Chapter 1 – Strategic mgmt.

and competitiveness
1. Define strategic competitiveness and above-average returns. What is the relationship
between strategic competitiveness and returns on investment?

ANS: Strategic competitiveness is achieved when the firm successfully formulates

and implements a value-creating strategy. Above-average returns are returns in excess
of what investors expect to earn from other investments with similar risk levels. Firms
will only be able to earn above-average returns if they develop a competitive
advantage. Competitive advantage derives from a strategy that competitors cannot
duplicate or find too costly to imitate.

2. Hypercompetition is a characteristic of the current competitive landscape. Define

hypercompetition and identify its primary drivers. How can organizations survive in a
hypercompetitive environment?

ANS: Hypercompetition is a condition of rapidly escalating competition based on

price-quality positioning, competition to create new knowledge and establish first-
mover advantage, and competition to protect or invade established product or
geographic markets. In hypercompetition, firms aggressively challenge their
competitors. Markets are assumed to be inherently unstable and changeable. The two
primary drivers of hypercompetition are the global economy and rapid technological
change. To survive in a hypercompetitive environment firms need strategic flexibility.
This demands continuous learning which allows the firm to develop new skills so that
they can adapt to the changing environment and to consistently engage in change.

3. Describe the industrial organization (I/O) model of above-average returns. What are
its main assumptions? What is the key to success according to the I/O model?

ANS: The I/O model of above-average returns argues that the external environment is
the primary determinant of firm success, rather than the firm’s internal resources. The
model has four underlying assumptions. First, the external environment is assumed to
impose pressures and constraints that determine the strategies that would result in
above-average returns. Second, most firms competing within a particular industry, or
in a certain segment of the industry, are assumed to control similar strategically
relevant resources and pursue similar strategies in light of those resources. Third,
resources used to implement strategies are mobile across firms, which results in
resource differences between firms being short-lived. Fourth, organizational decision
makers are assumed to be rational and committed to acting in the firm’s best interests
as shown by their profit maximizing behaviors. The key to success according to the
I/O model is to find the most attractive industry (the one with the highest profit
potential) in which to compete.

4. Describe and discuss the resource-based model of above-average returns.

ANS: The resource-based model focuses on the firm’s internal resources and
capabilities. These resources and capabilities determine the firm’s strategy and its
ability to earn above-average returns. The firm’s resources are inputs into its
production process. Resources must be formed into capabilities, the capacity to
perform a task or activity in an integrative manner. According to this model,
capabilities evolve over time and must be managed dynamically to achieve above-
 average returns. Resources and capabilities that give a firm a competitive advantage
are called core competencies. This model assumes that resources are not highly
mobile across firms; consequently, all firms within a particular industry may not
possess the same strategically relevant resources and capabilities. So, different firms
will have different core competencies. The organizations strategy is based on finding
the best environment in which to exploit its core competencies.

5. What are a firm’s vision and mission? What is the value to the firm of having a
specified vision and mission?

ANS: The firm’s vision is a picture of what it wants to be and what it wants to
ultimately achieve. The firm’s mission is based on its vision. It specifies the
business(es) in which the firm intends to compete and the customers it intends to
serve. The value of having a vision and mission is that they inform stakeholders what
the firm is, what it seeks to accomplish, and who it seeks to serve. A successful vision
is inspirational. The mission is more concrete and guides employees’ behavior as they
achieve the firm’s vision. Research shows that an effectively formed vision and
mission positively impact firm performance in terms of growth in sales, profits,
employment, and net worth.

6. Describe an organization’s various stakeholders and their different interests. Under

what condition can the firm most easily satisfy all stakeholders? If the firm cannot
satisfy all stakeholders, which ones must it satisfy in order to survive?

ANS: Stakeholders are the individuals and groups who can affect and are affected by
the strategic outcomes achieved and who have enforceable claims on a firm’s
performance. There are three principal types of stakeholders. First, there are the
capital market stakeholders. These stakeholders include the shareholders and the
major suppliers of capital to the firm. They are most interested in the return on capital
in relation to the risk incurred. The second group of stakeholders is the product
market stakeholders. This group includes customers, suppliers, host communities, and
unions representing workers. The customers seek a reliable product at the lowest
possible price. The suppliers seek loyal customers willing to pay the highest
sustainable price. Host communities want companies willing to be long-term
employers and providers of tax revenues. Union officials want secure jobs with good
working conditions for the workers they represent. The final group of stakeholders is
the organizational stakeholders. This group includes the employees (both managerial
and non-managerial). These stakeholders expect a firm to provide a dynamic,
stimulating, and rewarding work environment. The firm can most easily satisfy all
stakeholders if it earns above average returns. If the firm does not earn above-average
returns, it must prioritize its stakeholders by their power, urgency, and degree of
importance to the firm. The firm must then make trade-offs among the stakeholders.

7. Who are the firm’s strategic leaders? How do strategic leaders predict the profit
outcomes of different strategic decisions?

ANS: The firm’s strategic leaders include the CEO and top-level managers, but they
also include organizational members who have been delegated strategic
responsibilities. Strategic leaders use the strategic management process to help the
firm reach its vision and mission. Mapping an industry’s profit pool is one way
 strategic leaders can anticipate the profitability of different strategic decisions. A
profit pool is the total profits earned in an industry along all points in the value chain.
This helps the leaders determine where the primary sources of profit in the industry
are located and allows them to take actions to tap these sources.

