trustworthiness. Organizations should also select partners in
strategic alliances with trustworthy reputations and take steps to reduce
risk. In the trustee role, the organization has the responsibility of demonstrating trustworthy characteristics and transparency to employees and
potential partners. This can be done through the development of training
programs and increasing communication and fairness with partners.
Trust Maintenance
As previously outlined, the decision of a trustor to extend trust to a
certain trustee is largely dependent on the perceived risks associated with

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that decision.49 The decision to reciprocate an act of trust, however, is more


dependent on the benefits received by the trustee from prior acts of trust
in the relationship.50 The important takeaway is that organizations and
employees continuously analyze and estimate the benefits and costs of
maintaining trust with other parties. Organizations failing to proactively
manage trusting relationships might find once-hardened loyalties fraying
over time. In the following paragraphs, we outline a number of pragmatic
approaches to maintain trust from the perspective of the organization as
trustor and trustee.
Organization as Trustor
As we reviewed earlier, trust is granted mostly on the basis of the trustworthiness the trustor perceives in the trustee. Accordingly, organizations
should systematically evaluate the ability, benevolence, and integrity of
employees and potential partners over time to ensure trust is being wisely
granted. One consideration in this regard is to examine the type of contracts they use, as these can impact both perceived and actual trustworthiness of a potential trustee. For instance, studies have found that explicitly
defined contracts led parties to rely on the contract to monitor and dictate their partners behavior. As a result, trustors were less likely to attribute contract compliance to their partners trustworthiness, which in turn
led to strained trust development and reductions in pre-established trust.
However, in cases where parties relied on informally defined contracts,
trustworthiness could be more readily attributed, and there were higher
levels of trust. In these cases parties continued to look for behavioral indicators to guide their decision to continue to trust.51
Building on this idea, it is important that organizations that want to
maintain trust in their partners look for evidence of their partners transparency. Organizations need to be able to observe a degree of forthrightness in the communications received from stakeholders to appropriately
measure ability, benevolence, and integrity. As we mentioned earlier,
transparency can strengthen assessments of trustworthiness. The relationship between transparency and ability is evident in service work. For example, transparency can assist purchasers in making informed decisions
about the value of the services being offered based on clear assessments of
the sellers ability. Transparent communication from the trustee can also
facilitate the evaluation of benevolence and integrity. For instance, both
benevolence and integrity are signaled when a seller discloses material
information about a product defect to a buyer without being asked to do
so (insofar as this communicates concern for the trustors welfare at the
expense of the trustee, and it is an honest and fair thing to do). By being
able to more accurately evaluate the ability, benevolence, and integrity of
trustees, trustors are more capable of placing trust prudently.

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Organization as Trustee
Trustees are generally regarded to bear the primary obligation to maintain trust in a relationship. Organizations can employ a number of tactics
to develop trusting relationships through the demonstration of trustworthiness. The three tactics we describe here are signaling, follow-through,
and adaptation. Signaling occurs when firms indicate the trustworthiness
of the organization to partners and other stakeholders. Follow-through
is a means to validate trust after an organization is engaged in a contract
with its partners. Adaptation refers to making necessary shifts when problems arise to ensure partnership interests are accounted for. The following
paragraphs describe these tactics in turn.
Organizations can signal trustworthiness to stakeholders through warranties, disclaimers, and other performance-related assurances. The objectives of contractual assurances are to signal to customers and other
stakeholders the trustworthiness of the organization, primarily in terms
of their ability. The short-term objectives of such signals are to guarantee
the worth of organizational products and services. In the long term, the
organization is attempting to satisfy stakeholder demands in an effort to
generate an ongoing relationship with the stakeholder.
Although such assurances might generate enough goodwill to allow
two parties to come to terms around an exchange, the importance of followthrough is tantamount. Consider the example of a mail-in rebate. Offering
customers a mail-in rebate on a given product will likely increase sales.
However, it is vital for the organization to follow through as promised
in honoring the rebate in order to sustain trusting customers. Honoring
the agreement demonstrates to trustors that the firm has both the ability (i.e., competence to manage such a financial transaction) and integrity (i.e., willingness to uphold their end of the bargain as promised) to
follow-through.
Finally, adaptation refers to the trustees willingness to accommodate
the partner.52 Relationships often entail the need to be flexible to adapt to
changes that occur in an organization or in the environment. For instance,
an employee may be facing particularly acute demands outside of work
(e.g., spouse with a severe illness, etc.) that might elicit accommodation on
the part of the organization. Specifically, the organization can take steps
to enhance their trustworthiness from the employees perspective by offering assistance (such as referral to Employee Assistance Program [EAP]
resources, granting a leave, modifying the work schedule, reallocating
some work responsibilities) during this difficult time. Although adaptation is important during the entire trust relationship, it is central during
the maintenance phase of trust management. By demonstrating that the
organization cares about the interests of its stakeholders, adaptation indicates benevolence.

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The importance of maintaining trust is often taken for granted in ongoing relationships. Taking specific actions to manage trust can help organizations develop deep and lasting relationships with stakeholder groups.
As the trustor, organizations should look for evidence of their partners
commitment to being trustworthy. Indicators can be found in the extent
of their transparency in communications, although these perceptions are
also affected by the type of contracts employed. As the trustee, organizations should utilize signaling, follow-through, and adaptation to maintain
the perception that they are trustworthy.
Trust Repair
Although there are many tools to help organizations maintain trusting relationships, it is inevitable that at some point trust will be broken.
As the trustor, an organization may be harmed by another party and will
need to investigate whether or not to reestablish trust. On the other hand,
an organization may have violated another partys trust and undermined
its own trustworthiness. In the following section, we discuss how trustors and trustees can manage the aftermath of a violation. Specifically, we
examine how a trustor can evaluate a trustees behavior after a negative
outcome in a trusting relationship, and how a trustee can reestablish perceptions of trustworthiness after a violation.
Organization as Trustor
Organizations often deal with instances where their willingness to be
vulnerable leads to negative outcomes. As just one common example, employees are often trusted with money, property, and sensitive data belonging to the organization, yet recent studies suggest that the annual loss in
the United States due to employee theft stands at $994 billion.53 Somewhat
ironically, trust creates the potential to enable the very harm one seeks to
avoid:54 the willingness to be vulnerable to certain risks in a relationship
indicates the possibility that confident positive expectations will not be
fulfilled. An attribution analysis is central to understanding how an organization should proceed when such negative outcomes occur.55 After
a negative outcome in a trusting relationship, should the organization
partially or completely restore their willingness to be vulnerable to the
trustee again, or should they take other steps (sever the relationship, proceed under more guarded terms)?
Our analysis indicates that trust in another is largely a matter of assessing that partys trustworthiness, and the ease of that assessment increases
in proportion to that partys transparency. To the extent that the other
party is perceived to provide clarity, disclosure, and accuracy in regard
to the negative outcome, this enables a more accurate trustworthiness

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evaluation. Lower transparency calls for more careful and thorough


scrutiny, and might even call into question one or more trustworthiness
dimensions.
At any rate, when the result of the organizations trust is a negative outcome, the first order of business is to determine that outcomes cause. The
suspected cause might be the trustees ability, benevolence, or integrity, or
some other cause (e.g., some other entity or situational factor).56 Although
there may be an automatic tendency to regard the trustee as culpable,
there should be a data-driven process to determine whether or not the
cause actually implicates the trustee. The possibility of some other cause
leading to a negative outcome in a trusting relationship recognizes that
in some cases, the trustee is not to blame and therefore trustworthiness
should not be impugned and subsequent trust should not be withheld.
If the cause of the negative outcome is determined to stem from the
trustee, the next step is to determine if this negative outcome is due to
deficiencies in ability, benevolence, or integrity.57 At this point, a negative outcome in a trusting relationship can be properly labeled as a trust
violation. The perceived cause (ability, benevolence, or integrity) is then
evaluated in terms of controllability and stability.58 The degree of controllability should be considered because even though a cause may be related
to a trustee, the trustee might have little or no control over the outcome.
To the extent that this is the case, it mitigates the damage to the trustees
trustworthiness, as well as the degree to which subsequent trust should
be withheld. Stability refers to whether the cause is due to permanent and
unchanging causes, or to more temporary and fluctuating causes. Stability is especially crucial to understand in the context of trust repair since it
is the primary driver of future expectations. A negative outcome due to a
permanent cause leads one to expect the same result in future situations,
so subsequent trust should be withheld. Isolated incidents caused by temporary or changing circumstances indicate relatively stronger prospects
for repair.
If the cause of the trust violation is deemed to be some shortcoming in
ability, it should be noted that some forms of ability are not under volitional
control (e.g., general cognitive ability, physical coordination59), whereas
others are (e.g., skills and competencies that can be developed over time).
Similarly, aspects of ability such as general cognitive ability or aptitude are
highly stable over time, whereas skills and competencies are relatively less
stable insofar as they can be developed over time through training. Therefore, more controllable and more stable ability deficiencies should result
in a greater reduction in subsequent trust. That said, negative outcomes
due to highly uncontrollable yet highly stable forms of ability (e.g., general
cognitive ability) call for organizations to review the adequacy of their selection systems. For example, hiring an accountant with low quantitative
aptitude indicates a problem with the selection process.

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If the cause of the trust violation is perceived to be a deficiency in benevolence, this indicates controllable behavior on the part of the trustee.
That is, benevolence is a quality that the trustee can consciously and intentionally affect by engaging in behaviors helpful to or protective of the
trustor.60 Furthermore, once perceptions of low benevolence are formed,
these beliefs tend to be relatively stable.61 However, if the organization
finds evidence that an episode of low benevolence is an anomaly in an
otherwise well-developed relationship characterized by a vast number of
interactions where high benevolence had been established, subsequent
trust might be repaired (especially if the trustee offers some credible form
of repentance or change of heart). This is because under these circumstances, episodes of low benevolence are less stable.
If the cause of the trust violation indicates a lack of integrity (i.e., the
trustee is not enacting espoused values that the trustor finds acceptable),
this is regarded as highly controllable. Individuals choose the principles
they endorse and the level to which they adhere to them. Furthermore, integrity violations tend to be regarded as highly stable over time, such that
a trustee found to be dishonest on one occasion is more likely to be seen as
dishonest in general.62 Compared to ability and benevolence, integrity is
likely to be viewed as the most stable trustworthiness factor.63 Moreover,
since stability is the key driver of future expectations, and low integrity
may be seen as more stable than low ability or low benevolence, it is likely
to be the most resistant to repair. Our attribution analysis suggests that
organizations should be reluctant to extend subsequent trust to one who
has committed an integrity violation. Rather, organizations should ensure
that those they trust share the organizations values and principles, and
that they personally adhere to those values and principles.
Organization as Trustee
The surge of recent research on trust repair is not surprising given the
economic climate today.64 With the increased use of technology, information about organizations is more accessible. This means that more people
can investigate whether organizations are acting in a trustworthy manner.
Additionally, technology gives a platform to employees and stakeholder
groups to report on unwholesome actions made by organizations. The current environment has also brought changes in employment arrangements.
The traditionally loyal relationships that employees expected from their
organizations have dissipated due to mass layoffs, contractual structures,
and outsourcing. These recent changes in technology and our economy
have increased the possibility that organizations will be seen as having
violated the trust of employees and other stakeholder groups. Thus, it is
vital for organizations to understand how to repair their image of trustworthiness so they can resume the benefits of trusting relationships.

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Apologies have been acknowledged as a primary and essential aspect


in trust repair. Apologies convey both responsibility and regret by the offender,65 and often indicate that the transgression will not recur.66 Studies
have shown that sincere apologies inhibit aggression and help reconcile
relationships.67 Although executives may be reluctant to admit wrongdoing, studies have shown that reticent responses are less effective than sincere apologies.68
When an organization makes an extensive apology, it is a signal to
stakeholders that it intends to make amends and alter future behavior.69
Promises made in extensive apologies often provide explicit assurances
that the offender will take specific actions to rectify the problem. Such
amends help to ensure trustors of future trustworthiness through ability
and integrity. This often entails an investigation followed by tangible punishments, such as replacing the executives who were responsible for the
transgression.70 Alternatively, companies may promise to make process
improvements (which raise the quality of their goods or services and prevent mistakes from recurring). In either case, this should enhance subsequent perceptions of ability. Moreover, when the organization follows
through on promises of subsequent trustworthiness made in the apology,
stakeholders will see the organizations actions aligning with their words
(an indicator of integrity). As we previously mentioned, perceptions of integrity are resistant to change, and so it is highly important that the organization be diligent on following through with the promises made in the
apology. Neglecting to follow through will only serve to deepen the impressions of low integrity.71
Apologies may also convey benevolence by expressing concern for
those that were harmed by the violation.72 Organizations can do this by
explicitly stating how they will compensate the victims and expressing
remorse for their actions. Evidence of the trustees remorse and actions to
help restore the wrongdoing through payment or other means will likely
elicit positive feelings by the victims toward the trustee.
Timeliness is also an important aspect of trust repair. Although it is
important to take swift corrective action immediately following a trust
violation, organizations are often unaware of the source of the problem.
Because of this, early apologies are often scant and vague in their assessment of the issue. In order to properly restore trust, organizations should
be careful to be transparent regarding the issue. Transparent communication should clearly disclose how the error occurred, the actions the
company took to rectify the problem, and what preventative measures
the company will take in the future. Organizations should make sure that
these accounts clearly and accurately describe the cause of and response
to negative events.
There are a number of recent examples that showcase how organizations tried to restore trust after a violation. Most recently, the oil spill in

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141

Louisiana by British Petroleum provides an example of a mismanaged


trust repair attempt. In late April 2010, millions of gallons gushed into
the Gulf of Mexico and resulted in major damages to the economy and
environment in that region. British Petroleum CEO Tony Hayward made
a formal apology in June at a congressional hearing stating that We are
doing everything we can to contain oil . . . [and] pay all necessary cleanup
costs. I give my pledge we will not rest until we make this right.73 Although this statement may have been intended to enhance the perception of his benevolence by showing his concern for the people who were
harmed, most people did not believe the statement. This disbelief may
have been due to perceptions of low integrity and ability, formed when
the oil company issued inaccurate reports underestimating the amount of
oil that was spilled.74
Mattel is another company that issued recent apologies due to defective
and harmful products. As we outlined previously, Mattel issued a product
recall in 2007 when lead paint was found to in its toys. Mattel CEO Robert
Eckert responded by saying, We apologize to everyone affected by this
recall, especially those who bought the toys in question . . . Our goal is to
correct this problem, improve our systems and maintain the trust of the
families that have allowed us to be part of their lives by acting responsibly and quickly to address their concerns. This apology strives to convey benevolence for the customers who were affected by the purchases.
It also asserts that the company intended to correct the problem, thereby
promising to restore ability and integrity. Mattel reportedly responded to
300 inquiries by the media in the week that they became aware of the
problem and issued a recall.75 Their response illustrated their commitment
to disclosing information in a timely manner in order to rebuild a sense of
trust with its customers.
Organizations also have a responsibility to rebuild trust with employees after a violation. Downsizings76 and threats of downsizing have been
shown to result in lowered trust among employees.77 This occurs because
of a breach in the psychological contract, which is a tacit understanding
between employees and organizations that good work and commitment
by the employee will be rewarded in the future.78 When a company lays
off talented and loyal employees, it shows a lack of integrity and benevolence. Although employees are upholding their part of the psychological contract, the organization is not. In this situation, companies need
to be transparent with their employees as to the extent and duration of
the downsizing, and whether there will be future layoffs. Organizations
should also be sure to use fair procedures during layoffs in order to preserve the survivors perception of integrity to the furthest extent possible.79
This last section illustrates how organizations can repair relationships
once trust has been violated. We show how organizations can assess the
trustworthiness of trustees in the wake of a negative outcome in a trusting

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relationship, with implications for the degree to which subsequent trust


should be extended. Finally, we examine how organizations as trustees
can use apologies and corrective actions to help reestablish perceptions of
trustworthiness after a trust violation.
CONCLUSION
As we have shown in this chapter, trust is vital for effective relationships, yet challenging for organizations to manage. Therefore, we have
drawn from academic research to provide a practical guide for organizations seeking to establish, maintain, and repair trust in their relationships
with stakeholders in both trustor and trustee roles.

NOTES
1. Jason A. Colquitt, Brent A. Scott, and Jeffrey A. LePine, Trust, Trustworthiness, and Trust Propensity: A Meta-Analytic Test of Their Unique Relationships with Risk Taking and Job Performance, Journal of Applied Psychology 92
( July 2007): 909927. James H. Davis, F. David Schoorman, Roger C. Mayer, and
Hoon Tan Hwee, The Trusted General Manager and Business Unit Performance:
Evidence of a Competitive Advantage, Strategic Management Journal 21 (May
2000): 563576. Kurt T. Dirks and Donald L. Ferrin, Trust in Leadership: MetaAnalytic Findings and Implications for Research and Practice, Journal of Applied
Psychology 87 (August 2002): 611628. Roy J. Lewicki, Edward C. Tomlinson, and
Nicole Gillespie, Models of Interpersonal Trust Development: Theoretical Approaches, Empirical Evidence, and Future Directions, Journal of Management 32
(December 2006): 9911022. Tony L. Simons and Randall S. Peterson, Task Conflict and Relationship Conflict in Top Management Teams: The Pivotal Role of Intragroup Trust, Journal of Applied Psychology 85 (February 2000): 102111.
2. Peter M. Blau, Exchange and Power in Social Life (New York: Wiley, 1964).
3. J. David Lewis and Andrew Weigert, Trust as a Social Reality, Social Forces
63 ( June 1985): 967985.
4. Jay B. Barney and Mark H. Hansen, Trustworthiness as a Source of Competitive Advantage, Strategic Management Journal 15 (Winter 1994): 175190.
5. Sandra L. Robinson and Denise M. Rousseau, Violating the Psychological
Contract: Not the Exception but the Norm, Journal of Organizational Behavior 15
(May 1994): 245259.
6. Edelman, Trust Barometer 2009 Survey. Watson Wyatt, WorkUSA 2007 Survey.
7. Morton Deutsch, Trust and Suspicion, Journal of Conflict Resolution 2 (1958):
265279.
8. Peter Smith Ring and Andrew H. Van de Ven, Structuring Cooperative
Relationships between Organizations, Strategic Management Journal 13 (October
1992): 483498.
9. Denise M. Rousseau, Sim B. Sitkin, Ronald S. Burt, and Colin Camerer, Not
so Different After All: A Cross-Discipline View of Trust, Academy of Management
Review 23 ( July 1998), 395.

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10. Roger C. Mayer, James H. Davis, and F. David Schoorman, An Integrative Model of Organizational Trust, Academy of Management Review 20 ( July 1995):
709734.
11. Herbert W. Kee and Robert E. Knox, Conceptual and Methodological Considerations in the Study of Trust and Suspicion, Journal of Conflict Resolution 14
(September 1970): 357366.
12. Mayer, Davis, and Schoorman, An Integrative Model of Organizational
Trust.
13. Ibid., 717.
14. Edward C. Tomlinson and Roger C. Mayer, The Role of Causal Attribution
Dimensions in Trust Repair, Academy of Management Review 34 ( January 2009):
85104.
15. Mayer, Davis, and Schoorman, An Integrative Model of Organizational
Trust, 718.
16. Tomlinson and Mayer, The Role of Causal Attribution Dimensions in Trust
Repair.
17. Roy J. Lewicki and Barbara Benedict Bunker, Developing and Maintaining Trust in Work Relationships, in Roderick M. Kramer and Tom R. Tyler (Eds),
Trust in Organizations: Frontiers of Theory and Research (Thousand Oaks, CA: Sage,
1996): 114139.
18. Roderick M. Kramer, Stalking the Sinister Attribution Error: Paranoia inside the Lab and Out, Research on Negotiation in Organizations 7 (1999): 5991.
19. A. R. Elangovan, Werner Auer-rizzi, and Erna Szabo, Why Dont I Trust
You Now? An Attributional Approach to Erosion of Trust, Journal of Managerial
Psychology 22 (2007): 424.
20. Mayer, Davis, and Schoorman, An Integrative Model of Organizational Trust, 719.
21. Tomlinson and Mayer, The Role of Causal Attribution Dimensions in Trust
Repair.
22. Peter H. Kim, Donald L. Ferrin, Cecily D. Cooper, and Kurt T. Dirks, Removing the Shadow of Suspicion: The Effects of Apology Versus Denial for Repairing Competence- Versus Integrity-Based Trust Violations, Journal of Applied
Psychology 89 (February 2004): 104118.
23. S. Patel, A. Balic, and L. Bwakira, 2002. Measuring Transparency and Disclosure at Firm-level in Emerging Markets. Emerging Markets Review, 4: 32537.
24. R. Bushman, J. Piotroski, and A. Smith, 2004. What Determines Corporate
Transparency? Journal of Accounting Research, 2: 207252. N. Granados, A. Gupta,
and R. Kauffman, 2006. The Impact of IT on Market Information and Transparency: A Unified Theoretical Framework. Journal of the Association for Information
Systems 7(3): 148178.
25. Michael Pirson and Deepak Malhotra, Foundations of Organizational
Trust: What Matters to Different Stakeholders? Organization Science, published
online October 22, 2010.
26. Lewicki and Bunker, Developing and Maintaining Trust in Work Relationships.
27. Ibid.
28. E. M. Whitener et al., Managers as Initiators of Trust: An Exchange Relationship Framework for Understanding Managerial Trustworthy Behavior, Academy of Management Review 23, no. 3 (1998).

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29. P. R. Sackett and J. E. Wanek, New Developments in the Use of Measures


of Honesty, Integrity, Conscientiousness, Dependability, Trustworthiness, and Reliability for Personnel Selection, Personnel Psychology 49, no. 4 (1996).
30. Whitener et al., Managers as Initiators of Trust: An Exchange Relationship
Framework for Understanding Managerial Trustworthy Behavior.
31. John Thomas Delaney and Donna Sockell, Do Company Ethics Training
Programs Make a Difference? An Empirical Analysis, Journal of Business Ethics 11,
no. 9 (1992).
32. T. K. Das and B. S. Teng, Between Trust and Control: Developing Confidence in Partner Cooperation in Alliances, Academy of Management Review 23,
no. 3 (1998).
33. D. H. McKnight, L. L. Cummings, and N. L. Chervany, Initial Trust Formation in New Organizational Relationships, Academy of Management Review 23,
no. 3 (1998).
34. Ibid.
35. A. Larson, Partner NetworksLeveraging External Ties to Improve Entrepreneurial Performance, Journal of Business Venturing 6, no. 3 (1991).
36. Ibid.
37. CEO apologizes for Fisher-Price recall, August 2, 2007, USAToday.com. Retrieved from http://www.usatoday.com/money/industries/retail/20070801toy-recall_N.htm
38. A. Zibel, Countrywide Settlement: $600 Million to Settle Lawsuits Over
Subprime Loans, August 3, 2010, Huffingtonpost.com. Retrieved http://www.
huffingtonpost.com/2010/08/03/countrywide-settlement_n_668429.html.
39. Larson, Partner NetworksLeveraging External Ties to Improve Entrepreneurial Performance.
40. Pirson and Malhotra, Foundations of Organizational Trust: What Matters
to Different Stakeholders?
41. Das and Teng, Between Trust and Control: Developing Confidence in Partner Cooperation in Alliances.
42. G. R. Jones and J. M. George, The Experience and Evolution of Trust: Implications for Cooperation and Teamwork, Academy of Management Review 23, no.
3 (1998).
43. P. S. Ring and A. H. Van de Ven, Developmental Processes of Cooperative Interorganizational Relationships, Academy of Management Review 19, no. 1
(1994).
44. J. S. Adams, ed. Inequity in Social Exchange, Advances in Experimental Social
Psychology (New York: Academic Press, 1965).
45. S. D. Jap, Pie Sharing In Complex Collaboration Contexts, Journal of
Marketing Research 38, no. 1 (2001).
46. Z. Zhang and M. Jia, Procedural Fairness and Cooperation in PublicPrivate Partnerships in China, Journal of Managerial Psychology 25, no. 5 (2010).
47. Y. D. Luo, Procedural Fairness and Interfirm Cooperation in Strategic Alliances, Strategic Management Journal 29, no. 1 (2008).
48. J. P. Johnson, M. A. Korsgaard, and H. J. Sapienza, Perceived Fairness,
Decision Control, and Commitment in International Joint Venture Management
Teams, Strategic Management Journal 23, no. 12 (2002).
49. Rousseau, Sitkin, Burt, and Camerer, Not So Different After All.

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145

50. Deepak Malhotra, Trust and Reciprocity Decisions: The Differing Perspectives of Trustors and Trusted Parties, Organizational Behavior and Human Decision
Processes 94 ( July 2004): 6173.
51. Deepak Malhotra and J. Keith Murnighan, The Effects of Contracts on Interpersonal Trust, Administrative Science Quarterly 47 (September 2002): 534559.
52. Das and Teng, Between Trust and Control: Developing Confidence in Partner Cooperation in Alliances.
53. Report to the nation on occupational fraud and abuse (Austin, TX: Association of
Certified Fraud Examiners, 2008).
54. Edward C. Tomlinson, The Role of Trust in Employee Theft. In Ronald J.
Burke, Edward C. Tomlinson, and Cary Cooper (Eds.), Crime and Corruption in Organizations: Why it Happens and What to do about It (Ashgate: Gower, 2010).
55. Tomlinson and Mayer, The Role of Causal Attribution Dimensions in Trust
Repair.
56. Ibid.
57. Ibid.
58. Bernard Weiner, An Attributional Model of Motivation and Emotion (New
York: Springer-Verlag, 1986).
59. Ibid.
60. Tomlinson and Mayer, The Role of Causal Attribution Dimensions in Trust
Repair, 93.
61. Kramer, Stalking the Sinister Attribution Error: Paranoia inside the Lab
and Out.
62. Kim, Ferrin, Cooper, and Dirks, Removing the Shadow of Suspicion: The
Effects of Apology Versus Denial for Repairing Competence- Versus IntegrityBased Trust Violations.
63. Tomlinson and Mayer, The Role of Causal Attribution Dimensions in Trust
Repair.
64. K. T. Dirks, R. J. Lewicki, and A. Zaheer, Repairing Relationships within
and between Organizations: Building a Conceptual Foundation, Academy of Management Review 34, no. 1 (2009).
65. P. H. Kim, K. T. Dirks, and C. D. Cooper, The Repair of Trust: A Dynamic
Bilateral Perspective and Multilevel Conceptualization, Academy of Management
Review 34, no. 3 (2009).
66. H. Ren and B. Gray, Repairing Relationship Conflict: How Violation Types
and Culture Influence the Effectiveness of Restoration Rituals, Academy of Management Review 34, no. 1 (2009).
67. K. Ohbuchi, M. Kameda, and N. Agarie, Apology as Aggression Control
Its Role in Mediating Appraisal of and Response to Harm, Journal of Personality
and Social Psychology 56, no. 2 (1989).
68. D. L. Ferrin et al., Silence Speaks Volumes: The Effectiveness of Reticence in Comparison to Apology and Denial for Responding to Integrity- and
Competence-Based Trust Violations, Journal of Applied Psychology 92, no. 4 (2007).
69. M. E. Schweitzer, J. C. Hershey, and E. T. Bradlow, Promises and Lies: Restoring Violated Trust, Organizational Behavior and Human Decision Processes 101,
no. 1 (2006).
70. N. Gillespie and G. Dietz, Trust Repair after an Organization-Level Failure, Academy of Management Review 34, no. 1 (2009).

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71. E. C. Tomlinson, B. R. Dineen, and R. J. Lewicki, The Road to Reconciliation: Antecedents of Victim Willingness to Reconcile Following a Broken Promise, Journal of Management 30, no. 2 (2004).
72. Ren and Gray, Repairing Relationship Conflict: How Violation Types and
Culture Influence the Effectiveness of Restoration Rituals.
73. R. Simon and M. Muskal, Gulf Oil Spill: BPs Tony Hayward Apologizes,
June 17, 2010, Los Angeles Times. Retrieved from http://latimesblogs.latimes.com/
greenspace/2010/06/gulf-oil-spill-bps-hayward-apologizes.html.
74. R. Schoof, Review validates early report on where spilled BP oil went,
Nov ember 23, 2010, McClatchyDC.com. Retrieved from http://www.mccla
tchydc.com/2010/11/23/104217/review-validates-early-report.html.
75. A. Goldman and E. Reckard, August 8, 2007, LA Times. Retrieved from
http://www.latimes.com/business/printedition/la-fi-pr18aug18,0,3471349.
story?page=1&coll=la-headlines-pe-business.
76. A. K. Mishra and G. M. Spreitzer, Explaining How Survivors Respond to
Downsizing: The Roles of Trust, Empowerment, Justice, and Work Redesign,
Academy of Management Review 23, no. 3 (1998).
77. S. J. Ashford, C. Lee, and P. Bobko, Content, Cause, and Consequences of
Job Insecurity: A Theory Based Measure and Substantive Test, Academy of Management Journal 32 (1989).
78. S. L. Robinson and D. M. Rousseau, Violating the Psychological Contract
Not the Exception but the Norm, Journal of Organizational Behavior 15, no. 3 (1994).
79. J. Brockner, J. Davy, and C. Carter, Layoffs, Self-Esteem, and Survivor
GuiltMotivational, Affective, and Attitudinal Consequences, Organizational Behavior and Human Decision Processes 36, no. 2 (1985).

Chapter 8

Hypercompetition in
the 21st Century: A Look
Back and a Look Forward
Robert R. Wiggins and
Frances H. Fabian

INTRODUCTION
The term hypercompetition (sometimes hyper-competition), meaning very intense levels of competition, had appeared in sociology and
economic journals1 prior to the 1990s, but its use in the title of Richard
DAvenis 1994 book, Hypercompetition: Managing the Dynamics of Strategic
Maneuvering,2 made it part of the management lexicon. As a professor at
a top business school, the Tuck School of Business at Dartmouth College,
DAveni, had observed a business environment that seemed far more dynamic than the world described and predicted by the leading theories in
the field of strategic management, many of which were built on the foundation that had been laid at the Harvard Business School by Professor
Michael Porter and others.3
DAveni argued that Porters theories and prescriptions for managers
were based on ideas formed in, and using data from, the 1950s, 1960s, and
1970s, when the pace of change in technology and business was relatively

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sedate. The accelerating pace of change in the 1980s and 1990s (and presumably beyond) made these theories and prescriptions increasingly irrelevant, therefore making the need for new theories and prescriptions
increasingly urgent. DAveni also argued that Porters models, as well as
many other models being taught in business schools, were often static,
taking a snapshot of what is and what was, when what was needed were
dynamic models that could incorporate rapid changes in what could be
and what would be. In addition, Porters models were developed based
on data from manufacturing industries, making them less useful when
examining service industries, as any MBA student who has tried will
vouch for.
Hypercompetition today stands as a unique touch point for understanding a deeper self-assessment of global competition that is currently
roiling countries and economies. Since the 1994 publication of DAvenis
book, business schools and scholars have argued about the existence, pervasiveness, and importance of hypercompetition. The benefits of hypercompetition may arguably include the amazing productivity gains in all
business and supply chain management in the last two decades. Not only
do consumers live with an array of products recently unthinkable, but the
access to markets, products, and most importantly, information, through
the Internet have made domestic barriers unworkable.
But when new firms jump into the reality of hypercompetition by ceaselessly pushing the cost/quality frontier, they also leave behind the ravages
of costlier or more inefficient competitors. Unfortunately, it seems that
the ability to recuperate from such devastation at a community level has
not accordingly kept pace. This lag is even more concerning when such
wreckage has been unequally spread across countries, for example, raising the profile of BRIC (Brazil, Russia, India, China) countries and devastating manufacturing towns in the United States. As we will argue later,
hypercompetition may be spawning nostalgia for more secure or genteel systems, whether or not the belief in such possibilities is economically warranted. In the end, we believe that hypercompetition is likely a
permanent feature of the competitive landscape. Increasing our understanding of its mechanics by incorporating it more explicitly in the business curriculum is not as much as an endorsement as an acknowledgment
of the new global landscape.
In the following sections, we will review the past and current state of
the discussions and arguments concerning hypercompetition (A Look
Back). We will then discuss DAvenis four arenas analysis and its applications and implications for management education (Interlude: Four
Arenas Analysis). We conclude with some suggested extensions for each
of the arenas (cost quality, timing/know-how, strongholds, and deep
pockets) and with an overall observation on how hypercompetition is emblematic of a larger reassessment occurring about the nature of economic

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systems and its impact on nations as we move further into the 21st century
(A Look Forward).
A LOOK BACK
In this section, we will look back at the state of the field of strategic
management from practical, theoretical, and educational perspectives and
discuss the disruptions to these perspectives wrought by the introduction
of the idea of hypercompetition as professed by DAveni and others. We
will start with a discussion of sustained competitive advantage (SCA) and
its centrality to strategic management paradigms, then move on to the disruption to the field of strategic management caused by the introduction of
hypercompetition to the mix, and end with a brief discussion of the age of
temporary advantage.
Sustained Competitive Advantage
For most of the latter half of the 20th century, the fields of business policy
and its successor strategic management were dominated by the thinking
of the Harvard Business School and particularly the concept of competitive advantage4 popularized by Harvard professor Michael Porter5 in the
late 1970s and early 1980s. Competitive advantage was extended and expanded by Porter and others into the notion of SCA.6 The central tenet
is that some competitive advantages are significantly difficult for other
firms to imitate and hence potentially can be sustained for long periods
of time, which in turn leads to long-term profitability (at the expense of
the competition) for the firm with the SCA. The centrality of SCA to both
the teaching and research of strategic management is difficult to overstate.
The Harvard paradigm, based on structure-conduct-performance industrial organization (SCPIO) economics, which incorporates SCA through
Porters influence, was the primary research paradigm for decades and
is still prominently featured in almost all textbooks used to teach MBA
students around the world in the 21st century, including the textbooks
for other fields such as marketing and management information systems.
The centrality of SCA grew even stronger when many strategic management scholars embraced the resource-based view (RBV) of the firm7 in
a reaction against SCPIO. Specifically, SCPIO focused most of the attention
of managers on the environment external to the firm, arguing that external
factors constrained managers choices and essentially determined what
strategies would be possible and which would be successful. The model
was to examine the external environment using analytical techniques such
as Porters five forces to identify attractive industries with the potential
for sustainable competitive advantages and to choose to compete there; in
short, let the external environment determine your strategy.

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RBV offered a clear alternative to this idea by introducing the concept


that it is a firms stock of resources, particularly specialized resources that
are valuable, rare, imperfectly imitable, and nonsubstitutable,8 that determines what strategies could be possible and which could be successful. In
other words, SCPIO was focused almost exclusively externally, whereas
RBV was focused almost exclusively internally. What united the two
schools of thought was the concept of SCA. In SCPIO it was an outcome
based on external forces such as industry structure, whereas in RBV it became the very reason for a firms existence.9 RBV quickly gained traction
and adherents, and became integrated into strategic management textbooks, supplementing Porters more simplistic attempt at internal analysis, the value chain,10 with the richer analysis of resources, capabilities,
and core competencies.
The Disruption of Hypercompetition
Given the presence of SCA at the core of the two primary theories of
strategic management, it should come as no surprise that the reaction to
DAvenis 1994 book11 was not nearly as positive in the academic community as it was among working managers. One of DAvenis fundamental
arguments about the effects of hypercompetition was that it makes sustaining competitive advantages increasingly difficult, if not impossible.
Therefore, firms and managers needed to be more adaptable and learn to
both disrupt other firms advantages and also to concatenate shorter-term
competitive advantages of their own together if they wanted to maintain
higher levels of profits and economic performance over time. Proponents
of SCA disagreed, such as Porter who said in many industries, however,
what some call hypercompetition is a self-inflicted wound, not the inevitable outcome of a changing paradigm of competition12 and went on
to argue that it is likely limited to only some firms in high-technology
industries.
Shortly after publication of his book, DAveni served as a guest editor at
Organization Science, a well-respected management scholarly journal, for
two special issues that focused on new organizational forms and strategies for managing in hypercompetitive environments.13 The lead article
in the first issue was a large-scale empirical study by Thomas,14 who found
evidence of a hypercompetitive shift in 200 manufacturing industries
during the period from 1958 to 1991 (this was expanded in a later more
comprehensive study to cover 1950 to 200215). Other empirical articles in
the first special issue found evidence consistent with hypercompetition in
the software industry,16 showed processes by which 10 divisions of a large
multinational high-tech company dealt with hypercompetition,17 examined diversification of semiconductor startups,18 looked at hypercompetitive new product introductions in the Japanese beer industry,19 studied

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hypercompetitive escalation and de-escalation in the U.S. airline industry,20 and modeled concatenating advantages (eating your own lunch
before someone else does).21 The second special issue focused on theoretical extensions to existing theories to try to accommodate hypercompetition, including flexibility and adaptation,22 organizational capability
as knowledge integration,23 strategic flexibility,24 vertical integration and
rapid response,25 regional learning network organizations,26 social networks, learning and flexibility,27 and ended with an interesting and farranging discussion of spontaneous organizational reconfiguration based
on Xenophons Anabasis.28 These special issues demonstrate that some
management scholars did perform research to find empirical evidence of
hypercompetition, or extend existing theories to accommodate it. Other
scholars sought evidence to try to refute it.29 For an overview of the main
theoretical and empirical arguments on both sides, as well as a study offering considerable empirical support to the concept of hypercompetition,
see the 2005 Strategic Management Journal article by Wiggins and Ruefli,30
which not only covers most of the hypercompetition arguments, but also
summarizes much of the related extensive literature on the persistence of
economic performance.
Although strategic management scholars may have been somewhat
resistant to the idea of hypercompetition, scholars in the wider field of
general management and other related business fields realized that if the
predictions of hypercompetition were true, then their research and prescriptions needed to adapt. This led to articles on the effects of hypercompetition on a wide range of subjects including relationship marketing,31
managerial cognition,32 financial services,33 enterprise integration,34 project management,35 change management,36 adaptive supply chains,37 and
managerial mindsets.38
The Age of Temporary Advantage
In light of the empirical evidence, a growing number of scholars have
begun to accept that temporary advantages are increasingly important for
firms to understand, and have begun to include the concept in their research. Some scholars bought in early, such as Charles Fine of M.I.T., who
included in the subtitle of his 1998 book the phrase the age of temporary
advantage.39 In 2010, DAveni was one of a trio of guest editors of a special issue of the influential Strategic Management Journal titled The Age
of Temporary Advantage? (the question mark on the cover did not appear in the title of the paper introducing the special issue).40 Articles in the
special issue addressed topics such as integrating temporary advantage
into RBV,41 the roles of top management teams in an age of temporary advantage,42 the interactions of complementary products in a hypercompetitive environment,43 institutional development in emerging countries,44

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competitive action patterns in nascent markets,45 and under what conditions industry leaders should self-displace themselves.46
Still, the question mark alluded to above acknowledges a clear discomfort in the field. This discomfort may reflect a sense that perhaps temporary advantage is not pervasive, or it may reflect a resistance to a world
made up of temporary advantage. The discomfort of those clinging to SCA
was not helped by a series of articles in recent years, also in the Strategic
Management Journal, discussing the logical and philosophical issues in the
relationship between competitive advantage and superior performance;
some scholars even argued that research in the area was tautological.47
Regardless of the discomfort level of some scholars, the growing acceptance of hypercompetition as a reflection of reality is continuing to spread
throughout the academic community. Practicing managers working on
the front lines accepted the idea years ago, some even before they were
told what it was called. This leads us to our interlude, where we discuss
the fact that many business school students are still not told about hypercompetition, nor about the accompanying analytical techniques that could
be of great value when they graduate to become practicing managers.
INTERLUDE: FOUR ARENAS ANALYSIS
One of the fundamental contributions of DAvenis book48 was not to
strategic management theory but rather to strategic management education and practice, specifically, the four arenas analysis, a dynamic technique that focuses on multiple strategic interactions in each arena. Sadly,
few educators and managers take advantage of the richness of these analytical techniques, and instead stick with the more simplistic and static
analyses from Porter: for example, the five forces, the value chain, and
generic strategies. Indeed, few professors recognize the irony of trying to
prepare MBAs for the business world with talk of the unique attributes of
SCAs while teaching them the same techniques that all other MBAs have
learned or are learning, giving their students no competitive advantages
of their own. Allow us to very briefly summarize each of the arenas in four
arenas analysis, and to contrast them with their more traditional analytical counterparts.
The Cost-Quality Arena
The first arena, cost quality, is where DAveni makes arguably his greatest contribution. Porter stated that there are only two basic competitive
advantages, and thus only two main generic strategies: cost leadership
and differentiation (plus their smaller target market versions, focused cost
leadership and focused differentiation), and further, that if you attempt
to do both at once you will become stuck in the middle and do neither

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well.49 Picture a line with one of the two generic strategies at both ends,
and you are advised to locate your business-level strategy near one of
the two end points. DAveni instead makes this limited continuum into a
two dimensional construct, with price on the y-axis and perceived quality on the x-axis (and by using perceived quality, branding and advertising come into play, as it is possible to improve consumers perceptions
of brand quality with advertising). Now a cost leader is lower cost with
lower perceived quality, and a differentiator is higher cost with higher
perceived quality. Plotted on our axes we still have a line, but it is now one
that goes up from left to right. More importantly, this line creates an efficiency frontier so that firms above or to the left of the line are dominated
by firms on the line who offer either lower prices or better perceived quality or both (which is comparable to Porters stuck in the middle), but also
allows for firms to be in the middle offering moderate perceived quality
at moderate prices as long as they stay on the line (e.g., Macys between
Wal-Mart at the lower left and Nordstom at the upper right). Moreover, it
allows for more reasoned discussion of firms like Target, which is a cost
leader overall yet differentiated when compared to Wal-Mart (Target is
slightly to the right of and above Wal-Mart on the efficiency frontier).
The cost-quality arena also subsumes Porters strategic groups, with
what DAveni calls within-segment positioning, where a cluster of
firms near each other in cost and quality directly compete, and betweensegment positioning, where nearby clusters can begin to directly compete with firms that formerly were not direct competitors. Other strategic
interactions in the cost-quality arena include price wars, full-line producer
strategies (cover-all niches), outflanking and niching, and the move toward ultimate value (e.g., the commoditization of a mature industry).
DAveni illustrates the power of cost/quality arena analysis in a chapter
that includes a complete four arenas analysis that covers the entire history of the Cola Wars (Coke versus Pepsi), using the cost/quality arena
to show multiple competitive moves over time, from Pepsis introduction of the 12-ounce bottle in the 1930s to Cokes New Coke debacle of
the 1980s.50 In addition to transforming price and quality decisions from
dichotomous (low cost or differentiation) to two dimensional, the costquality arena also subsumes most of the rivalry among existing firms
from Porters five forces.
The Timing and Know-How Arena
Although there is no direct correlation between the timing and knowhow arena and Porters analyses, it does capture some of the support
activities of the value chain as well as capture centrally the concepts of
first-mover advantages. In fact the first strategic interaction in the arena
is capturing first-mover advantages such as response lags, economies

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of scale, brand loyalty (product differentiation), advertising and channel


crowding (access to distribution channels), user-base effects (the network
externality), learning effects, and preemption of scarce assets (linking to
RBV of the firm). Note that many of these first-mover advantages appear
in Porters five forces as static barriers to entry, but here they are being
dynamically built. The longer the response lag before the second mover
responds, the greater the capability of the first mover to expand the firstmover advantages. For example, when Apple introduced the Macintosh in
1984, it was several years before serious competition arrived (some would
argue that it wasnt until Windows 3.0 that there was a truly viable competitor, which would be a response lag of six years, by which time Apple
was on Mac OS 6). The second strategic interaction is imitation and improvement, whereby second and late movers can overcome first-mover
advantages, as is often observed in the real world (Windows did eventually prevail over the Macintosh, despite the very long response lag).
Other strategic interactions in this arena include creating impediments to
imitation (patents, deterrent pricing, secret information, size economies,
contracts, bundling, restrictive licensing, threats of retaliation51), overcoming the impediments (where DAveni shows how each impediment in the
previous strategic interaction can be countered), transformation and leapfrogging, and downstream vertical integration.
In high-technology industries, the timing and know-how arena is often
where the action is. Although imitation is frequently discussed in scholarly articles as well as the popular press, DAvenis addition of the word
improvement changes the playing field. Whereas many authors only
discuss pure imitation (knockoffs), DAveni notes that it is often improvements made by imitators that change the nature of the game. TiVo didnt
merely imitate ReplayTV, they added valuable features such as the Season Pass. Apple didnt just imitate existing smartphones, they added features such as the App Store to the iPhone (the Android-based phones, on
the other hand, primarily just imitated). These examples are particularly
appropriate as both of these industries have moved onto the creating
impediments and overcoming impediments strategic interactions as
evidenced by the sea of patent litigation in the smartphone industry and
the TiVo/Dish Network patent lawsuits (which have recently been joined
by Motorola and Microsoft).
The Strongholds Arena
The strongholds arena maps onto Porters entry barriers in the five forces,
but again is dynamic rather than static, as indicated in the first strategic
interaction, building entry barriers, many of which are built in the other
arenas. Then comes launching forays into a competitors stronghold, the
incumbents short-run counterresponses (often no response at all), the

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incumbents delayed reaction (often too late), overcoming the barriers,


slow learners and the incumbents reaction to entrants who dont get the
message, and unstable standoffs.
The strongholds arena is the best example of the dynamic versus
static approaches. In Porters five forces, entry barriers are present or
not, and if present, reduce the threat of new entrants coming into the industry to increase competition. DAvenis strategic interactions, on the
other hand, posit strategies for jumping over or slipping under or going
around entry barriers, so that even in the presence of strong entry barriers, incumbent firms should not feel safe. An interesting comparison can
be drawn between the two approaches by looking at a Harvard Business
School case, Microsofts Networking Strategy,52 set in 1991 when Novell was the industry leader. A classic Porter analysis shows Novell to
have a powerful competitive advantage, and even the instructors note
that accompanied the case suggested that students would come to the
conclusion that Microsoft probably couldnt win a fight with Novell and
should walk away. But, of course, Microsoft did win this fight in a hypercompetitive fashion, by shifting the rules and moving the battle to
their own stronghold (desktop operating systems) and out of Novells
(network operating systems).
The Deep Pockets Arena
The deep pockets arena best maps onto the SCPIO concept of market
power, and deals with strategies for both successful incumbents (who have
the deep pockets and the market power that comes from being large and
successful) as well as for smaller firms seeking to overcome their larger rivals advantage. The strategic interactions in this arena include drive em
out, using the courts or Congress to derail the deep-pocketed firm, large
firm thwarting the antitrust suit, small firms neutralizing the advantage of
the deep pocket, and the rise of a countervailing power.
Although the deep pockets arena is the least remarkable of the four,
it does offer some hope for the small firm when facing a Microsoft or a
Google. In addition, the increasing power of the European Union when
it comes to antitrust-type activities gives the small firms even more hope.
Had DAveni written his book more recently, the strategic interaction
would probably have been called using the courts, Congress, and/or the
European Commission.
Before we move to the next section, A Look Ahead, to where we think
the theories and practical aspects of hypercompetition are going, allow us
to encourage both managers and educators to look into four arenas analysis and how they might use it in their businesses and in education. The
dynamic nature of the four arenas greatly enhances the insights that can
be gleaned from the analysis as opposed to the static analyses of the past.

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Earlier adopters may even find it gives them a competitive advantage, albeit likely a temporary one.
A LOOK AHEAD
In their introduction to the special issue on temporary advantage discussed previously, editors DAveni, Dagnino, and Smith took their own
look ahead.53 Before we begin ours, let us very briefly summarize some of
their key points, with which we concur. They point out that some research
streams that have already begun have good potential for dealing with temporary advantage in the future, notably competitive dynamics and dynamic
capabilities. They also suggest wave theory and chaos theory as potential
sources of future insights. Their boldest speculation is that perhaps firms
have multiple strategies for dealing with multiple competitors, which
would mean that treating firms as having a single unified strategy could
potentially be folly, and that research may have to move to the firm-dyad
level of analysis to allow for a different strategy for each competitor.54
In the following sections, we argue that research imperatives based on
the four arenas of competition provide a compelling foundation for thinking about some noteworthy issues ahead for hypercompetition. Specifically: (1) the cost-quality arena needs to incorporate more directly the
increasingly social dimension of quality; (2) the timing/know-how
arena needs to enhance its explication of managerial processes; (3) the
strongholds arena needs to advance beyond the what of strongholds to
the implications of the which firm and where of these entry barriers;
and finally, (4) the deep pockets arena needs to consider the global ramifications of increasing national instability to the protection and preservation of such advantages.
We follow this with the single larger issue of where hypercompetition
stands as a justifiable normative approach given its unsettling acceptance
of the temporary. Although its descriptive portent is fairly settled, the
implications for competitive behavior may be playing a part in a recent
global blowback in political and economic philosophies that question the
desirability of free enterprise based on waves of creative destruction.55
We conclude with some alarm at the inadequate attention to the repercussions of the alternative, while acknowledging that modern societies, and
our research paradigms, have not sufficiently addressed the implications
of economic life under hypercompetition.
The Cost-Quality Arena
Hypercompetition theory advanced our understanding of business
strategy with the insight that firms simultaneously select both a cost
and quality position. The ensuing strategic interactions (e.g., price wars,

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157

niching, etc.) reflect gambits to move perceived products along the cost/
quality frontier, with position measured by the product of one firm relative to another firm. Such a view envisions products as holding important
objective values both of price and features.
A substantial deficit in this area is the need to adopt some of the more
postmodern understandings of product choice and evaluations of quality. Simply, there is increasing evidence that consumers do not implement
straightforward routines to assess product quality, that is, activate some
decision set of preexistent utilities.56 Rather the value of products is increasingly understood to be relative and subjective, arising out of social
interaction. For instance a recent study chronicled how social communications gradually evolved toward consensus among influential actors,
leading to a measure of value for the new product category of modern
Indian art.57
Simply, how people choose to consume products seems heavily, and
with the rise of social networking increasingly, influenced by the preferences of influential social peers.58 Along with these enhanced communications influences is the rise of virtual products; thus it is not unusual
for firms to experience bandwagon effects where entire markets tip based
on a (possibly unwarranted) consensus on the desirability of a product.59
Such a view of the cost-quality dimension opens up different options in
strategic interaction in the cost-quality arena; specifically it focuses on garnering communities, loyalties, and relationships. Firms may also seek out
the quality of complementarity with successful products of other firms,60
or seek out alliances that actually raise their rivalry with firms representing opposing communities.61
The Timing and Know-How Arena
The timing and know-how arena represents the true chess game of innovation and imitation that underlies product evolution and the successful adaptations firms undertake to stay in the game. Hypercompetitions
emphasis on these tactical plays and counterplays has had a salubrious
impact on strategy research generally. RBV has clearly evolved from static
resources toward dynamic capabilities, which stresses the ability to
manage and organize various types of resources dynamically, and thus increasingly incorporates a more explicit hypercompetitive view of sequential advantages.62
But, whereas DAvenis initial tome clearly emphasized the importance
of managerial decisions to launch strategic interactions, arguably other
literatures are only now catching up with this behavioral aspect of competition. For instance, the dynamic capability literature increasingly focuses on managers, and how they scan the environment and respond with
reactive decisions. As prominent strategy scholar David Teece recently

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explained: Sensing (and shaping) new opportunities is very much a scanning, creation, learning, and interpretive activity.63
Simply, we reiterate recent calls by others to go to managers to gain
primary data on how competitive moves are implemented.64 An emphasis on increasing our understanding of the managerial aspect reflects
our earlier contention that the depictions of hypercompetition were best
received by managers (versus academics) because they resonated with
managerial reality. Hypercompetition research should rightly claim its
original stake in managerial decision making and empirically pursue
investigations on how firms best implement timing and know-how in
strategic interactions. For instance, a recent hypercompetition study indicated top management teams must avoid destructive conflict in favor
of well-integrated group behaviors. In the face of hypercompetitive uncertainty, positive behavioral integration raised the levels of competitive
interactions and was related to increased performance.65 As hypercompetition research elaborates the strategic interactions of first-mover innovation and second-mover imitation, it should include the contingencies
of how to configure top management teams and structure decision processes. Such prescriptions must balance for instance, the need for diversity for comprehensive scanning and successful competitive actions,66
while reining in differences that can create disruptive conflict. Accordingly, it must also address how compensation plays a role in top management team functioning.67
The Strongholds Arena
Hypercompetition theory offered a substantive set of options for addressing the entry barriers once capable of providing long-term competitive advantages. Basically, hypercompetition changed the impression of
rock-walled castle strongholds to sandcastles ever susceptible to new tides
and constant rebuilding. Importantly, it did not depict stronghold competition as fruitless, but transitory.
Still, a review of business research indicates that little research has examined issues of strongholds, and a recent study may give a clue as to
why it has been underdeveloped empirically. Specifically, the nature and
performance of stronghold strategies may be highly contingent on not just
the what of tactics, but on characteristics of the firms pursuing these
strategies and the markets they are in. Chen and colleagues observed
competitive moves in markets that differed in the length of their competitive advantages, that is, new markets with highly temporary advantages
versus more established markets.68 In addition, they differentiated firms
based on high and low performers. These two contingencies together
indicated that high performers are disruptive in new markets, whereas
low performers seek to be disruptive in established markets. The study

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159

also indicated that strongholds are alive and well in mutual forbearance
behaviorswhen firms abstain from competingamong high performers.
As a fairly new paradigm, an absence of attention to some aspect of
hypercompetition, (such as strongholds in empirical research), may be
an indication that the theory as of yet is underdeveloped. The study of
Chen and colleagues above indicates that competing on strongholds may
vary widely by market types and firm identity. Other contingencies may
also be important, such as the unique vagaries of industries. For instance,
the globalizing supply chain of the fashion industry created new abilities
to implement vertical integration as a stronghold against existing distribution and brand strongholds.69 The fact that it is not easy to generalize
across conditions in regard to the wielding of strongholds argues that a
more rigorous identification of contingencies is needed. This is especially
important in the fact that successful strongholds often indicate anticompetitive behavior and thus inefficient markets. Hypercompetition theory
should play a central role in identifying the competitive forays capable of
dismantling these uniquely tailored strongholds.
The Deep Pockets Arena
That hypercompetition theory depicts the deep pockets arena as not
based on unassailable advantages is a distinct contribution to conventional views. Specifically, quite a number of the delineated strategic interactions highlight the fact that countervailing powers exist (e.g., legislative
and judicial action, other deep pocket firms) to a deep pocket competitor.
Hypercompetition provides strategies that advise both the deep pocket
firm and a small agile competitor.
As the deep pockets arena maps closely to the idea of market power, it
similarly requires a clear identification and boundary for that market of
interest. Historically, national boundaries often serve to demarcate deep
pocket markets as they embody the institutional system that protects (or
breaks up) the deep pocket advantage. The differences in institutional/
government support for entrenched interests indicates that assaults on
deep pocket firms in some nations, for example, many emerging economies, will be much less successful than other contexts. Indeed, a recent
study examining emerging marketsand employing the same nonparametric techniques as Wiggins and Rueflis 2005 research in mature
marketsdiscovered that SCA, and not hypercompetition, was much more
prevalent.70 On an informative note, though, these markets also showed
evidence of increasing movement toward hypercompetition overall.
The importance of changes in the institutional environment in advancing or retarding hypercompetition is likely to become a high-profile issue
with globalization in a world of recessionary developments. One goal for
further research was summed up in the aforementioned study finding

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increasing hypercompetition in emerging markets: is institutional development mainly eroding nonmarket advantages of privilege groups or is it
creating business opportunities for new entrants that allow them to catch
up with leaders through market mechanisms that compensate nonmarket
advantages?71 In contrast to a sanguine view of institutional development, recent political events that topple and threaten existing regimes do
not map directly onto a template of institutional development that reflects global economic mores. In sum, the relative importance of the deep
pockets arena in housing hypercompetitive strategic interactions will be
highly correlated to the types of institutions arising in coming years.
SUMMARY: A WORLD THAT PINES FOR
MORE GENTEEL LEVELS OF COMPETITION?
Expanding on the earlier observation that institutional/national economies are in great flux, we conclude by arguing that hypercompetition
theory faces much more existential challenges to its legitimacy. Hypercompetition is increasingly viewed by political observers not as a descriptive
reality, but as the manifestation of economic worldviews that are being
heavily scrutinized at both a national and global scale. Early descriptions
of hypercompetition by DAveni himself dismissed the alternative models, the old, genteel, stable oligopolies that defined competition during
the 20th century are rapidly restructuring,72 with a sense of inevitability.
Specifically, much of economic and management theory, and certainly
hypercompetition, has been premised on a worldview that recognizes advantages to the spread of free market principleswith its competitive
back and forth parlayson a global scale. As argued by Bhagwati in his
2004 book, In Defense of Globalization,73 many of the ills blamed on globalization in general do not distinguish between some of the positive (e.g.,
free markets) versus negative (free flows of capital) practices, which are
differentially regulated.
At the time of that writing, though, the huge post 2007 recessionary developments had not occurred. Dialogue did not yet reflect the now current
reevaluation of the basic advantages of capitalism occurring in management theory evidenced by the frequent critical use of the term in academic
journals (for instance, as reflected in a recent article title: U.S. Capitalism:
A Tarnished Model?74). Libertarians and conservatives have entered the
fray to argue that current events make a straw man criticism of capitalism, noting that noncapitalist regulatory constraints are not without
blame for the financial collapse of recent years.75 The unsustainable debt
obligations of the United States and Europe also endanger the legitimation of the hypercompetitive model.
We will not take the side of one force or the other in the above controversy. What we will conclude with is the need for hypercompetition

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161

theory to become much more introspective on the implications of its tenets. In particular, performativity theory refers to the perspective that
the theories we elaborate and advance not only describe phenomena, but
act to frame behavior. Management theorists have often reflected a concern
for how theory legitimates or promotes particular ethically questionable
behavior (e.g., assuming guile among players76), or advancing untested
economic processes and systems overall.77 Hypercompetition, with its acceptance of temporary advantage as the natural outcome of competitive
markets, needs to recognize that the chaotic rise and fall of businesses accompanying such a temporary advantage paradigm is likely to engender
populist resistance to the casualties of this constant change.
Thus, whereas hypercompetition theory dismisses the genteel levels
of competition of the past, in the throes of world recession and significant
unemployment, movements increasingly hearken to calls for such gentility. These forces dismiss hypercompetition as a force for destruction. It is
important that hypercompetition continues to reinforce the ethical downside of the alternativesystems with extensive SCAsthat often reflect
monopolistic and oligopolistic practices.78 But what is more needed in hypercompetition is a critical self-evaluation of its neutral stance on competitive interactions and temporary advantage. For instance, research has
explicitly acknowledged how hypercompetitive parlays can lead to the
Alice in Wonderland Red Queen effect (to run as fast as they can to stay
in place, and twice as fast as that79), noting importantly that whereas rivalry reduces the final value of many competitive moves, the competitive
moves still advance overall firm performance.80 In the modern environment, hypercompetition cannot assume the luxury that its audience will
see rising firm performance as worth running twice as fast.
In summary, a full-throated defense of the creative aspects of temporary advantage is called for, rather than a nonchalant dismissal of its collateral destruction. Second, hypercompetition must engage in an explicit
critique to discriminate between when particular strategic interactions relate to firm performance (potentially only on a temporary basis) and when
they relate to performance for a wider stakeholder community.
Hypercompetition is a flashpoint because it embodies the fact that the
optimal economic paradigm is not clear cut. In a world with an SCA, a
firm can self-actualize to the highest pinnacle of performance, and the
rise of the learning and knowledge paradigms for successful firms clearly
paralleled the good life we prescribe for individuals. Unfortunately, we
have found that such an economy filled with stable performance champions was just as likely to be a world of collusion and power consistent
with the skepticism of industrial organization (I/O) economics, and one
denying societal members the best products at the best prices.
On the other hand, the hard place represented in hypercompetition is
one of instability, unpredictability, and short time horizons. This paradigm

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promises that the consumers in the society will see rising standards of living (and products) based on material measures, that is, as the constant dynamic tactical plays among firms advances the cost/quality frontier. But
this material success is accompanied by a lack of security for individual
stakeholders in the constantly losing firms, such as the employees and
community members harmed by the failure of businesses. If hypercompetition managers and scholars avoid this debate, other actors will enthusiastically reinstate a more genteel competition.
NOTES
1. Victoria Lawson and Thomas Klak, Conceptual Linkages in the Study of
Production and Reproduction in Latin American Cities, Economic Geography 66,
no. 4 (1990); T. R. Young, The Sociology of Sport: Structural Marxist and Cultural
Marxist Approaches, Sociological Perspectives 29, no. 1 (1986).
2. Richard A. DAveni, Hypercompetition: Managing the Dynamics of Strategic
Maneuvering (New York: The Free Press, 1994).
3. Michael E. Porter, Competitive Strategy: Techniques for Analyzing Industries and
Competitors (New York: The Free Press, 1980); Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: The Free Press, 1985).
4. H. Igor Ansoff, Corporate Strategy (New York: McGraw-Hill, 1965).
5. Michael E. Porter, The structure within industries and companies performance, Review of Economics and Statistics 61, no. 2 (1979); Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors.
6. Raphael Amit and Paul J. H. Schoemaker, Strategic Assets and Organizational Rent, Strategic Management Journal 14, no. 1 (1993); Jay B. Barney, Firm Resources and Sustained Competitive Advantage, Journal of Management 17(1991);
Kathleen Reavis Conner, A Historical Comparison of Resource-Based Theory and
Five Schools of Thought within Industrial Organization Economics: Do We Have
a New Theory of the Firm? Journal of Management 17 (1991); Pankaj Ghemawat,
Sustainable Advantage, in Strategy: Seeking and Securing Competitive Advantage,
ed. Cynthia A. Montgomery and Michael E. Porter (Cambridge, MA: Harvard
Business Review, 1986); Christine Oliver, Sustainable Competitive Advantage:
Combining Institutional and Resource-Based Views, Strategic Management Journal 18, no. 9 (1997); Porter, Competitive Advantage: Creating and Sustaining Superior
Performance; Michael E. Porter, What Is Strategy? Harvard Business Review 74, no.
1 (1996).
7. Barney, Firm Resources and Sustained competitive Advantage; Conner,
A Historical Comparison of Resource-Based Theory and Five Schools of Thought
within Industrial Organization Economics: Do We Have a New Theory of the
Firm?; Kathleen Reavis Conner and C. K. Prahalad, A resource-based theory of
the firm: Knowledge versus opportunism, Organization Science 7, no. 5 (1996);
Birger Wernerfelt, A resource-based view of the firm, Strategic Management Journal 5 (1984).
8. Barney, Firm Resources and Sustained Competitive Advantage.
9. Conner, A Historical Comparison of Resource-Based Theory and Five
Schools of Thought within Industrial Organization Economics: Do We Have a

Hypercompetition in the 21st Century

163

New Theory of the Firm?; Conner and Prahalad, A Resource-Based Theory of


the Firm: Knowledge versus Opportunism.
10. Porter, Competitive Advantage: Creating and Sustaining Superior Performance.
11. DAveni, Hypercompetition: Managing the Dynamics of Strategic Maneuvering.
12. Porter, What Is Strategy? 61.
13. Anne Y. Ilinitch, Richard A. DAveni, and Arie Y. Lewin, New Organizational Forms and Strategies for Managing in Hypercompetitive Environments,
Organization Science 7, no. 3 (1996).
14. L. G. Thomas, III, Dynamic Resourcefulness and the Hypercompetitive
Shift, Organization Science 7, no. 3 (1996).
15. L. G. Thomas and Richard DAveni, The Changing Nature of Competition
in the US Manufacturing Sector, 19502002, Strategic Organization 7, no. 4 (2009).
16. Greg Young, Ken G. Smith, and Curtis M. Grimm, Austrian and Industrial
Organization Perspectives on Firm-level Competitive Activity and Performance,
Organization Science 7, no. 3 (1996).
17. D. Charles Galunic and Kathleen M. Eisenhardt, The Evolution of Intracorporate Domains: Divisional Charter Losses in High-Technology, Multidivisional Corporations, Organization Science 7, no. 3 (1996).
18. Dong-Jae Kim and Bruce Kogut, Technological Platforms and Diversification, Organization Science 7, no. 3 (1996).
19. Tim Craig, The Japanese Beer Wars: Initiating and Responding to Hypercompetition in New Product Development, Organization Science 7, no. 3 (1996).
20. Javier Gimeno and Carolyn Y. Woo, Hypercompetition in a Multimarket
Environment: The Role of Strategic Similarity and Multimarket Contact in Competitive De-Escalation, Organization Science 7, no. 3 (1996).
21. Barrie R. Nault and Mark B. Vandenbosch, Eating Your Own Lunch: Protection Through Preemption, Organization Science 7, no. 3 (1996).
22. Henk W. Volberda, Toward the Flexible Form: How to Remain Vital in Hypercompetitive Environments, Organization Science 7, no. 4 (1996).
23. Robert M. Grant, Prospering in Dynamically-Competitive Environments:
Organizational Capability as Knowledge Integration, Organization Science 7, no.
4 (1996).
24. Anne D. Smith and Carl Zeithaml, Garbage Cans and Advancing Hypercompetition: The Creation and Exploitation of New Capabilities and Strategic
Flexibility in Two Regional Bell Operating Companies, Organization Science 7, no.
4 (1996).
25. James Richardson, Vertical Integration and Rapid Response in Fashion
Apparel, Organization Science 7, no. 4 (1996).
26. Jon Hanssen-Bauer and Charles C. Snow, Responding to Hypercompetition: The Structure and Processes of a Regional Learning Network Organization,
Organization Science 7, no. 4 (1996).
27. Julia Porter Liebeskind et al., Social networks, Learning, and Flexibility:
Sourcing Scientific Knowledge in New Biotechnology Firms, Organization Science
7, no. 4 (1996).
28. Kenneth E. Aupperle, CrossroadsSpontaneous Organizational Reconfiguration: A Historical Example Based on Xenophons Anabasis, Organization Science 7, no. 4 (1996); Asaf Zohar and Gareth Morgan, Refining Our Understanding
of Hypercompetition and Hyperturbulence, Organization Science 7, no. 4 (1996).

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Strategic Management in the 21st Century

29. Gerry McNamara, Paul M. Vaaler, and Cynthia Devers, Same as It ever
Was: The Search for Evidence of Increasing Competition, Strategic Management
Journal 24, no. 3 (2003).
30. Robert R. Wiggins and Timothy W. Ruefli, Schumpeters Ghost: Is Hypercompetition Making the Best of Times Shorter? Strategic Management Journal 26,
no. 10 (2005).
31. Evert Gummesson, In Search of Market Equilibrium: Relationship Marketing Versus Hypercompetition, Journal of Marketing Management 13, no. 5 (1997).
32. William C. Bogner and Pamela S. Barr, Making Sense in Hypercompetitive
Environments: A Cognitive Explanation for the Persistence of High Velocity Competition, Organization Science 11, no. 2 (2000).
33. Chittipa Ngamkroeckjoti and Lalit M. Johri, Coping with Hypercompetition
in the Financial Services Industry in Thailand: Environmental Scanning Practices of
Leaders and Followers, International Journal of Bank Marketing 21, no. 6/7 (2003).
34. Rajiv Kishore, Hong Zhang, and R. Ramesh, Enterprise Integration using
the Agent Paradigm: Foundations of Multi-Agent-Based Integrative Business Information Systems, Decision Support Systems 42, no. 1 (2006).
35. Mariano Gallo and Paul D. Gardiner, Triggers for a Flexible Approach to
Project Management within UK Financial Services, International Journal of Project
Management 25, no. 5 (2007).
36. Thomas Biedenbach and Anders Sderholm, The Challenge of Organizing
Change in Hypercompetitive Industries: A Literature Review, Journal of Change
Management 8, no. 2 (2008).
37. Michael Hlsmann, Jrn Grapp, and Ying Li, Strategic Adaptivity in
Global Supply ChainsCompetitive Advantage by Autonomous Cooperation,
International Journal of Production Economics 114, no. 1 (2008).
38. Somnath Lahiri, Liliana Prez-Nordtvedt, and Robert W. Renn, Will the
New Competitive Landscape Cause Your Firms Decline? It Depends on Your
Mindset, Business Horizons 51, no. 4 (2008).
39. Charles H. Fine, Clockspeed: Winning Industry Control in the Age of Temporary
Advantage (Reading, MA: Perseus Books, 1998).
40. Richard A. DAveni, Giovanni Battista Dagnino, and Ken G. Smith, The
Age of Temporary Advantage, Strategic Management Journal 31, no. 13 (2010).
41. David G. Sirmon et al., The Dynamic Interplay of Capability Strengths and
Weaknesses: Investigating the Bases of Temporary Competitive Advantage, Strategic Management Journal 31, no. 13 (2010).
42. Ming-Jer Chen, Hao-Chieh Lin, and John G. Michel, Navigating in a Hypercompetitive Environment: The Roles of Action Aggressiveness and TMT Integration, Strategic Management Journal 31, no. 13 (2010).
43. Chi-Hyon Lee et al., Complementarity-Based Hypercompetition in the
Software Industry: Theory and Empirical Test, 19902002, Strategic Management
Journal 31, no. 13 (2010).
44. Francisco Diaz Hermelo and Roberto Vassolo, Institutional Development
and Hypercompetition in Emerging Economies, Strategic Management Journal 31,
no. 13 (2010).
45. Violina Rindova, Walter J. Ferrier, and Robert Wiltbank, Value from Gestalt: How Sequences of Competitive Actions Create Advantage for Firms in Nascent Markets, Strategic Management Journal 31, no. 13 (2010).

Hypercompetition in the 21st Century

165

46. Gonalo Pacheco-de-Almeida, Erosion, Time Compression, and SelfDisplacement of Leaders in Hypercompetitive Environments, Strategic Management Journal 31, no. 13 (2010).
47. Richard J. Arend, Revisiting the Logical and Research Considerations of
Competitive Advantage, Strategic Management Journal 24, no. 3 (2003); Rudolphe
Durand, Competitive Advantages Exist: A Critique of Powell, Strategic Management Journal 23, no. 9 (2002); Thomas C. Powell, Competitive Advantage: Logical
and Philosophical Considerations, Strategic Management Journal 22, no. 9 (2001);
Thomas C. Powell, The Philosophy of Strategy, Strategic Management Journal 23,
no. 9 (2002); Thomas C. Powell, Strategy without Ontology, Strategic Management Journal 24, no. 3 (2003).
48. DAveni, Hypercompetition: Managing the Dynamics of Strategic Maneuvering.
49. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors.
50. DAveni, Hypercompetition: Managing the Dynamics of Strategic Maneuvering:
182204.
51. Ibid., 9295.
52. David B. Yoffie, Microsofts Networking Strategy (Boston: Harvard Business
School Publishing, 1991).
53. DAveni, Dagnino, and Smith, The Age of Temporary Advantage.
54. Ibid., 1382.
55. Joseph A. Schumpeter, The Theory of Economic Development (New York: Oxford University Press, 1934).
56. See the literature spawned by the initial work by Russell W. Belk, Possessions and the Extended Self, The Journal of Consumer Research 15, no. 2 (1988).
57. Mukti Khaire and R. Daniel Wadhwani, Changing Landscapes: The Construction of Meaning and Value in a New Market CategoryModern Indian Art,
Academy of Management Journal 53, no. 6 (2010).
58. Hiroaki Hayakawa, Bounded Rationality, Social and Cultural Norms, and
Interdependence via Reference Groups, Journal of Economic Behavior & Organization 43, no. 1 (2000).
59. See the potential for tipping points and bandwagon effects in Kent D.
Miller, Frances Fabian, and Shu-Jou Lin, Strategies for Online Communities,
Strategic Management Journal 30, no. 3 (2009).
60. Lee et al., Complementarity-Based Hypercompetition in the Software Industry: Theory and Empirical Test, 19902002.
61. Young, Smith, and Grimm, Austrian and Industrial Organization Perspectives on Firm-level Competitive Activity and Performance.
62. Constance E. Helfat and Margaret A. Peteraf, The Dynamic ResourceBased View: Capability Lifecycles, Strategic Management Journal 24, no. 10 (2003).
63. David J. Teece, Explicating Dynamic Capabilities: The Nature and Microfoundations of (Sustainable) Enterprise Performance, Strategic Management Journal 28, no. 13 (2007).
64. Ken Smith, Walter J. Ferrier, and Hermann Ndofor, Competitive Dynamics Research: Critique and Future Directions, in Handbook of Strategic Management,
ed. Michael A. Hitt, R. Edward Freeman, and Jeffrey S. Harrison (Oxford UK:
Blackwell Publications, 2001).
65. Chen, Lin, and Michel, Navigating in a Hypercompetitive Environment:
The Roles of Action Aggressiveness and TMT Integration.

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66. Walter J. Ferrier and Douglas W. Lyon, Competitive Repertoire Simplicity


and Firm Performance: The Moderating Role of Top Management Team Heterogeneity, Managerial and Decision Economics 25, no. 6/7 (2004).
67. Andrew D. Henderson and James W. Fredrickson, Top Management Team
Coordination Needs and the CEO Pay Gap: A Competitive Test of Economic and
Behavioral Views, The Academy of Management Journal 44, no. 1 (2001).
68. Eric L. Chen et al., Life in the Fast Lane: Origins of Competitive Interaction
in New vs. Established Markets, Strategic Management Journal 31, no. 13 (2010).
69. Richardson, Vertical Integration and Rapid Response in Fashion
Apparel.
70. Hermelo and Vassolo, Institutional Development and Hypercompetition
in Emerging Economies.
71. Ibid., 1471.
72. Ilinitch, DAveni, and Lewin, New Organizational Forms and Strategies
for Managing in Hypercompetitive Environments, 211.
73. Jagdish Bhagwati, In Defense of Globalization (Oxford: Oxford University
Press, 2004).
74. Richard Whitley, U.S. Capitalism: A Tarnished Model? Academy of Management Perspectives 23, no. 2 (2009).
75. Stephen Moore and Tyler Grimm, Straw Man Capitalism and a New Path
to Prosperity, Harvard Journal of Law & Public Policy 33, no. 2 (2010).
76. Sumantra Ghoshal and Peter Moran, Bad for Practice: A Critique of the
Transaction Cost Theory, The Academy of Management Review 21, no. 1 (1996).
77. Fabrizio Ferraro, Jeffrey Pfeffer, and Robert I. Sutton, Economics Language and Assumptions: How Theories Can Become Self-Fulfilling, The Academy
of Management Review 30, no. 1 (2005).
78. DAveni, Dagnino, and Smith, The Age of Temporary Advantage.
79. Lewis Carroll, Through the Looking Glass (London: Macmillan and Co., 1872).
80. Pamela J. Derfus et al., The Red Queen Effect: Competitive Actions and
Firm Performance, Academy of Management Journal 51, no. 1 (2008).