8. Explain the relationship of the strategic management process to organizational ethics.

ANS: Almost all strategic management process decisions have ethical implications
because they affect stakeholders. The decisions of the strategic leaders influence the
organization’s culture which is based on the organization’s core values (which are
also influenced by the strategic leaders). The organization’s culture can be functional
or dysfunctional, ethical or unethical. Consequently, the strategic leader’s role has a
large impact on whether the organization is a good citizen.

9. What are the primary aspects of the strategic management process? You may
reference specific chapters from the text in formulating your response.

ANS: This is a roadmap question for the entire strategic management course.
Students will likely have a far greater understanding of the big picture after having
gone through the entire course.

The strategic management process consists of three primary processes: analysis

(chapters 2 & 3), strategy formulation (chapters 4-9) and implementation (chapters
10-13).

Analysis. Analysis involves the development of an understanding of the external

environment (Chapter 2) and internal organization (Chapter 3). These analyses are
completed to identify opportunities and threats in the external environment and to
decide how to use the resources, capabilities, and core competencies in the firm’s
internal organization to pursue opportunities and overcome threats.

Formulation. With knowledge about its external environment and internal

organization, the firm forms its vision and mission (Chapter 1) and makes decisions
as to what strategies to utilize to provide returns to shareholders. These decisions
involve the selection of business-level strategies (Chapter 4), which are the firm’s
actions designed to exploit its competitive advantage over rivals), and its corporate
level strategy (Chapter 6), which is the firm’s scope, which ranges from a single
product market to unrelated, diversified firm competing in multiple product markets.
The ability to utilize a strategy will be impacted by competing firms. This is described
as the dynamics of competition (Chapter 5). Formulation involves the selection of
mechanisms such as acquisition and restructuring the firm’s portfolio of businesses
(Chapter 7) and the use of cooperative strategies (Chapter 9) wherein firms form a
partnership to share their resources and capabilities in order to develop a competitive
advantage. The firm must also make decisions on the span, business level strategies,
and mechanisms for international expansion (Chapter 8).
 Implementation. Implementation is putting the formulated plan into action.
Implementation is facilitated by different mechanisms used to govern firms (Chapter
10), the use of appropriate organizational structure and mechanisms to control the
firm’s operations (Chapter 11), the patterns of strategic leadership appropriate for the
firms strategy and competitive environments (Chapter 12), and the use of strategic
entrepreneurship (Chapter 13) as a path to continuous innovation.

The objective of all of these activities is to manage the firm in a manner that produces
above average rates of return.

CASE
Case Scenario 1: Palmetto.
Palmetto was an early pioneer of personal data assistants (PDAs) and dominates that
market space (in terms of market share) with its core product, the Palmetto Pidgy.
Because this product category was entirely new to the market, Palmetto had to
internally develop the hardware and software sides of the business, and today is both a
manufacturer of PDAs and a programmer and licensor of its PDA operating system
software. Recently, however, the hand-held device maker’s performance has taken a
dive as a result of slumping sales and costly inventory problems. New large entrants
are entering both the equipment and software sides of its business, putting further
pressure on margins. Management is currently considering its options, including the
break up of Palmetto into two separate, independent public companies - one devoted
to hardware, the other software.

1. (Refer to Case Scenario 1) What primary business strategy issues does Palmetto face?

ANS: Recognizing that students have only just been introduced to strategy in this
introductory chapter, the Palmetto scenario helps frame and contrast the basic
business and corporate strategy questions. The best answers to the first question will
start by noting that Palmetto appears to be in two distinct businesses, hardware and
software, which in turn are likely to have very different success factors and
competitors. Students can then begin talking about these competitors and the potential
resources they bring to the table (for instance, Microsoft in software and Sony in
miniaturized consumer electronics). This scenario also leads to a natural discussion of
the attractiveness of the PDA market, and where the most money is likely to be made.

2. (Refer to Case Scenario 1) What primary corporate strategy issues does Palmetto
face?

ANS: Since the business strategy question should have revealed that Palmetto is
actually in at least two distinct businesses, the best answers to the corporate strategy
question will begin by assessing which of the businesses is more attractive, and
whether or not Palmetto needs to be in both to compete, or should specialize in either
software or hardware. Companies which are diversified will have a corporate strategy
that encompasses various businesses with different business strategies. Students can
be prompted to debate the tradeoffs between retaining both businesses versus
breaking the company in two - a useful role play exercise entails asking students to
walk through the likely resource allocation tradeoffs that the diversified Palmetto
must currently make.
3. (Refer to Case Scenario 1) How do the I/O and resource-based models help you make
recommendations to Palmetto’s management regarding a split into two companies?
Do they lead to the same recommendation?