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Chapter 9

Strategy and EntrepreneurshipA


Discussion of Strategic Entrepreneurs
Franco Gandolfi

INTRODUCTION
The term entrepreneur is, in many ways, one of the most excessively used
and misunderstood modern-day business concepts. Entrepreneur
is often used to refer to individuals who own their businesses. These
people may have launched a business endeavor from scratch, purchased
an existing entity, or inherited a business operation. It must be understood, however, that an entrepreneurially minded person is much more
than a mere owner and/or operator of a business endeavor. So, what exactly is an entrepreneur?
The term entrepreneur has its origin in the French word entreprendre,
which literally translates into undertaking. Over the years, the term
has taken on a variety of meanings. On the one extreme, an entrepreneur
is a person who is exceptionally talented and skilled and who is seen
as a pioneer of revolutionary change, possessing characteristics found
only in a small fraction of society. On the other extreme, an entrepreneur is simply a person who pursues a business-type endeavor. In such
a capacity, it is probable that he or she is working for himself or herself.

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Unsurprisingly, many definitions of an entrepreneur have emerged.


Some of them are the following1:
By definition, an entrepreneur is
a person who organizes, manages, and assumes the risks of a business or enterprise;
a person who possesses a new enterprise, venture, or idea and is
accountable for the inherent risks of the outcome;
a person who organizes, operates, and assumes the risk for a business venture;
an owner or manager of a business enterprise who, by taking risks
and initiative, attempts to make profits; and
an individual with a vision, who orchestrates the time, talent,
money, and resources of other people to make the vision real.2
The last definition of an entrepreneur is interesting from a number
of viewpoints: First, there is no reference to the assumption of risk in that
the entrepreneur has passed the risk element onto investors. Second, there
is no reference to a new venture; an entrepreneur can orchestrate a vision of
existing businesses into a more efficient and effective organization of business entities. Third, there is no reference to profitability in that some of the
greatest, manifested visions have been in the world of not-for-profit endeavors. Fourth, there is no reference to the operation of a business, since many
forms of businesses, including licensing and franchising, have emerged to
enable others to operate businesses. Last, the reference to vision suggests
that the actual vision may not be owned by the entrepreneur, that is, he or
she may have borrowed or even stolen somebody elses vision.

THE ENTREPRENEUR AND THE NOTION OF VISION


Consistent with this definition, an entrepreneur is alleged to have the
innate ability to conceive, conceptualize, and cast a vision. History books
are filled with examples of visionary entrepreneurial leaders. Some notable ones are the following:
Thomas Edison: His vision was to provide relief from human drudgery and the elevation of the human spirit through science;
Henry Ford: His vision was to bring mobility to the masses, specifically to bring the cost of a car down to where the worker who built
it could afford to buy it;
Sam Walton: His vision was for people to save money so they could
live better;

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Bill Gates: His vision was to see a personal computer on every desk
and in every home; then to empower people through great software;
Steve Jobs: His vision was to have an Apple computer on every desk
(not realized yet) and for people to have an Apple device in every
hand (currently being realized);
Richard Branson: He has several visions, from being able to provide
affordable records for everyone to affordable travel to destinations
in outer space (not realized yet);
Walt Disney: He also had multiple visions; one of them was to create the happiest place on earth.3
The one characteristic that all these visionary entrepreneurial leaders had or have in common was or is the aspect of a distinctive vision.
These leaders envisioned things that did not yet exist and created and
transformed the visions into reality. Of course, although there is high
probability that these distinguished leaders experienced many great obstacles and challenges, they nonetheless mastered the ability to orchestrate other peoples resources in order to breathe life into their visions.

SOME HISTORY OF ECONOMIC THEORIES


UNDERLYING ENTREPRENEURSHIP
At its most basic, the notion of economic theory is concerned with two
major societal questions. First, how does a society utilize scarce resources
to create and build wealth? Second, how does that society distribute the
created wealth among its members? Wealth creation and wealth distribution present fundamental and, at times, even controversial questions
pertaining to the development and progress of any society. It has long
been established that entrepreneurship, human creativity, and the innovation of scientific ideas are major mechanisms and catalysts for the creation and distribution of societal wealth. The notion of entrepreneurship
is not new. In fact, some authors have reported that entrepreneurship
has been around for quite some time and, as a direct result, a number of
different schools of thought have emerged, including the classical capitalist economic theory, the neoclassical theory, and the Schumpeterian
school of thought.
Classical Capitalist Economic Theory
Back in 1776, Adam Smith, a Scottish social philosopher and economist, described a capitalist as an owner-manager who organized, synthesized, and combined resources into an industrial enterprise. It was

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during this time that the French term entrepreneur was introduced in
order to identify the owner-manager, or entrepreneur, of an industrial
enterprise.4
Neoclassical Theory
The classical capitalist economic theory espoused the view that selfinterest, also referred to as the invisible hand, would guide participating individuals toward entrepreneurial behavior. However, by the
end of the 19th century, economic theorists argued that the market comprised many buyers and sellers who interacted in a way that ensures
that supply equals demand. The market was seen at equilibrium (i.e.,
balanced) and, thus, perfect. This would be achieved, it was argued, by
fluctuations in prices and supply levels. Therefore, it was posited that
wealth would be created and distributed due to the nature of the perfect market. Within this school of thought, there is little place for the
traditional manager-owner, the entrepreneur. The neoclassical theory is
widely regarded and taught as the mainstream view of economics. Also,
within this framework, a perfect market is defined as having (1) many
buyers and sellers, with neither group wielding a decisive influence on
the market prices, (2) prices set by the markets themselves, (3) products
and services that are equivalent in substance but differ in price, and
(4) buyers and sellers that have access to complete knowledge of the
market and the transactions that occur.5
Schumpeterian Vision
In the early 20th century, Austrian economist and political scientist
Joseph Schumpeter rejected neoclassical economic thinking. He took a
decisive pro-entrepreneurship stance and argued that innovation capability was the key driving force for new goods and services. Schumpeter
posited that the market was chaotic rather than perfect due to entrepreneurs continually providing the markets with creative ideas and innovative solutions. In fact, the concept of creative destruction rescinds the
neoclassical theorists notion of a perfect market. New ideas, products,
and services create a dynamic market mechanism, producing demand
that leads to perpetual wealth creation and wealth distribution.6
Evolving Views of Entrepreneurship
Simply put, an entrepreneur is an individual involved in an entrepreneurial activity. As pointed out, a multitude of definitions on the
notions of entrepreneur and entrepreneurship have emerged. Various
professionals view these elements through the lenses of their respective

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175

disciplines. For instance, the economist views the entrepreneur as a factor of production, alongside land, labor, and capital. The sociologist asserts that certain cultures promote or impede the developing forces of
entrepreneurship. In India, for example, the Gujaratis and Sindhis are
known for their sense of entrepreneurship. To a psychologist, an entrepreneur is a person driven by certain intrinsic forces, such as the need to
attain something, to experiment, to accomplish, or perhaps to escape the
authority of others. To a businessman, an entrepreneur may be a threat
or an aggressive competitor, whereas to another businessman the same
entrepreneur may be an ally, a source of supply, a customer, or someone
who creates wealth for others, as well as someone who finds better ways
to utilize resources, reduce waste, and generate jobs that others are glad
to assume.7
Various influential contributors have understood entrepreneurs differently over time. Some of the more notable ones are as follows:

Richard Cantillon (1725): An entrepreneur is a person who pays a certain price for a product to resell it at an uncertain price, thereby
making decisions about obtaining and using the resources while
consequently admitting the risk of enterprise.
J. B. Say (1803): An entrepreneur is an economic agent who unites all
means of productionland, labor, and capitalin order to produce a product. By selling the product in the market he pays rent
of land, wages to laborers, and interest on capital. The difference
is his prot. He shifts economic resources out of an area of lower
productivity and yield and into an area of higher productivity and
greater yield.
Joseph Schumpeter (1934): Entrepreneurs are innovators who use a process of challenging the status quo of existing products and services
and setting up new ones.
David McClelland (1961): An entrepreneur is a person with a high need
for achievement. He is energetic and a moderate-high risk taker.
Peter Drucker (1964): An entrepreneur continually seeks change,
responds to it, and exploits opportunities. Innovation is a specic
tool enabling the effective entrepreneur to convert a source into a
resource.
Peter Kilby (1971): Emphasizes the role of the imitatorentrepreneur
who does not innovate per se but imitates technologies innovated
by others.
Albert Shapero (1975): Entrepreneurs take initiative, accept the risk of
failure, and have an internal locus of control.
Gifford Pinchot (1983): Introduced the concept of the intrapreneur as an
entrepreneur within an already established organizational entity.

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Although many definitions and understandings of entrepreneurship


exist, all stress four basic aspects of being an entrepreneur regardless of
the field. First, entrepreneurship inherently involves the creation process.
Something new is created, possessing value both to the entrepreneur and
to the audience for which it is designed and developed. Such an audience
may be the market of buyers for business innovation, the hospitals administration for a new admissions procedure, prospective students for a
new college program, or the constituency for a new service provided by
a not-for-profit organization. Second, entrepreneurship requires the full
devotion of the necessary time and effort. Only those going through the
entrepreneurial process appreciate the significant amount of time and effort it takes to create something new and to make it operational. Third, assuming risks is yet another aspect of entrepreneurship. Depending upon
the field of effort of the entrepreneur, these risks take a variety of forms,
but usually center around financial, psychological, and social areas. The
fourth and final part of the definition involves the rewards of being an entrepreneur. The most important of these rewards include independence
and personal satisfaction. Money is viewed less as a reward and more an
indicator of the degree of success for profit-seeking entrepreneurs.
TYPES OF ENTREPRENEURS: A CATEGORIZATION
Unsurprisingly, a number of different types of entrepreneurs have
been identified over the years,8 including the following:
1. Nascent entrepreneur (i.e., an individual considering pursuing
entrepreneurship);
2. Novice entrepreneur (i.e., an individual moving into entrepreneurship for the rst time);
3. Serial entrepreneur (i.e., an individual has launched several entrepreneurial endeavors in a sequential fashion);
4. Lifestyle entrepreneur (i.e., an individual who, valuing passion
before prot when launching a business, combines personal interests and talent with the ability to earn a living long term);
5. Habitual entrepreneur (i.e., an individual has launched or is currently launching several entrepreneurial endeavors in a parallel
fashion); and
6. Entrepreneurial manager (i.e., an individual has the characteristics
of an entrepreneur but is in an employment relationship with an
employer; also called an intrapreneur).
Although the distinction of the types of entrepreneurs has at least
some academic value, the more significant issue is the question of what

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177

exactly constitutes a successful entrepreneur. To state it differently, what


are some key characteristics, attributes, attitudes, and behaviors that
successful entrepreneurs have shown to possess and display?
CHARACTERISTICS OF SUCCESSFUL ENTREPRENEURS
Stevensons Six Dimensions
Howard Stevenson studied successful entrepreneurs in both startup and established business situations and developed a preliminary
description of entrepreneurial behaviors based on six critical dimensions of business practice.9 At one end of each dimension, there is the
individual entrepreneur who feels confident enough to be able to seize
an opportunity irrespective of the resource requirement. At the other
end of the dimension, there is the individual manager who attempts
to employ and fully utilize the disposable resources as efficiently
as possible. Table 9.1 depicts the six dimensions and their extremes
graphically:
Stevensons work highlights six personal traits that successful entrepreneurs possess: tolerance for ambiguity, the ability to create an illusion of stability, risk management, attention to detail, endurance, and
a long-term perspective. Stevenson remarked that entrepreneurs have
the tendency to identify opportunities, harness and pull together the required resources, execute and implement an action plan, and harvest the
rewards in a timely and flexible way.
Table 9.1
Six Dimensions of Entrepreneurship
Key Business
Dimension

Entrepreneur

Traditional
Manager

Strategic orientation

Opportunity driven

Resource driven

Commitment to
opportunity

Quick and short

Long and slow

Commitment of
resources

Minimal with many


stages

Complete in a
single stage

Concept of control

Use or rent

Own or employ

Management
structure

Networks with
little hierarchy

Formalized
hierarchy

Compensation and
rewards

Value-based and
team-based

Individual and
hierarchical

Source: Adapted from Stevenson (1983).

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The Mind of an EntrepreneurTimmons Work


Jeffrey Timmons studied the mind of various successful entrepreneurial individuals and found that entrepreneurs share a common set of
attitudes and behaviors.10 Accordingly, Timmons posits that successful
entrepreneurs:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Work very hard;


Are driven by a deep sense of commitment and perseverance;
Have an optimistic outlook;
Strive for integrity;
Have a competitive desire to excel and win;
Are dissatised with the status quo;
Seek opportunities and improvements constantly;
Use failure as a tool for learning, development, and growth;
Shun perfection in favor of effectiveness; and
Hold a strong belief that they can personally make a difference.

Moreover, Timmons suggested that successful entrepreneurially


minded individuals possessed solid general management skills and
business know-how and were found to be endowed with creative and
innovative capabilities.
In a similar vein, the Entrepreneurship Forum of New England (EFNE)
suggests the following six qualities of a successful entrepreneur:11
Dreamer: Imagines how something can be better and different.
Innovator: Demonstrates how the idea applied outperforms current
practice.
Passionate: Expresses so the idea creates energy and resonance with
others.
Risk taker: Pursues a dream without all the resources lined up at the
start and distributes the risk.
Dogged committer: Stays with executing the innovation and to make
it work.
Continuous learner: Explores constantly and evolves to do best
practice.
Characteristics of EntrepreneursBygraves Work
William Bygrave studied the characteristics of entrepreneurs and presented a list of 10 salient characteristics in the form of 10 Ds that were
found in successful entrepreneurial individuals.12 These key characteristics and their description are depicted in Table 9.2.

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179

Table 9.2
Key Characteristics of Successful Entrepreneurs
Characteristic

Description

Decisiveness

Entrepreneurs make decisions swiftly and decisively.

Dedication

Entrepreneurs are completely dedicated and work


tirelessly.

Destiny

Entrepreneurs wish to be in charge of their own destiny.

Details

Entrepreneurs are obsessed with the critical details.

Determination

Entrepreneurs implement entrepreneurial ventures with


great determination and commitment.

Devotion

Entrepreneurs are deeply devoted and absolutely love


what they do.

Distribute

Entrepreneurs distribute ownership with key employees.

Doer

Entrepreneurs act upon their decisions resolutely.

Dollars

Entrepreneurs view the bottom line as the measure of


success rather than as a motivational driving force.

Dream

Entrepreneurs are visionaries and possess the ability


and drive to materialize their own dreams.

Source: Adapted from Bygrave (1997).

Having reviewed some of the key characteristics of successful entrepreneurs, what does the actual process of entrepreneurship entail?
THE PROCESS OF ENTREPRENEURSHIP
A number of scholars have conceptualized, analyzed, and formalized
the process of entrepreneurship. The process of entrepreneurship, at its
most basic, is a three-stage process comprising opportunity discovery,
venture creation, and exploitation.13 Accordingly, this three-phase process comprises the following distinct stages:
The innovation phase: It is in this phase that the entrepreneur conceives, generates, and selects ideas for new products and services;
The implementation phase: This process is generally triggered by
a decision to pursue an idea and encompasses the acquisition
of viable resources, including, among others, capital, labor, and
technology;
The growth phase: It is in this phase that the new entrepreneurial venture first shows signs of progress, growth, and commercial
success. As such, the entrepreneur needs to secure new resources,

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especially managerial capacity, in order to support and sustain the


viable growth of the entrepreneurial initiative.
Of course, each phase is affected by a variety of external factors, such
as personal characteristics of the entrepreneur, the environment, and the
characteristics of the actual innovation.14
At the heart of an entrepreneurial process is an opportunity. The recognition and assessment of opportunities is critical to the viability and
success of entrepreneurial endeavors. A good business opportunity
rests on an underlying demand for the product or service. Such products and services should possess value-adding properties that generate
profits (for-profit endeavors) or create self-sufficiency (not-for-profit endeavors). Next, resources need to be harnessed and utilized judiciously.
More specifically, in the early stages of an entrepreneurial activity, the
entrepreneur needs to minimize and tightly control all resources; in later
stages, he or she will seek to maximize and own the resources. The understanding and appointment of team members is crucial for success
since the team requires persistence, tolerance, ambiguity, creativity,
leadership, communication, and adaptability. Ultimately, the tool that
integrates these three elements togetheropportunity, resources, and
teamis the business plan.15
INFLUENCING THE ENTREPRENEURIAL
ENGAGEMENTA MOTIVATIONAL ASPECT
Why do people take personal, financial, and social risks pertaining to
entrepreneurial activities? It has been reported that individuals decide
to pursue elements of entrepreneurship for a number of reasons. One
distinction that has been made in the literature is the aspect of positive
or pull factors versus negative or push factors of entrepreneurship.16 Examples of so-called pull strategies include the need for achievement, a
desire to be independent, and social development possibilities. In contrast, push factors may include dissatisfaction with the present professional and/or financial situation, family pressures, involuntary exit
from employment, and the risk of unemployment. Within the context of
global entrepreneurship, the distinction between opportunity-based and
necessity-driven entrepreneurship is of great significance.17
Although there are a variety of discussions contrasting opportunitydriven versus necessity-driven entrepreneurship, there appears to be
some agreement that necessity entrepreneurs are driven mainly by push
motivations, whereas pull factors predominate for opportunity-based
entrepreneurs.18 Opportunity entrepreneurship reflects many startup ventures seeking to take advantage of arising business opportunities, whereas necessity entrepreneurship exists due to a lack of better

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professional choices. Opportunity entrepreneurs frequently pursue business opportunities for personal interest and while still employed.19 Individuals pursuing entrepreneurial activities out of necessity may see
these opportunities as their best current choice, while not necessarily the
preferred occupation. Still, a necessity-based activity may evolve into an
attractive alternative over time.20
Empirical research shows that the distinction between opportunitybased and necessity-driven entrepreneurship is an important one in both
theoretical and practical terms. First, it has been reported that opportunity and necessity entrepreneurs differ in terms of level of education,
socioeconomic characteristics, and age.21 Second, a start-up situation
has consequences in the way the operation is managed as well as for
its ensuing business performance. For instance, individuals who launch
their own businesses due to financial incentives tend to behave differently from individuals who desire to create an entrepreneurial venture in
order to pursue work-life choices.22 Necessity-driven entrepreneurs tend
to be less satisfied than their opportunity-motivated peers. At the microlevel, the outcomes have revealed aspects of inferior performance on the
part of necessity entrepreneurs, whereas at the macrolevel, opportunity
and necessity entrepreneurs have shown to have a different impact on
job creation and economic growth.23 Third, the study of the interplay
between business activity and entrepreneurial cycles has shown that
opportunity entrepreneurship leads the business cycle by two years,
whereas necessity entrepreneurship leads the business cycle by only
one year.24 Last, it has been observed that the determinants of nascent
opportunity and necessity entrepreneurship differ, yielding important
consequences for policy makers. Measures to stimulate necessity-driven
entrepreneurship do not necessarily benefit opportunity-driven entrepreneurship, and vice versa.25
ENTREPRENEURSHIP VERSUS INTRAPRENEURSHIP
In many ways, the successful entrepreneur embodies the popular vision and manifestation of business success in todays world. The entrepreneurially savvy individual starts a new venture from scratch, secures
the required resources, and builds it into a sustainable business venture.
Of course, this takes a tremendous amount of vision, innovation, and
dedication. It has been well documented in both the literature and popular press that the process of entrepreneurship is ridden with peril and
tangible risk. Sadly, many entrepreneurial start-ups end up in commercial demise. Unsurprisingly, not everyone aspires to become an entrepreneur. Moreover, although there are probably tens of millions of potential
entrepreneurs in the United States alone, most people simply are not in
a position to pursue their entrepreneurial dreams and ideas for a variety

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of reasons, including but not limited to financial constraints, family concerns, and others.26
The values and aspirations of the ambitious entrepreneur are not confined to new start-ups. The goals and rewards of the entrepreneurially
minded person are in fact realizable within the confides of existing organizations. The intrapreneur, also known as the internal entrepreneur or
corporate entrepreneur, has become increasingly recognized for his or
her capacity to act as a catalyst to build and add value to the organizations overall performance and success.27
The term intrapreneur first appeared in a research paper by U.S. management consultants and authors Gifford and Elisabeth Pinchot in 1978
and entered into the American Heritage Dictionary in 1992. An intrapreneur has been defined as:
A person within a large corporation who takes direct responsibility
for turning an idea into a profitable finished product through assertive risk taking and innovation.28
The advent, definition, and conceptualization of the concept of intrapreneurship were products of commercial developments of the late
20th century. This era was dominated by large corporations bloated with
extraneous employees, heavy on hierarchy and hierarchical layers, burdened by slow communication systems, and stifled by a rigid interface
between the organizations and their many stakeholders. Indeed, it was
in the late 20th century and the early days of the 21st century, where
revolutions in technology and communication unfolded, which in turn
have affected markets and entire societies. As a direct consequence, organizations have become fluid, actions instantaneous, and change discontinuous and unrelenting.
In the midst of all these unveiling changes, firms rely heavily on their
ongoing innovative capabilities for vitality and success. Clearly, it is now
widely understood that information is ubiquitous, ideas are pervasive,
and most resources are readily available. This combination, presenting
both challenges and opportunities for firms and employees, may in fact
constitute the beginning of a new age of entrepreneurship: the rise of the
intrapreneur.
Intrapreneurship mobilizes individuals within organizations to put
their passion, creativity, innovative capacity, and talents into play in
order to maximize their creative potential and achievements. Firms
are forced to foster an environment where an intrapreneurial mindset
among employees can develop and thrive. It has been reported that
such attempts yield increased levels of employee motivation, engagement, and retention, as well as heightened innovation ultimately leading
to the development of a competitive edge. Although there are legitimate concerns for both employers and employees, including the fear of

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unrelenting change and the risk of losing valuable resources, yet in this
day and age, developing and empowering intrapreneurially minded
people is critical to the ongoing success, relevance, and triumph of
any organization.
So, how can a culture of intrapreneurship within firms be attained?
First and foremost, the intrapreneur does not need an assigned intrapreneurial role by the firm. The intrapreneur needs to empower himself
or herself to create his or her own enriched role for the betterment
and sake of the organization. Second, intrapreneurship can be found
in any organization; for-profit and not-for-profit, small and large, local
and global, mainstream and niche, private and public, as well as in all
industries and government-owned agencies. Third, intrapreneurship is
not confined to the development of new processes, products, and services. Intrapreneurial behavior on the part of an employee permeates
all organizational facets and includes improving efficiencies, developing
new markets, and taking existing products and services to new heights.
Examples of Intrapreneurial Activities
A number of firms have reaped deep admiration, fame, and prominence for cultivating internal intrapreneurial cultures that promote individual and organization innovation. A well-cited example of the power
of intrapreneurial innovation is the well-known Skunk Works group at
Lockheed Martin. This group, originally named after a reference in a
cartoon, was first assembled in 1943 in order to build the P-80 fighter jet.
The project was secretive and internally protected since it was to become
part of the United States war efforts.29
At 3M, formerly known as the Minnesota Mining and Manufacturing Company, employees are allowed to spend up to 15 percent of their
working time on projects for the advancement of the firm. Based on the
initial success of this practice, 3M has since introduced a $3 million inhouse intrapreneurial program to fund projects that may not necessarily attract funding through ordinary channels. These so-called genesis
grants offer up to $85,000 to selected innovators to carry forward their
projects.30
A number of technology firms have a strong culture of innovation and
in-house development. Prominent examples include Hewlett-Packard
(HP), Microsoft, Intel, Oracle, and Google. The last-named has been
recognized frequently for permitting its employees to spend up to
20 percent of their time pursuing in-house innovation and intrapreneurial activities.31
A classic example of intrapreneurially minded individuals and their
subsequent successes is found in the ascent of John Warnock and Charles
Geschke, formerly employees at Xerox. Frustrated with the rigidity of
the Xerox culture and disenchanted with the lack of support for their

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innovative ideas, Warnock and Geschke both resigned from Xerox as


employees and launched Adobe Systems, which is now an S&P 500 firm
with revenues close to $4 billion.32

STRATEGIC ENTREPRENEURSHIP
The 21st century business landscape has been characterized by revolutionary, unpredictable change, increased levels of risk, fluid firm and
industry boundaries, new managerial mindsets, and innovative business models. In fact, this new atmosphere can be described in terms
of four distinct driving forces: change, complexity, chaos, and contradiction.33 The ability to navigate through this challenging environment has
become a focal point of scholars in the disciplines of economics, strategic management, and entrepreneurship. Strategic entrepreneurship
is a relatively new term that has arisen in the business literature representing the intersection of strategy and entrepreneurship. To date, the
exact nature of strategic entrepreneurship has remained somewhat elusive and abstract.34
Strategic entrepreneurship has been discussed mainly within the
realm of corporate entrepreneurship. Strategic entrepreneurship refers
to a broader array of entrepreneurial phenomena. Although they may
or may not result in new business entities being added to the firm, they
all involve organizationally consequential innovative activities that are
adopted in the pursuit of sustainable competitive advantages. It has
been reported that strategic entrepreneurship involves opportunityseeking (i.e., entrepreneurship) and advantage-seeking (i.e., strategic
management) behaviors simultaneously.35 These innovations are the
foci of strategic entrepreneurship initiatives and represent the means
through which opportunity is created and exploited. As such, innovation can occur anywhere and indeed everywhere within the firm.
An emphasis on an opportunity-driven mindset enables management
to obtain a competitively advantageous position for the firm. Such innovations may constitute fundamental changes from the organizations
past strategies, products, services, markets, structures, capabilities, or
business models, or, alternatively, the innovations may represent fundamental bases that differentiate the firm from its industry competition.
Thus, there are two salient aspects that ought to be considered when a
firm showcases strategic entrepreneurship:
1. To what degree is the rm transforming itself relative to where it
was in the past?
2. To what degree is the rm transforming itself relative to industry
benchmarks and standards?36

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As noted above, some organizations are known to exhibit very high


levels of innovation consistently; they are known as entrepreneurially
minded firms whose operations are deeply rooted in entrepreneurial
corporate cultures. However, innovation is not confined to the culture
but may be embedded in the actual industry in which the firm operates. For instance, technology-based and fashion-related industries have
a tendency to demonstrate continuous entrepreneurial behaviors. Therefore, innovation per se may not prove to be the basis on which firms are
differentiated from their industry rivals. Rather, it may be the products,
services, and processes that result from innovation that determine how
well they are differentiated from the industry rivals.
Literature shows that strategic entrepreneurship can take on five
distinct forms, namely, strategic renewal, sustained regeneration, domain redefinition, organizational rejuvenation, and business model
reconstruction.37
In strategic renewal, the organization redefines its relationships with
its competitors by altering its competitive strategies and practices. As
such, new strategies constitute strategic renewal when they represent
a fundamental repositioning of the organization within its competitive
landscape. Strategic renewal has also been labeled strategic innovation
or value innovation.
Second, sustained regeneration refers to an entrepreneurial practice
whereby the organization introduces new products and services or enters new markets on a regular basis. Within this strategic framework, the
firm is in constant pursuit of entrepreneurial opportunities. Sustained
regeneration serves as a basis for pursing competitive advantages where
short product-life cycles, rapidly changing technological standards, and
segmenting product categories and market arenas are common practice.
Sustained regeneration cannot be represented by a one-off event but exists when a corporation demonstrates a pattern of recurrent new product
innovations and market entries. Therefore, firms that pursue sustained
regeneration practices enjoy a reputation of innovation powerhouses.
Third, domain redefinition refers to an entrepreneurial strategy whereby
the organization creates a new product-market arena that others have
not yet recognized or explored. Within this framework, firms move into
unchartered waters or blue oceans.38 Technically speaking, these pioneering elements are product-market arenas in which new categories are
represented. Domain redefinition can lead to the redefinition of boundaries of existing industries or provide a landscape for the emergence of
new industries. There is an underlying expectation that first-mover status will provide a basis for sustainable competitive advantage for the
firm.
Fourth, organizational rejuvenation refers to an entrepreneurial strategy
where the organization purports to improve or sustain its competitive

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position by modifying existing internal processes, capabilities, or structures.39 Within this framework, the emphasis of the innovation is to
focus on a set of core attributes linked with the firms internal operations. As such, the main effort is to create a powerful organizational
vehicle through with the firms strategy can be implemented. Organizational rejuvenation has the capacity for the firm to attain a sustainable
competitive advantage without changing its business strategy, product
offerings, or served markets. In fact, there are times when organizational
rejuvenation entails a fundamental redesign of the entire firm, such as
a business process reengineering (BPR) endeavor, which purports to reconfigure an organizations value-chain elements. Organizational rejuvenation can also involve single innovations that have deep implications
for the organizational entity, such as a strategic restructuring effort, or
multiple smaller innovations that collectively contribute to increased
levels of effectiveness or efficiency at strategy implementation. However, in true organizational rejuvenation, the innovative endeavors cannot simply imitate initiatives that are commonplace to the industry but
must, at least temporarily, differentiate themselves from existing industry practices.
Fifth, business model reconstruction refers to an entrepreneurial strategy where the organization recalibrates its business model to improve
operational efficiencies. Popular activities within the business model
reconstruction model include strategic elements, such as outsourcing,
which rely upon external contractors for activities previously provided
internally, and vertical integration, which combines supplier or distributor functions within the ownership or control of the firm.
STRATEGIC ENTREPRENEURSHIP
CONCEPTUAL FRAMEWORKS
Simply put, strategic entrepreneurship can be considered as the intersection of two distinct bodies of literature: strategy and entrepreneurship. This entity comprises the integration of both concepts and
constitutes a combination of exploration and exploitation aspects.
More specifically, strategic entrepreneurship, defined as exploration for
future sources of competitive advantage, combined with exploitation of
current sources of competitive advantage, has been proposed as a way
for decision makers to manage uncertainty.40
A number of conceptual frameworks have appeared in the business
literature. The foundational conceptual framework of strategic entrepreneurship, which was published in 2001, comprised six key domains.41 It
has been posited that activity in these six areas can be jointly classified
as entrepreneurial and strategic.

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1.
2.
3.
4.

Innovation (i.e., creating and implementing ideas);


Networks (i.e., providing access to resources);
Internationalization (i.e., adapting swiftly and expanding);
Organizational learning (i.e., transferring knowledge and developing resources);
5. Growth (i.e., stimulating success and change); and
6. Top management teams and governance (i.e., selection and implementation of strategies).
Management scholars originally commented that there was an
overly strong emphasis on strategy, overlooking the themes central to
entrepreneurship. As a consequence, a revised framework emerged a
few years later, which included external networks and alliances, resources and organizational learning, and innovation and internationalization.42 Although the models have similarities, the latter framework
with its emphasis on resources, competencies, and capabilities has a
strengthened view on both strategy and entrepreneurship. In 2003, the
original authors of the 2001 framework introduced a modified framework having revised the dimensions pertinent to entrepreneurship.
They included the aspects of entrepreneurial mindset, entrepreneurial
leadership, entrepreneurial culture, the strategic management of resources, and the application of creativity to develop innovations. The
full integration of these dimensions is believed to result in wealth creation.43 It has been reported that the modified model reflects a substantial change in the direction of the literature. Thus, there are four key
dimensions that are commonly associated with the notion of strategic
entrepreneurship:
1. an entrepreneurial mindset consisting of insight, alertness, and
exibility to use appropriate resources;
2. an entrepreneurial culture and leadership where innovation and
creativity are fostered;
3. the strategic management of resources, which includes human,
social, and nancial capital; and
4. the application of creativity to foster both incremental and radical
innovation.
Later in the first decade of this new millennium, it was underscored
that strategic entrepreneurship should strike a balance between opportunity-seeking (i.e., exploration) and advantage-seeking (i.e., exploitation)
behaviors, thereby highlighting the importance of and need for continuous innovation.44 Additional models and frameworks have since been
established and published. However, the strategic entrepreneurship

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emphasis has to some extent remained theoretical with little guidance


and practical support.
INTEGRATING ENTREPRENEURSHIP WITH STRATEGY
Reviewing the bodies of literature of entrepreneurship and strategic
management suggests strongly that both disciplines are concerned with
firm performance. Whereas entrepreneurship promotes the pursuit of
sustainable competitive advantages by means of market, process, and
product innovations, it is strategic management that presents the tools
for firms to establish and exploit sustainable competitive advantages
within a confined environmental context.
In order to integrate entrepreneurship with strategy, it is important
to discuss the concepts of dominant logic and dynamic dominant logic.
The former, dominant logic, refers to the way in which executives understand and conceptualize a business operation and make critical decisions regarding the allocation of resources. Dominant logic has been
defined as the lens through which managers see emerging opportunities and options for the firm.45 Put differently, dominant logic relates
to the main means and methods that a firm utilizes in order to pursue
profitsthat is, how a firm has succeeded or continues to succeed in its
operations. Interestingly, although the dominant logic of a firm attempts
to capture prevailing mindsets, it also filters and interprets information
obtained from the environment, which, ultimately, guides the strategies,
systems, processes, and displayed behaviors within an organizational
entity. As such, managers have been found to consider only information
that is perceived to be relevant to the entitys dominant logic.
The latter concept, a dynamic dominant logic, is an extension of the
original concept of dominant logic whereby entrepreneurship acts as the
basis on which the firm is to be conceptualized and resources to be allocated.46 As a dynamic dominant logic, entrepreneurship has the capacity to promote strategic agility, flexibility, creativity, and continuous
improvement throughout the organization.47
It has been posited that entrepreneurship is more than a preselected
course of action; it is certainly more than a managerial mindset. Entrepreneurship has the ability to provide a theme or direction for a firms
entire business operation. Strategically speaking, entrepreneurship must
be an integral part of an organizations business strategy. Whereas strategy determines the direction of a firm, it is the integration of entrepreneurship into strategy at the organization level that has the capacity to
greatly enhance the strategic possibilities of the firm.48
Finally, the purposeful integration of entrepreneurship into strategy
has two key aspects: entrepreneurial strategy and a strategy for entrepreneurship. Entrepreneurial strategy encompasses discussions and

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issues regarding the application of creativity and entrepreneurial thinking to the development of a core strategy for an organization. Strategy
for entrepreneurship, in contrast, is concerned with the need to develop
a strategy to guide entrepreneurial activities taking place within the organization.49 This, however, is based upon the understanding that firms
that embrace entrepreneurship outperform firms that fail to focus on entrepreneurship in the long run.50
ENTREPRENEURSHIP EXTENDS ITS INFLUENCE
THE RISE OF THE SOCIAL ENTREPRENEUR
The notion of social entrepreneurship is an emerging academic discipline challenged by competing and conflicting definitions, conceptual
frameworks, and limited empirical evidence. It is clear that the process
of entrepreneurship can be applied to the creation of economic as well as
social goals. Indeed, the late Peter Drucker suggested that the entrepreneur always looks for change, responds to change elements, and exploits
change as opportunities.51 This is regardless of whether the opportunity
has commercial or social motivations. Traditionally, the focus of institutional entrepreneurship has been on for-profit entities, whereas the term
social entrepreneurship has been used to describe activities with social
purposes. However, in recent years, social entrepreneurs increasingly
have been seen as individuals pursuing entrepreneurial (i.e., for-profit)
activities with embedded social purposes.
Over the past decade, the discussion on social entrepreneurship, especially in the popular media and in the business press, has focused on the
successes of high-profile business entrepreneurs. In 2006, for instance,
Bill Drayton, founder of Ashoka, a not-for-profit organization dedicated
to promoting and supporting social entrepreneurs, publicly proclaimed
that social entrepreneurship has the capacity to spark a worldwide productivity miracle. Draytons ideas have since enticed influential business individuals including e-Bay founder Jeff Skoll, who launched the
Skoll Foundation with its focus on promoting social entrepreneurship.
So what exactly motivates social entrepreneurs? The Skoll Foundation describes these social entrepreneurs as individuals who are motivated by altruism and a profound desire to promote the development
and growth of equitable civil societies who pioneer innovative, effective,
and sustainable approaches to meet the needs of the marginalized, the
disadvantaged, and the disenfranchised. As such, social entrepreneurs
are the wellspring of a better future.52
The response from the academic community on the emergence of this
new phenomenon has been less enthusiastic. Although scholars have
examined and conceptualized social entrepreneurship, the field has remained immature and lacks depth, richness, and prescription.53