ANS: The best answers will begin by noting that the two models should be viewed as
complementary and applied in an integrative manner. Since the perspectives are
complementary, the choice of I/O or resource-based perspective as a starting point is
simply a matter of taste. For instance, the discussion can then flow to how the I/O
perspective will help management understand the characteristics of the two basic
industries in which it participates (hardware and software), and perhaps lead to
insights into what factors allow one firm to compete effectively against other industry
incumbents. The resource-based model can then be applied to develop an
understanding of where Palmetto is strongest in terms of resources, capabilities, and
core competencies. Further industry analysis can show whether or not these resources
will likely lead to competitive advantage in their respective markets. Through the
combination of these two perspectives, students can then help management determine
whether Palmetto can afford to remain a diversified firm or if it can only compete
effectively by focusing on either its hardware or software business.

4. (Refer to Case Scenario 1) The I/O perspective would help Palmetto in its decision of
whether to split into two companies (one hardware, the other software) by
determining where it is strongest in resources, capabilities, and core competencies.
F

Case Scenario 2: Jewell Company.

Jewell Company is a diversified manufacturer and marketer of simple household
items, cookware, and hardware. In its annual report, it expresses its strategy as
follows: “Jewell manufactures and markets staple volume lines to the volume
purchaser. We aim to increase shareholder value by continuing to build a company
with superior earnings per share growth and return on investment (ROI), and to earn a
reputation for excellence in performance and management. We plan to do this by
merchandising to the customer goods market a multi-product offering with superior
customer service performance for maximum market leverage. Through this we will
achieve an ROI of 20% plus EPS growth of 15%, with the constraint that debt not
exceed half of our equity.”

5. (Refer to Case Scenario 2) Which groups of stakeholders does Jewell’s statement

appear to speak to?

ANS: This statement focuses on capital market stakeholder groups and one product
market group, the customers. The best answers will note how each sentence speaks to
which stakeholders, identify the groups to which the stakeholders belong, and explain
why the statement addresses their interests. The best answers will also identify which
stakeholder groups are not directly mentioned, such as employees, host communities,
and suppliers.

6. (Refer to Case Scenario 2) Does Jewell Company’s statement of strategy include a

vision statement or a mission statement? Why or why not?
 ANS: A vision statement is an ideal description of an organization and gives shape to
its intended future. It is the “big picture” of the organization and is intended to elicit
passion. A vision statement is simple, positive, and emotional. Jewell’s strategy
statement does not appeal to the emotions, nor is it simple. It does not look toward a
long-term future, but to the short-term future. Not only is the strategy statement’s
focus on economic issues incompatible with a vision statement, it is incompatible
with a mission statement. Since all firms strive for above-average earnings, this goal
does not differentiate one firm from another. Jewell’s statement approaches a mission
statement in that it identifies its products and customers. The commitment to
excellence in performance and management may be inspiring.

7. (Refer to Case Scenario 2) Jewell Company’s statement that it intends to increase

shareholder value by continuing to build a company with superior earnings per share
growth and return on investment indicates the importance of the capital market
stakeholder group to the company.

ANS:
T

Case Scenario 3: Vivendi

Vivendi Universal is a French firm that started in 1853 as Companie General des
Eaux. It grew from a French water utility company into one of the world’s largest
conglomerates. Under the corporate leadership of then CEO Jean-Marie Messier,
Vivendi Universal became a highly diversified company involved in music,
publishing, film, pay TV, telecoms, Internet, water distribution, thermal energy
supply, building and heavy public construction projects, waste management, electrical
energy services, real estate and other activities. The company’s rapid expansion in the
late 1990s and early 2000 brought about financial and legal trouble resulting in the
replacement of chairman and CEO Jean-Marie Messier who had been responsible for
much of the expansion. Mr. Messier was forced out of the company in July, 2002, in
a liquidity crisis and mounting shareholder anger. The acquisitions made by Mr.
Messier saddled the company with billions of dollars of debts. Vivendi shares
plummeted 80 percent during the last six months Mr. Messier was CEO, according to
the Wall Street Journal.

Meanwhile, the SEC indicated that a disputed severance payment of $23 million to
Mr. Messier may actually constitute “ill gotten gains,” reported the Wall Street
Journal. In 2003, Vivendi had a corporate loss of €23.3 billion. On the brink of
bankruptcy, Vivendi Universal brought in Jean-Rene Fourtou to replace Mr. Messier
as CEO. According to the business media, Mr. Fourtou has taken a dying enterprise
and given it a survival plan. He sold numerous Vivendi Universal businesses,
bringing the company to focus on Cegetel, a phone company; SFR, a cell phone
company; Canal Plus, a television company; and Universal Music. Mr. Fourtou was
able to reduce Vivendi’s debt from 37 billion euros in 2002 to a projected 5 billion
euros by the end of 2005. The company showed its first quarterly profit at the end of
2003, allowing Mr. Fourtou to arrange a loan from a banking consortium and give the
company hopes that credit-rating agencies would raise its debt from junk-bond status,
according to The New York Times.
 Today (2011), Vivendi is a world leader in video games (Activision Blizzard), music
(Universal Music Group), the French leader in alternative telecoms (SFR), the
Moroccan leader in telecoms (Maroc Telecom Group), the leading alternative
telecoms provider in Brazil (GVT) and the French leader in pay TY (Canal+ Group).
Vivendi also owns 100% of zaOza (a subscription-based community legal sharing
site), 93% of Digitick (the French leader in e-tickets), and 99.5% of Wengo (the
French leader in telephone-based expert assistance). According to Vivendi’s web site,
the company puts innovation at the core of its strategy. It seeks to continuously
launch innovative products and services combined with its diversification strategy. To
enhance its innovation focus, in October 2010 Vivendi formed an Innovation Division
with the purpose of increasing internal innovations and identifying new growth
sectors. The company’s annual report (December 31, 2010) shows an adjusted net
income of €2,698 million. The current CEO is Jean-Bernard Levy and the Chairman
is Jean-Rene Fourtou.

8. (Refer to Case Scenario 3) Who are the stakeholders of Vivendi and how well did
Vivendi perform in the eyes of its stakeholders under the leadership of Mr. Messier
and then Mr. Fourtou?

ANS: Stakeholders are the individuals and groups who can affect, and are affected
by, the strategic outcomes achieved by the firm and who have enforceable claims on a
firm’s performance. Stakeholders support an organization as long as its performance
meets or exceeds their expectations. Under Mr. Messier, Vivendi grew ever larger and
more diverse, its financial performance declined. Thus it lost the support of its capital
market stakeholders, its shareholders. They rebelled, and the result was the firing of
Mr. Messier, the instigator of the growth, and the installation of Mr. Fourtou, who
immediately began divesting most of the companies Mr. Messier had purchased. A
second stakeholder group was the individuals and organizations holding Vivendi debt
(bonds and bank loans) that were threatened by the impending bankruptcy of the firm.
Mr. Fourtou pleased this group of stakeholders by reducing the debt of the firm by
selling off the excess companies. Finally, shareholders were also supported by the
SEC, which investigated the multi-million severance payment to Mr. Messier. Under
Mr. Fourtou’s leadership, the company renewed it focus on innovation and became a
leader in many of the industries in which it competed. These actions would have been
positive for organizational (e.g., employees and managers) and capital market
stakeholders (e.g., shareholders) as well as product market stakeholders (e.g.
customers) who would be able to purchase innovative products and services from
Vivendi.

9. (Refer to Case Scenario 3) Who was ultimately for the problems at Vivendi and the
later solution to those problems?

ANS: Some believe that every organizational failure is actually a failure of those who
hold the final responsibility for the quality and effectiveness of a firm’s decisions and
actions. Strategic leaders are the people responsible for the design and execution of
strategic management processes. At Vivendi Universal, Mr. Messier, the former CEO,
seems to have borne the brunt of public blame. But Vivendi’s top management team
and the board of directors must assume some of the blame because Mr. Messier did
not act alone. The pivotal role that can be played by a CEO as a strategic leader is also
illustrated by the successful changes instituted by Mr. Fourtou and Mr. Levy , the new
 CEO who brought the firm back to a leadership position in many of the industries in
which Vivendi competed and insituted a focus on innovation throughout the
company. These efforts were shown in the firm’s profitabilty in 2010.

10. (Refer to Chapter Case Scenario 3) Vivendi’s rapid expansion in the late 1990s and
early 2000 under CEO Messier was the main contributor to the firm’s above-average
returns.

ANS: F

11. (Refer to Case Scenario 3) The stakeholder group most affected by Vivendi’s rapid
decline of its stock value were product market stakeholders.

ANS: F

Chapter 2 – External Environment: Opps, threats, competition & competitor

analysis

1.Explain why it is important for organizations to analyze and understand the external
environment.

ANS: Organizations do not exist in isolation. The external environment of the

organization presents threats and opportunities which the organization must address in
its strategic actions. Parts of the organization’s external environment are changing
rapidly, such as technology, and the organization must constantly adjust to these
changes. The information that the organization gathers about competitors, customers
and stakeholders is used to build the organization’s capabilities or to build
relationships with stakeholders in the external environment. The information that the
organization gathers about the external environment must be matched with its
knowledge of its internal environment to form its vision, to develop its mission, and
to take actions that result in strategic competitiveness and above-average returns.

2. Identify and describe the three major parts of the external environment. What is the
purpose of the firm’s collecting information about these aspects of its environment?

ANS: The external environment has three major parts. The first is the general
environment, which is composed of dimensions in the broader society that affect
industries and their firms. These environmental segments are: demographic,
economic, political/legal, sociocultural, technological, and global. The second part of
the external environment is the industry environment, which involves five factors that
influence a firm, its competitive actions and responses, and the industry’s profit
potential. These five factors are: the threat of new entrants, the power of suppliers, the
power of buyers, the threat of product substitutes, and the intensity of rivalry among
competitors. The competitor environment is the third part of the external environment.
The firm must be able to predict competitors’ actions, responses, and intentions. With
the information collected about these aspects of its external environment, the firm can
develop its vision, mission, and strategic actions.
3. Describe and discuss the four activities of the external environmental analysis
process.

ANS: The external environmental analysis process includes four steps: scanning,
monitoring, forecasting and assessing. The scanning of the environment includes the
study of all segments of the general environment in order to detect changes that may
occur in the future or already are occurring. This is critical in a volatile environment.
Scanning often deals with ambiguous, incomplete, or unconnected data and
information. When analysts monitor the environment, they observe environmental
changes to see if an important trend is emerging from those spotted by scanning. It is
critical for the firm to detect meanings in these events and trends so that it can be
prepared to take advantage of opportunities these trends provide. Forecasting builds
on scanning and monitoring to develop feasible projections of what might happen,
and how quickly it will occur. Forecasting is important in helping the firm adjust sales
to meet demand. Finally, through assessing, the analyst determines the timing and the
significance of the effects of environmental changes and trends on the strategic
management of the firm. Assessment must specify the competitive relevance of the
data.