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How can a social entrepreneur be defined? A social entrepreneur is an


individual, group, network, organization, or alliance of organizations
that seeks sustainable, large-scale change through pattern-breaking
ideas in what or how governments, nonprofits, and businesses do to
address significant social problems.54 More pragmatically, a social entrepreneur is an individual who recognizes a social problem and uses
entrepreneurial principles to create a business venture in order to generate social change. Whereas a traditional business entrepreneur typically
measures the success of his or her efforts in terms of profitability and
return on investment (ROI), the social entrepreneur is interested in furthering social and environmental goals.
A debate over the exact definition of social entrepreneurship persists,
reinforcing the need for a more constrained definition.55 It appears that
the current literature lacks empirical evidence of the successes, scalability, and sustainability of social improvements. It has even been reported
that the proliferation of new social entrepreneurial activities may actually create competition and inefficiencies in an already highly fragmented social sector.56
Social entrepreneurship has been studied and analyzed from three
distinct approaches. The first approach views not-for-profit organizational entities as social entrepreneurships. The second approach, in contrast, focuses on how social entrepreneurship can be successful through
profit mechanisms, and a third approach emphasizes and focuses on the
social change aspects of social entrepreneurship.57 Unambiguously, the
latter view is comparable with a Schumpeterian perspective in that entrepreneurs are essentially agents of change.
Social EntrepreneursPast and Present
Interestingly, although the formal study of social entrepreneurship is
relatively new, it must be clear that the notion of the social entrepreneur
has existed throughout human history. Indeed, socially minded, entrepreneurially driven individuals whose tireless work typifies the concept
of social entrepreneurship have literally changed the world. Some of
them include the following:
Vinoba Bhave: Founder of Indias land-gift movement;
Akhtar Hameed Khan: Pakistani founder of the grassroots movement
for rural communities (Comilla model) and the low-cost sanitation
program for squatter settlements (Orangi pilot project);
Maria Montessori: Italian founder and developer of the Montessori
approach to early childhood education;
Florence Nightingale: English founder of the first nursing school and
creator of modern-day nursing practices;

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Robert Owen: Welsh founder of the worldwide Cooperative Movement; and


Friedrich Wilhelm Raiffeisen: German principal founder of the credit
union and cooperative bank sectors now forming a major segment
of the European banking system.
The endeavors of some (if not all) of the individuals listed above have
brought about deep societal impact and lasting change on a global scale.
Equally important, the list of contemporary social entrepreneurs shows
a rich diversity of individuals who have aspired and continue to tackle
societys most pressing problems using creative and innovative entrepreneurial solutions.
The following snapshot is a small, incomplete overview:
Ibrahim Abouleish: Egyptian founder of SEKEM, a biodynamic agricultural firm, alternative medicine, and educational center based
in Cairo;
Ela Bhatt: Indian founder of SEWA (self-employed womens association) and SEWA Bank;
Bill Drayton: U.S. founder of Shoka, Youth Venture, and Get America Working!;
Marian Wright Edelman: U.S. founder and president of the Childrens Defense Fund (CDF) and strong advocate for disadvantaged
U.S. children;
Jamie Oliver: English TV chef who campaigns to improve childrens
diet at schools. He also trains young people to become chefs. He
founded a social enterprise, Fifteen, which employs newly trained
youngsters;
Muhammad Yunus: Bangladeshi founder of the Grameen Bank and
inventor of the microcredit, which earned him the 2006 Nobel
Peace Prize; and
Willie Smits: Indonesian founder of the Borneo Orangutan Survival Foundation and founder and chairperson of the Masarang
Foundation.
There are various debates over who does and who does not count as
a social entrepreneur. For instance, some have advocated restricting the
term to founders of organizations that rely upon earned income generated directly from paying customers. This is in contrast to others who
have extended this by including incomes earned by contracting with
public authorities, and yet others include receiving grants and donations as part of the social entrepreneurship model. Most fundamentally, discussions continue regarding the delineation between business

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entrepreneurship, with its focuses on wealth creation and economic development, and social entrepreneurship with its emphasis on generating
social capital and making the world a better place.58
CONCLUDING THOUGHTS
This chapter has established that strategic entrepreneurship is the
utilization and stimulation of entrepreneurial activity in order to attain
strategically defined goals, including but not limited to differentiation,
diversification, integration, and the pursuit of sustainable competitive
advantages. Entrepreneurial activities present significant potential to
achieve such ambitious goals and are thus deemed effective tools for the
strategically minded executive. The research has also established that
strategic entrepreneurship is comparable with the notions of corporate
entrepreneurship at the strategic and corporate levels and intrapreneurship at the more tactical, operational, and individual levels. Like entrepreneurship in a broad sense, strategic entrepreneurship is a business
phenomenon that has antecedents and outcomes on various levels of
analysis. This field of management will benefit from further conceptual
and empirical study.
Finally, at the individual level, strategic entrepreneurial activities entail the systematic pursuits and exploitation of opportunities that align
with a persons existing knowledge and available resources, even where
the creation of wealth may not be the final goal. On a more corporate, regional, or national level, strategic entrepreneurship embodies the design
and development of a framework that fosters entrepreneurial endeavors
by individuals, agencies, and firms pursuing organizational, regional,
and national goals. These goals are not confined to financial development and economic growth; they also include the sustainable use of natural resources, as well as the pursuit of improved levels of individuals
well-being and overall quality of life.
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39. Kuratko, D. F. & Audretsch, D. B. (2009). Strategic entrepreneurship: Exploring different perspectives, Entrepreneurship Theory and Practice, 33 (1), 117.
40. Ireland, R. D., Hitt, M. A., Camp, S. M., & Sexton, D. L. (2001). Integrating
entrepreneurship and strategic management actions to create firm wealth, Academy of Management Executive, 15 (1), 4963.
41. Luke, B., Verreynee, M. L., & Kearins, K. (2010). Innovative and entrepreneurial activity in the public sector: The changing face of public sector institutions,
Innovation: Management, Policy and Practice, 12 (2), 138153.
42. Hitt, M. A., Ireland, R. D., Camp, S. M., & Sexton, D. L. (2001). Guest editors
introduction to the special issue strategic entrepreneurship: Entrepreneurial strategies for wealth creation, Strategic Management Journal, 22 (67), 479491.
43. Ireland, R. D., Hitt, M. A., & Sirmon, D. G. (2003). A model of strategic entrepreneurship: The construct and its dimensions, Journal of Management, 29 (6),
963989.
44. Ireland, R. D. & Webb, J. (2007). A multi-theoretic perspective on trust and
power in strategic supply chains, Journal of Operations Management, 25: 482497.
45. Prahalad, C. K. (2004). The blinders of dominant logic, Long Range Planning,
37: 171179.
46. Morris, M. H., Kuratko, D. F., & Covin, J. G. (2008). Corporate Entrepreneurship and Innovation, Mason, OH: Thomson/South-Western Publishers.

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47. Kuratko, D. F., & Audretsch, D. B. (2009). Strategic entrepreneurship: Exploring different perspectives on an emerging concept, Entrepreneurship Theory and
Practice, 33 (1): 117.
48. Kuratko, D. F., Ireland, R. D., & Hornsby, J. S. (2001). Improving firm performance through entrepreneurial actions: Acordias corporate entrepreneurship
strategy, Academy of Management Executive, 15 (4), 6071.
49. Kuratko, D. F. & Audretsch, D. B. (2009). Strategic entrepreneurship: Exploring different perspectives on an emerging concept, Entrepreneurship Theory and
Practice, 33 (1): 117.
50. Morris, M. H., Kuratko, D. F., & Covin, J. G. (2008). Corporate Entrepreneurship and Innovation, Mason, OH: Thomson/South-Western Publishers.
51. Drucker, P. (1985). Innovation and Entrepreneurship, New York: Harper and
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52. http://bricksandmortar.wordpress.com/social-entrepreneurship/.
53. Dees, J. G., & Anderson, B. B. (2006). Framing a theory of social entrepreneurship: Building on two schools of practice and thought. In Research on Social
Entrepreneurship: Understanding and Contributing to an Emerging Field, R. MosherWilliams (ed.). ARNOVA Occasional Paper Series, 1 (3), 3966.
54. Light, P. C. (2006). Reshaping social entrepreneurship, Stanford Social Innovation Review, 4 (3), 4651.
55. Center for the Advancement of Social Entrepreneurship (CASE) (2008). Advancing the field of social entrepreneurship, Center for the Advancement of Social Entrepreneurship, Fuqua School of Business, Duke University, Durham, NC.
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56. Nicholls, A. (2006). Playing the field: A new approach to the meaning of social entrepreneurship, Social Enterprise Journal, 2 (1), 15.
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58. http://usasbe.org/knowledge/proceedings/proceedingsDocs/2009/Pa
perID187.pdf.

Chapter 10

The Competitive Advantage of


Strategic Alliances: Companies
Profiting from Partnerships with
Competing and Noncompeting
Companies
George Nakos

INTRODUCTION
In an increasingly complicated global business environment, companies
have discovered that it is impossible to go alone. The tool that firms from
large multinationals to small- and medium-sized enterprises have found to
be successful in helping them navigate treacherous foreign markets is the
formation of strategic alliances. In an interconnected world, a networked
company that has the ability to locate and form the appropriate strategic partnerships will be able to gain a sustainable competitive advantage.
The proliferation of strategic alliances in multiple industries, from health
care to computer research is changing the way business is conducted internationally and small and large business need to be aware of these developments. A capacity to collaborate that a company may possess
has become an important asset that differentiates it in the marketplace.1

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197

Companies that do not have the ability to cooperate or are reluctant to


form networks and alliances are operating at a competitive disadvantage.
A strategic alliance is an interorganizational cooperative agreement that
leads to the allocation of resources and skills by two or more organizations
for the achievement of common goals, as well as goals unique to individual partners.2 A wide variety of partnerships exist and a company may engage in distinctive partnerships for a multitude of reasons. For example,
a firm can engage in sales partnerships with either intermediate customers or ultimate customers; supplier partnerships with goods suppliers or
services suppliers; lateral partnerships with competitors, nonprofit organizations, and various government entities; or even internal partnerships
among the various business units of a firm, its functional departments,
and the employees of the company.3
Companies engage in alliances because they expect to gain benefits and
improve their competitive advantage. Alliances provide firms with a wide
variety of tangible and intangible benefits. An alliance can supply a company with a more effective way of entering foreign markets, an ability
to circumvent foreign market barriers, a way to defend its home market
from foreign and domestic intruders, or an inexpensive approach of extending its product line. At the same time, a firm incurs certain costs by
engaging in strategic alliances and it needs to do a thorough cost-benefit
analysis prior to selecting potential partners. These drawbacks include the
managerial time that the firm spends in negotiations; loss of freedom to
act alone in the areas of common agreement; potential loss of proprietary
technology to the partner that may be used later on to directly compete
against the products of the company; relying too much on a partnership
and as a result not developing internal capabilities necessary to compete
successfully in an industry; and the liquidation costs of a potential partnership termination which can be huge and very expensive for many companies to handle.4
Strategic alliances also differ in the scope and importance for a particular firm. An alliance can be extremely important and whether this will be a
successful partnership may determine the future survival of a company. In
this type of all-encompassing alliance, two companies may attempt to integrate all their functional areas. Many airlines in recent years have signed
very close alliances that have integrated them with other airlines. For example, Delta Airlines has signed a very wide cooperative agreement with
Air France, the European carrier. This type of agreement requires a high
level of cooperation from almost all the functional areas of the two companies. It is also a very risky partnership because both parties have a huge
investment and if the partnership is not successful both parties will suffer
a substantial loss. On the other hand, in most cases, the vast majority of
alliances usually concentrate in one particular function of a company. The
Japanese carmaker Toyota announced in August 2011 a strategic alliance

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with Ford Motor Company to jointly develop a gas-electric hybrid fuel


system for sport utility vehicles and pick-up trucks. The new alliances
main goal is to keep large vehicles affordable while they meet stricter fuel
efficiency rules mandated by new U.S. federal government guidelines.5
This type of partnership, although important for both companies, involves cooperation of only certain functional areas of the two corporations. Although they will be cooperating in these areas, the two companies
will still be fierce competitors.
This chapter will explore the growth of strategic alliances in recent
years, the reasons that motivate companies to enter into partnerships with
firms in domestic and foreign markets, and the potential competitive advantage that a company can gain from a strategic alliance. In addition, the
advantages and disadvantages of engaging in alliances with competitors
and not competitors will be investigated.

EVOLUTION OF ALLIANCES
The rapid growth of alliances in recent years originated in the radical changes that the world economy has experienced. The rise of the
globalization challenge with the dismantling of trade barriers and huge
improvements in communications technology, accompanied by the rapid
industrialization of previously underdeveloped nations, led many companies located in developed nations to realize that they did not have the
required resources to compete in the global environment by themselves
anymore. As early as the 1970s many U.S. and European companies found
it difficult to respond to the challenge posed by technologically advanced
Japanese companies and decided to form alliances with other companies
to defend their home turf. In the late 1970s, General Motors, a company
that had dominated car making in the previous four decades, was forced
into an alliance with Toyota, a Japanese company that had mastered the
art of making the inexpensive quality compact cars that consumers faced
with high gasoline costs were demanding. The two companies had very
different motivations to enter into a strategic alliance. General Motors was
eager to learn how to increase its quality and produce smaller quality vehicles. Toyota, on the other hand, was willing to share its technology with
a competitor, in order to expand its access to the lucrative U.S. car market.
Its hope was that if it showed the U.S. government and public that it was
willing to cooperate with U.S. companies, it would be a lot less likely that
General Motors and other U.S. domestic automobile manufacturers would
use their considerable political muscle to force the U.S. government to impose punitive tariffs and other trade restrictions on Japanese car imports.
In later years, the expansion of multinational companies in emerging
markets with uncertain political, legal, and economic environments led

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199

them to form partnerships with indigenous players familiar with the local
markets. Moreover, the restrictions that many fast-growing nations have
placed on foreign direct investment and majority acquisition of local concerns, forced companies to try to find local partners. A large number of
multinationals were forced to locate a local partner in China because legal
regulations did not allow them to operate in the market independently.
In recent years the complexity of the business world and the need to
introduce new products at an increasingly rapid pace, have led companies to the creation of strategic partnerships with other companies possessing complementary qualities. Apple Computers is a company that has
greatly benefited by alliance partnerships. It has concentrated its efforts
in the development, design, and marketing of new products while it outsources the actual manufacturing of its products to trusted alliance partners. Apple has been successful precisely because it is only concentrating
in the business functions that can perform better than other companies
and it has delegated activities such as manufacturing, where it does not
possess a competitive advantage to other companies. Most of the manufacturing is undertaken in China with many of the electronic components
originating in other Asian countries or other parts of the world. Nike is
another company with a similar strategy. It has also relied on manufacturing alliances to create new products. It is concentrating only in the parts
of the product value chain that it thinks it possesses a comparative advantage. The more mundane parts of the value chain are outsource to companies that have allied themselves with Nike. Both companies have been
successful because they have identified the areas of the value chain that
they can undertake successfully while delegating other parts of the product to strategic allies. It is important to remember that both companies
learned valuable lessons early on when they tried to vertically integrate
themselves and perform most manufacturing internally. The final product
was too expensive for their customers and their sales suffered. When the
late Steve Jobs tried to create NEXT, his failed computer venture in the
1990s, he tried to establish a state-of-the-art manufacturing facility in California to actually assemble its computers. However, the result was that the
manufactured products were too expensive and the company went out of
business. When Steve Jobs returned to Apple, having learned his lesson,
he decided that the company had to concentrate on the areas that it had a
comparative advantage and outsourced manufacturing operations to alliance partners.
MOTIVATIONS FOR ENTERING INTO A
STRATEGIC ALLIANCE
Although the reasons and motivations of companies to undertake strategic alliances may evolve and change through the years, most companies

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use alliances when they are faced with specific circumstances in the external environment. The following are some of the most common motivations for initiating and forming strategic alliances.6
Entering new international markets. Although in the past companies were
more comfortable utilizing exporting, wholly owned subsidiaries, or joint
ventures to enter new markets, increasingly they tend to utilize strategic
alliances. Cooperating with local companies in a target market or other
international companies familiar with the political and economic environment of a country, provides an expanding firm with the complementary
skills and resources necessary for success. Strategic alliances are especially
useful in foreign markets characterized by a high degree of risk and uncertainty.7 The skills provided by a partner in the strategic alliance will
allow a company to navigate more safely the turbulent waters of an uncertain environment. Even large multinational companies that usually prefer to operate independently through wholly owned subsidiaries around
the globe may decide to locate a partner prior to entering an unfamiliar
new market because they may need the complementary skills that only a
partner in a strategic alliance is able to provide. For example, The CocaCola Company, which usually prefers to operate through wholly owned
vertically integrated subsidiaries, has selected a Greek company, 3E, as
a partner in establishing operations in the former communist nations of
Eastern Europe and the republics that emerged from the breakdown of
the Soviet Union. The Greek company possesses valuable skills and experience in successfully operating in countries with high levels of bureaucratic red tape and corruption. In the past, 3E had established successful
subsidiaries in Sub-Saharan Africa and in several politically unstable
Balkan countries.
Circumvent foreign market barriers. A firm will partner with a company
familiar with the local political, economic, legal, and regulatory risks in
order to circumvent the barriers making it difficult for new foreign companies to enter that market. There is a wide range of market barriers that
may inhibit a company from successfully expanding in a target market.
Trade barriers are the most common and easy to recognize obstacles, but
companies also have to face barriers such as how difficult it is to establish a distribution network or the difficulty to obtain attractive real estate
locations for an expanding restaurant chain. In many countries, McDonalds, the U.S.-based fast food giant, formed alliances with local partners
that possessed access to local real estate. These alliances were particularly
valuable in many European countries with old historic city centers, which
offered limited attractive restaurant locations. In Japan the high retail fragmentation acts as a barrier to foreign companies attempting to enter the
market. An alliance with a local distributor may allow a company to establish itself in Japan at a fairly low cost.

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201

Defend home market competitive position. A very common practice among


international companies is to engage in a partnership with another company in order to enter the home market or other markets in which the
competitor has a large market share. By entering an important market for
a competing company, a firm tries to divert the resources of the competing company in defending its home turf instead of using them in capturing market share in the home market. Wal-Mart, the U.S.-based retailer
powerhouse, has formed alliances with local companies in several Latin
American countries. The expansion of Wal-Mart in Latin America where
its French competitor Carrefour has traditionally been very strong has
provided fierce competition for the French company and has stalled any
plans that it had to expand to North America.
Extend the product line. Even the largest multinational companies may
discover that they have certain gaps in their product line. Engaging in a
strategic alliance may provide a company with a quick way to offer new
products to its existing or new customers. For many years PepsiCo, the
soft drinks giant, had a distribution strategic alliance with the 7UP company to distribute the eponymous product. This alliance benefited both
companies because 7UP did not have to invest in an independent distribution system while PepsiCo could offer a product that was competing
against Sprite, the brand offered by its archrival Coca-Cola Company in
this product category.
Entering new emerging industries. Most established companies have mature products and are constantly looking for new opportunities in emerging industries. Companies may not be able to explore these new industries
on their own because they may not have the monetary or other resource
base to effectively develop new products. Many companies do not possess the entrepreneurial spirit needed to succeed in new emerging industries. Multiple strategic alliances have been formalized in recent years in
the automobile industry, as car companies try to develop new hybrid fuel
or electric technologies. Many of these companies prefer to share the cost
for the development of the new innovative technology instead of trying to
develop the expertise on their own. In the pharmaceutical industries large
firms have formed alliances with smaller research companies that have a
tendency to be more entrepreneurial and have a track record of developing new innovative drugs.
Changing industry structure. Strategic alliances can totally alter the structure of an industry by bringing together new technologies to radically
change the way companies operate in that industry. Large U.S. retailers
such as Target have successfully used technology in recent years to form
close strategic alliances with their suppliers. Retailers do not have to order
new merchandise but new technology provides suppliers with information of when quantities of their products fall below a certain level.

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Reduce future competition. Many companies form strategic alliances


with potential competitors in order to eliminate the potential of this company becoming a future direct competitor. This is a very common strategy among internationally expanding retailers. When an international
retailer expands in a specific market, in many cases it decides form an alliance with a large local retailer. When Gap decided to expand to the Russian market and open local stores, it decided to form an alliance with Fiba
Holding, a firm active in the market and that also manages Gaps stores in
Turkey and the Ukraine. By forming an alliance with a company active in
the local market, Gap Inc. gained local expertise and did not have to compete directly with Fiba Holding Company.8
Increase available resources. Many companies engage in strategic alliances in order to use the manufacturing, distribution, or human resources
of their partners. By utilizing partner resources, a firm does not have to
make substantial investments in their own proprietary infrastructure.
PepsiCo has expanded in many Latin American countries by signing alliance agreements with local companies that possess the manufacturing
facilities and the distribution network to reach the market. These agreements have provided the company the resources to reach these markets
without having to invest in expensive manufacturing facilities and distribution networks.
Acquisition of new skills. Many companies, when they realize that they
lack certain skills, may engage in strategic alliances in order to learn from
their partners. Companies in developing countries tend to look for partnerships with more advanced companies that will provide them with
technological know-how that they need. General Motorss alliance with
Toyota in the early 1980s provided the company with much needed manufacturing technology and allowed it to improve the quality of its cars.
Gaining competitive advantage from alliances. Although almost all companies recognize the importance of alliances in helping them explore new
markets, product lines, and technologies, for a variety of reasons relatively
few partnerships truly increase the competitive position of a business. According to a recent authoritative study of alliance success rates, more than
60 percent of them fail to meet their goals and objectives.9 A company has
to work very closely with its alliance partner in order to maximize the
benefits of the partnership and minimize the drawbacks inherent in any
cooperative agreement.
Companies engage in strategic alliances in order to gain a competitive
advantage or eliminate the competitive advantage gap that separates them
from a more successful competitor. The factors that may push companies
to engage in strategic alliances in order to gain a competitive advantage
usually fall in two major categories: strategic or operational.10 An alliance
that serves long-term strategic purposes may assist a company to enter a
new market or product category whereas an operational alliance strives

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203

to improve an operational function of a company. In international markets strategic alliances allow a company to overcome the disadvantages
associated with its status as a foreign firm and compete on equal terms
with local companies.11 Strategic alliances tend to enhance the competitive
advantage of a company because they provide a company with time to
observe, experiment, and try a variety of problem-solving arrangements
with other companies while it is in the process of building capabilities.12
Companies may use strategic alliances in order to acquire new knowledge
or utilize knowledge from partnerships in directing a companys future
mergers and acquisition decisions.13
International alliances contribute to the competitive position of a company by allowing a firm to:
1 Create critical mass in a specic foreign country or region;
2 Expand its specialized skills by exploiting the skills that partners are
bringing;
3 Expand its knowledge of foreign markets and quickly become an
insider;
4 Introduce new products and services; and
5 Create value through alliance learning.
Although additional benefits of partnering with other companies exist,
these are the main reasons that companies engage in alliances. In most
industries a critical mass is needed in order to become a serious competitor. Alliances provide you with a quick way to achieve a critical mass, the
minimum required size that a company needs in order to be successful
in a specific industry. When Delta airlines changed its strategy and decided to focus on the international as well as the domestic market, its international alliances allowed it to service those parts of the world where
Delta did not haveor planned to havea presence. For example, its alliance with Air France enabled it to offer service to many countries of Africa
where Air France traditionally had a very strong presence due to the historic ties between France and many African nations. It would have been
very difficult for Delta to service these destinations if it was relying only
on its own fleet. Similarly, Delta established a strong presence in Latin
America through alliances with Aeromexico in Mexico and Gol in Brazil.
Through these airlines Delta can offer service to smaller cities in these two
large emerging markets of Latin America. It is obvious that no airline by
itself can develop the global network that can be provided by strategic alliances. In addition, an airline has to be part of a global alliance in order
to participate in the various types of reward programs. The expectation of
greater service and the prospect of earning the same rewards from several
airlines have made it necessary for even large airlines to participate in a
global alliance. This is the main reason that in recent years three alliance

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systemsStar alliance with 27 members, Skyteam with 15 airlines, and


Oneworld with 12 participantshave developed and have dominated the
global airline industry.
In addition to creating marketing alliances, which makes it necessary
for participants to join a specific alliance, the achievement of a critical
mass is very important as industries develop and a common technological standard emerges. The company that succeeds in convincing alliance companies to adopt its technology will reap substantial profits. In
the 1980s, Microsoft won the personal computer battle because it provided
a common platform to a large number of independent companies looking
for an efficient operating system for their personal computers. Microsoft
operating systems, initially the MS-DOS system and then the various Windows versions, became the dominant technological standard and allowed
Microsoft to earn profits by selling complementary products to computer
users worldwide. Apples refusal to share its operating system with other
companies, limited the companys ability to capitalize on the popularity
of its operating system. Thus Apple computers despite the widespread
perception that its products were technologically superior, was reduced to
a niche player. It is possible that if Apple had decided to share its technology with other companies and create technical alliances with software developers, it would have succeeded in making the Apple operating system
the dominant technology in the market. In recent years, Google has been
successful through alliances in making the Android operating system for
smartphones and tablet computers, one of the dominant technologies in
the market. In an ever changing technological world with rapid technological changes, a company has to be very quick in forming the right alliances that will allow it to establish its own technology as the dominant
standard in the market.
Every company regardless of its size lacks certain specialized resources. Other companies that possess these resources make attractive
alliance partners. This enhancement of a companys resources through cospecialization is a major reason that firms form partnerships. A local company usually has certain unique proprietary skills that create value to the
partnership. There is a wide variety of specialized skills that a company
may bring into a partnership. For example, a firm may have an extensive
distribution system that it is very hard for other companies to replicate.
When the Coca-Cola Corporation entered the Japanese market it decided
to invest in an extensive distribution network. In recent years this network has given Coke a competitive advantage in the Japanese market
and has made it an attractive partner for companies that want to gain access to Japanese consumers. As a result Coke earns approximately 20 percent of its global profits in Japan although it only sells 10 percent of its
products there.14 In other cases, a company may be seeking technological
know-how or ability to operate in politically and economically unstable

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205

environments. In many emerging markets, alliances with local companies


provide access to local politicians. A company with the right experience
will be able to navigate complicated regulations that may take years for
an outsider.
Although large multinational companies are perceived as all powerful
because of their size and technological expertise, in many foreign markets
they may have major disadvantages. These shortcomings originate from
a lack of political connections, deficient knowledge of the local culture,
or the presence of economic nationalism, which may curtail a companys
ability to establish a strong presence in many foreign markets. This is the
so-called liability of foreignness that inhibits companies from expanding abroad. Companies can overcome these obstacles by forming alliances
with local companies. These alliances have the ability to turn a foreign
company from an outsider into an insider player in that market. Furthermore, partnering with local companies in many emerging markets is
not an alternative that a company has, but it may be the only option to
enter a market due to restrictions imposed by the local government. China
in recent years has liberalized many of its restrictions on foreign companies entering its market, but regulations still make it mandatory for companies operating in technologically advanced industries to have a local
partner. A foreign company has to think very carefully if it wants to partner with a local Chinese company, considering the transfer of technology
requirements and potential infringement of patents. However, many companies make the decision that the size and potential of the Chinese market
makes the risk of the probable loss of technology worth it.15
With product life cycles becoming increasingly shorter, companies
need to constantly introduce new products in order to remain competitive
in an increasingly crowded marketplace. As new products are becoming
increasingly complex, even large companies find themselves without the
required skills to successfully develop groundbreaking products. The lack
of necessary skills has increased in recent years due to the tendency of
many companies to outsource even essential functions in the production
chain. For example, large automakers have formed strategic alliances with
their competitors in order to develop new electric cars. In the 1970s, Western companies were amazed to discover the Keiretsu production system in
Japan. Japanese companies were operating as alliances of a large number
of smaller firms producing products for a large corporation. It appears
that as companies in Western countries have abandoned a vertical form of
production, where most components of a product were manufactured internally, most of them have created their own Keiretsus. As a result, development, manufacturing, and introduction of new products have become
the joint effort of an alliance instead of the work of an individual company.
In the past new knowledge creation tended to be concentrated in certain
parts of the world. Most new products and novel production techniques

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in the early 19th century originated in Great Britain, the birthplace of the
Industrial Revolution. However, by the end of the 19th century as the
industrial revolution started spreading in other parts of the world, new
product creation started occurring also in North America and the rapidly
industrialized areas of Western Europe. At the present time as more regions of the planet have adopted free market policies, the development
of new products could occur anywhere in the world. For example, in the
1970s, the most exciting incremental improvements in automobile manufacturing were coming out of Japan, a country that until then was known
for adopting technology developed elsewhere. As a result of the spreading of innovation across the globe, companies need to be ready to learn
new technologies and adopt new products from anywhere in the world.
Alliances provide companies with a very efficient way to learn from other
companies. It is an efficient way for companies to learn what other firms
in faraway countries are doing.
DRAWBACKS OF ALLIANCES
Even if strategic alliances with other companies can contribute to a
firms competitive advantage, firms have to always be aware of the potential negative aspects of alliances. A recent report published by Business
Wire looked at the important issues that may lead to success or failure in
the pharmaceutical industry.16 This industry has a very high number of
alliances between large pharmaceutical corporations and smaller biotechnology companies. It is a symbiotic relationship for both parties because
large companies constantly need to introduce new drugs because many of
the patents in their older products are expiring or new drugs cut into the
profitability of their products. On the other hand, small biomedical companies need the larger companies because they usually lack capital and
marketing expertise to promote their discoveries. So, while large companies constantly need to bring new drugs to market to replace products facing patent expirations, small biotech companies continuously require new
funding for research and development. The cost of introducing new drugs
has increased from approximately $100 million in the 1990s to $1 billion
in 2008.17 This skyrocketing cost is forcing more and more companies into
strategic alliances.
Alliances in the pharmaceutical industry as well as alliances in other
industries tend to fail because they dont employ consistent reproducible
metrics to evaluate alliance performance. This luck of metric standardization leads to conflict as the two partners tend to draw different performance conclusions.
Many alliances are also plagued by constant management changes, cultural differences, and not-consistent expectations. Although the chemistry among the managers who negotiated the initial alliance between two

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207

companies may have been very strong, the new people who may come
into these positions at later stages may not have sufficient knowledge or
desire to successfully deal with their counterparts in the other company.
For an alliance to be successful the two companies have to be very careful
in avoiding constant management changes or to appoint managers who
have the abilities and the incentives to maintain the preexisting relations
with other companies. Cultural differences can be detrimental for the future of an alliance.
Differences in culture are not only relevant for international alliances,
but can also be paramount even for alliances among domestic companies.
Differences in corporate cultures have to be recognized and accepted by
the two respective companies. It is important for two potential partners
to realize their cultural differences early in order to closely work together.
The alliance between the French Renault company and the Japanese carmaker Nissan Motor Corporation is an example of an alliance plagued by
huge cultural differences. Many knowledgeable observers at the time of
the alliance announcement doubted that it had any chance of success.
Characteristically, Gerald C. Meyers, the chairman of American Motors
Company in the 1980s and a person familiar with the culture of Renault
because his company had a manufacturing alliance with it in the 1980s,
stated that if there are two cultures that could not get together, its these
two.18 Other critics of the alliance questioned that the two companies
could find enough synergies in purchasing, distribution, or manufacturing in order to make the alliance successful. However, the two companies
had very strong motivations to undertake this very risky alliance. Renault,
although fairly strong in Europe, did not have any substantial presence in
any other parts of the world. An alliance with Nissan could provide the
company with access to potentially lucrative Asian and North American
markets where Nissan had a strong presence. Nissan, on the other hand,
had accumulated high losses in the 1990s and was desperate to form an alliance that could provide it with an infusion of fresh capital. So, although
huge cultural differences existed, both companies had a vested interest
for the alliance to be successful. These strong incentives for a successful
outcome were combined with the strong leadership of Carlos Ghosn, the
charismatic head of Renault. A truly remarkable person, Carlos Ghosn
was born in Brazil to Lebanese parents and was educated in the most
prestigious European schools. He went back to Brazil, where he became
the head of the local Renault subsidiary. His success in running the local
company led him to the leadership of the Renault Company in France.
He devoted time, capital, and energy in the alliance with Nissan and despite the negative predictions of most automobile analysts he was able to
turn Nissan around and make it a very successful company once again.
He became a national hero in Japan, one of the few times that a foreigner
was accepted by the hermetically closed Japanese business culture.19 The

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Renault alliance with Nissan clearly shows how even in the existence of
huge cultural differences, an alliance can be successful if strong leadership
exists and both companies understand the importance of the alliance for
the survival of the two parent companies.
Many alliances also fail due to different expectations of the two partners. The two companies have to be very clear on what they want to
achieve from the partnership. If common expectations do not exist, the
partnership is bound to fail. The alliance of Harbin Brewery, a major Chinese brewer, and SABMiller, the South Africanbased global beer powerhouse is an example of a partnership that failed due to inconsistent
expectations. Harbin Brewery had signed an alliance with SABMiller in
2005 but a few months later accused it of not delivering on the agreement,
and the promised partnership benefits did not materialize. Harbin Brewery had expected that SABMiller would ease price competition in the markets in which both had a presence. On the other hand, SABMiller was
counting on distribution synergies that did not occur. The inconsistent expectations led to the dissolution of the partnership and resulted in a bitter
takeover battle with SABMiller attempting a hostile takeover.20 The problem with this alliance was that SABMiller decided to use the alliance with
Harbin Brewery as a first step for a potential takeover. On the other hand,
Harbin Brewery saw the alliance as a way of eliminating competition and
reducing its distribution expenses. If common expectations do not exist
and companies do not develop trust, the alliance is bound to fail.
MANAGING ALLIANCES WITH COMPETITORS
AND NONCOMPETITORS
Although the importance of strategic alliances for the success of a company has been equally recognized by academics and practitioners, most
of the alliance observers tend not to recognize that not all alliances are
the same. An alliance with a noncompeting company that is operating in
a complementary industry may be very different from an alliance with a
competitor. Therefore, it has become apparent that not all alliances are the
same and the impact that different partnerships have on the competitive
position and overall profitability of a company needs to be thoroughly
examined.21
Strategic alliances with noncompetitors can provide a company with the
tools that it needs to succeed in a specific market. Noncompeting companies can provide a wide array of benefits, from cost sharing and risk sharing, to providing valuable proprietary knowledge that these firms may
possess. A foreign firm may provide knowledge of the political environment and government contacts that are crucial for the success of the partnership. Overall, companies tend to find alliances with noncompetitors as
being beneficial for them. The only major drawback of a partnership with

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209

a noncompetitor is the opportunity cost of the time spent in managing the


alliance. Many companies spend considerable time in trying to establish
alliances with noncompetitors even in cases that it may be cheaper to undertake certain tasks internally by developing in-house resources. Companies have to be vigilant to make certain that the benefits of an external
partnership outweigh the costs necessary in sustaining that partnership.
However, when companies form alliances, they do not always limit
themselves to partnerships with noncompeting companies; on many occasions, they form links with competing companies. A company will form
an alliance with a competitor because it will perceive certain benefits such
as access to distribution channels, cultural knowledge of a specific market,
or government connections. In many situations, a company may not have
a choice in not forming an alliance with a competitor because in todays
complex business environment a firm can be a customer, competitor, supplier, and partner all at the same time. A company may actually find itself
in a close alliance with a competitor not be design, but as a result of an
accident. Although most U.S.-based fast food companies had a partnership with the Coca-Cola Company to supply them with soft drinks in the
domestic and international markets, Burger King had a very strong association with the PepsiCo Company. This was a very important alliance
for PepsiCo because it has historically lagged behind Coke in soft drink
sales due to its weak fountain sales. However, PepsiCos decision to aggressively expand into the fast food market by acquiring Kentucky Fried
Chicken, Pizza Hut, and Taco Bell, put it in a position of competing directly with one of her bigger customers, Burger King. Although PepsiCo
tried to salvage the alliance, in the end, Burger King decided to switch
supplier partners and start selling the products of the Coca-Cola Company. This decision exemplifies the problems associated with alliances
with competitors. Although obvious benefits exist, the competitive spirit
of the two companies may destroy even the most well-designed alliance.
Over time, a firm will form alliances with competitors because it believes that the partnership will provide advantages associated with learning, reduced costs, and shared resources. In many cases, it is a lot easier to
form alliances with competitors, because both companies know their market intimately and tend to talk the same language. Although it may be difficult for representatives of an engineering and a transportation company,
for example, to find a common language, these problems do not exist
between two engineering companies, where executives tend to have similar backgrounds. In addition, in alliances among competitors, know-how
can be transferred more easily from one partner to another because both
companies share common industry-specific knowledge and resources.22
It is much easier, for instance, for a pharmaceutical company that wants
to enter a foreign market, to form an alliance with another pharmaceutical company that operates in that market instead of forming an alliance

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with a local company that does not have extensive experience in the drug
industry.
Despite the many advantages that a company may get by forming alliances with competitors, in many occasions distrust and the high cost of
monitoring the behavior of a partner may totally diminish the advantages
of an alliance and may lead to negative results. The big problem in alliances with competitors is the question of trust. In many cases it is almost impossible for a company to trust a competitor. This is the reason
that monitoring costs can be extremely high. A company has to constantly
watch if a competitor keeps its side of the agreement and it does not try
to take advantage of the companys technology or proprietary know-how.
Because a company spends too much time watching its partner, it may not
pay enough attention to its target market. This diversion of attention may
lead to negative performance.23
Another major problem of alliances with competitors is the development of a dependency relationship. A firm may rely too much on a competitor in certain areas and it may not develop its own expertise. For
example, if a company does not develop its own distribution network, but
instead uses the distribution network of a competitor, it will be in trouble
if its partner decides for whatever reasons to discontinue the alliance. This
is what happened to Naya, a Canadian bottle water company, when its
distribution alliance with the Coca-Cola Company was terminated when
Coke decided to start producing Dasani, its own brand of bottled water.
Overnight Naya lost its access to the large U.S. market and had to declare
bankruptcy.24
CONCLUSION AND SUGGESTIONS FOR CREATING
SUCCESSFUL ALLIANCES
This chapter has shown the increasing importance of alliances in todays complex business environment. Alliances have become ever more
popular because they offer the promise of new technologies and markets.
However, while a lot of companies have been successful in forging rewarding alliances, other firms have failed. Many observers have noticed
the paradox of the fact that although alliances have grown by 25 percent a
year and many companies derive more than a third of their revenues from
alliances, the failure rate for alliances is more than 60 percent.25
The question then arises of what makes some alliances succeed whereas
others fail. Academic research has shown that for an alliance to succeed
trust needs to be present and all the parties need to have similar goals and
objectives.26 Managers also need to pay attention to the motivations that
the two or more parties have in forming an alliance. Alliances with competitors and noncompetitors also seem to have different rates of success.
The high monitoring costs associated with alliances with competitors may

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211

make these types of partnerships too difficult to manage. In an article in


the Harvard Business Review, Jonathan Hughes and Jeff Weiss identified
several principles that companies could follow that would more likely create successful alliances:27
Focus less on defining the business plan and more on how youll work
together. Many companies pay too much attention to the business
plan and they do not emphasize the partners working relationship.
If trust and communication does not exist between the partners the
alliance will fail. Successful alliances rely on the capacity of individuals on both companies working together.
Develop metrics pegged not only to alliance goals but also to alliance progress. Most alliances select financial goals such as profitability or market share as metrics of the success of the alliance. However, most
alliances do not return positive results in their initial stages. In addition to financial metrics, companies need to set measurements that
will try to calculate the alliances progress. For example, are the two
companies willing to share information and ideas; what the speed of
decision making is; and what the development of new ideas is?
Instead of trying to eliminate differences, leverage them to create value.
Managers need to always remember that two companies forge an
alliance because they have different cultures and skills and they
want to benefit from the different capabilities that a partner brings
in. Very soon managers forget that the two companies have different
sets of skills and they try to find common ground. Firms may benefit
more if instead of looking for commonalities, they try to leverage the
different skills that their partner is bringing.
Go beyond formal governance structures to encourage collaborative behavior. Companies tend to spend a lot of time negotiating the initial
agreement between two companies and forget to actively nurture
the relationship following the completion of the negotiation stage.
Structures need to be put in place to encourage collaborative behavior during the life of the alliance.
Spend as much time on managing internal stakeholders as on managing the
relationship with your partner. Companies forget that they constantly
have to work with external and internal stakeholders. Some firms
emphasize too much the relationship with the external partner and
they ignore the interests of internal players. Many alliances have
been undermined from a companys insiders who felt threatened by
the potential success of an alliance.
Alliances have become effective tools in assisting companies in conquering new markets and technologies. Most companies are using

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alliances to expand into new markets or to introduce new products. However, for an alliance to be successful the leadership of a company needs to
show commitment to the partnership goals and actively manage the internal and external stakeholders. If a company follows the right practices, it
will greatly improve its alliance success rate. In an increasingly complex
global environment companies cannot operate alone but they constantly
need the assistance of the right partners. If they develop the right techniques to manage their alliances, it will greatly improve their competitive
advantage. A capacity to collaborate will become a necessary skill for
success in the future.
NOTES
1. Doz, Y. and Hamel, G. 1998. Alliance Advantage: The Art of Creating Value
through Partnering, Harvard University Press, Boston, MA.
2. Varadarajan, R. and Cunningham M. 1995. Strategic Alliances: A Synthesis of Conceptual Foundations, Journal of the Academy of Marketing Science 23 (4):
282296.
3. Morgan, R. and Hunt, S. 1994. The Commitment-Trust Theory of Relationship Marketing, Journal of Marketing 58 ( July): 2038.
4. Day, G. 1995. Advantageous Alliances, Journal of the Academy of Marketing
Science 23 (4): 297300.
5. Bunkley, N. Ford and Toyota to Work Together on Hybrid System for
Trucks, New York Times, August 22, 2011, New York edition.
6. Varadarajan, R. and Cunningham, M. 1995. Strategic Alliances: A Synthesis of Conceptual Foundations, Journal of the Academy of Marketing Science 23 (4):
282296.
7. Demirbag, M., McGuinness, M., and Altay, H. 2010. Perceptions of Institutional Environment and Entry Mode: FDI from an Emerging Country, Management International Review 50 (2): 207240.
8. Gap Inc. Expands Presence in Russia with First Banana Republic Store,
Business Wire (English), August 9, 2011.
9. Ellis, C. 1996. Making Strategic Alliances Succeed, Harvard Business Review 74 (4): 89.
10. Varadarajan, R. and Cunningham, M. 1995. Strategic Alliances: A Synthesis of Conceptual Foundations, Journal of the Academy of Marketing Science 23 (4):
282296.
11. Fernhaber, S., McDougall-Covin, P., and Shepherd D. 2009. International
Entrepreneurship: Leveraging Internal and External Knowledge Sources, Strategic Entrepreneurship Journal 3: 297320.
12. McEvily, B. and Marcus A. 2005. Embedded Ties and the Acquisition of
Competitive Capabilities, Strategic Management Journal 26: 10331055.
13. Lin Z., Peng M., Yang H., and Sun S. 2009. How Do Networks Drive
M&As? An Institutional Comparison between China and the United States, Strategic Management Journal 30 (10): 11131132.
14. Terhune, C. 2006, Jul 11. Wall Street Journal. Coke Tries to Pop Back in Vital
Japan Market; Country Accounts for 20% of Profit, But Missteps, Sales Drop-Off
Have The Company Searching for the Fizz.

The Competitive Advantage of Strategic Alliances

213

15. Doz, Y. and G. Hamel. 1998. Alliance Advantage: The Art of Creating Value
through Partnering, Harvard University Press, Boston, MA.
16. A Guide to Successful Pharmabiotech Alliance Strategies: Providing a
Comprehensive Analysis of Driving Synergies, Avoiding Failure and Managing
Relationships, Business Wire, October 20, 2008.
17. Ibid.
18. Howes, D. Analysis: Renault gambles on Nissan: Experts Predict Alliance Wont Succeed, See Culture Clash as Primary Drawback, The Detroit News,
March 18, 1999.
19. Mr. Renault-Nissan Is Upbeat; Setback with GM Alliance Doesnt Faze
Brilliant Turnaround Specialist, The Baltimore Sun, October 6, 2006.
20. Dickie, M. and Guerrera, F. Harbin Hits out at SABMiller over Alliance
BREWING, Financial Times, May 7, 2004.
21. Ross, W. and Roberson, D. 2007. Compound Relationships between Firms,
Journal of Marketing 71: 108123.
22. Ritala, P., Hallikas, J., and Sissonen, H. 2008. The Effect of Strategic Alliances between Key Competitors on Firm Performance, Management Research 6
(3): 179188.
23. Ibid.
24. Hayes, C. Naya Seeks Bankruptcy after End of Coke Link, New York Times,
December 23, 1999, New York edition.
25. Hughes, J., and Weiss, J. (2007). Simple Rules for Making Alliances Work,
Harvard Business Review 85 (11): 122130.
26. Morgan, R. and Hunt, S. 1994. The Commitment-Trust Theory of Relationship Marketing, Journal of Marketing 58 ( July): 2038.
27. Hughes, J., and Weiss, J. (2007). Simple Rules for Making Alliances
Work, Harvard Business Review 85 (11): 122130.

Chapter 11

Strategic Integrity Management


as a Dynamic Capability
Michael Fuerst and
Andreas Schotter

INTRODUCTION
In recent years, integrity and compliance management have developed
beyond being reactive and rather static mitigation activities for correcting or minimizing negative effects from ethics breaches or other managerial misconducts. Today, leading firms deploy integrity and compliance
management approaches that proactively influence organizational core
processes and employee behaviors. There are two main reasons for this
change, including increased pressures from outside of the firm to become
better corporate citizens, and from within the firm, driven by more educated and diverse employees, especially from generations X and Y.1
Both trends are reactions to the many publicized cases of company misconduct, such as corruption (e.g., Siemens 2008), accounting fraud (e.g.,
Enron or Lehman Brothers), and human rights violations (e.g., Shell)
over the last decade. We therefore suggest that in the interest of preventing and reducing those cases in the future a more analytic and less
ideology-driven discussion about the real and systemic root causes of
integrity issues needs to take place. We describe how leading firms use

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215

integrity management dynamically as a strategic tool that creates positive


effects on firm performance.
Unethical conduct should not just be viewed as lack of integrity or lack
of certain character qualities of some individual employees. Such a perspective does not recognize the complexity of most corporate integrity
or compliance issues. Research has shown2 that the apparent frequency
of ethical misconduct is being caused by organizational factors, including corporate cultures that create enormous psychological pressures on
individuals. This then leads to situations where even managers who are
considered highly moral deviate from everyday ethical norms. Even more
importantly structural causes are typically the driving forces behind systemic misconduct. These include unbalanced incentives systems that
determine bonuses, salary increases or career progression without any
consideration of moral behaviors,3 a lack of responsible leadership,4 or a
climate in which speaking up is not an accepted practice but instead, represents a career risk that could lead to repercussions.5
Jennings6 uncovered some of the reasons for the collapse of companies based on ethics issues in her book, Solutions to the Corporate Integrity
Quandary. Companies need to be more proactive in integrating general
organizational processes and structural designs rather than being reactive
and defensive, solely focused on mitigation and damage control. In this
chapter, we describe how dynamic integrity management processes can
be integrated into organizational systems in order to avoid negative conduct. Further, we will build a road map of how integrity management can
actively drive positive effects on firm performance.
THE SOURCE OF CORPORATE INTEGRITY ISSUES
The popular claim that organizational compliance failures are mainly
caused by the ethical misconduct of a few individuals, often referred to
as bad apples, does not really address the actual structural problem of
integrity and compliance failures.7 At best, this is moral finger-pointing,
which is not helpful in identifying the underlying causes in a systematic
and sustainable way. In order to adequately identify and judge ethical misconduct it is not enough just to focus on motives and the lack of individual
level character traits followed by post hoc punishment of the alleged ethics offenders. We argue that organizations should base their compliance
processes on deep contextual understanding and on clearly defined organizational integrity drivers and on interdependencies of these two in
order to gain control over threats to misconduct in organizations.8
Another critical point within the ethics, compliance, and integrity debate is ambiguous terminology. Here especially, the term compliance
seems to be problematic for practical design and implementation of integrity and compliance management programs. The reason is that the

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existing terminology is at best vague and interpretations are very scattered, context dependent, and often not easy to understand across the
entire organization. For example, does compliance mainly refer generically to the compliance with legal, industry specific or internal standards and values, or are there other norms, standards, and values that
are not explicit or not located within the organization itself? If there are
other norms, what are they and what do they mean to the daily operation of organizations? For example, should there be a formal integrity
and compliance manager and should this manager be explicitly responsible for detecting and punishing corruption, bribery, accounting fraud,
privacy, quality, regulatory, IT compliance breaches, human rights, or antitrust violations? Or should compliance management be not so much
an issue-driven task but instead a programmatic management approach
that supports the development of values-driven best practices and ethical behaviors from all internal and external stakeholders?9 We use the
term compliance in an alignment and evaluation sense and we use the
term integrity to refer to an overarching, behavior-driving principle that
is values driven and that incorporates a specific set of managerial and organizational values across the entire organization, while taking environmental dynamism into account. By environmental dynamism10 we refer
to the increasingly more prevalent phenomenon that organizations have
to constantly adjust to multiple institutional and cultural environments
across diverse geographic and demographic boundaries that are often
transitional, as in the case of emerging markets. But no matter how a corporation frames its integrity and compliance program, a values-driven
approach instead of a rules-based approach is the most effective strategy
to empower employees in an organization to behave with integrity in
critical situations, systemically, effectively, and in compliance. This then
leads to higher, rather than lower, levels of ethical conduct.11 So the question remains: what should a blueprint for such an integrity management
system look like?
POSITIONING WITHIN THE ORGANIZATIONAL CONTEXT
Integrity management should not just be viewed as a misconductlimiting organizational instrument. Instead, strategic integrity management should be used to foster ethical behaviors that ultimately drive firm
performance by stimulating and empowering positive behaviors. Integrity management then becomes an active part of every core process of an
organization that develops shared values along the organizations strategic priorities, its core competencies, and among its internal and external
stakeholders. This argument builds on the notion of connectivity between
integrity management concepts and the debate about the external social
responsibilities of organizations.

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217

Effective integrity management is forward looking, beyond philanthropy or charity, in a direction in which social responsibility is perceived
as a concept that drives change through economic means. Its processes
serve as a platform for disruptive innovation in the social context within
an organization.12,13 The allocation of responsibilities for compliance to
specific groups or individual actors and functions has an intermediate effect on the design of individual compliance systems. Integrity management then becomes a dynamic capability that aligns, shapes, extends, or
modifies an organizations resources and processes toward higher levels
of performance.14 We suggest an integrated approach. Doing business with
integrity means doing the right things. This drives performance through
building a culture of integrity, managing risks, strengthening internal and
external reputation, and improving competitive advantage.
FIVE REASONS TO INVEST IN AN
INTEGRITY MANAGEMENT PROGRAM
Sustaining and increasing organizational competitiveness is more and
more linked with the willingness and ability of managers to build business models along ethical principles and to contribute to positive societal change.15 If we revert to the basic assumptions of institutional16 and
organizational economics17,18,19 it becomes obvious that ethical values of
individuals, organizations, and societies are always basic elements of the
governance and control mechanisms of any transaction between individuals or organizations. An economic transaction entails a set of informal constraints that are being caused by the incompleteness of markets.
Contractual arrangements, therefore, are an integral part of a functioning transaction. Williamson20 used the term atmosphere in this context, without specifically referring to values, morality, or ethics. This
was later done by Wieland,21 who introduced a theory of the ethics of
governance. The structures that govern economic transactions contain
explicit values, morals, and/or cultural preferences that can be theoretically conceptualized as formal and informal institutions. In this theoretical approach specific mechanisms exist on different governance levels
such as law, societal- and organization-specific cultural patterns, or formal control and management mechanisms within an organization. The
ultimate objective behind these formal and informal governance structures is to stabilize or to increase the mutual gain of an economic and
social transaction between different transaction partners.22 In this theoretical scenario the development of ethics becomes endogenous rather
than exogenous to the economic process.23 This means that moral issues
are conceptualized as a genuine part of the classic economic problem to
overcome the scarcity of resources and competencies in a competitive
setting.24,25,26

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A crucial element of the individual or collective ethical values, and the


relevant governance structures that establish, promote, and enforce adherence with these values, is a set of moral or ethical resources that have an
economic value, while having an impact on the initiation, enforcement,
and the monitoring of a transaction.27
The moral resources of a company that represent the foundation of its
culture and identity work as a filter for the perception and the selection
of risks that managers take in the context of business opportunities. These
moral resources also serve as governance parameters for management, but
only if these parameters are properly embedded in the governance mechanisms of the organization. Integrity management functions as a moral,
relevant governance mechanism.28 It plays a critical role in this context as
the values and qualities of individuals and organizations determine which
strategic options are perceived and considered as being appropriate and
how these and subsequent strategic objectives will be achieved throughout a firms value-creation process.
On a more tactical level, this leads to five dominant reasons for investing in integrated, proactive, and dynamic integrity management, including (1) recognizing ethical responsibility and safeguarding the integrity
of the company,29 (2) generating new growth opportunities through innovation and performance-driving integrity activities,30 (3) protecting and
improving the reputation of a company,31 (including maintaining attractiveness for current and future employees in mind), (4) establishing valuessensitive risk management that focuses on systemic risk-mitigation drivers32 rather than tactical risk minimization, and (5) fostering a culture of
integrity that systematically enables employees to behave in line with ethical expectations and standards.33 We suggest that these five dimensions
will strengthen the business case for integrity and compliance management, particularly if it is closely linked and aligned with the strategic priorities of a company.
Although the general recognition of ethical responsibilities and the protection of reputation, as well as the management of risks, are often communicated in corporate brochures and annual reports, specific objectives
of integrity and compliance programs or integrity management processes
are still only rarely identifiable in practice. There is often a discontinuity between communicating expectations of ethical conduct in theory, and
managerial actions in practice. Instead, managers often argue that illegal or illegitimate behavior is often unavoidable because competitors do
not consider legal or ethical standards to the same extent and therefore a
company would be at risk of losing important contracts or that potential
customers would not consider the firms products or services if certain
requests were not accepted. These same managers argue that refusing requests that are in conflict with ethical behavior leads to lower levels of
competitiveness and ultimately threatens firm survival. In our research

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219

we often hear the aphorism: when in Rome do as the Romans do! Examples of this perspective are vast. For example, executives at Chiquita
Brands International Inc., argued along the same lines when they tried to
justify illegal payments to the Revolutionary Armed Forces of Colombia
(FARC) and the National Liberation Army (ELN) terrorist organizations
in Colombia, who have killed thousands of innocent people with weapons
purchased from these payments.34 Another example is the bribery scandal that recently surrounded Germanys Siemens AG, one of the leading
global conglomerates in Europe and often touted as Germanys General
Electric (GE). In early 2007, a court convicted two former Siemens managers of paying 6 million euros in the late 1990s and early 2000s to help the
company win contracts from an Italian energy conglomerate worth approximately 450 million euros. The company had to pay a 38 million euro
penalty. The following year, Siemens accepted a $1.34 billion fine when
investigators identified dubious payments of more than 1.3 billion euros
over a period of four years in the early 2000s.35 Whereas in the Chiquita
case managers avoided prosecution and only the company paid a fine to
the U.S. Justice Department, in the Siemens case, managers were penalized individually for criminal misconduct.
Despite the obvious negative effects on the bottom line when caught,
some questions arise. Why should business limit itself to just imitating
competitor conduct? Is it not a basic element of doing business and of
being entrepreneurial to differentiate oneself from competitors? Furthermore, bribing someone to get a contract just means paying for closing a
deal, which means that the contract is not based on the value proposition
of the related product or service. When those practices are systemically extended over a longer period of time and then become culturally accepted
within the organization, the interest, appetite, and ability of individuals
to innovate will gradually decline. This then leads to lower levels of competitiveness and an even greater dependence on questionable business
practices.
We argue that an integrity management program that addresses and
integrates best practices systematically into daily operations and makes
them part of a shared managerial agenda, daily routines, and explicit
performance rewards36 will not only eradicate bad behaviors, but will
also improve overall firm competitiveness. It will also help to overcome
structural obstacles to innovation and differentiation, as integrity management becomes a competence-enhancing organizational capability.
Prerequisite for the ability to realize these advantages is first the recognition that ethics or ethical behavior is not a hassle and that the investment
in an integrity management program is not just a checklist item that protects the firms license to operate. Instead, integrity management is an opportunity to realize greater advantages for the business and the societies
in which it is embedded. Ethics and subsequently integrity management

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Strategic Management in the 21st Century

is a persistent force that challenges the organizational status quo. Second, a concept is needed, which allocates the responsibilities for ethical
behavior efficiently and which links integrity management with the core
organizational activities, the key resources, and the business strategy of
the organization.
BASIC PRINCIPLES FOR AN EFFECTIVE
INTEGRITY MANAGEMENT PROGRAM
In this section, we will discuss which specific factors truly effective integrity management should be based on. We use the descriptor truly effective in this context in a slightly provocative manner. The reason is that
having observed so many ethical failures in companies that claimed to
have effective compliance programs aligned with the requisite legal systems (e.g., U.S. sentencing guidelines), it appears to us that such programs
did not address the key drivers that effect managerial behavior. Later, we
will suggest an organizational framework and a series of principles for
an integrity and compliance management program. The specific functional responsibilities for integrity management can be drawn from these
principles.
One of the most essential responsibilities of the executive team and the
board of directors of a company is to establish firm specific, values-based
standards that are relevant and understandable by employees. Even the
most comprehensive policy framework will not necessarily assure responsible behavior when the standards are written in technical legal language
only and when they are too lengthy for employees to comprehend or even
read. It typically drives negative reactions in employees, including hostility and sarcasm, when it becomes obvious that policies were established
with the sole purpose of representing a legal line of defense for the company instead of being drafted for the purpose of facilitating good decision
making.
It is the responsibility of every single individual within the firm to follow these standards and to make decisions that are in line with the internal
values and standards. The executive team and operational management
are then ultimately responsible for promoting, monitoring, and enforcing
the adherence to these standards. This responsibility cannot be delegated
or outsourced, especially not to an integrity and compliance department
because ensuring compliance is not the responsibility of a separate department with, often, only limited insights due to incomplete information and
sometimes limited execution power. Instead, in the interest of accountability, the monitoring responsibility rests with the top management of
the organization.
Consequently an integrity and compliance department should not approve or sign off on business transactions for integrity compliance; rather,

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221

it should be called upon by management for consultation and advice in


dilemma situations or in cases of ethical doubt. Also, the integrity and
compliance department should not be made responsible for monitoring
specific business transactions, as proposed in many descriptions of the
roles and responsibilities of the integrity management function37 because
we believe that integrity management and compliance are genuine management tasks in the execution of core business and daily transactions;
therefore, these should not be delegated away.
Similar to the overarching responsibility of top management, every department should be responsible for ensuring that business is being conducted in line with internal standards, values, and laws. Delegating this
monitoring is bad practice because separating business process responsibilities and integrity and compliance responsibilities increases compliance
risks.38 In such a scenario the risk preferences of an individual actor would
be split from rewards that might be generated if the business objectives
are achieved. This is fundamentally opposite to the economic paradigm
that suggests that earnings have to be allocated where the risk is taken for
a specific transaction. The global economic crisis of 2008, which was triggered, to large extend, by a huge decoupling of risks and rewards in financial transactions and bonus systems,39 made it clear why an integrated
approach is essential. Department managers should be actively supported
in the task of ensuring responsible business practices by functions as they
develop and implement processes, systems, and tools to train employees
in responsible behaviors and to audit compliance with internal standards
and regulations.
The responsibility of the integrity and compliance department is to develop an integrity program that supports management in ensuring ethical
and legal business conduct. Such a program is a catalyst for establishing,
promoting, and enforcing ethical standards through adequate processes
and activities. Its success is based on ethical leadership, executed by all
relevant layers of management, and by an effective organizational culture that includes a climate of speaking up, skills training to balance ethical, legal, and economic factors, values-based pay for performance, and
ethics-sensitive recruitment and career progression.
In 2008, KPMG,40 in a large sample study, identified basic drivers of
misconduct, including pressure to achieve business goals, being paid for
just making the numbers, as well as a general lack of specific evidence for
the fact that following ethical standards was being taken seriously. When
these drivers are combined with the fact that most employees see training
as being useful for understanding pertinent integrity standards, and that
few firms provide such training, this problem adds to the persistent and
surprisingly frequent occurrences of new integrity crises.
Although it is the responsibility of management to execute, an effective
integrity program should be developed by the integrity and compliance

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Strategic Management in the 21st Century

department and be enforced in cross-functional efforts that are closely


linked with business processes. This means that the accountability for specific activities within such a program is part of responsibility of the different support functions such as HR, legal, audit, and the core business
functions, including sales, marketing, operations, and other such areas. If
we apply these principles and responsibilities for the individual actors in
the integrity and compliance system within a company we can structure
them along the following dimensions:
Top Management
1. Developing values-based mission, vision, and strategy.
2. Developing an organizational structure that allows an integrated
approach to integrity and compliance management.
3. Enabling employees to make ethical decisions by positively inuencing the organizational context in which these decisions are
taken.
4. Empowering critical integrity and compliance functions to be effective in developing and implementing integrity- and compliancedriven processes.
5. Holding itself and its members explicitly accountable to these standards (lead by example).
Individual Employees
1. Actively adhering to laws and relevant internal values and standards.
2. Supporting others within and outside the organization to act on the
values and standards.
3. Actively speaking up in cases of noncompliance or ethics violations.
Business Line Management
1. Enabling employees to take ethical decisions by positively inuencing the organizational context in which these decisions are taken.
2. Promoting and enforcing adherence to laws, values, and standards
through responsible leadership.
3. Assessing compliance with values and standards in performance
management and incentive programs.
4. Fostering a speak-up climate.
5. Monitoring and sanctioning misconduct as well as implementing
audit recommendations.

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Support Functions (HR, Finance, Legal)


1. Establishing and maintaining function-specic standards, ensuring
consistent behavior with internal standards and laws.
2. Establishing processes to enforce function-specic standards and
support management in implementing them.
3. Identifying functional areas of risk.
4. Monitoring the implementation status of the processes.
Internal Audit
1. Evaluating the effectiveness of internal control systems and identifying areas for improvement.
2. Conducting audits and agreeing with line management on corrective actions.
3. Reporting the audit results and conclusions to the board of directors.
Integrity and Compliance
1. Developing and managing the integrity program that supports top
management in adhering to and enforcing ethical conduct.
2. Supporting the board of directors and top management in establishing and maintaining a code of conduct and other relevant business
conduct standards.
3. Supporting line management in implementing the code of conduct,
supporting other functions in establishing standards.
4. Training of employees on good business conduct standards and
responsible behavior.
5. Advising management and employees during situations that present ethical dilemmas.
6. Monitoring the implementation status of the integrity program.
7. Conducting risk assessments with regard to the relevant drivers of
risk and advising management on mechanisms to deal with these
risks.
8. Reporting independently to the board of directors and the executive
team.
Complaints Handling Department
1. Receiving all reports about suspected and actual misconduct and
assigning responsibilities for investigation.
2. Reporting to the board of directors and top management.

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BASIC PRINCIPLES FOR AN ORGANIZATIONAL SET-UP


OF AN INTEGRITY AND COMPLIANCE DEPARTMENT
The common approach of having an integrity and compliance department sidelined from actual organizational processes has a tendency
to absorb the responsibility for adherence to integrity standards or laws
without focusing on the real drivers of unethical behaviors. Instead, such
a disintegrated approach often leads to large efforts and investments into
formulaic awareness-training programs, certification processes, and monitoring mechanisms, which only increase bureaucracy without having any
real effect on business conduct as such. This problem, linked with ongoing cost increases for compliance over the past decade41 with, at the same
time, not much of an impact of these programs on the frequency or severance of misconduct in general, supports our call for a sounder integrated
prevention-focused approach, instead of a purely control and mitigationfocused approach.
As pointed out earlier, the KPMG42 study identified that pressures
to achieve short-term, purely profit-maximizing business objectives at
any cost, in combination with flawed managerial reward structures that
support these short-term goals and a lack of credible signals from management that ethical standards have to be taken seriously are the main
reason for managerial misconduct. However, most organizations compliance activities are rather static and have not addressed the dynamic
changes in the business and social environment. These static approaches
are often limited to communication: a (one time) establishment of standards, awareness training on the code of conduct, and post hoc investigations into suspected or actual cases of misconduct. In addition, the
integration of the code of conduct and business conduct standards into
actual incentive schemes is only institutionalized in less than one-third of
all organizations.43
This indicates that a deeper recognition of the real drivers of behaviors
and root causes of systemic ethical misconduct has not been widely adopted as part of the managerial mindset or the actual compliance framework in most organizations. One of the reasons for the lack of adoption
might be that it is very difficult to demonstrate the business case for an
integrity and compliance program because of a lack of tangible success
stories. The difficulties in measuring the impact of those programs on
profitability further complicate its general acceptance. This can result in
cases where entire integrity and compliance programs are at risk of being
eliminated when cost-cutting needs arise. We therefore argue that integrity and compliance management should become a set of support capabilities that drive firm performance dynamically. We specifically argue for
a dynamic capability perspective when it comes to integrity and compliance management.

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225

Recent scholarly works in the strategic management field44 have


pointed to the importance of dynamic capabilities in the face of increasing
environmental turbulence. Dynamic capabilities are strategic processes
used to create new competencies and to mobilize resources effectively
for the development of competitive advantage. Reconfiguring existing
resources into new competencies is the core logic underlying the dynamic capabilities perspective. However, the value-creation notion that
underlies the prevailing cognitive assessment of whether a resource or
a dynamic capability is recognized as valuable in the sense of creating a
sustained competitive advantage seems to make integrity management
ineligible to be considered valuable. Often integrity and compliance activities are categorized as costs, hence, a value reducer instead of a critical
capability that enables other resources and capabilities to create value in
a sustained fashion. The net effect of integrity activities is often not explicitly accounted for.
ELEMENTS AND CORE ACTIVITIES OF AN
EFFECTIVE INTEGRITY AND COMPLIANCE PROGRAM
The values and integrity standards of a company give a clear sense of
direction and support for employees in their daily work. However, the
reality is that the transformation of ethical principles into the daily business of a company will not be realized just because integrity and compliance standards are formally established and codified. Execution requires
rather more, including the effective integration of these standards into
the systems and processes that are influencing the behaviors of individual employees despite the competitive pressures created by the external
environment. We will now describe the key elements and activities that
we recognize as being critical for the success of an effective integrity and
compliance management program. As a practical road map for this approach we apply Novartiss integrity and compliance program,45 which
has been developed by one of the authors of this chapter.46 Novartis is
a world-leading Switzerland-based health care company that operates
globally.
In order to achieve effective integrity and compliance management, it
makes sense to establish a values-based and behavioral-based integrity
and compliance program. The basic purpose and role of such a program
is to support the management of a company in giving life to its values
and standards. Such a program should be process driven. It should focus
on the processes that influence the key behavioral drivers and it should
consist of three core elements, including establishing, promoting, and enforcing the integrity standards of a company. This is achieved through
specific processes that include elements required by U.S. sentencing
guidelines but go clearly beyond the ones mandated. Such an approach is

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conceptually and materially very different compared to the traditional


rules-based, static compliance approach. The specific processes include
responsible leadership; pertinent incentive schemes; training of skills for
responsible and ethical decision making; legal-, integrity-, and economic
performancebased thinking when making decisions; and a speaking-up
culture in which employees can safely raise concerns or bring up innovative solutions to the integrity or compliance challenges of the organization. The conceptual core of such a program is that the success and the
decrease in the number of misconducts is not just a function of the management of specific issues such as anticorruption, antitrust or privacy, activities involving communication, or whistle-blowing.
Although these processes and activities are important, it is critical to
understand that the management of the organizational context and the
main behavioral drivers are crucial elements when promoting and enforcing ethical behaviors successfully. It should be an integrated capability
that drives processes toward higher performance through values-based
management.

Establishing Integrity Standards


The task of generating and building trust can only be mastered successfully if the behavior in specific transactions is based and guided by
high integrity standards. Such standards are relevant for encouraging
employees to behave responsibly and in line with the values of a company. This is especially true in gray areas that are characterized by ambiguous facts, high economic or financial pressures, and different cultural
paradigms.
It is recommended that integrity standards, such as a code of conduct
or issue-specific policies and guidelines, are developed from and linked
with the mission and the core values of the organization. In addition, it
is paramount (while today still not necessarily reality) that these policies
and guidelines are not phrased in an extremely technical, complex, and
too-detailed language that cannot be understood easily by employees.
They should be written in simple language that can be comprehended
quickly while providing issue-specific principles that can be applied directly but with enough managerial discretion and that guide behaviors in
different local situations or circumstances. On the highest level, a code of
conduct should provide answers to two questions:47
1. How can the company meet the growing ethical and legal expectations in increasingly dynamic societies and markets?
2. What are the key behavioral strengths than can improve competitive
advantage and differentiate the company from competitors?

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A code of conduct clarifies to all relevant internal and external stakeholders that standards guide behaviors. It communicates the commitment
of the firm toward responsible business practices. A code of conduct reduces the likelihood of systemic misconduct by clearly framing behaviors
that are not allowed and by linking behavioral expectations and conduct
with performance management. It stimulates positive behaviors and
it supports the positive branding of a company, both internally and externally. A code of conduct helps employees to understand and manage
cultural diversity, which then leads to higher levels of cross-cultural collaboration. In addition, a code of conduct enables operating with simplicity since fewer layers of control and supervision are needed.
Whereas the first question is mainly referring to the risk management,
the second question addresses performance impact. Both provide a clear
sense for the purpose of a code of conduct. We call this the commonly
agreed frame of action that reflects ethical and legal expectations of all
stakeholders. It aids in reducing risks caused by misconduct and drives
performance. However, the sheer existence of standards does not guarantee that such standards are relevant and applied. Therefore, code of
conduct and integrity standards have to be incorporated into all critical
management processes in order to drive and foster responsible behaviors
and the values-compliant execution of daily routines.
Promoting Responsible Behavior
An integrity management program should aim to develop and promote
an ethical culture through responsible leadership by the management of
a company. In addition, performance should be evaluated based on two
dimensions: individual business task execution effects on the bottom line
of the company, and how these outcomes have been achieved. Tools such
as the balanced score card48 approach, or the total performance excellence
approach49 described in the chapter on management frameworks in this
volume are useful practical enablers of integrity-driven rewards schemes.
Responsible Leadership
One of the tasks of the leadership of an organization is to communicate
company standards and to demonstrate their importance and the adherence to these standards in daily operations to all employees and other
stakeholders including suppliers, customers, investors, regulators, etc.
Leadership should always promote and follow the highest ethical standards proactively. The reason is that there is nothing that provokes more
contempt in a company than seeing managers making fancy presentations
about the importance of values and ethical standards and then falling
short ethically in their own conduct. In addition, a highly ethical manager

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who acts in line with critical values as an individual, but fails to communicate those values, is not empowering his colleagues and subordinates to
act ethically themselves.50
Furthermore all management levels should generate an atmosphere
where employees can speak up, raise concerns, and discuss integrity
dilemmas before these dilemmas turn into negative outcomes for the organization. Management should actively encourage all members of the
organization to develop innovative ideas and business solutions based on
integrity and compliance standards. The latter seems to be especially important in the recent debate about the rise of integrity management as a
driver of superior firm performance. The reason is that recent shifts in
general perceptions about ethical standards force companies to include
the assessment of economic and societal outcomes as part of their daily
routines. Integrity management that builds on this premise contains very
often undiscovered and unrecognized potential to drive competitiveness
and differentiation. To stimulate a climate of open discussion, management should establish speaking-up programs that could include intranet
blogs and informal cross-functional, departmental and hierarchical meetings on a routine basis. In addition, active open discussions about cases
of misconduct, actions taken, and lessons learned should take place in a
positive rather punitive atmosphere.
Integrating Values and Integrity Standards
One of the most important elements of an integrity management program is the anchoring of an organizations values and standards in the
performance management and remuneration system. The reason is that
reward-driven systems are the most effective mechanisms for influencing
individual behaviors. To be clear, incentives and rewards do not only refer
to monetary or material incentives or rewards. Individual managerial
motivation can be fostered by a multitude of different factors. Incentive
schemes should be adapted to the needs and preferences of individuals
and could include nonmonetary wards such as, for example, sabbaticals,
training or development, or other recognitions. In some countries, such as
in China, these rewards are highly valued since access to knowledge and
training is not readily available outside firms.
The recent global financial crisis has shown very clearly that one of
the most crucial drivers for big integrity risks is not the fact that a few
employees behave notoriously unethical (bad apples). In fact this kind
of crises is being fueled through systems that measure employees only
along one parametermeeting business objectives without considering
whether these objectives could or do cause a conflict with ethical standards and whether the set objectives have been met in line with the values
and ethical principles of the company. We call these systems bad trees.