4. Describe the seven segments of the general environment.

ANS: 1) The demographic segment encompasses factors such as population size,

geographic distribution, age structure, ethnic mix, and income distribution. 2) The
economic segment involves the nature and direction of the economy in which a firm
competes or may compete, domestic as well as global. 3) The political/legal segment
is the arena in which organizations compete for attention, resources, and a voice in
laws and regulations guiding the interactions among nations. 4) The sociocultural
segment is concerned with society’s attitudes and cultural values. 5) The
technological segment includes institutions and activities involved with creating new
knowledge and transforming it into new outputs, products, processes, and materials.
6) The global segment includes new global markets, existing markets that are
changing, international political events, and critical cultural and institutional
characteristics of global markets. 7) The physical segment includes potential and
actual changes in the physical environment (such as global warming) and business
practices that are intended to positively deal with those changes (such as control of
carbon emissions and other environmentally friendly actions).

5. Identify the five forces that underlie the five forces model of competition. Explain
briefly how they affect industry profit potential.

ANS: 1) Threat of new entrants: New entrants threaten existing firms’ market share.
They increase production capacity in an industry which results in lower profits for all
firms, unless demand is increasing. The new entrant may force the existing firms to be
more effective and efficient in production, and to compete on new dimensions. 2)
Power of suppliers: Suppliers with high power can increase prices and decrease the
quality of their products sold to the firm. If firms are unable to pass along price
increases to customers, their profits diminish. 3) Power of buyers: When buyers
(customers) have high power they can force prices down, and require increases in
quality and service levels, thus driving profits down. 4) Substitutes: Substitutes
perform the same or similar functions of the firm’s product. The price of the substitute
 places an upper limit on prices firms can charge for the original product, limiting
industry profits. 5) Intensity of competitive rivalry affects the firm’s ability to make a
profit as competitors’ actions challenge the firm or competitors try to improve their
market position. Increasing rivalry reduces the ability of weaker firms to survive.

6. Describe the factors that raise the competitive nature of an industry’s rivalry.

ANS: The competitive rivalry in an industry can be based on price, product quality,
and product innovation in an attempt to differentiate the firm’s product from its rivals’
products. The factors that can increase competitive rivalry include the following: 1)
numerous and equally balanced competitors; 2) slow or no industry growth; 3) high
fixed costs, high storage costs of inventory, or perishable products; 3) lack of
differentiated products or low cost of product switching by customers; 4) high
strategic stakes for the competitors; and 5) high barriers for firms wishing to exit the
industry, causing firms to remain in an industry where they cannot reasonably expect
to make a profit.

7. What are high exit barriers and how do they affect the competition within an
industry?

ANS: Exit barriers are economic, strategic, and emotional factors causing companies
to remain in an industry, even though the profitability of doing so is in question. The
following are common sources of exit barriers: 1) specialized assets which cannot be
used in another business or location; 2) fixed costs of exit, such as labor agreements
which penalize a firm for ceasing operation; 3) strategic interrelationships or mutual
dependence of business units wherein one business of a corporation serves another
corporate business; 4) emotional barriers that cause owners to be sentimentally
attached to the business or to their own role in it; 5) government and social
restrictions that prevent a firm from closing, often in order to prevent the loss of jobs
in a country or community.

8. What is a firm’s strategic group? What effect does the strategic group have on the
firm?

ANS: The firm’s strategic group is the set of firms that emphasize similar strategic
dimensions and use a similar strategy. The firms in a strategic group occupy similar
positions in the market, offer similar goods to similar customers, and may make
similar decisions about production technology and organizational features.
Competition among firms in a strategic group is more intense than the competition
among a firm and those firms outside its strategic group. Actions of members in the
firm’s strategic group affect its strategic decisions in many areas including pricing,
product quality, and distribution.

9. What do firms need to know about their competitors? What legal and ethical
intelligence gathering techniques can be used to obtain this information?

ANS: Competitor analysis helps firms identify: 1) what drives the competitors by
understanding the competitor’s future objectives); 2) what the competitor is doing and
is capable of doing by understanding the competitor’s current strategy; 3) what the
competitor believes about the industry by understanding the assumptions made by the
 competitor; and 4) what the competitor’s capabilities are by understanding the
competitor’s strengths and weaknesses. Firms can legally and ethically gather public
information, such as annual reports, SEC reports, UCC filings, court records, and
advertisements. Firms can also attend trade fairs to obtain competitors’ brochures,
view exhibits, and discuss products. This data combines to form competitive
intelligence.

CASE

Case Scenario 1: The Boys and Girls Club.

The Boys and Girls Club (BGC) is a national non-profit organization geared to
provide America’s youth with the tools and skills they need to become healthy adults,
responsible citizens, and effective leaders. By bringing parents, neighbors, educators,
and civic leaders together with our youth, BGC believes it can instill these crucial life
lessons at an age when they’re most needed. The national organization is
headquartered in Atlanta, GA, and serves as a service hub for over 3,700 club
locations around the U.S. Each local club is directed by a volunteer board of directors
and staffed by professional youth development workers (usually including an
executive director, a program director, and an arts director) and many volunteers who
just enjoy working with young people and want to make a difference in their lives.
While affiliated with the national center, each local BGC is locally funded.