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An example is the case of Jerome Kerviel, a French trader who was at the
center of the 2008 Societe Generale trading and breach of trust incident.
Societe Generale is a major Paris-based bank and financial services firm.
Kerviels practices have allegedly caused a 4.9 billion Euros loss to investors. In a statement he alluded that Societe Generales senior management
had never shown interest in his specific business methods, but that they
were very happy with the results of his work.51
It seems logical for firms to establish and use a two-dimensional performance measurement and incentive structure that evaluates both whether
an employee has met his business objectives (what to achieve), and
whether he/she has achieved the objectives in line with the pertinent values and ethical standards (how to achieve). This two-dimensional approach is of importance because ethical behavior will not be achieved by
cutting or capping incentives or bonuses at the upper end or because a
positive correlation between performance and reward is a crucial element
of economic order.
Conceptualize this as a two-dimensional matrix that evaluates on the
vertical axis performance along dimensions related to fulfillment of the
business objectives and on the horizontal axis performance along dimensions related to values and behaviors. The critical motivation is to systemically assure and safeguard that business objectives are met in line with
the integrity standards and that these in combination determine rewards.
Such a model fosters and institutionalizes an ongoing dialogue about
the values adequacy of business objectives. In other words, it evaluates
whether the agreed objectives are compatible with the ethical standards of
a company. The two dimensions described appear to be adequate in the
governance of risks, in reducing bonus excesses, and to satisfy expectations of society with regard to the ethical behavior of companies.
Research has shown that the effective implementation and application
of such an incentive system as part of an integrity and compliance program is the most important indicator of its credibility, its effectiveness,
and of the capabilities of ethically oriented management. Furthermore, it
bears potential for innovation and differentiation as it forces management
and employees to challenge common assumptions about the appropriateness of objectives and the way business is being executed.
Training
Training is a critical element of an integrity and compliance program.
Research in this area has shown that employees, and even more the management of a company, need specific skills to identify, analyze, and balance ethical, legal, and economic considerations in order to be able to
make values-based decisions. A training program should be based on
a two-step model. The first layer of training activities should seek to

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transmit information about integrity and compliance concepts and specific knowledge. It should raise awareness about the ethical standards
and specify expected behavior. This can be done in face-to-face training
sessions or through online training instruments. Critical top management
support is needed in order to establish active role models. For example,
senior management and the board of directors should participate in those
training sessions on a regular basis. Training should be specific to the target audiences based on individual job-related and company-related risk
assessments.
The second layer focuses on the development of integrity management
and execution skills. Managers should be trained in how to use integrity
management practices as crucial tools when making business decisions.
This should then ultimately lead to ethically acceptable results. The skill
dimension becomes especially important in situations where the complexity of business decisions, information asymmetry, business pressures, globalization effects, management across diverse cultures, and the demand
for sustainable business models is growing. The objective of such skills
training mainly focuses on the clarification of the major behavioral drivers
and the transfer of knowledge about how to manage these. Conceptually,
skills training aims at developing the competencies of managers to engrain ethics and values in the institutional framework of an organization,
and thereby follows the concept of building organizations as collective
moral actors.52 It also introduces practices and links these practices with
the integrity and compliance function of the organization.
Enforcing Integrity Standards
In order to enforce integrity standards, an integrity and compliance
program should entail an integrated approach regarding decision-making
processes, monitoring, whistle-blowing, and audits. Management should
be firm in executing both rewards and punishment. Whenever possible,
positive as well as negative examples should be communicated, including their respective effects on the bottom line. In reality this is not often
the case, especially in firms that are afraid that the reporting of negative
effects could hurt investor confidence. Our own field research shows that
the positive effects from corporate culture change toward a high integrity
performance culture, far outweigh potential negative effects in the financial markets.
Decision Making
Another critical success factor for an effective integrity and compliance
program is the integration of integrity considerations in the decision-

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231

making processes throughout the value chain, starting with research


and development, then manufacturing, and then distribution, including marketing and sales. The processes that are important to consider
are mostly generic ones, such as managing conflicts of interests, sustainable procurement, ethics in recruitment, and career development.
However, sometimes process modifications are necessarily based on industry characteristics. For example, the approval processes for certain
promotional activities are different in the pharmaceutical industry compared to other industries with less direct personal healthrelated impact. The same applies to the processes that should enforce adherence
with human rights.
Monitoring and Reporting
Enforcing responsible business practices needs meaningful and specific
assurance and monitoring processes. The responsibility for monitoring the
implementation of an integrity program rests with the integrity and compliance function, whereas the responsibility for monitoring whether employees adhere to integrity standards and compliance criteria rests with
the respective functional or departmental management. The latter cannot
be delegated to the integrity and compliance department since it would
otherwise disconnect responsibilities, behaviors, and rewards, effectively
rendering the rewards tool described earlier ineffective.
The monitoring of the implementation status can, for example, be done
with a Web-based self-assessment tool that generates a data set about
risk areas and potential gaps in the implementation processes of certain standards. These data can also be used for benchmarking to identify best-practice activities, which then can be replicated by others across
the organization. Another monitoring instrument is the use of an integrity
survey that monitors the ethical climate and the specific risk areas within
an organization.
Further, reporting to internal and external stakeholders is an important task in order to generate transparency and for organizational selfgovernance purposes. For this reason it can make sense to build a direct
reporting line from the chief integrity and compliance officer to the CEO
and a member of the senior management or the board of directors. Regardless of how the structure is built, it is critical that the chief integrity
and compliance officer have sufficient decision-making power without
being suppressed by speak-up problems in an organization, especially to
senior management.
For external communication purposes a company should use specific
sections in the general annual report. In addition, a specific annual integrity report, or a report on progress for the UN Global Compact, which

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focuses on principles in the areas of human rights, labor, the environment,


and anti-corruption, could further boost the effectiveness of integrity and
compliance efforts, especially with external stakeholders. The purpose
of such reporting should be to provide reasonably transparent insights
into the most material topics, integrity management processes, and into
their objectives and results. This reporting has the potential to create structural changes to entire industries. For example, Apple now frequently reports on the environmental impact of its products during product launch
events, and almost all competitors followed this example.
Whistle-Blowing
Whereas many of the processes mentioned earlier are preventive in nature, an organization also needs instruments to reveal, investigate, and
sanction integrity and compliance violations. It is of utmost importance
for the success of an integrity and compliance program to give sufficient
weight and focus to the elements that have the potential to influenceone
of those is making misconduct explicit. Employees should be able to report actual or suspected cases of misconduct without repercussions. This
process is often referred to as whistle-blowing. Such a process must
guarantee confidentiality, anonymity, and protection from any form of
retaliation.
In order to demonstrate credibility of the whistle-blowing process, the
process needs to be made explicit and easy to use. Further, all employees should understand how the process works, including how incoming
reports are being handled and how investigations are conducted. Further, the number of reports that have been received and investigated as
well as the results and learning from the investigations should be made
public across the organization. We suggest not making the whistleblowing mechanisms a responsibility of the integrity function. The reason
is that the role of an integrity and compliance officer should be much more
that of a trainer and advisor in cases of ethical doubts. If the prosecution
function is combined with the training and advisory functions, conflict of
interests could arise and trust could be reduced, which will make both essentially ineffective.
Independent, Internal Assurance
The final activity required for an integrity and compliance program is
an independent internal check of the effectiveness of the internal control
systems and the spotting of voids along the processes. As with all audits
the responsibility for all compliance audits should be with the audit department as it is typically independent from the operational management.
It also usually reports directly to the chairman of the board of directors

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233

instead of the CEO. The integrity and compliance department would then
be responsible for advising the audit function about potential risk factors
that need to be considered during the next audit cycle.
CONCLUSIONS
In this chapter, we described a model for an integrity and compliance
program that should be easy to implement in a most organizations, regardless of size, industry, or location. The proposed integrity and compliance program is conceptually very different form the traditional,
rules-based mitigation-driven compliance programs that still dominate
practice. Traditional programs used to focus predominately on rule setting and monitoring. In contrast, the fundamental idea of the described
behavioral-based program builds on a solid foundation of values and then
addresses the most important drivers of behaviors without letting traditional elements such as monitoring or sanctioning out of sight. Without
having such a behavioral and holistic perspective, integrity and compliance management will be less effective in identifying and preventing integrity risks.53
In addition, the proposed integrity and compliance program enables
firms to react to increasing levels of environmental dynamism caused by
the effects of globalization and societal change processes. The program
proposed in this chapter enables managers to identify and develop business opportunities based on business integrity capabilities. More and
more firms take advantage of these opportunities to, for example, reach
consumers at the base of the pyramid or to provide additional value
to consumers, who, in return, show greater loyalty. These additional effects become a critical source of competitive advantage. Overall, the establishment of an effective integrity and compliance program requires
more than written standards. It requires an integrity mindset that is ambitious and fully committed to doing the right things while doing
things right.

NOTES
When not otherwise indicated, statements made in this chapter represent the
personal opinions and perspectives of the authors.
1. Schroer, W. J. 2011. The Social Librarian: Generations X, Y, Z and the Others. http://www.socialmarketing.org/newsletter/features/generation3.htm (Retrieved October 30, 2011).
2. Sharpe Paine, L. 1994. Managing Organizational Integrity. Harvard Business
Review 72(2): 106117.
3. Fuerst, M. 2005. Risk Governance. The Perception and Management of MoralEconomic Risks (translated from German). Metropolis Verlag: Marburg.

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4. For this topic see Ostergaard, D. 2010. Sustainable Leadership. In J. Wieland


and St. Grueninger (Eds.): Handbuch Compliance Management. Erich Schmidt
Verlag: Berlin.
5. Jennings, M. 2006. The Seven Signs of Ethical Collapse: How to Spot Moral
Meltdowns in Companies . . . Before Its Too Late. St. Martins Press: New York.
6. Ibid.
7. Fuerst, M. 2010. Grundprinzipien und Gestaltung eines nachhaltigen Integrittsmanagements. In J. Wieland and St. Grueninger (Eds.): Handbuch Compliance
Management. Erich Schmidt Verlag: Berlin.
8. Worth a read in this context is an article published by P. S. Goodman and
G. Morgenson in the New York Times from December 27, 2008, about the business
practices within Washington Mutual. http://www.nytimes.com/2008/12/28/
business/28wamu.html (Retrieved January 15, 2011).
9. Wieland, J. 2001. The Ethics of Governance. Business Ethics Quarterly 11(1):
7388.
10. Teagarden, M. B., Drost, E., and Von Glinow, M. A. 2005. The Life Cycle of
Academic International Research Teams: Just When You Thought Virtual Teams
Were All the Rage . . . Here Come the AIRTs! In D. Shapiro, M. A. Von Glinow & J.
Cheng (Eds.): Managing Multinational Teams: Global Perspectives, Advances in International Management 18: 311345.
11. Wieland, J. and Grueninger, S. 2003. Values Management Systems and Their
Auditing. In J. Wieland (Ed.): Standards and Audits for Ethics Management Systems.
The European Perspective. Springer Verlag: Berlin.
12. Porter, M. E. and Kramer, M. R. 2011. Creating Shared Value. Harvard Business Review 89(1): 6277.
13. For disruptive innovation for social change see also Christensen2 et al.
2006. Disruptive Innovation and Social Change. Harvard Business Review 84(6):
94101.
14. Drnevich, P. L. and Kriauciunas, A. 2010. Clarifying the Conditions and
Limits of the Contributions of Ordinary and Dynamic Capabilities to Relative
Firm Performance. Strategic Management Journal 32: 254279.
15. Nidumolu, R., Prahalad, C. K., and Rangaswami, M. R. 2009. Why Sustainability Is Now the Key Driver of Innovation. Harvard Business Review 87(6):
5664.
16. North, D. 1990. Institutions, Institutional Change and Economic Performance.
Cambridge University Press: Cambridge.
17. Williamson, O. E. 1991. Comparative Economic Organization. The Analysis of Discrete Structural Alternatives. Administrative Science Quarterly 36: 269296.
18. Williamson, O. E. 1993. Calculativeness, Trust, and Economic Organization.
Journal of Law and Economics 36: 453487.
19. Williamson, O. E. 1993. The Evolving Science of Organization. Journal of Institutional and Theoretical Economics March: 3663.
20. Williamson, O. E. 1975. Markets and Hierarchies: Analysis and Antitrust Implications. A Study in the Economics of Internal Organizations. The Free Press: New York.
21. Wieland, J. 2001.
22. Ibid.
23. Ibid.
24. Penrose, E. T. 1959. The Theory of Growth of the Firm. Blackwell: Oxford.

Strategic Integrity Management as a Dynamic Capability

235

25. Wernerfelt, B. 1984. A Resource-Based View of the Firm. Strategic Management Journal 5(1): 171180.
26. Dosi, G. and Teece, D. J. 1998. Organizational Competences and the Boundaries of the Firms. In R. Arena and C. Longhi (Eds.), Markets and Organizations,
Springer Verlag: New York.
27. Wieland, J. 2001.
28. Fuerst, M. 2005.
29. Barnard, C. I. 1938. The Functions of the Executive. Cambridge University
Press: Cambridge.
30. Porter, M. E. and Kramer, M. R. 2006. Strategy & Society: The Link between
Competitive Advantage and Corporate Social Responsibility. Harvard Business Review 84(12): 7892.
31. Wieland, J. 2001.
32. Fuerst, M. 2005.
33. Wieland, J. 2001.
34. Schotter, A. and Teagarden, M. 2010. Blood Bananas: Chiquita in Colombia.
Thunderbird Cases Series [A09-10-0012].
35. Sims, G. T. 2007. 2 Former Siemens Officials Convicted for Bribery. The
New York Times. http://www.nytimes.com/2007/05/15/business/worldbusiness/
15siemens.html (Retrieved January 7, 2011).
36. Fuerst, M. 2005.
37. Corporate Executive Board: Compliance and Ethics Leadership Council.
2008. The State of the Compliance and Ethics Function. https://www.celc.exec
utiveboard.com/Public/Default.aspx (Retrieved January 7, 2011).
38. Fuerst, M. 2005.
39. Stiglitz, J. E. 2010. Freefall: America, Free Markets, and the Sinking of the World
Economy. W.W. Norton & Company, Inc: New York.
40. KPMG. 2009. Integrity Survey 20082009, page 6. http://www.kpmg.com.
br/publicacoes/forensic/Integrity_Survey_2008_2009.pdf (Retrieved January 7,
2011).
41. See the study of the CELC from 2008, which is showing that the budget of
the compliance departments have increased up to 36 percent from 2007 to 2008.
42. KPMG. 2009, p. 6.
43. Ibid., p. 14.
44. See chapter in this volume by A. Schotter and M. Teagarden, Resources
and Dynamic Capabilities: The Foundations of Competitive Advantage.
45. Novartis. 2010. Novartis and the UN Global compact. http://www.corp
oratecitizenship.novartis.com/downloads/managing-cc/ungc_case_study_lee_
tavis.pdf (Retrieved May 15, 2011).
46. Although the Integrity & Compliance Program of Novartis is referenced
here, it is important to clarify that the views and perspectives mentioned are solely
the ones oft the authors and not necessarily that of Novartis AG.
47. Integrity & Compliance at Novartis. http://www.corporatecitizenship.
novartis.com/downloads/business-conduct/Integrity_and_compliance.pdf
(Retrieved May 31, 2011).
48. Paine, L. S. Deshpand, R., Margolis, J. D., and Bettcher, K. E. 2005. Up to
Code. Does your Companys Conduct Meet World Class Standards? Harvard Business Review 83(12): 122132.

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49. Kaplan, R. S. and Norton, D. P. 1996. Using the Balanced Scorecard as a Strategic Management System. Harvard Business Review 74(1): 7585.
50. See chapter by A. Schotter in this volume, Dealing with Complexities: The
Role of Management Frameworks.
51. Ostergaard, D. 2010.
52. Davet, G. 2009. Der Minus-Mann. Die Zeit Online. http://www.zeit.
de/2009/15/Banker-15 (Retrieved January 9, 2011).
53. Wieland, J. 2001. Die Tugend kollektiver Akteure. In J. Wieland (Ed.): Die
Moralische Verantwortung Kollektiver Akteure. Physica Verlag: Heidelberg.

Chapter 12

Strategic Value Management:


A New Generation of Strategic
Management Thinking
Juan Pablo Stegmann

INTRODUCTION
Michael Porter revolutionized strategic management with his books
Competitive Strategy and Competitive Advantage almost three decades ago.
He integrated all of the existing thought about competitive strategy.
Strategic value management (SVM) is a new approach to strategic
management that bridges strategic management with stock value creation, creating a new standard that integrates all existing strategic management, business strategies (marketing, human resources, operations,
etc.), and business ethics.
SVM has radical new insights, not only for business organizations,
but also for governments. Even more, it provides a much needed ethical
approach to business.
SVMs most important discovery is the fact that normal strategies of
perfect competition (typically low-cost strategies) destroy stock value
(economic value added, EVA, lower than 2%), strategies in monopolistic competition (typically differentiation) have a weak stock

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value creation ability (EVA from 2% to + 4%), oligopolistic strategies


(alliances and collusion) create stock value (EVA from 4% to 8%), and
monopoly strategies based on unique resources create higher levels of
stock value (EVA above 8%).
Strategic management is silent regarding the fact that 50 percent of
business firms fail to create stock value, even when following mainstream prescriptions of strategy theorists. Many are probably blaming poor implementation when the problem is actually the lack of
theory linking strategies and stock value creation. SVM address this
conceptual failure by linking the strategic environment with recommended strategies and their financial results in terms of stock value
creation.
This is a powerful source of critical thinking because it helps address the question of which strategies must be implemented in different
strategic environments and what financial results can be expected as a
result. This solves current strategic managements lack of metrics, lack
of accountability, as well as the feeling that every strategy is valid and
produces good results.
SVM simplifies strategic management thinking. After decades of specialization strategic management has produced numerous and confusing
theories and models. SVM eliminates this confusion; complex strategic
issues are simplified to include the three dimensions of stock value creation: profits, sales growth, and capital. These are linked to strategic
management dimensions: competition, innovation, and resources. This
approach simplifies and eliminates the current atomization of the literature and explains differences among theories in terms of contingencies.
Marketing, finance, human resources, operations, and business ethics
are thereby streamlined and simplified.
SVM is also extremely valuable for nonbusiness organizations, such
as government, the armed forces, nonprofit organizations, and churches,
because it incorporates concepts such as public opinion, political power,
and treasury budget allocations into business strategy terms.
SVM modernizes strategic management by effectively integrating
modern disciplines such as industrial economics, game theory, transaction costs economics, agency theory, the resource view of the firm (RVF),
intellectual capital (IC), and knowledge management.
By introducing economic analysis, SVM provides profound insights
into business ethics. Most strategic management and business management literature remains silent on the ethical consequences of managerial
decisions. The vast majority of managers ignore the fact that in order to
create stock value, firms need to have a positive EVA, resulting in profits above those of the competition. This puts tremendous pressure on
managers, forcing them to make decisions that often conflict with their
personal values.

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It helps to introduce political and moral philosophy into business


strategy. Economics was born as a branch of the former; by introducing economic-styled analysis, SVM naturally incorporates ethics into
business, with very powerful results.
SVM helps to link business to religion. The three pillars of SVM are resources, power, and creation, which belong to the core of biblical as well
as other religious traditions.
Hopefully SVM can help to develop integrity inside organizations
and civil society by creating new awareness and maturity, and by linking managerial decisions with their consequences in the community. The
financial crisis of 2008 should not be repeated and SVM has important
insights to help avoid it in the future.

LITERATURE REVIEW
Sources of Firms Economic Performance
Based on research on 168 public firms, a model is introduced, where the
horizontal axis is the EVA of a firm and the vertical axis is its growth. Two
new variables are added to this model: market power and knowledge.
The variable market power is an indicator of the level of aggressiveness of the competition in a market. A low level of market power indicates that the competition is intense and the products sold in that market
are normally identified as commodities (perfect competition). An average
market power indicates that the competition is less intense and companies
are able to differentiate for some time (monopolistic competition). A higher
market power indicates that the level of competition is even softer as a
result of very weak competition (oligopolistic competition). The highest
market power indicates complete lack of competition (perfect monopoly).
The variable knowledge is a systemic variable indicating the level of
IC of a firm in terms of how much knowledge is received from the environment, how much knowledge is incorporated in the value chain, and
how much knowledge the firm incorporates in the final product.
The Link between Stock Value Creation and Strategic
Management
SVM links the financial dimensions of stock value creation with strategic management drivers. The EVA financial model describes how a firm
creates stock value.
In order to create stock value firms need to:
Have profits, in terms of a positive EVA (profits minus cost of
funds or, in other words, the profits of the firm minus the profits of

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Figure 12.1
Strategy-Value Model

similar firms), which is produced by the strategic management


driver of market power,
Have sales growth, which is driven by the strategic management
driver of innovation (new products, new channels, new businesses,
new locations, new technologies, new value chains, etc.), and
Manage capital, which is driven by the strategic management driver
of unique inimitable resources.
Welcome to the strategy-value model, the backbone of SVM. Figure 12.1
introduces one simplified version of the strategy-value model. Throughout the rest of this chapter we will show other layers.
THE FIRST DIMENSION OF SVM: PROFITS
DRIVEN BY COMPETITION
During the last few decades, several industrial economists have connected competitive environments with their recommended competitive
strategies. As can be seen in Figure 12.2, SVM goes a step further and links
competitive environments to the ability to create stock value, producing a model that joins the competitive environment with competitive

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strategies and expected financial results in terms of profits (EVA). This


is a new concept within the literature, showing which strategies produce
good or bad financial results and in what environments these strategies
are effective. As such, SVM has profound implications.
Firms operating in perfect competition tend to have very low profits
(EVA below 2%). Products tend to be standard and undifferentiated.
Typical industries operating in perfect competition are commodities,
agribusiness, natural resources, metals, and chemicals.
Since firms in perfectly competitive markets cannot determine prices
(they are determined by the markets), and products are undifferentiated,
key competitive strategies are focused on keeping costs low by raising
efficiency, using lean manufacturing, and trying to generate economies
of scale. In order to reduce the competitive intensity, firms need to consolidate the industry by way of acquisitions or alliances. Promotion
strategies may be risky: the more information, the more perfect the competition becomes, the more power is given to the customer to select the
most aggressive competitor. Distribution strategies are limited to push
strategy (sell using the channels) with a very frugal low-level channel,
combined with low-cost logistics, which attempt to simplify distribution
and reduce cost.
Figure 12.2
Environments, Strategies, Results

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Firms operating in monopolistic competition have EVAs close to zero.


Their products can be differentiated; however, differentiation is based
mostly on the lack of ability or willingness of competitors to engage in
imitation. Typical industries that tend to operate in monopolistic competition are: manufacturing, food, autos, electronics, consumer products,
transportation, and commercial banking.
The strategies in monopolistic competition are what most marketing
management textbooks recommend. Product strategies are based on differentiation and positioning with some branding and packaging. Pricing
strategies permit some degree of linear and nonlinear pricing (typically,
promos, combos, long-term agreements). Promotion strategies are connected to pull strategies such as advertising, personal selling, and customer relationship management. Distribution strategies can rely on
more sophisticated push strategies such as using higher-level channels
with more value added (insurance, advisory, financing, etc.) as well as
advanced logistics and supply chain management.
Firms operating in oligopolistic competition tend to have much higher
profits (EVA between 4% and 10%). Some industries operate as true oligopolies: colas, corn flakes, peanut butter, cellular telephony, oil, some
branded products, etc.
The core of an oligopoly strategy is that firms do not compete on the
basis of some aspects of the marketing mixtypically price.
Figure 12.2 shows that strategies in perfect and monopolistic competition are based on actions, whereas strategies in oligopolies and
monopolies are based on resources. For oligopolies the key resource is
maturitythe ability of the competitors to avoid competing.
Firms operating as a pure monopoly have much higher profits (EVA
above 10%). Typical monopolistic firms include Microsoft (Windows
and Office), Intel (in some products), some utilities with market protection, and some pharmaceutical firms (in products protected by
patents).
Monopolistic strategies are based on unique inimitable resources. The
stronger such resources are, the higher the entry barriers. The word resources has a wider meaning here: experience, technology, innovation,
capital, relationship with customers or channels, customer switching
costs, economies of scale or scope, control of channels, strong image,
and government policy such as patents or market protection (utilities).
In some cases new entrants are unavoidable and in such cases it is better for a monopoly to soften the competition and play an oligopolistic
friendly collusion strategy.
You may wonder how to determine what competitive environment
your firm or industry operates in. Porters five forces model helps to determine where an industry or firm operates in terms of perfect or monopolistic competition. Industrial economics developed a model called

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the supergame, based on game theory, which helps to see whether an


industry can operate as an oligopoly. Industrial economics and the resource based view (RBV) of the firm developed parallel models to determine whether a firm can operate as an oligopoly or whether a single
firm can be a full monopoly.
Figure 12.3 provides a conclusion to this analysis of competition: you
can place industries in the strategy-value model according to their life
cycle. New products tend to be monopolistic, but when new competitors enter into the segment, competition becomes more intense, and the
product may end up as a standard product in perfect competition. This
helps us to understand why some industries typically create or destroy
stock value.
Takeaways
I suggest that you use the information that has just been explained, to
contrast your competitive environment, your strategies, and your financial results. This will help you to critique your firms past decisions and
eventually to have an idea about its future. If you have the time to repeat
the same exercise with other firms or industries (my students have done
it with thousands), you will be surprised by the consistency of the model.
In further pages we will expand these insights. Be careful, EVA is also
affected by the resource strategies as discussed below.

Figure 12.3
Strategy-Value Model and Industry Timeline

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THE SECOND DIMENSION OF SVM: SALES


GROWTHDRIVEN INNOVATION
Typically strategic management literature covers sales growth and innovation randomly through several topics, each author placing it in different
sections: entrepreneurship, related and unrelated diversification, mergers
and acquisitions, growth strategies, new product development, new markets, new customer strategies, new business development, international
strategies, research and development, cultural innovation, internal new
ventures, corporate strategies, alliances and joint ventures, vertical integration, outsourcing, portfolio management, industry life cycle, and more.
SVM simplifies such atomization by focusing on the second and third
dimension of the strategy-value model: innovation strategies and resources strategies.
Innovation and Resources Strategies
Figure 12.4 relies on and modifies McKinseys staircases to growth.
It provides a platform for understanding the link between innovation
and resources, showing how firms that expect to grow steadily need to
have special resources.
Figure 12.4
Innovation Strategies

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SVM shows how it is possible for a company to acquire resources, use


its own resources, or share third-party resources in order to produce an
innovative strategy. Each approach has both benefits and risks.
Increase in customer share can be accomplished by proposing to current customers alternative products based on each customer, at different
prices. This is called price discrimination, and consists of the classical
promos and combos that you can see in many businesses. Some products are owned (McDonalds offers combos of their own products), are
acquired (Disney offers packages of parks, hotels, cruises), or originate
with third parties (Amazon sells books from partners).
A firm may increase in market share by using its own resources, such
as sales force or telemarketing, by acquiring the markets of firms with
similar products or services (AT&T acquiring Cingular), or by sharing
customers with other firms or organizations (American Airlines with
Avis).
Innovation in products and services can be managed internally by a
firm, either led by a single division such as R&D (Hewlett Packard), or
by the entire organization (3M). It can be accomplished by acquiring resources (Gillette acquiring Duracell, Parker pens, etc.) or sharing resources
(Johnson and Johnson partnering with universities or venture funds).
Innovation in the value chain keeps the same products but provides
new value propositions. An example would be when using its own, acquired, or shared resources Ikea created a new revolutionary way to
market furniture in a small box that the customers assemble at home.
New business can be led internally (Citibanks cross-functional
teams), by acquiring resources (Disney buys ABC channel), or by shared
resources (Enron partners with power generation plants). Finally, new
locations can be handled internally (exports), by acquiring new resources (Daimler acquires Chrysler), or by sharing resources (McDonalds franchises overseas, or Coca-Cola establishes a partnership with
Mitsubishi to market their products in Japan).

Growth and Stock Value Creation


A second critical insight that SVM introduces is the connection between growth and stock value creation. If a firm has low market power,
innovation can be too risky and not advisable. The financial resources
associated with innovation may not be recovered, as a competitor may
reach the market first. If profits are low, growing may empower the
losses. This suggests that innovation is quite unlikely in intense competitive environments. As Schumpeter stated, innovation makes sense
in monopolistic situations and innovation helps to preserve and defend
firms operating in monopolistic environments.

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By relying on the EVA model, SVM incorporates such insights, and


provides a clear criterion: growth without EVA destroys stock value and
therefore is not advisable, unless the firm expects to gain market power,
thereby ending up with growth and a positive EVA. This has been the
case for some dot-coms, such as Amazon, which is steadily reinforcing its market power and EVA. Many dot-coms that had very negative
EVAs, were able to obtain funding for their ventures with the expectation of high sales growth leading the firm into a monopolistic situation.
However, such investments may turn speculative; when such positive
EVAs do not materialize, the investors abandon the firm leading it to
a collapse. This happened massively during the Internet bubble at the
turn of the millennium.
Takeaways
As you can see strategies related to growth and innovation fell into
disgrace during the 1970s because of the massive failure of such strategies, even though everybody recognizes that growth and innovation
strategies are important.
We now understand when innovation strategies make sense and how
they can be streamlined with the rest of the strategies of the organization
in order to create stock value. You can now better connect the strategic
environment, the strategies, and the financial results. In certain environments the strategies may produce good or bad financial outcomes.
THE THIRD DIMENSION OF SVM, CAPITAL
DRIVEN BY RESOURCES
Resource strategies are the single most important dimension of SVM
to predict the future success or failure of an organization. Many times
you can observe a paradox: the current financials of a firm and all current indicators are in good shape; however, the stock value of the firm
has a poor performance. There seems to be no explanation until you look
at the resources: they are like a crystal ball, they help you to predict the
future.
An example is Dell. During the 1990s, Dell had unique resources that
provided them an outstanding stock value performance, with the highest EVAs in the history of corporate America. However, during the last
few years, several other firms began to imitate them. Dell responded by
outsourcing manufacturing, with the result that its unique delivery system stopped being unique, which in turn led to intense competition with
other firms. Although Dells financials were still good, its stock value
had a very poor performance because the giant computer maker had lost
its unique position in the market.

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Resources are the backbone of both the competitive and growth strategies that we discussed before. How can they help to predict the future?
Resources Part 1: Physical versus Intellectual Capital
Managers face pressure to create stock value. Even if they do their
best, it is difficult in some industries to create stock value for the type of
capital they use, no matter what managers might try.
Some industries require large amounts of physical capital. According
to Leif Edvinsson, the European IC giant, physical capital has several
problems: it follows the law of decreasing returns (the more you invest,
the lower the profits), it wears out and deteriorates, and it can be imitated easily leading the industry into perfect competition.
The opposite is true if your industry is based on IC. IC can be reproduced without new investments (the cost to produce a new MS Word
program, sold for several hundred dollars, is merely the cost of a CD and
the box), whereas the cost to reproduce a ton of steel, with high physical capital, is very close to its price). IC can grow steadily with investments (that is why Microsoft stock is 20 times larger than its book value,
whereas for U.S. Steel the relationship is close to 1:1). IC does not wear
out like physical capital. On the contrary, knowledge and customer relationships can grow with no limit. When Rover and Honda signed a
strategic alliance some decades ago, Honda acquired Rovers IC, knowledge, and relationships about the European market.
Figure 12.5 shows these two types of capital and links them to the first
two dimensions of stock value creation: the higher the IC, the higher the
profits and sales growth. This links the strategic environments that we
saw in Figure 12.2 with the resource strategies and the financial results.
Clearly, for industries that require large amounts of physical capital, this
has a negative impact on their ability to create stock value.
Resources Part 2: Unique, Inimitable and Rare Resources
to Boost Market Power and Innovation
Resources are a critical economic concept because they are responsible for creating future cash flow.
There are two separate economic theories that explain higher profits. Industrial economics theory suggests that industries have high profits when their entry barriers are high. The Resource view of the firm
posits that profits are the consequence of unique, inimitable, and rare
resources.
Figure 12.6 shows how SVM integrates both: high entry barriers or the
uniqueness of the resources produce market power. Here it is the combination of barriers and resources, which is responsible for the high profits.

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Figure 12.5
Resources and Growth

Figure 12.7 portrays how resources can be used to support competitive and growth strategies. Most managers and business people have
used the SWOT analysis (strengths, weaknesses, opportunities, and
threats) in their careers, ignoring that the SWOT is a powerful conceptual piece for understanding how firms internal resources are critical
for developing market power and innovativeness. As we saw earlier, internal resources are responsible for market power and sales growth, the
two pillars of stock value creation.
Strengths and weaknesses (SW) emerge from unique resources that
make the firm stronger than its competitors. Such unique resources
provide a firm with higher profits than its competitors. To understand
strengths you need to visualize both demand and supply: customers expect certain specific attributes from their suppliers and are willing to
pay a higher price to the firms that supply such attributes. Some firms,
based on their unique resources, can provide such attributes. This is the
origin of differentiation strategies. Without differentiation prices would
be similar for all firms. For example, some customers are willing to pay
a higher price for a Toyota because Toyota provides the attributes that
the customers expect, based on Toyotas unique resources. This enables
Toyota to charge higher prices, which leads them to a positive EVA in an
industry where many competitors have negative EVAs.

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Figure 12.6
Resources and Entry Barriers

Opportunities and threats (OT) emerge from the ability of a firm to


take advantage of factors or actors in the external environment: economics, political, regulations, demand, technology, etc. For example,
in a recession, a firm that supplies systems which help to reduce cost
can be extremely successful: the internal resources of that firm permit
Figure 12.7
Resources and SWOT

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it to transform an external factor such as a recession into a business


opportunity.
In summary, firms with adequate resources can generate profits (or
losses) based on their strengths (or weaknesses), and can raise (or reduce) their sales by transforming external environmental factors into
business opportunities (or threats).
This approach is extremely valuable; the SWOT stops being just an
analytical tool, it goes a step further, and helps to produce a synthesis,
a practical conclusion, in terms of the future ability of the firm to create
stock value and in terms of profits and sales growth, based on its unique
resources. In addition, the SWOT is not an abstract thinking tool, as it is
now strongly connected with the strategic environment (internal and external), the firm strategies, and the financial results. In conclusion, firm
resources become central to determine future success in terms of its ability to create stock value.
Resources Part 3: Resources Developed Internally versus
Acquired versus Shared
The decision to own, buy, or share resources is a critical factor in creating stock value.
During the last decade, Skandia, the Swedish financial and insurance group, turned their formerly poor financial performance into outstanding growth (almost 100% per year) by outsourcing the part of their
operations that required high physical capital (tellers) and keeping for
themselves the part that helped develop IC. This consisted of knowledge
(product and business development) and relationships (alliances with
partner firms to market their products).
Examples such as Skandia or Dell show that, on a first look, sharing
resources is a very promising strategy. However, this approach also has serious problems. The introduction of economic analysis provides a very powerful insight into determining when sharing resources is convenient or not.
According to Torger Reve there are three ways to share resources and
they all have large economic benefits. First, diversification alliances,
wherein firms that provide different products or services (such as Amazon, which uses their channels to sell products from partners) provide
economies of scope by sharing resources that help growth into new arenas.
Second, horizontal alliances (e.g., VISA and Bank of America) provide
economies of scale, by sharing resources with the competition, and boost
profits by avoiding competitive wars. Third, upstream and downstream
alliances (e.g., Amazon and LG) provide economies of integration, by
sharing resources with customers and suppliers. Such integration leads to
stronger market power through lower costs and higher quality as well as
reinforcement of the relationships with buyers and suppliers and ability
to develop joint resources.