1. (Refer to Case Scenario 1) How are the various facets of the general environment
(Table 2.1 in Strategic Management) likely to be important for BGC?

ANS: The best answers will begin by noting that BGC has a mission focused on the
education and social development of needy youth. Thus, the demographic, economic,
sociocultural segments, and physical may be the segments of primary importance.
Within the physical segment, for instance, BGC may consider what it can do to
respond to climate change and depletion of energy resources. The global segment is
also a natural discussion point since contexts far from home may not come to our
attention until after a critical stage has been passed. For instance, the presence of
immigrants and refugees in a community many affect the needs of the BGC’s
clientele.

2. (Refer to Case Scenario 1) Why would attention focused on victims of natural

disasters be a threat to the BGC?

ANS: The best answers will observe that BGC is entirely dependent upon local
donations for its operations and public focus on other causes will likely draw away
donation dollars that had been historically earmarked for BGC. This alternative
charitable giving serves donors as a substitute for donations to BGC.

3. (Refer to Case Scenario 1) How might the BGC respond to threats to their
donations at both local and national levels?

ANS: Since BGC is governed locally by a board of directors drawn from the
community, the local organizations should use these members to rally support against
their dwindling donation base. The board and BGC staff members can also reach out
to other local organizations and community governments. At a national level, image
 ads and the lobbying of various national organizations (government, teachers’
associations, minority outreach organizations, environmental groups, etc.) can be
initiated and managed through the BGC headquarters in Atlanta.

4. (Refer to Case Scenario 1) The purpose of the Boys and Girls Club (BGC) is to instill
in youth the tools and skills needed to become healthy adults, responsible citizens,
and effective leaders. If the BGC were to initiate programs about women’s issues,
women in the workforce, workforce diversity, and changes in work and career
preferences, it would be contributing to an understanding of which segment of the
general environment?

a) Demographic
b) Sociocultural
c) Economic
d) Technological

ANS: b) Sociocultural

Case Scenario 2: B.B. Mangler.

B.B. Mangler is a top U.S. business-to-business distributor of maintenance, repair,
and service equipment, components, and supplies such as compressors, motors, signs,
lighting and welding equipment, and hand and power tools. Its industry is typically
referred to as MRO, which is an acronym for maintenance, repair, and supplies. MRO
products are typically small, fairly inexpensive (light bulbs and washers), but often
needed on short notice. It states its strategy as having the “capacity to offer an
unmatched breadth of lowest total cost MRO solutions to business.” Mangler’s
GoMRO sourcing center for indirect spot buys locates products through its database
of 8,000 suppliers and 5 million products. Mangler has 388 physical branches in the
U.S., including Puerto Rico (90% of sales), 184 in Canada, and 5 in Mexico.
Customers include contractors, service and maintenance shops, manufacturers, hotels,
governments, and health care and educational facilities. Mangler also provides
materials-management consulting services.

5. (Refer to Case Scenario 2) Historically, Mangler appears to have relied on its physical
locations for market presence in the U.S. and northern South America. What threats
does the Internet pose to its location-based strategy?

ANS: The best answers will start by noting that Mangler’s location-based strategy is
also likely to require quite a bit of investment in inventory (keeping all those parts on
hand at each of its branches in the U.S., Canada, and Mexico). Given that it competes
in a low-cost industry, and itself competes on cost, an Internet-based MRO competitor
may be able to create an even lower cost structure (as Amazon.com did with books).
The Internet seems like a natural fit for the MRO market. Such an online strategy may
be particularly effective for those MRO items that are less time-critical.

6. (Refer to Case Scenario 2) What opportunities does the Internet provide to Mangler,
both domestically and internationally?

ANS: Answers to this question suggests several different responses to the ways in
which the Internet could be capitalized on domestically by Mangler. The best answers
 for the international strategy question will begin by noting that just as Mangler’s
many domestic locations provide a barrier to entry in its markets by potential
competitors (i.e., it already has the market share to cover its high physical location
costs and also is likely to have tremendous goodwill), so too have they been a barrier
against Mangler’s entry into other international markets like Europe, Asia, and other
parts of Latin America. The Internet does away with this barrier to a great extent,
which levels the playing field between Mangler and the incumbents of those
respective international markets.

7. (Refer to Case Scenario 2) How should Mangler respond to the threat of new Internet-
based entrants?

ANS: There are several possible avenues and the best answers will note these
alternatives. The most obvious response would be for Mangler to start up a web-based
complement to its location-based delivery system. A related response might involve
the centralization of low-demand, high-cost items to parts of the country, which could
then be funneled rapidly to the actual local outlets using the Internet as an internal
market. Finally, Mangler could hedge this threat by investing in the most promising
online rivals.

8. (Refer to Case Scenario 2) The use of the Internet by Mangler would enhance its low
cost strategy and reduce the barriers of entry to markets in Europe, Asia, and Latin
America

ANS: T

Case Scenario 3: Barracuda Inc.