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Interesting, right? The magical words, sharing resources, are behind


every aspect of alliances. Your conclusion will be: you must always develop partnerships with any stakeholder around. However, the reality
shows that firms develop their own resources and acquire entire firms,
which seems irrational. Have we missed anything?
Sharing resources has economic benefits and economic costs, known
as transaction costs. Transaction costs are the result of the opportunistic behavior of partners. You may find out that your supplier is not reliable, and this has an impact on your own production; a contractor receives
your advance payment and then is declared insolvent. You may limit these
problems by contracts, but contracts may not be complete; perfect opportunistic behavior cannot be eliminated (bounded rationality, difficulties specifying or measuring performance, and asymmetric information).
Organizational Resources
SVM also integrates into a single model the various types of organizations explained earlier. Figure 12.8 shows how Gareth Morgan provided
some metaphors to understand different types of organizations.
Figure 12.9 paraphrases Morgan: commodity industries/perfect competition environments (at the left) require simple mechanistic organizations; however, more sophisticated competition and fast-moving

Figure 12.8
Images of Organizations

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Figure 12.9
Strategy-Value Model and Organizational Types

environments (at the right) require organizations that can react to the environment as organisms and can even lead the markets as brains.
Takeaways
This may be the first time that you have seen how resources strategies are critical in creating stock value and forecasting the future. This
is because resources are the backbone of both competitive and growth
strategies. More than that, you can now translate and convert everything
that has been described into the dimensions of competition, growth, and
resources, as well as profits, sales growth, and capital. The previous
charts can be applied to your organization to help determine the viability of your current strategy. With this approach strategic management
becomes a simple and powerful tool that can be used in the competitive
enterprise. Now that you have the big picture, lets see some important
applications.
SVMS APPLICATION TO SUSTAINABILITY
Most strategic management and business strategies books do not
talk about ethics or sustainability, probably under the mistaken belief
that this is not business. In other words, there is no place for ethical conduct in business. Apparently there is no ethical concern behind

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differentiation, low-cost strategies, the marketing 4 Ps, lending or borrowing, partnering, and so on. But SVM is a completely different approach that shows that ethics and strategy are deeply interconnected.
SVM proposes that behind every decision there is a need to maximize
stock value (pay special attention to the word maximize). The EVA
model introduces a dramatic insight that most business managers ignore: to maximize stock value, firms need to have a positive EVA, or in
other words, be more profitable than the average firm. This has powerful consequences, as 50 percent of the firms automatically destroy stock
value and the ones that create value need to compete fiercely to remain
so. This puts a tremendous pressure on managers, which is transmitted
to the entire economic system.
As we saw earlier, to maximize EVA, firms need to maximize market power, by satisfying consumers more than the competition. This can
produce negative social distortions.
The need to control consumers leads to consequences, which include
abuses in advertising, manipulation of consumer autonomy, advertising of alcohol and tobacco, violence in movies and music, a high-interest
loan market and financial greed, financial speculation, product liability,
product safety and risks, consumer health, genetically modified products, protection of infants, deception and bluffing in sales, false information about a product or service, false price claims, bait and switch
practices, and unfulfilled promises.
The need to outperform the competition leads to actions such as unfair
competition, abuse of monopoly power, dumping, contributions to political parties, espionage, and bribery. The EVA has a second dimension,
the need to grow, which has an impact on the third dimension described
earlier, that is, resources, such as the environment and human resources.
The abuse of environmental resources produces air, water, and land pollution, depletion of resources, environmental accidents, bioengineering
abuses, global warming, acid rain, ozone-layer depletion, and hazardous
waste.
The abuses of human resources produces employee screening, overwork, sweatshops, employees lack of privacy, discrimination, workplace safety, downsizing, layoffs, and abuses in executive pay.
The financial meltdown of 2008 showed how global financial funds
abused their superior knowledge and financial resources to manipulate markets, thus producing catastrophic consequences. According to McKinsey,
global funds are four times larger and grow two times faster than global
annual GDP. When the real estate market started to weaken in 2002,
fund managers moved to oil, pushing the price from $25/barrel (2002)
to $100 (2008), an increase of 300 percent. The same happened with other
commodities (food, feedstuff, beverages, and industrial raw materials),
which increased their prices by 150 percent during the same period,

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while global inflation was 25 percent and global GDP growth was 34
percent (data from the Economist Intelligence Unit, EIU). Even worse,
this speculation on commodities was the main reason for the inflation
during those years that led central banks to raise the interest rate from
1 percent in 2003 to 5.25 percent in 2006 (EIU), which triggered all the
negative effects on the population.
Speculation has existed for centuries, but the bad news now is that the
speculators are global giants and that globalization leaves governments
with little power to control them.
SVM explains such excesses of the system and the need of firms to
maximize stock value. It addresses abuse of market power and the tendency toward win-lose interactions between the investors and other
stakeholders.
In the middle of the real estate crisis of last year many people could
not sell their houses unless they reduced prices drastically. People could
not stop using gas, in spite of its high price, and could not stop eating
even though grain prices increased, and so on. Individuals experienced
the win-lose power of speculation: the global funds won, you lost.
Countries that suffered speculative attacks on their currencies can
state their devastating effects: financial systems meltdowns, savings
and pension funds evaporated, prices of house fell to one-third, and so
on.
The multibillionaire bailouts provided by the IMF and the U.S. Treasury will have to be paid for many years by us and our children in terms
of new government debt and taxes.
Although global funds had yields between 100 and 200 percent in
short periods, the people were left in devastating conditions.
From Quest for Value to Quest for Values
The global funds are business firms led by managers whose goal is to
maximize stock value, following the mandates of their shareholders and
investors. They are pension funds, mutual funds, institutional investors
who are administering the savings of their clients, workers, and families,
you, and me. There are countless ethically responsible funds; however,
they carry only 0.5 percent of the total investments.
There seems to be a massive lack of awareness that investors and
shareholders have the final responsibility for the many wrongdoings
described above.
SVM generates a new level of awareness by linking business strategies with peoples decisions to maximize stock value. A new level of
awareness must emerge, a new level of social responsibility, a new universal ethics, involving all stakeholders from all over the world.
SVM is born of the incorporation of economic thinking into strategic
management. Economics as a discipline originated as a branch of moral

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philosophy; therefore, it is a powerful way to introduce ethical dimensions into business disciplines.
Probably the architects of modern business ethics did not realize the
consequences of their thinking. In their intuitions, a little speculation, or
a little level of market power was not a serious concern. But today speculation is 10 times larger than the real economy.
Adam Smith had wisdom that can help us today. He solved a dilemma
between two extremes. Hobbes believed that people were wicked and
vicious therefore should be controlled, whereas Locke believed that people were naturally good, so they should be free. Adam Smith stood in
the middle. People can have values and virtues, but not everyone has
them, so institutions need to intervene to preserve personal liberties. It
is a continuous learning process in which we need to find ways to improve our system.
The pressure to maximize stock value is so strong that regulations
cannot cover all possible implications, especially in a global economy,
because firms can export their wrongdoings to other nonregulated
regions.
According to Milton Friedman, if firms do not maximize stock value,
they can suffer serious consequences. Upset investors may abandon
such firms leading to a fall in stock values that can then lead to a lack
of equity financing. Other competitors can use their power to eliminate
good-willed firms. Therefore managers with good intentions may have
a hard time trying to enact their personal ethics.
Is there any solution to this dilemma? It is by incorporating values
into the economic system. A firm with strong values can be rewarded by
the community, employees, clients, partners, and the government. This
may take place through larger sales, stronger relationships, and better
exchange of knowledge as a result of mutual trust. In that case there
is no contradiction between maximization of stock value and ethical
values.
The community must enact its values. Investors need to invest in ethical firms or ethical investment funds, even though their yields may not be
as high as they would be otherwise. Consumers would need to buy from
ethical firms, even though they may not have the best prices.
This requires more transparency, similar to the credit rating agencies,
but oriented to rate firms and investment funds based on their values.
The only way the entire economic system would act with values is by a
universal ethics, where all members become aware of their responsibilities and enact them.
For people who believe in the Bible (Judaism, Christianity, and
Islam), the God of Genesis gives power to Adam (Have dominion
over the fish), resources (I give you every plant . . . to be your
food), and innovation (God took the man and settled in the Garden of Eden to cultivate and care for it). This provides a spiritual

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support to the three dimensions of stock value creation. For Eastern


religions, Hinduism, Buddhism, Daoism, and Confucianism, the maximization of stock value must be put in harmony with the values of
the other stakeholders. Today, the Dalai Lama is a strong defender of
the need to have universal ethics based on personal values. Similarly
Greek philosophy (such as Aristotle) searches for a harmony based on
virtues such as prudence (wisdom), moderation, and justice. This incorporates the value of all stakeholders happiness. The ethics of rights
(Kant) conforms to Greek philosophy. Ethical values must be universal
in order to be ethical, so maximization of shareholder wealth must also
maximize the wealth of the other stakeholders to be acceptable. Winlose situations are not acceptable.
Takeaways
In summary, it is not true that ethics and business are divorced realities. SVMs approach creates awareness of this and provides philosophical and practical solutions, by incorporating values into stock value
maximization.
SVM FOR A GOVERNMENT AGENCY, ARMED
FORCES, NONPROFIT ORGANIZATIONS
SVM has also very powerful insights if you work for the government,
armed forces, or nonprofit organizations by overcoming limitations of
traditional strategic management.
What is the capital of a government agency, its main resource?
Its political capital, political support, a good image with the public,
and the ability to satisfy voters and tax payers.
Political profits are driven by their power, which is dependent
upon how the agency satisfies its customers and how the government
satisfies its voters. In this case the competition can be a previous government, the opposition, a potential new entrant, such as a future president,
or can be other alternative uses of taxpayer money. The strength of such
power, as in business, depends on the strength of resources. Political
capital provides the authorities with the ability to manage the budget
and the revenues of each government agency.
Innovation is also fueled by political capital in the form of budget allocations. An agency needs resources to take advantage of opportunities
arising from changes in political events, regulations, economic situations, demand, technology, personalities, etc.
Similar to business, any organization can apply the triad resourcespower-innovation to analyze the strategic environment, strategies, and
financial results.

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CONCLUSION
SVM is a new way of thinking about strategic management. It proposes a higher degree of simplicity (and simplicity leads to perfection,
whereas atomization leads to confusion), critical thinking, and consistency. This approach helps to develop IC: individual knowledge (simplicity enables higher understanding), organizational knowledge (by
sharing a common understanding and language), and relationships
(by leading individuals and organizations to build trust based on clear
values).
This chapter shows how SVM creates awareness that stock value
maximization is behind most business dimensions. This would not be a
problem for many, as long as such maximizing became a win-win situation for the other stakeholders, namely, for the rest of society. However,
as we saw earlier, this is not always the case.
Strategic values management should lead to deeper reflections
strongly connecting business with the society: what are our values (personal and business), what makes us happy, what type of world do we
want for our children, how do we build integrity rewarding those that
share our values? The divorce of society from business management
should end.
Strategic values management should propose a wider and integrated view: ultimately, how do we build a better world, how do we
develop business visions, missions, cultures, and goals, consistent with
our personal values. How should customers, investors, or shareholders, reward firms that care for the society, that act with integrity, that do
not abuse their market power, are sensible for the environment and for
human resources, and have global funds that do not speculate?
This is a challenge, but, as Adam Smith proposed, we need to consistently improve what we have.

APPENDIX: LITERATURE REVIEW


Literature Related to Market Power and Resources
The first aspect that is critical for the firms economic performance
is related to the ability of the firm to compete with other firms. There
are two relatively well-differentiated bodies of research that examine the
sources of a firms success.
Industrial Organization (IO) theorists Brandenburger and Nalebuff,1
Chamberlin,2 Coase,3 Dixit and Skeath,4 Penrose,5 Fudenberg and Tirole,6 Nelson and Winter,7 and Martin8 believe that the economic performance of a firm depends on the industry structure. Bain,9 the father of IO
thinking, demonstrated that the profitability of manufacturing sectors in

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which the eight largest firms concentrated 70 percent of their sales were
twice as profitable as sectors with lower concentrations. He also showed
that sectors with high entry barriers (cost advantages, product differentiation, or economies of scale) permitted the incumbent to charge higher
prices than strictly competitive prices. Michael Porter10 integrated and
popularized the rich research developed after Bain, proposing his five
forces approach, which provides strong linkages between industry
structure, firm strategy, and profitability. This view was followed by
various extensions, the most critical of which incorporated game theory
into IO. Interestingly, Porters second book (Competitive Advantage)11 is
somewhat of a betrayal of his original view, showing that what makes
a firm more or less profitable is its own value chain (a firms internal
aspect) and how its value chain compares to competitors value chains.
This second approach came to be defined as the resource view of the firm
(RVF, Coase, Penrose, Teece,12 Rottemberg,13 Rumelt,14 Barney,15 Reve,16
Wernerfelt,17 Dierickx and Coolr,18 Garvin,19 Conner,20 Ghemawat,21
Peteraf,22 Hamel and Prahalad,23 Eisenhardt and Schoonhovern,24 and
Priem and Butler).25 Here, it is not the industry structure but the ability
of the firm to develop unique inimitable resources that drives competitive advantage.
Empirical research has produced mixed results. Schmalensee26 drilled
down into the components of Bains cross-sectional work, concluding
that industry effects impact 75 percent of variance of ROA, corporate
effects do not exist, and market share has a negligible impact. Rumelt
found the opposite: business unit effects are six times larger than industry effects. Rumelt states, business units differ from one another
within industries a great deal more than industries differ from one another. Roquebert, Phillips, and Westfall27 tried to reconcile Rumelt and
Schmalensees findings, but ended up supporting Rumelt.
McGahan and Porter28 introduced corporate effects, which they found
to be less influential than industry effects.
In the battle of ideas the RVF (the firm as responsible for the success)
appears to be the winner and IO (the industry as responsible for success) is an outdated perspective. This author disagrees. This chapter incorporated a contingent approach: both industry and firm factors matter. It
demonstrated that industry factors are critical for businesses characterized by low market power, whereas firm factors are critical in industries
characterized by high market power.
Literature Related to Growth and Resources
There is a second aspect that is critical to a firms success and is related to the ability of the firms to grow. According to McKinsey (see
Baghai et al.29), firms that want to grow steadily need to develop a

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special capability platform consisting of business specific core competencies, growth-enabling capabilities, privileged assets (mostly intellectual assets), and special relationships. Edvinsson30 classifies all these
items as IC, that is, knowledge and relationships.
Literature Related to How to Measure a Firms Economic
Performance, and Its Connection with Industry
and Firms Factors
The literature has proposed several indexes to measure firm economic performance. Bothwell, Cooley, and Hall31 and Qualls32 used
sales costs/sales, similar to the Lerner index. Holterman33 included
other variables such as output/person, output/capital, output/costs,
and similar ones using profits instead of output. He also used the Lerner
index and growth of productivity. Bothwell34 approached the concept
of stock value as a proxy of economic performance by mentioning free
cash flow; however, he finally used return on equity (ROE) and return
on assets (ROA).
Other streams of research focus on the EVA as a value-based management tool. Probably the most advanced and inclusive one is Fletchers research, which presents an integrated value-based management
model, linking the EVA and balanced score card to decide and monitor
strategies. Some authors have incorporated the EVA in their analysis,
including Pettit,35 Ittner, Larcker, and Meyer 36 and Banker, Potter, and
Srinivasan.37 Most of these works relate to the pros and cons of EVA in
accounting and strategic management.
There is no research that has linked the EVA model with IO or RVF
indicators as such. The closest link between stock value creation and industry factors is presented by Lindenberg38 and Montgomery and Wernerfelt.39 They reframed Tobins q as a concept related to stock value
creation (the difference between the market value of the stock and its
book value, which is the net present value of discounted future EVAs).
Lindenberg reformulates Tobins q correlations with specific assets
(capital special factors and monopoly power: scale economies and patents). Montgomery and Wernerfelt relate it to intangibles (value of intangibles, collusion, unique Ricardian factors, and disequilibrium factors).
Literature Related to Models to Measure
a Firms Economic Performance
Financial accounting has produced several financial models to measure a firms economic performance. Several of those models measure
stock value creation. However, their limitation is that they do not take
into account the soft side of business, such as the strength of customer

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relationships, the ability of employees, or the efficiency of processes.


These elements, called intangibles, are critical for economic success
and cannot be measured adequately by traditional financial measures.
There are two very popular models to measure business performance
that incorporate nonfinancial intangibles: the balanced scorecard model
(Kaplan40) and the IC model (Edvinsson41). Both models propose a set of
indicators grouped in the following dimensions: financial, customers,
employees, processes, and growth. However, both models are limited by
the difficulty of measuring intangibles.
The EVA equation, as presented by Stern Stewart42 and Copeland,43
solves the limitations of both the financial and the nonfinancial views.
The EVA is strongly aligned with the balanced scorecard and the IC models: the net present value of all future EVAs is equivalent to IC, which
measures the value of intangibles, the value of the customers, employees, processes, and the ability to grow. The operating capital of the EVA
model is equivalent to the financial perspective of the balanced scorecard and the IC models.
Literature Related to Concentration as a Proxy
of Market Power
According to IOs Joe Bain, concentration fosters collusion and this
leads to high profitability.
This author agrees with Curry and George44 that the literature has not
resolved the question of which index is the best to use to measure concentration. Lerner proposed his famous index, where margin divided
by price is an indication of the departure from the competitive ideal.
Concentration is strongly linked with the number of competitors, as in
the case of Bain who uses the K-firm index (value product contributed
by the first K larger firms). For Bain, concentration has an impact on
the success of collusive behavior on higher margins. However, Bain recognizes that the correlation is quite poor. Concentrations of profits are
clearly high or low, but with no linear relationship in the middle. This
view is captured by Herfindhal who demonstrates that by using squared
values the impact of smaller firms is less than proportionate.
Mann,45 Weiss,46 and Comanor and Wilson47 use seller concentration
and entry barriers. Curry analyzes several indexes of concentration.
Bain, Mann, and Qualls conclude that concentration and entry barriers impact profits. Bothwell disagrees with Bain: collusion (linked to
concentration) and entry barriers do not correlate with margins. Scherers48 theory is that concentration has a negative impact on margins
(scale economies have no impact). Rhoades and Cleaver49 present strong
evidence that concentration correlates with margins.

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Literature Related to Entry Barriers


as Components of Market Power
Another variable is the height of the entry barriers, which consequently has an impact on the concentration index. Rumelt separates tangible and intangible entry barriers, demonstrating that tangible entry
barriers have less impact than intangible entry barriers. Tangible entry
barriers are used by Densetz,50 who views absolute or relative firm
size as an entry barrier, related to efficiency and innovation. In contrast,
Sheperd,51 Gale,52 and Bothwell use market share.
The financial situation of competitors also has an impact on entry
barriers. Stigler,53 Fisher,54 and Hall55 use risk differentials to incorporate three risks: return volatility, financial leverage, and nondiversifiable
risk. Bothwell uses leverage, profit variability, and nondiversifiable risk: BETA. Higher risks generate higher returns.
Economies of scale is another important entry barrier. Bain uses the
formula of capital-output = book value of assets/sales. Bothwell uses
scale economies and absolute capital requirement (assets/sales).
Holterman postulates that the entry barrier = size of the plant and that
the height of entry barriers depends on the plants size and advertising.
Intangible entry barriers are also used by Bain, such as producerconsumer goods as a dummy variable to incorporate differentiation.
Bothwell and Holterman use advertising intensity with ad expenses.
Comanor and Schmalensee use ad expenses as a proxy of product differentiation. Schmalensee developed a sophisticated model that explains
the relationship between advertising and monopolies (advertising may
invite new entrants to enjoy friendly customers).
The impact of entry barriers on margins is a matter of dispute. For
Bothwell, market share correlates with margin where firm size is a barrier to entry. Schmalensee, however, arrives to the opposite conclusion
wherein market share barely has an impact on profits. Bothwell concludes that advertising correlates with margin. Bain disagrees and believes advertising and margin correlate because high differentiation
increases high monopoly, and consequently high ad expenses are justified because they drive high margins.
Growth is another element that seems to correlate with entry barriers
and margins according to Rhoades and Cleaver.
Bothwell demonstrates that Bain was wrong: risk premium does not
correlate with margin. For Bothwell companies do not collude; the entry
barriers of firm size and risk premium do not impact margins.
The impact of knowledge as an entry barrier is also a matter of debate. For Rumelt, knowledge always makes sense: diversification is
based on economies of scope, idiosyncratic investments, and uncertain

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inimitability. Companies between 1949 and 1974 that diversified grew


from 30 percent to 63 percent; this growth mostly occurred when these
companies remained in related business (K matters). Densetz shows that
efficiency and innovativeness are both linked to knowledge and impact
on profits.
In summary, the literature identifies several components of market
power, such as concentration, firm size, advertising, knowledge, growth,
and others. However, there is not an index of market power as such.
Literature Related to Intellectual Capital
When this author began working on this paper more than 10 years
ago, some evidence was found that indicated knowledge was responsible for the success of firms, both in their ability to grow and to create
market power. However, the evidence was confusing: some knowledge
businesses were successful whereas some others were not. For example,
companies of the new economy such as dot-com or portals had high levels of knowledge but did not create stock value.
Is a driver of success being a knowledge company? Or is the success
based on being a knowledge organization? Or, does success come when
a company produces knowledge products (e.g., software)?
A valid definition of knowledge as a driver of success requires a systemic view. The ability of a firm to develop knowledge is part of a
whole system:
1. It requires knowledge inputs from the internal and external environments,
2. It requires the organizational ability to transform knowledge into
something that the stakeholders value (customers, employees,
shareholders, lenders, government, etc.), and
3. It can produce a nal output that does not require a new cost each
time it is produced (the law of increasing returns of IC).
The value of this approach results from forcing the RVF to be systemic, incorporating the environment and final output as parts of the
system. This thinking is consistent with the organic view of the organization, as described initially by Morgan56 and finally accepted by most
of modern organization academics. Not only do organizations belong to
a system, but they also need to have the ability to adapt to that system
in order to survive.
This approach is consistent with most of the existing literature on
the RVF. Some authors do not mention that firm success is the result of
the connection between the firm and its environment, and instead place
their focus solely on resources. Amit and Schoemaker57 concentrate on

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financial or physical assets, human capital, and incorporating the capabilities required to deploy resources (information based, tangible or intangible processes, patents, licenses). Barney focuses on the VRINO
resources (value, rare, inimitable, nonsubstitutable, organization oriented). Eisenhardt and Martin state that dynamic capabilities can be a
source of competitive advantage. Fiol, Eisenhardt, and Martin state that
resources can be imitated easily so employees must innovate all the time
to keep rents high. Makadok58 states that firms create their resource base
either by resource picking or through capacity building. Nelson and
Winter posit that success is based on the employees behavior in terms
of routines to make and implement decisions. Penrose states that success depends on the ability of managers to select and configure the right
resources. Spender59 argues that success requires dynamic capabilities.
Wernerfelt suggests that within one industry firms have different performance and results because of their tangible assets, intangible assets,
and capabilities.
On the other side, several authors defend the systemic-organic view
that is incorporated in this research. Black and Boal60 state that networks and relationships are resources required to interact with the system. Chakravarty61 suggests that success is measured by the ability to
satisfy stakeholders and the ability to have a positive evolution and
transformation. Fahy62 states that resources must be environment oriented, the organization must meet customer needs, and the firms key
resources must be based on the market. Farjoun63 bases his proposal on
Mintzbergs organic view of strategy as emerging from the organization.
Hamel and Prahalads core competencies are strongly systemic-organic
(see note 23). Kogut64 states that different types of networks are required
for different industries: biotech, auto, software, microprocessors, labs,
financial institutions. Peteraf states that competitive advantage is based
on resources, heterogeneity produces monopolistic rents, ex-post limits to competition sustain rents, ex-ante limits to competition maintain
low costs, and imperfect mobility sustains resources within the firm (see
note 20). Schumpeter65 proposes that creative destruction is a natural
process of the economic environment. Williamson66 (transaction costs
economics) proposes that assets are not imitated by competitors for the
cost it generates, but sharing assets (integration, alliances) can create potential free riding and, consequently, extra costs.
These authors do not refer specifically to knowledge but just mention resources in general. This research is focused on the central role
of knowledge as a critical resource. Marr et al.67 consider that knowledge is required to create a strategy, implement it, motivate employees,
and communicate with the stakeholder. Spender expands on the types
of knowledge and how they impact on the firms resources. Teece and
Pisano state that dynamic capabilities are the basis for firm learning.

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Rumelt identifies several reasons for success: producer learning, isolating mechanisms, property rights, imperfect information, buyer switching costs, buyer search costs, reputation, and causal ambiguity. Miller68
believes that based on the predictability or uncertainty of the environment in some cases it is better to employ transactional or knowledge
based resources, stressing that physical assets do not adapt easily to
changing environments. However, investments in knowledge are subject to uncertainty. Mahoney69 talks of the capacity to learn as a key
resource. Nahapiet and Goshal70 incorporate social capital as a key resource. It is required to develop IC, which include culture, trust, norms,
social networks, and communication channels. Dyer and Nobeoka71
state that knowledge sharing is the key, in that it requires organizations
to develop network identity, routines, supplier associations, consulting
teams, voluntary learning teams, interfirm employee transfers, and rules
for knowledge protection. Cohen and Levinthal72 state that absorptive
capacities are critical to learn and innovate. Dierickx and Cool state that
it is the stock of knowledge that accumulates through steady investment
that drives success. Grant73 focuses on knowledge as a key resource because it allows creation of a common language and culture.
Finally, how can knowledge be measured? Literature on this topic is
still relatively young. Several authors have elaborated proposals on how
to measure IC, which is a more ample definition of knowledge. According to Edvinsson and Malone, Roos,74 Bontis,75 Canibano,76 Sullivan,77
Mouritsen,78 and Andriessen79 the value of the company is the result of
its book value (equal to the physical capital) plus the market value added
(equal to the IC). The value of the IC depends upon the value of the customer, human, structural, and organizational capital. Joia80 summarizes
their view in the following equation: intellectual capital = human capital + innovation capital + process capital + relationship capital.
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About the Editors and Contributors

TIMOTHY J. WILKINSON (PhD, University of Utah) is professor and


Charles L. Boppell Dean of the School of Global Commerce & Management at Whitworth University in Spokane, WA. Wilkinson, a noted expert
in the area of exports and export promotion, has published more than 35
articles in refereed journals. These include publications in Long Range Planning, Journal of World Business, Journal of Business Research, Journal of International Business Studies, Journal of International Management, and the Journal
of Small Business Management. He also publishes applied research in journals intended for business people. These articles have appeared in the MIT
Sloan Management Review, Business Horizons and the Wall Street Journal. His
coauthored book, The Distribution Trap (with Andrew R. Thomas), won the
Berry-AMA Prize for the best book in marketing published in 2010.
VIJAY R. KANNAN is a professor of operations management and director of international programs at the Jon M. Huntsman School of Business,
Utah State University. Dr. Kannan received his B.Sc. from the London
School of Economics, MBA from Indiana University, and PhD from Michigan State University. He was a Fulbright Scholar at the Indian Institute
of Management, Lucknow, and has also taught at universities in China,
France, and Vietnam. Dr. Kannan has published over 30 articles in the
areas of operations and supply chain management in journals including
Decision Sciences, the International Journal of Production Research, the International Journal of Operations and Production Management, and the Journal
of Supply Chain Management. His work has also appeared in publications
of the Institute for Operations Research and Management Science, the
Decision Sciences Institute, and the American Production and Inventory

270

About the Editors and Contributors

Control Society. He is the editor of International Business in the 21st Century, Volume 2: Going GlobalImplementing International Business Operations (Praeger). He has twice served on the board of the Decision Sciences
Institute and currently serves as the editor of its Decision Sciences Journal
of Innovative Education. He is also an associate editor for Decision Sciences
Journal and the Journal of Supply Chain Management.
EMILY AMDURER is a PhD student in the organizational behavior program in the Weatherhead School of Management at Case Western Reserve
University. Her research interests include job insecurity, interpersonal
trust, and citizenship and deviant workplace behaviors.
BRIAN S. ANDERSON is an assistant professor of entrepreneurship at
the Richard Ivey School of Business, University of Western Ontario. He
was previously a visiting assistant professor at the Kelley School of Business, Indiana University, where he also completed his doctoral studies in
strategic management and entrepreneurship. His research examines strategy in the context of entrepreneurial firms and has appeared in Academy
of Management Journal and Strategic Entrepreneurship Journal. Prior to his
career in academia, Dr. Anderson was an entrepreneur, either founding or
serving in a senior leadership position for a half-dozen start-ups, primarily in the technology and electronic commerce spaces. He has also served
in the government, handling communications and legislative affairs for
the Colorado State Treasurer. Lieutenant Anderson is a Supply Corps officer in the U.S. Navy Reserve, where he specializes in expeditionary logistics. He received his undergraduate degree in business administration
from the University of Colorado, and a masters degree in strategic management from the University of Denver.
YARA ASAD is the director general for the International Chamber of
Commerce (ICC) in Palestine. In this role, she presents the services of
ICC in her country by promoting international services and standards,
networking with international companies with the goal of opening new
markets and opportunities for the Palestinian companies and to attract
investors into the Palestinian market. Yara received her executive MBA
from Duke University in North Carolina in 2006, and is currently enrolled
in the PhD program in Management Strategy at the International School
of Management in Paris. Within the past 10 years, she has focused her career on marketing and communications strategy with a focus on PR/CSR
strategy and business development in the pharmaceuticals, telecommunications, and food and beverage sectors. Yara was assigned as the Middle East operations manager at Pharmaceutical Service Corporations Inc.,
during which time she has achieved various goals, and led four major
generic manufacturing companies in Palestine to become CGMP (current

About the Editors and Contributors

271

good manufacturing practices) certified by the World Health Organization (WHO), and as a result opened new export opportunities for certified
companies. Yara is also certified by the Cisco Entrepreneurship Institute
to facilitate the institutes curriculum developed by Stanford University
on how to start and grow a business, aiming at encouraging entrepreneurship in Palestine.
ARINDAM BANDOPADHYAYA is chairman and professor of finance in
the accounting and finance department at the University of MassachusettsBoston. He is also the director of the College of Managements Financial
Services Forum. A two-time recipient of the Deans Award for Distinguished Research, Dr. Bandopadhyaya has published in journals including the Journal of International Money and Finance, Journal of Empirical
Finance, Journal of Banking and Finance, and Review of Economics and Statistics. He teaches courses in corporate finance, international finance, and
managerial economics, and has received multiple teaching awards in the
College of Management, including Professor of the Year Award and the
Betty Diener Award for Teaching Excellence. He has on multiple occasions
been the College of Managements nominee for the Chancellors Award
for Distinguished Teaching. Professor Bandopadhyaya received his PhD
from Indiana University.
LAURA BIROU serves on the faculty of the sustainable supply chain
management program at Louisiana Tech University and as a director for
the International Institute for Advanced Purchasing and Supply. Dr. Birou
is a graduate of Michigan State University with a BA in marketing, an
MBA in purchasing and transportation management, and a PhD in business administration specializing in purchasing, operations, and strategic
management. She has over 25 years of experience in the field of supply
chain management working both as a consultant and for organizations
that include American Hospital Supply and Hewlett Packard. Laura is
known for innovative educational and problem-solving approaches in the
areas of purchasing, operations, supply chain management, strategy and
ethics. Her research efforts are currently devoted to humanitarian supply
chain management, sustainability, supplier relationship management, and
supply chain management education. She has publications in the Journal
of Operations Management, International Journal of Purchasing and Materials
Management, International Journal of Physical Distribution and Logistics Management, and Production and Inventory Management Journal.
MATTHIAS BOLLMUS is currently a PhD student at the Sheldon B.
Lubar School of Business at the University of Wisconsin-Milwaukee.
His research interests are firm strategy, strategic alliances, and financial
flexibility.

272

About the Editors and Contributors

LANCE ELIOT BROUTHERS is professor of management in the Coles


College of Business at Kennesaw State University. He received two PhDs:
one in Government from Florida State University, the other in Marketing from the University of Florida. His primary research interests involve
international business strategy issues including entry mode choice, market selection, product strategy and understanding emerging markets and
their global champions. His seventy plus publications appear in many
prestigious journals, including Strategic Management Journal, Journal of
Management Studies, Journal of International Business Studies, and Journal
of Management. He currently sits on six editorial review boards including Journal of International Management, Management International Review,
Journal of Management Studies, Journal of International Business Studies and
Journal of Management.
KRISTEN CALLAHAN is a faculty member in the accounting and finance
department at the University of Massachusetts-Boston. She received her
Master of Science in finance from Boston College and holds the certified
financial planner designation. Prior to joining University of MassachusettsBoston on a full-time basis, she worked extensively in the financial services
industry, where she helped launch start-ups transition into successful enterprises. Her teaching interests include corporate finance, investments,
and financial policy, and she is keenly interested in developing financial
literacy workshops, especially for young adults.
WILLIAM CHRISTENSEN is dean of the Udvar-Hazy School of Business at Dixie State College, Utah, and teaches undergraduate and graduate courses in strategic management. He earned his doctorate in business
administration at Oklahoma State University and has also done doctoral
work at Michigan State University. Before embarking on an academic
career, Dr. Christensen held executive positions at Mercury Marine and
Clark Material Handling Company, and was an international buyer for
Whirlpool Corporation. Dr. Christensen has consulted for a number of
companies including Whirlpool, Pennzoil, and Dell Computers, and
has published research in journals including the Journal of Operations
Management.
LINDA CLARK-SANTOS, PhD, is an Affiliate at the Center for Creativity and Innovation, Boise State University. She also serves as an executive
coach for the Boise State University Executive MBA program.
KRISHNA S. DHIR is the Henry Gund Professor of Management at Berry
College, Georgia. He has previously served as the director of the School of
Business Administration at the Pennsylvania State University at Harrisburg, as a manager with the CIBA-GEIGY AG in Basle, Switzerland, and

About the Editors and Contributors

273

as manager of the pilot plant with Borg-Warner Chemicals in Washington,


West Virginia. Dr. Dhir has published in numerous journals, including
Applied Mathematical Modeling, Corporate Communications: An International
Journal, Decision Sciences, IEEE Transactions on Engineering Management,
International Journal of the Sociology of Language, Journal of Information and
Optimization Sciences, and Journal of the Operational Research Society. He was
the President of the Decision Sciences Institute during 20112012, which
honored him with its Dennis E. Grawoig Distinguished Service Award
in 2008. He is also a recipient of the 2001 James A. Jordan Jr. Award and
2000 Provosts Award, both for teaching excellence, from Pennsylvania State University at Harrisburg. He earned his PhD from the University of Colorado at Boulder, MBA from the University of Hawaii, MS in
chemical engineering from Michigan State University, and B.Tech., also
in chemical engineering, from the Indian Institute of Technology, Bombay. He is a fellow of the Operational Research Society of the United
Kingdom.
FRANCES H. FABIAN, PhD, is an assistant professor in the Department
of Management at Fogelman College of Business & Economics, University
of Memphis.
MICHAEL FUERST, PhD, is a Manager of Integrity and Corporate Citizenship for Novartis AG in Switzerland.
FRANCO GANDOLFI serves as the director of the MBA program and
professor of management in the School of Global Leadership & Entrepreneurship at Regent University, in Virginia Beach, Virginia. Prior to his current position, Dr. Gandolfi held senior academic positions at Cedarville
University and Central Queensland University in Sydney, Australia. He
specializes in human resources management, change management, and
strategic management and regularly advises corporations in the United
States, Australia, and Switzerland. Dr. Gandolfi has published more than
50 peer-reviewed journal articles and is the author of five books, including the much acclaimed book Corporate Downsizing Demystified: A Scholarly
Analysis of a Business Phenomenon.
ROBERT P. GARRETT, JR, is an assistant professor of managemententrepreneurship at Oregon State University. He received his PhD in strategic management and entrepreneurship from the Kelley School of Business at Indiana University in 2008. His research focuses on corporate
entrepreneurship and venturing.
SOUMEN GHOSH is a professor of operations management in the College of Management at Georgia Institute of Technology (Georgia Tech).

274

About the Editors and Contributors

He also served as the director of the Center for Quality and Change
Leadership for eight years. He received his PhD in business administration with specialization in operations management and MS in industrial and systems engineering from the Ohio State University. He holds a
BS in mechanical engineering from Birla Institute of Technology (India).
His research and teaching interests are in the areas of global operations
strategy, supply chain strategy, operations strategy, product development
and supply chain interface, quality management, and manufacturing
planning and control.
TRACY L. GONZALEZ-PADRON, PhD, is the Director of the Ethics Initiative and Assistant Professor of Marketing and International Business
at the University of Colorado, Colorado Springs.
R. SCOTT HARRIS is a Professor at the College of Business, Montana
State University Billings.
AARON HAYDEN is an MBA candidate at the Albers School for Business
and Economics. He is the founding program coordinator for Seattle Universitys Center for Business Ethics. His interests are in the areas of strategy and corporate responsibility.
TOM HINTHORNE received his BS degree in forest engineering from
Oregon State University and his MBA and PhD in business from the
University of Oregon. Prior to a 25-year teaching career, Professor Hinthorne spent 20 years in the forest products industry, including 15 years
as manager of raw materials planning for a Canadian multinational forest products firm. Professor Hinthorne has taught strategic management,
international business, and small business management and entrepreneurship. As director of the small business institute program for 12 years,
he guided teams of senior students as they developed business plans for
regional clients and entered and won business plan competitions. Since
1993, he has guided the development of some 250 student business plans.
He has been a member of the North American Case Research Association
(NACRA) since 1994, and he has been an author and presenter of 15 cases
and instructors manuals at NACRAs annual meetings. He has published
articles in the Strategic Management Journal (1), Industrial Management (1),
the Case Research Journal (8), and several textbooks and journals. In 1997
and 2007, the Associated Students at Montana State UniversityBillings
recognized Professor Hinthorne as the Outstanding Faculty Member in
the College of Business. In addition, the faculty has variously awarded
his teaching, research, and service. He has been a reviewer for the Case
Research Journal since 2004, and he has won several awards for reviewing excellence. For six years, he was a member of the board of directors of
NACRA and coeditor of the annual meeting proceedings.

About the Editors and Contributors

275

RONALD J. HREBENAR is Professor of Political Science at the University of Utah. He earned his PhD from the University of Washington-Seattle
and he is former director of the Hinckley Institute of Politics and former
chairman of the Department of Political Science at the University of Utah.
Dr. Hrebenar is author or editor of 16 books and over 60 articles and chapters on interest groups, lobbying, political parties, and campaigns. His
most recent book is Parties, Interest Groups and Political Campaigns, coauthored with Matthew Burbank and Robert Benedict (2012).
BIANCA JOCHIMSEN is an account strategist for Google Ireland Ltd.,
with responsibility for the German, Austrian and Swiss markets. She
holds BBA and MBA degrees from Boise State University, where she was
also a scholarship tennis player. Prior to joining Google, Bianca worked at
Boise States Centre for Creativity and Innovation.
JAMES S. KEEBLER is the Charles S. Conklin Chair and Eminent Scholar
and professor of supply chain management in the College of Business
at Clayton State University, in Morrow, Georgia. Dr. Keebler focuses on
strategic planning and performance measurement in logistics and supply chain management. He has published in several academic journals,
including the Journal of Business Logistics, Journal of Transportation Management, Journal of Marketing Theory and Practice, Benchmarking: An International Journal, Leadership and Organizational Management, as well as a variety
of practitioner journals. He is coauthor of books Keeping Score: Measuring
the Business Value of Logistics in the Supply Chain (1999, Council of Logistics Management) and Supply Chain Management (2000, J. T. Mentzer, Editor, Sage Publications). Prior to entering academia, Dr. Keebler had over
25 years of practical experience in manufacturing, marketing, and logistics management across several industriesfood, pharmaceuticals, health
care, electronics, and consumer products.
DAWN KEIG is an assistant professor in the College of Business & Mass
Communication at Brenau University in Gainesville, Georgia. She is currently a doctoral student at Kennesaw State University in Kennesaw,
Georgia. Dawns research interests include international corporate social
responsibility, institutional dynamics, and business ethics.
DAVID R. KING earned his PhD in strategy and entrepreneurship from
Indiana Universitys Kelley School of Business. After retiring from the
U.S. Air Force, he joined Marquette University as an associate professor in
the College of Business Administration where he teaches undergraduate
and graduate business strategy. His research focuses on complementary
resources, merger, and acquisition (M&A) integration and performance,
technology innovation, and defense procurement. An award-winning researcher, Daves research appears in Strategic Management Journal, Academy

276

About the Editors and Contributors

of Management Journal, Journal of Management, Journal of Management Studies, and Organization Science.
JAMES R. KROES is an assistant professor of supply chain management
at Boise State University. He received his doctorate in operations management and masters in management from the Georgia Institute of Technology, and an undergraduate degree in mechanical engineering from
Rensselaer Polytechnic Institute. His research interests include supply
chain management, outsourcing strategy, and environmental operations.
C. JAY LAMBE is a marketing professor in the Albers School of Business and Economics at Seattle University, and was previously a faculty
member at Virginia Tech and Texas Tech University. He received his PhD
from the Darden School at the University of Virginia. His research interests include business-to-business marketing, relationship marketing,
marketing strategy, and strategic alliances. He has also served as a consultant on these topics to businesses such as Cap Gemini Ernst & Young
and MasterCard International. Dr. Lambe has published in journals
including the Journal of the Academy of Marketing Science, Journal of Product Innovation Management, European Journal of Marketing, and Journal of
Business-to-Business Marketing. Prior to his academic career, he worked
for 10 years in business-to-business marketing for both AT&T and Xerox.
He is a member of the editorial review boards of the Journal of Businessto-Business Marketing and Industrial Marketing Management. Dr. Lambe is
a past recipient of the Mortar Board/Omicron Delta Kappa Outstanding
Faculty Member Award at Texas Tech University and a past winner of
the American Marketing Association Winter Educators Conference Best
Overall Paper Award.
HWANWOO LEE is a doctoral student in management at the C. T. Bauer
College of Business, University of Houston. He earned a bachelors degree
in sociology at Sogang University, Seoul, Korea, and a Master of Arts in
human resources and industrial relations (HRIR) at the University of Minnesotas Carlson School of Management. Prior to pursuing doctoral studies, Hwanwoo worked as a compensation/benefits staff member with an
insurance company and as an HR consultant for a global HR consulting
firm. His primary research interests pertain to HRM issues such as staffing, compensation, performance management and strategic HRM.
JENNIFER LEONARD, PhD, is an Associate Professor of Management at
the College of Business, Montana State University Billings.
EDWARD LEVITAS is currently an associate professor at the Sheldon B.
Lubar School of Business at the University of Wisconsin-Milwaukee. His

About the Editors and Contributors

277

research activity focuses on technology and new product development,


particularly among biotechnology and pharmaceutical firms. He has examined how strategic alliances, financial asset availability, technology
transfers, and managerial incentives affect firm innovation and survival.
ANDREW MANIKAS is an assistant professor in the College of Business
at the University of Wisconsin, Oshkosh. He earned his BS in computer
science and MBA in materials and logistics management from Michigan
State University, and his PhD from the Georgia Institute of Technology.
Prior to completing his doctorate, he was an instructor for supply chain
optimization courses for i2 Technologies. He has also worked as a management consultant for KPMG Peat Marwick, Computer Sciences Corporation, and Deloitte Consulting.
DREW MARTIN, PhD, is a professor of marketing at the College of Business and Economics, University of Hawaii at Hilo.
AMITAVA MITRA is a professor of quality and business analytics in
the College of Business at Auburn University. His research interests are
in the areas of quality assurance, quality management, warranty analysis, applied statistics, and multicriteria modeling. Dr. Mitra has published
numerous articles, some of which have appeared in journals such as Management Science, Decision Sciences, the Journal of the American Statistical Association, the Journal of the Operational Research Society, IEEE Transactions on
Engineering Management, and IEEE Transactions on Reliability, Quality Engineering. Dr. Mitra is also the author of Fundamentals of Quality Control
and Improvement, Third Edition ( John Wiley & Sons). He has conducted
short courses for professionals in total quality management, quality assurance, statistical process control, and design of experiments, and assisted
with the implementation of statistical process control in industries. He is
listed in several national and international biographical listings including
Personalities of America, Men of Achievement, Whos Who of Emerging
Leaders in America, and Whos Who in American Education.
ROBERT MOUSSETIS, PhD, is an associate professor of international
business at North Central College in Illinois.
GEORGE NAKOS, PhD, is an associate professor of marketing at Clayton
State University, Georgia.
NANCY K. NAPIER is executive director of the Center for Creativity and
Innovation, a professor of international business in the College of Business and Economics at Boise State University, and an adjunct professor at
Aalborg University (Denmark). She has published five books and in

278

About the Editors and Contributors

numerous academic and practitioner journals. She managed a nine-year


capacity-building project at the National Economics University in Hanoi,
Vietnam, and was recently awarded Vietnams Ministry of Education and
Trainings Medal of Honor for contribution to education in Vietnam. Her
most recent books are Insight: Encouraging Aha! Moments for Organizational
Success and The Creative Discipline: Mastering the Art and Science of Innovation.
ANDREW SCHNACKENBERG is a PhD candidate of organizational behavior at the Weatherhead School of Management at Case Western Reserve University. His research interests include institutional transparency,
trust, organizational control, and governance.
ANDREAS SCHOTTER is an assistant professor of strategic management at Thunderbird School of Global Management in Arizona.
MATTHEW SEMADENI is an associate professor of strategy and Weimer
Faculty Fellow at the Kelley School of Business, Indiana University. His
research interests include competitive strategy, corporate strategy, knowledge, and top management teams, and his work has been published in
the Strategic Management Journal, the Academy of Management Journal, Organization Science, the Journal of Business Venturing, and the Journal of Management. He received his PhD from Texas A&M University, and prior to
joining the Kelley School was on the faculty of the Moore School of Business at the University of South Carolina.
YONG-CHUL SHIN is an assistant professor of accounting at the University of Massachusetts, Boston. He received his PhD from the Sloan School
of Management at Massachusetts Institute of Technology. His research
interests include insider trading and voluntary disclosure of accounting
information. He has published several papers in the Journal of Financial
and Quantitative Analysis, Journal of Modern Accounting and Auditing, and
International Review of Accounting, Banking and Finance. His teaching interests include financial accounting, financial statement analysis, financial
accounting theory, and accounting fraud examination.
MARC D. SOLLOSY is an instructor of management and marketing at
West Texas A&M University.
LOREN M. STANGL is a marketing lecturer at the College of Business,
Massey University, New Zealand.
JUAN PABLO STEGMANN is a Research Center Executive Director at
UNAD. He has taught as a Professor of International Business at Norwich

About the Editors and Contributors

279

University and a Professor of Strategic Management at University of


Maryland University College.
MARY B. TEAGARDEN, PhD, is a professor of global strategy and editor of Thunderbird International Business Review at Thunderbird School of
Global Management in Arizona.
ANDREW R. THOMAS is assistant professor of marketing and international business at the University of Akron and a New York Times bestselling
business writer. His book, The Distribution Trap: Keeping Your Innovations
from Becoming Commodities, was winner of the Berry-American Marketing
Association Prize for the Best Book of 2010. Some of his other books include Supply Chain Security Innovation, Global Manifest Destiny, Aviation Insecurity, The Rise of Women Entrepreneurs, Growing Your Business in Emerging
Markets, Managing by Accountability, Defining the Really Great Boss, Change
or Die!, and Direct Marketing in Action, which was a finalist for the BerryAMA Prize in 2008. His latest works include Soft Landing: Airline Industry
Strategy, Service, and Safety and The Greatest Thing Ever Built: The Saturn V
Rocket. A successful global entrepreneur, Professor Thomas has traveled to
and conducted business in more than 120 countries on all seven continents.
EDWARD C. TOMLINSON is an associate professor of management and
Mulwick Scholar in the Boler School of Business at John Carroll University. He received his PhD from the Fisher College of Business at The Ohio
State University. His primary research interests include interpersonal
trust, behavioral integrity, and deviant workplace behavior. His publications have appeared in several of the most prestigious management
journals, including Academy of Management Review, Journal of Applied Psychology, and Journal of Management. He recently coedited (with Ron Burke
and Cary Cooper) a book entitled Crime and Corruption in Organizations:
Why It Happens and What to Do About It, published by Gower. He currently
serves on the inaugural editorial board of Journal of Trust Research.
QUAN HOANG VUONG, PhD, is senior researcher at the Brussels-based
management research institute Centre Emile Bernheim, a unit of the University of Brussels (ULB). He received the Vietnam National Book Award
2007 and the Vietnam Journalism Award 2010. He has published widely
in academic and practitioner journals and also manages a consultancy
firmDHVP Researchwhich provides economics and business insights
in Vietnam.
ALISON WALL taught undergraduate management and human resources at Louisiana Tech University. She is currently researching employee training efficacy and individual/organization-level outcomes. Her

280

About the Editors and Contributors

research interests include individual/trait-level characteristics, work environments and outcomes, and sustainability. She has made a number of
conference presentations, some of which have appeared in the proceedings of the Academy of Management, Southern Management Association,
and Alliance of Universities for Democracy.
STEVE WERNER is a professor in the management department in the
C.T. Bauer College of Business, University of Houston. He received his
PhD in human resource management (HRM) from the University of Florida. His research focuses on compensation and international HRM. He
has published in academic and practitioner publications such as Academy
of Management Journal, Journal of Applied Psychology, Strategic Management
Journal, Journal of International Business Studies, Journal of Management, Journal of Management Studies, Human Resource Management Review, and International Journal of Human Resource Management.
ROBERT R. WIGGINS, PhD, is an associate professor in the Department
of Management at Fogelman College of Business & Economics, University
of Memphis.
ROBERT D. WINSOR is a professor of marketing at Loyola Marymount
University in Los Angeles. He earned a PhD in marketing and management from the University of Southern California. Dr. Winsors research
has been published in 120 peer-reviewed articles and book chapters on
topics ranging from business ethics to competitive strategy. Journals in
which he has been published include the Journal of Marketing, Journal of
Business Research, Journal of Business Ethics, Journal of Business Venturing,
Journal of Marketing: Theory and Practice, Journal of Management Inquiry,
Journal of Consumer Marketing, Journal of Services Marketing, Journal of Organizational Change Management, Family Business Review, and Marketing
Theory.

Index

Abandonment options, 110


Abell, Derek, 67. See also Threedimensional view of productmarket decisions
Abouleish, Ibrahim, 191
Accenture: enterprise performance
management (A-EPM) framework,
5051; SAP-based advanced performance management solution,
4445, 5051
Adobe Systems, 184
Agency theory, 35
Air France, 197
Airline industry, strategic alliances,
2034
Alliance contracts, in options, 111
Amazon.com, 25
American Motors Company, 207
Amit, R., 26263
Anabasis (Xenophon), 151
Analyzers strategy (in Miles and
Snow typology), 7
Andriessen, D., 264
An Inquiry into the Nature and
Causes of the Wealth of Nations
(Smith), 92
Ansoff, H. Igor, 56, 37, 44. See also
Product-market growth matrix

Antitrust-type activities, 155


Apple Computers: alliance partnerships of, 110, 199; direct duplication problems, 9899; Jobs vision
for, 173, 199; Macintosh introduction, 154; product life cycles, 103;
strategic questions asked by, 92
Aristotle, 256
The Art of War (Sun Tzu), 29, 31
Aspinox, 68, 6971, 75
Asset specificity dimension (of TCE),
7172
Automobile industry, strategic alliances, 198
Bain, Joe, 257, 260
Balanced scorecard, 44, 4749. See also
Strategy maps
The Balanced Scorecard: Translating
Strategy into Action (Kaplan and
Norton), 47
Banker, R., 259
Barnard, Chester, 31, 37
Barney, Jay, 1315, 35, 92, 95, 258. See
also Resource-based view; VRINO
framework
Barwise, P., 56
Benchmarking, of options, 12022

282
Beyond the Familiar: Long-Term Growth
through Customer Focus and Innovation (Barwise and Meehan), 56
Bhagwati, Jagdish, 160
Bhatt, Ela, 191
Bierman, L., 96
Bilateral dependency (in TCE), 72
Biotechnology platform, 206
Black, J., 263
Black-Scholes model, of options, 113
Boal, K., 263
Bontis, N., 264
Boone, Mary E., 39
Borneo Orangutan Survival Foundation, 191
Boston Computer Group, 18
Bothwell, J., 259, 261
Bounded rationality assumption (in
TCE), 6768
Bower, J. L., 122
Brandenburger, A. M., 257
Branson, Richard, 173
BRIC (Brazil, Russia, India, China)
countries, 148
British Petroleum oil spill, 14041
Brouthers, K. D., 15
Brouthers, L. E., 15
Buddhism, 256
Bureaucratic market transactions,
in TCE: coordination costs, 80;
enforcement costs, 8182; monitoring costs, 81; negotiating costs,
7980
Burger King, 209
Business element (in spider chart),
5556
Business-level managers, 29
Business process reengineering
(BPR), 186
Business strategy theories, 321;
competition-based theories,
1719; framework for, 45; future
developmental directions, 1920;
industry-based foundations, 913;
managerial implications, 2021;
product-market-based views, 4,
59, 1920; reasons for studying,
34; resource-based theories, 1317

Index
Business Wire, 206
Butler, J. E., 14, 95, 258
Bygraves, William, 17879
Canibano, L., 264
Cansilware, 6970, 75
Cantillon, Richard, 175
The Carnegie Experience, 66
Castle, Joshua, 69
Chakravarty, B., 263
Challagalla, Goutam, 75
Chamberlin, E., 257
Chandler, Alfred, 3233, 37
Chen, Eric L., 15859
Childrens Defense Fund (CDF), 191
Chiles, Todd H., 74
China: Apple counterfeiting in, 99;
intellectual property limitations,
103; liberalization of restrictions in,
205; Wal-Mart presence in, 26
Chiquita Brands International Inc.,
219
Christianity, 255
Christiansen, C. M., 122
Clausewitz, Carl von, 31
Cleaver, J., 260
Coase, R. H., 33, 34, 257, 258; market
efficiency problems of, 66
Coca Cola Company, 153, 204, 209
Comanor, W., 260
Company strategies, 28
Competition-based theories (of business strategy), 1719; competitive
dynamics, 1819; future developmental directions, 20; reasons for
emergence of, 1718; strategic conflict, 18
Competitive Advantage (Porter), 237,
258
Competitive advantage foundations,
91103
Competitive dynamics theory, 1819
Competitive exclusion principle
(Gause), 18
Competitive forces model (Porter),
911; five forces (described),
911; limitations of, 11
Competitive Strategy (Porter), 237

Index
Compliance costs, in TCE, 79, 8182
Conduct strategy, 32
Confucianism, 256
Conner, Kathleen Reavis, 258
Continuous learners, 178
Contracting costs, in TCE, 7778
Cool, K., 95, 264
Cooley, T., 259
Coordination costs, in TCE, 80
Copeland, T., 260
Corporate integrity issues, 21516
Corporate-level management, 29
Corruption in business, 214
Costco, 25
Cost creation (transaction costs), in
TCE: compliance costs, 79; contracting costs, 7778; monitoring
costs, 78; search costs, 7677; transaction costs, 7677
Cost-quality arena (in four-arenas
analysis), 15253
Countrywide, 132
Curry, B., 260
Customer element (in spider chart),
56
Cyert, Richard, 6667
Dagnino, Giovanni Battista, 156
Dalai Lama, 256
DAnnunzio, L., 42
Daoism, 256
DAveni, Richard, 147. See also Fourarenas analysis
Day, George: generic competitive
strategies, 1113
Ds of entrepreneurship (Bygrave),
17879
Deep pockets arena (in four-arenas
analysis), 15556
Defender strategy (in Miles and Snow
typology), 7
Deferral options, 110
Dell, 25, 9192
Delta Airlines, 197
Densetz, H., 261
Dierickx, I., 95, 258, 264
Dimensions of entrepreneurship, 177
Direct duplication issues, 9899

283
Disney, Walt, 173, 247
Disruption of hypercompetition,
15051
Distribution element (in spider
chart), 56
Diversification option (productmarket growth matrix), 6
Dixit, A. K., 257
Downsizing, 27, 29, 141, 253
Drayton, Bill, 191
Dreamers, 178
Drucker, Peter, 175
DuPont, 32, 37
Dyer, J. H., 264
Dynamic capabilities perspective,
5; described, 1617, 1013; as
extension of resource-based view,
93; IBM example, 20; limitations
of, 17; routines and capabilities,
103
Eastern religions, 256
Eastman Kodak, 2627, 34
eBay, 25
Eckert, Robert, 141
Economic value added (EVA),
23744, 246, 24849, 25153
Economist Intelligence Unit (EIU),
254
Edelman, Marian Wright, 191
Edison, Thomas, 172
Edvinsson, L., 260
Eisenhardt, K. M., 16, 258, 263
Enforcement costs, in TCE, 8182
Enron accounting fraud, 214
Enterprise resources planning (ERP),
44
Entrepreneurial managers, 176
Entrepreneurs (entrepreneurship),
17192; balanced scorecard relevance, 47; categories of, 17677;
characteristics of, 17879; classic
capitalist economic theory and,
17374; defined, 17172; evolving
views of, 17476; industry-based
strategic approach relevance, 20
Entrepreneurs/entrepreneurship:
integrating strategy with, 18889;

284
intrapreneurs compared with,
18184; minds of, 178; motivational aspects of, 18081; neoclassical economic theory and, 174;
notable entrepreneurs, 26, 17273,
175; notion of vision and, 17273;
phases of, 17980; of Sam Walton, 26; Schumpeterian vision of,
174; six dimensions of, 177; social
entrepreneurs, 18992; and strategic alliances, 132; strategic entrepreneurship, 18488; successful
qualities of, 178; transaction cost
economics and, 65; underlying
economic theories, 17376
Entrepreneurship Forum of New
England (EFNE), 178
European Union (EU): airline industry alliances, 197; antitrust-type
activities, 155; automobile industry, 208; real estate alliances, 200;
Siemens AG global conglomerate,
221; technological challenges, 199;
unsustainable debt obligations,
160
Evolution of strategic management,
2933
Explicit knowledge, 15
Ferrier, Walter, 1819. See also Competitive dynamics theory
Financial driver, 54
Financial Times, 40
Fine, Charles, 151
Fisher, F., 261
Fisher-Price toys, 132
5PS model (by Pryor, White,
Toombs), 44, 4647
Five forces analysis of industry (of
Porter), 911
Food and Drug Administration, 131
Ford, Henry, 172
Ford Motor Company, 198
Fortune magazine: admired company
list, 26
Four-arenas analysis: cost-quality
arena, 15253; deep pockets arena,
15556; strongholds arena, 15455;

Index
timing and know-how arena,
15354
Framework for major business strategy theories, 45
Frazier, Gary, 75
Friedman, Milton, 255
Fudenberg, D., 257
Fuji Corporation, 27
Fundamental transformation (in
TCE), 72
Gale, B., 261
Game theory, 35
Garvin, D., 258
Gates, Bill, 173
Gateway, 25
Gause, Georgy, 18
General Electric (GE), 219
General Motors (GM), 32, 37, 42,
198
Generations X and Y, 214
Generic competitive strategies (Porter
and Day): differentiation strategy,
12; focus strategy, 12; limitations
of, 1213; overall cost leadership
strategy, 1112
Geoge, K., 260
Germany: bribery scandal, 219; WalMart presence in, 26
Geschke, Charles, 18384
Geske, R., 118
Ghemawat, P., 258
Ghosn, Carlos, 207
Global financial system meltdown, 40
Google, 25, 27, 68, 121, 183
Goshal, S., 264
Governance structure choices, in
TCE: hierarchical governance, 83;
hybrid governance, 8384; market
governance, 8283; outsourcing considerations, 84; quasi-integration,
86; related diversification, 87; unrelated diversification, 87; vertical
integration, 8485
Grant, Robert, 1516, 95, 264. See also
Knowledge-based view
Grey, Cindy, 74
Greybar, 74

Index
Growth options, 110
Growth phase of entrepreneurship,
17980
Gujaratis of India, 175
Habitual entrepreneurs, 176
Hall, T., 259, 261
Hambrick, D. C., 89
Hamel, G., 258, 263
Harbin Brewery, 208
Harmony, Mark, 6970, 74
Harvard Business Review, 39, 40, 47,
211
Harvard Business School, 147, 149,
155
Hayward, Tony, 141
Henderson, Bruce, 18
Hewlett-Packard (HP), 9596, 183
Hierarchical governance structure, of
TCE, 83
Hinduism, 256
Hitt, M. A., 96
Holterman, S., 259
Hughes, Jonathan, 211
Hybrid governance structures, of
TCE, 8384
Hypercompetition: Managing the
Dynamics of Strategic Maneuvering
(DAveni), 147
Hypercompetition theory, 14762;
cost-quality arena, 15253; deep
pockets arena, 15556; disruption of, 15051; strongholds arena,
15455; sustained competitive
advantage, 14950; timing and
know-how arena, 15354
IKEA, 52
Impactedness and information asymmetry, 7374, 7778, 79, 8687
Implementation phase of entrepreneurship, 17980
In Defense of Globalization (Bhagwati),
160
India: entrepreneurship in, 175;
hypercompetition and, 148
Industrial organization (IO) economics theory, 3637, 93, 25758

285
Industrial organizations: S-C-P paradigm, 9
Industrial Revolution, 206
Industry-based foundations of business strategy, 913; competitive
forces, 911; future developmental
directions, 20; generic competitive
strategies, 1113
Information asymmetry and impactedness, 7374, 7778, 79, 8687
Information technology (IT): effectiveness measurement of, 48;
influence of advances in, 44; infrastructure reengineering of, 4243;
software development for, 50
ING Insurance and Asset Management Asia-Pacific, 40, 5152
Innovation phase of entrepreneurship, 17980
Innovators, 178
Input market advantages, of options,
11920
In Search of Excellence (Peters and
Waterman), 45
Integrity management programs:
anchoring of values in, 228; decision making factor, 23031; department development, 22425;
elements, core activities, 22533;
establishing standards, 22627;
ethical behaviors fostered by,
21617; functional responsibilities
for, 22021; independent, internal
assurance, 23233; monitoring and
reporting, 23132; need for management training in, 230; reasons
for investing in, 21720; responsible behavior promotion, 227;
responsible leadership, 22728;
role in ethical culture promotion,
227; standards enforcement, 230;
standards establishment, 22627;
training component, 22930; value
and standards integration, 22829;
whistle blowing process, 232
Intel, 48, 183
Intellectual property (IP): protection
of, 43

286
Intrapreneurs and intrapreneurship,
175, 176, 18184
iPad, 99, 110
iPhone, 99, 110
iPod, 99, 110
Islam, 255
Iterative investing, 114
Ittner, Christopher, 40, 259
Japan: beer industry, 15051; Coca
Cola competitive advantage, 204;
kaizen (method of continuous
improvement), 41; Keiretsu production system, 205; 2011 earthquake,
7071
JIT (just in time) systems, 80
Jobs, Steve, 173, 200
Judaism, 255
Kaizen (method of continuous
improvement), 41
Kant, Immanuel, 256
Kaplan, R., 4749, 260
Keiretsu production system (Japan),
205
Kemp, Jacques, 40, 5152, 55, 58.
See also Toward performance
excellence
Kentucky Fried Chicken, 209
Kerviel, Jerome, 229
Key performance indicators (KPIs),
5258
Kilby, Peter, 175
Klein, B., 33
K-Mart, 25
Knowledge-based view (KBV): components of, 1516; limitations of, 16
Kochhar, R., 96
Kogut, B., 122
KPMG, 221, 224
Larcker, David, 40, 259
Learning options, 110
Leffler, K., 33
Lehman Brothers, 4041
Lehmann Brothers accounting fraud,
214

Index
Lenovo, 9192
Levitas, E., 14
Lifestyle entrepreneurs, 176
Lockheed Martin, 183
Louisiana oil spill, 14041
Macys, 153
Mahoney, J., 264
Makadok, R., 263
Malone, M. S., 264
Management frameworks, 3959;
A-EPM solution, 5051; background information, 4043; balanced scorecard approach, 44; 5Ps
model, 44; key performance indicators, 5258; McKinsey & Company,
executive survey, 3940; performance drivers, 5355; SAP-based
framework, 4445; 7S framework,
44; spider chart, 5558; toward performance excellence, 40, 45, 5153,
55, 5758; varying success of, 4345
Management implications, in
TCE, 8488; governance: outsourcing, 84; governance: quasiintegration, 86; governance: related
diversification, 87; governance:
unrelated diversification, 87; governance: vertical integration, 8485
Mann, M., 260
March, James, 6667
Market development option
(product-market growth matrix), 6
Market-governance structure, of
TCE, 8283
Marketing driver, 53
Market penetration option (productmarket growth matrix), 6
Market power, 75; literature related
to, 25758
Market power (in TCE), 75
Markets and Hierarchies (Williamson),
67
Marr, B., 263
Martin, S., 257
Mattel, 132, 141
McClelland, David, 175

Index
McGahan, A. M., 258
McKinsey & Company, 3940, 43, 45
McMackin, John F., 74
Meehan, S., 56
Mercedes, 48
Mexico: Wal-Mart presence in, 26
Meyer, M., 259
Meyers, Gerald C., 207
Microeconomics theory, 30
Microsoft, 25, 121, 183, 204
Microsofts Networking Strategy
(Harvard Business School case),
155
Miles, Raymond, 78
Miller, D., 95
Minds of entrepreneurship, 178
Minnesota Mining and Manufacturing Company (3M), 183
Mintzberg, Henry, 44
Modifiers of transaction cost economics: information asymmetry, impactedness, 7374;
market power, 75; small numbers
exchange, 73; trust and reputation,
7475
Monitoring costs, in TCE, 78, 81
Montgomery, C. A., 3637
Mouritsen, J., 264
Nahapiet, J., 264
Nalebuff, B. J., 257
Namlux (Japanese firm), 7071
Nascent entrepreneurs, 176
National Liberation Army (ELN) terrorist organization, 219
The Nature of the Firm essay
(Coase), 66
Naya water bottle company, 210
Ndofor, Hermann, 14, 1819. See also
Competitive dynamics theory
Necessity-driven entrepreneurs, 181
Negotiating costs, in TCE, 7980
Nelson, R., 257
Net present value (NPV) approaches,
to options, 11213, 11819
New Jersey Bell, 31
Nissan Motor Corporation, 207

287
Nobeoka, K., 264
Nokia Corporation, 68, 102
Nolan, Bernadette, 68
Norton, D., 4749
Novartis health care company, 225
Novice entrepreneurs, 176
Nucor Steel, 25
Oliver, Jamie, 191
Oneworld alliance, 204
Operational driver, 54
Opportunistic behavior assumption
(in TCE), 6869
Opportunity entrepreneurship,
18081
Options and strategic management,
10822; background information,
10810; Black-Scholes model, 113;
description, 11011; input market advantages, 11920; iterative
investment and commitment, 114;
mismanagement issues, 114; net
present value (NPV) approaches,
11213, 11819; perceived value
and benchmarking, 12022; portfolio of options vs. options on a portfolio, 11415; real option valuation,
11213; risk acceptance, 120; role
irreversibility role, 111; stylized
categories of, 110; uncertainty role,
11112; unique discount rates,
11819; unique opportunity recognition, 11718; unique value
notion, 11517
Oracle, 183
Organizational driver, 5354
Organizational performance drivers,
5355
Organizational trust. See Trust (organizational trust) management
Organization Science journal, 150
Patent ownership, 108
Penrose, E., 257, 258
PepsiCo Company, 209
Perceived value, of options, 12022
Peteraf, M., 258

288
Peters, Tom, 45
Pettit, J., 259
Pfizer, 110, 119
Pickett and Sterling, 95
Pinchot, Elisabeth, 182
Pinchot, Gifford, 175, 182
Pisano, Gary, 1617, 34, 26364.
See also Dynamic capabilities
perspective
Pizza Hut, 209
Platform options, 110
Polanyi, M., 11516
Polaroid Company: strategic failure
of, 2627
Porter, Michael: Competitive Advantage, 237, 258; competitive forces
strategies, 911; Competitive Strategy, 237; DAvenis comments on
theories of, 14748; fiver forces
model, 93; four arenas analysis
association, 15354; generic competitive strategies, 1113; highlevel framework proposal, 44;
industry analysis focus, 37; Novell
analysis, 155
Portfolio driver, 53
Potter, G., 259
Prahalad, C. K., 258, 263
Priem, R. L., 14, 95, 258
Product development option
(product-market growth matrix), 6
Product element (in spider chart),
56
Product-market-based views of
business strategy, 4; future developmental directions, 1920; limitations of, 89; Miles and Snow
typology, 78; product-market
growth matrix, 56; summary of
components, 5; three-dimensional
view of product-market decisions,
67
Product-market growth matrix (of
Ansoff): matrix description, 56;
strategic options of, 6
Prospectors strategy (in Miles and
Snow typology), 7
Pryor, Mildred Golden, 44, 4647

Index
Pull factors of entrepreneurship, 180
Push strategies of entrepreneurship,
180
Qualls, D., 259
Rare resources, 9798
R&D cycle time, 98.103
Reach element (in spider chart), 55
Reactors strategy (in Miles and Snow
typology), 7
Real option valuation, 11213
Renault Company, 2078
Resource-based theories of business
strategy: dynamic capabilities perspective, 1617, 1013; knowledgebased view, 1516; resource-based
view, 1315, 3536
Resource-based view (RBV), 1315;
assumptions of, 17, 20, 3536;
foundations of, 9496; hypercompetition and, 157; limitations of,
1415, 16; literature related to, 258.
See also VRINO (valuable, rare,
inimitable, not substitutable, organized) framework
Return on investment (ROI), 9
Reve, T., 258
Reverse engineering, 98
Revolutionary Armed Forces of
Colombia (FARC), 219
Rhoades, S., 260
Risk acceptance, in options, 120
Risk preference assumption (in TCE),
6970
Risk takers, 178
Role irreversibility role in options,
111
Roos, J., 264
Ruefli, Timothy, 151, 159
Rumelt, R. P., 11, 95, 258, 26162
SABMiller (African brewery), 208
Sanchez, Maria, 7374
Santos, F. M., 16
SAP-based advanced performance
management solution, 4445,
5051

Index
Say, J. B., 175
Schmalensee, R., 258
Schoemaker, P.J.H., 26263
Schumpeter, J. A., 33, 175, 263
SCPIO. See Structure-conductperformance industrial organization economics (SCPIO)
Search costs, in TCE, 7677
Serial entrepreneurs, 176
7S model, 44, 4546
SEWA (Self-Employed Womens
Association), 191
Shapero, Albert, 175
Shapiro, Carl, 18. See also Strategic
conflict theory
Sheperd, W., 261
Shervani, Tasaddiq A., 75
Shimizu, K., 96
Shuen, Amy, 1617, 34. See also
Dynamic capabilities perspective
Siemens AG, 214, 219
Simon, Herbert, 66
Sindhis of India, 175
Skeath, S., 257
Skunk Works group (Lockheed
Martin), 183
Skyteam alliance, 204
Sloan, Alfred, 42
Small numbers exchange, 73
Smith, Adam, 92, 255
Smith, Ken, 1819, 156. See also Competitive dynamics theory
Smits, Willie, 191
Snow, Charles, 78
Snowden, David J., 39
Social entrepreneurs, 18992
Societe Generale trading, breach of
trust incident, 229
Sollaz, 7172
Solutions to the Corporate Integrity
Quandary (Jennings), 215
South Korea: Wal-Mart presence in,
26
Southwest Airlines, 25
Spender, J., 263
Spider chart, 5558
Srinivasan, D., 259
Standard Oil, 32, 37

289
Star alliance, 204
Starbucks, 48, 103
Sterling and Pickett, 9495
Stevenson, Howard, 177
Stigler, G., 261
Strategic alliances, 196212; adaptability of, 86; Business Wire report
on, 206; cost factors, 197; drawbacks of, 2068; evolution of, 32,
19899; liability of foreignness
of companies, 205; management
with competitors, noncompetitors,
20810; motivations for entering
into, 199206; partnership choices,
131, 134; scope and importance of,
19798; suggestions for creating,
21012
Strategic conflict theory, 18
Strategic decisions, 2829
Strategic entrepreneurship, 18486;
business model reconstruction
strategy, 186; conceptual frameworks, 18688; description, 184;
domain redefinition form, 185;
organizational rejuvenation form,
18586; reasons for engaging in,
197; strategic renewal form, 185;
sustained regeneration form, 185
Strategic integrity management,
21433; corporate integrity issues,
21516; integrity management
programs, 21620; positioning
within the organizational context,
21617
Strategic management: company
strategies, 28; evolution of, 2933,
3738; evolution of theories in,
3337; role of, 2728; strategic decisions, 2829; strategic managers,
29; strategy and, 2729
Strategic management, evolution of
theories of, 3337; agency theory,
35; game theory, 35; industrial
organization theory, 34, 3637;
resource-based view, 1315, 3536.
See also Transaction cost economics
Strategic Management Journal, 15152
Strategic managers, 29

290
Strategic value management (SVM),
23764; application to sustainability, 25256; in the armed forces,
256; capital driven by resources,
24652; in government agencies,
256; implications of, 238; literature
review related to, 23940; in nonprofit organizations, 256; profits
driven by competition, 24043;
sales growth-driven innovation,
24446
Strategy, early concepts, 2538; failure of Polaroid, 2627; strategic
decisions, 2829; strategic managers, 29; success story examples,
2526
Strategy and Structure (Chandler), 32
Strategy maps, 4749
Strengths, weaknesses, opportunities, threats (SWOT) analysis. See
SWOT (strengths, weaknesses,
opportunities, threats) analysis
Strongholds arena (in four-arenas
analysis), 15455
Structure-conduct-performance
industrial organization economics
(SCPIO), 9, 32, 14950, 155
Structure of industry, 3031
Sun Tzu, 29, 31
Sustainability and strategic value
management, 25256
Sustained competitive advantage
(SCA): description, 3536, 14950;
disruption of hypercompetition and,
150, 152; firm self-actualization
and, 161; methods of gaining, 37;
methods of sustaining, 100; prevalence of, 159; rare resources and,
98; sources of, 30; strategic management evolution and, 32; transition from short-term competitive
advantage, 94; value-creation
notion and, 225
Switching options, 110
SWOT (strengths, weaknesses,
opportunities, threats) analysis,
28, 53
Sy, T., 42

Index
Tacit knowledge: Polanyis swimmer
example, 11516
Taco Bell, 209
Target, 25, 153
TCE. See Transaction cost
economics
Technology: Abells related dimension proposal, 7; biotechnology
platform, 206; communications
technology evolution, 198; cost
factor issues, 95; and entrepreneurship, 179; hierarchical governance structures considerations,
83; high-tech industry timing and
know-how, 154; hypercompetition and, 14748, 150; information
technology, 48, 50, 139; in-house
innovators (examples), 18385;
innovation cycles, 48; and monopolistic strategies, 242; and onset
of Information Age, 33; operating system comparisons, 204;
operational driver and, 54; opportunities, threats and, 249; pharmaceutical industry and, 108, 11415;
Polaroids failure of, 26; resourcebased strategies and, 102; software
development for, 50; and strategic
alliances, 2012, 204; transfer coordination cost factors, 80; transfer
issues, 205; VRINO resources and,
93, 98
Teece, David, 1617, 34, 37, 15758,
258, 26364. See also Dynamic capabilities perspective
Theories of business strategy. See
Business strategy theories
Third World economies, 32
3M Corporation, 183
Three-dimensional view of productmarket decisions (Abell), 67
Thyssen-Henschel (German company), 95
Timing and know-how arena
(in four-arenas analysis),
15354
Timmons, Jeffrey, 178
Tirole, J., 257

Index
Toombs, Leslie, 44, 4647
Toward performance excellence
(TPE) framework, 40, 45, 5153, 55,
5758
Toyoda, Akio, 41
Toyota, 98; strategic alliances of,
19798; strategy-strategy execution
misalignment, 4142
Transaction cost economics (TCE),
4, 6588; asset specificity dimension, 7172; bounded rationality
assumption, 6768; bureaucracy
costs, 79; bureaucratic coordination, 80; bureaucratic enforcement, 8182; bureaucratic
monitoring, 81; bureaucratic
negotiating, 7980; compliance
costs, 79; contracting costs, 7778;
coordination costs, 80; hierarchical governance structure of, 83;
historical background, 6567;
hybrid governance structures of,
8384; information asymmetry,
impactedness, 7374; management implications, 8488; marketgovernance structure of, 8283;
market power, 75; monitoring
costs, 78; opportunistic behavior
assumption, 6869; relevance to
strategic management, 33, 34; risk
preference assumption, 6970;
search costs, 7677; small numbers exchange, 73; transaction frequency dimension, 71; trust and
reputation, 7475; uncertainty
dimension of, 7071
Transaction costs, in TCE, 7677
Transaction frequency dimension (of
TCE), 71
Tris-Plex, 69
Trust and reputation, 7475
Trust (organizational trust) management, 7475, 12642; emotional
attachment issues, 12930; transparency factors, 129; trust development, 13034; trust maintenance,
13537; trust maintenance: organization as trustor, 135; trust repair,

291
13742; trustworthiness factors,
12729
Tuck School of Business (Dartmouth
College), 147
Uncertainty dimension (of TCE),
7071
Uncertainty role in options,
11112
UN Global Compact, 23132
Unique value notion, in options,
11517
United Airlines, 25
United States (U.S.): Apple retail
store expansion, 99; decline of
automobile industry, 33; employee
theft losses data, 137; entrepreneurial activities, 18182; entrepreneurship potential, 18182;
intrapreneurial activities, 183;
management frameworks, 41;
manufacturing towns devastation,
148; technological challenges, 198;
unsustainable debt obligations,
160
US Airways, 25
U.S. Justice Department, 219
Value chain analysis, 97
VRINO (valuable, rare, inimitable,
not substitutable, organized)
framework, 1314, 9394; application of framework, 100101;
description, 9697; difficult to
imitate, 98100; nonsubstitutable,
98100; organized to be
exploited, 100; rarity, 9798; valuable, 97
Wall Street financial meltdown
(2008), 40
Wal-Mart, 2526, 48, 103, 118, 153;
retail success ranking, 26
Walton, Sam, 118, 172
Warnock, John, 18384
Waterman, Robert, 45
Weiss, Jeff, 211, 260
Werner, S., 15

292
Wernerfelt, Birger, 1315, 92, 94,
258, 263. See also Resource-based
view
White, Chris, 44, 4647
White, J. C., 44
Wieland, J., 217
Wiggins, Robert R., 151, 159
Williamson, Oliver, 3334, 6667,
217
Wilson, T., 260

Index
Winter, S. G., 257
Wook, Luke, 74
Xenophon, 151
Xerox Corporation, 18384
Yunus, Muhammad, 191
Zander, U., 122
ZDell, 25

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