Barracuda Inc. is a lamp fixture manufacturer that is considering an entry strategy into
the U.S. home furnishings manufacturing industry. The existing landscape consists of
many players but none with a controlling share. There are presently 2500 home
furnishings firms, and only 600 of those have over 15 employees. Average net profit
after tax is between 4 and 5%. While the industry is still primarily comprised of
single-business family-run firms that manufacture furniture domestically, imports are
increasing at a fairly rapid rate. Some of the European imports are leaders in
contemporary design. Relatively large established firms are also diversifying into the
home furnishings industry via acquisition. Supplier firms to the home furnishings
industry are in relatively concentrated industries (like lumber, steel, and textiles).
Retailers, the intermediate customer of the home furnishings industry, have been
traditionally very fragmented. Customers have many products to choose from, at
many different price points, and few home furnishing products have strong brands.
Also, customers can switch easily among high and low-priced furniture and other
discretionary expenditures (spanning big screen TVs to the choice of postponing any
furniture purchase entirely).

9. (Refer to Case Scenario 3) Using the five-forces framework, summarize the

opportunities and threats facing Barracuda as it considers entry into the home
furnishings manufacturing industry. Which threats are greatest to current incumbents?

ANS: The best answers will be based on an application of the five forces model to the
scenario. From this model students should be able to point out that the most
 significant threats are the power of consumers, lack of economic power with
suppliers, and increasing presence of imports. These characteristics plus the highly
fragmented nature of the industry itself are likely to translate into near-perfect
competition leaving no single player with a clear advantage. Opportunities may exist
in particular niches, depending on the internal strengths of new entrants. In terms of
the larger market, there appears to be an opportunity for a large firm to consolidate
the industry and add brand power, thereby potentially gaining power over suppliers
and customers.

10. (Refer to Case Scenario 3) How intense is competitive rivalry likely to be among
incumbents of the home furnishings manufacturing industry?

ANS: The best answers will be able to walk through the determinants of rivalry
spelled out in pages 57 through 58. The fact that this industry is fairly characterized as
having nearly perfect competition suggests that rivalry is high. Larger players are
likely to have significant exit barriers, particularly given the slow growth, high fixed
costs, lack of differentiation, and low profitability of the market overall. Thus, new
larger entrants to this industry may further escalate the degree of competition.

11. (Refer to Case Scenario 3) Is the furniture industry described above attractive?

ANS: Astute students may begin by noting that this industry is attractive if you are in
a position that is currently less attractive than that demonstrated by the home
furnishings business. Beyond that, discussion should generally lead to the recognition
that this industry is currently unattractive - summarized by its paltry profit margins,
fragmented membership, lack of power over suppliers and customers, and high degree
of rivalry.

12. (Refer to Case Scenario 3) Given the characteristics of buyers (customers) in the U.S.
home furnishings manufacturing industry (many products to choose from, few home
furnishing products have strong brands, and customers can easily switch among high
and low-priced furniture), buyers would be considered weak and their effect would be
to make the industry more atrractive.

ANS: F

Chapter 3—The Internal Environment: Resources, Capabilities,

Competencies, and Competitive Advantages

1.Describe the importance of internal analysis to the strategic success of the firm.

ANS: By analyzing its internal environment, a firm determines what actions it can
take based on its unique resources, capabilities and core competencies. The firm’s
core competencies are the source of the firm’s competitive advantage. Internal
analysis allows the firm to compare what it is capable of doing (what it “can do”)
with what it “might do” (which is a function of opportunities and threats in the
external environment). Matching what a firm can do with what it might do allows the
firm to develop its vision, pursue its strategic mission, and select and implement its
strategies. This allows the firm to leverage its unique bundle of resources and
capabilities to gain competitive advantage.
2. What are the differences between tangible and intangible resources? Which category
of resources is more valuable to the firm?

ANS: Resources are either tangible or intangible. Tangible resources are those assets
that can be observed and quantified. There are four types of tangible assets: financial
resources (borrowing capacity, ability to generate internal funds); physical resources
(plant and equipment, access to raw materials); technological resources (patents,
trademarks, copyrights, and trade secrets), and organizational resources (formal
reporting structure, planning, controlling and coordinating systems). Intangible
resources are those assets in the firm that are less visible. There are three types of
such resources: human resources (knowledge, trust, management capabilities, and
organizational routines), resources for innovation (ideas, scientific capability, and
capacity for innovation), and reputation (reputation with customers, i.e., the firm’s
brand name and perceptions of product quality, and relationships with suppliers).
Intangible assets develop over time and are deeply rooted in the organization’s
history. Consequently, they are difficult for competitors to analyze and imitate. In
addition, intangible resources can be leveraged to create new value to the firm. These
properties give intangible resources a greater ability to create sustainable competitive
advantage than do tangible resources.

3. Define capabilities and how they affect the firm’s strategic success.

ANS: Capabilities exist when resources have been purposely integrated to achieve a
specific task or tasks. Examples of tasks are human resource activities, product
marketing, and research and development. Capabilities are based on developing,
carrying, and exchanging information and knowledge through the firm’s human
capital. Many of the firm’s capabilities are based on the unique skills and knowledge
of its employees and their functional expertise. The knowledge possessed by human
capital is among the most significant of a firm’s capabilities. Capabilities are often
developed in specific functional areas (such as manufacturing or marketing) or in a
part of a functional area (e.g., advertising).

4. Describe the four specific criteria that managers can use to decide which of their
firm’s capabilities have the potential to create a sustainable competitive advantage.

ANS: Managers must identify whether their firm has capabilities that are valuable
and nonsubstitutable from the customer’s point of view, and unique and inimitable
from the firm’s competitors’ point of view. Only capabilities with these four
characteristics are core competencies that can lead to sustainable competitive
advantage. A valuable capability is one that helps the firm to exploit opportunities or
to neutralize threats in the external environment. Rare means that few if any
competitors possess the particular capability. Costly-to-imitate means a capability
cannot be easily developed by other firms. Often, this kind of capability is rooted in
the organization’s culture or its unique history. Capabilities may also be costly to
imitate if they are causally ambiguous or involve social complexity. Finally,
nonsubstitutable capabilities do not have strategic equivalents that are rare and
inimitable.

5. Describe a value chain analysis. How does a value chain analysis help a firm gain
competitive advantage?
 ANS: A value chain analysis allows a firm to understand the activities that create
value for the firm and those that do not. A value chain analysis follows the product
from its raw-material stage to the final customer. The purpose is to add as much value
as possible as cheaply as possible and to capture that value. To conduct a value chain
analysis, managers should study and identify all activities of the firm and evaluate
their impact on the effort to create value for the customer. This analysis should be
conducted with an attempt to assess the competitor’s capabilities in these same areas.
There are two central types of activities in a value chain, value chain activities and
support functions. Value chain activities are activities or tasks the firm completes in
order to produce products and then sell, distribute, and service those products in ways
that create value for customers. The support functions are activities or tasks the firm
completes in order to support the work being done by the value chain activities. If the
firm can either perform the activity in a manner that is superior to how competitors
perform it or perform a value-creating activity that competitors cannot complete, then
the activity may be a source of competitive advantage.

6. Why is it important to prevent core competencies from becoming core rigidities?

ANS: All core competencies have the potential to become core rigidities and to
generate failure. Each competence is a potential weakness if it is emphasized when it
is no longer competitively relevant. The success that the competence generated in the
past can generate organizational inertia and complacency. A core competence can
become obsolete if competitors figure out a better way to serve the firm’s customers,
if new technologies emerge, or if political or social events shift in the external
environment. Managers studying the firm’s internal organization are responsible for
making certain that core competencies do not become core rigidities.

CASE

Case Scenario 1: Heartsong LLC.

Heartsong LLC is a designer and manufacturer of replacement heart valves based in Peoria,
Illinois. While a relatively small company in the medical devices field, it has established a
worldwide reputation as the provider of choice high-quality, leading-edge artificial heart
valves. Most of its products are sold to large regional hospital systems and research
hospitals. Specialty heart centers are another emerging, but fast-growing, market for its
valves. While Heartsong would like to grow quickly, its growth is constrained by the need to
finance larger production runs and then carry this additional inventory. For products like
those of Heartsong, vendors typically do not collect payment until the unit is actually used in
surgery. Moreover, heart valves are usually required on short notice which means that they
must be either onsite, or inventoried at a nearby location. If nearby, then transport of the unit
to a hospital or heart center occurs within a matter of hours, and sometimes minutes. For this
reason, accelerated growth would require Heartsong to both finance increased production of
its heart valves, along with carrying increased levels of inventory that are in fact sitting on
their customers’ shelves. In fact, inventory-carrying cost is its single largest cost outside of
research and development. While profitable growth is necessary if Heartsong is to continue
extending its competitive advantage through increasingly greater investments in basic heart
valve R&D, it is not clear that the company can internally support all these increased
financial commitments (R&D, manufacturing, and inventory). Doc Watson, the CEO of
Heartsong, is considering an outside contractor, EdFex, to handle the inventorying,
warehousing, and delivery of its valves. EdFex has secure, high-tech warehouses in most
major population centers around the country, and can ensure delivery of a product to these
markets from its warehouses in less than one hour.

1. (Refer to Case Scenario 1) What value-chain activities appear to underlie Heartsong’s

competitive advantage?

ANS: The best answers will begin by noting that Heartsong has the capacity to design
leading-edge medical products and then take these designs and turn them into reliably
manufactured, high-quality replacement heart valves. Thus, basic R&D and quality
precision manufacturing are likely to be critical value-creating facets for this firm.

2. (Refer to Case Scenario 1) Why might an outsourcing arrangement with EdFex be

attractive to Heartsong?

ANS: The best answers will start by observing that the scenario suggests that
Heartsong needs to grow if it is going to continue being competitive and successful.
However, Heartsong is also capital constrained and an outsourcing arrangement with
EdFex allows it to more efficiently manage this significant aspect of its cost base
(inventory and delivery). This outsourcing solution would be ideal if it would allow
Heartsong to maintain a centralized warehouse with heart valve inventory in major
population centers, instead of its present practice of carrying inventory on the shelves
of each of its hospital customers. As a result, Heartsong could grow its market
presence, while more efficiently managing the need to have heart valves available on
short notice.

3. (Refer to Case Scenario 1) What are the implications of an EdFex outsourcing

arrangement for the capabilities underlying Heartsong’s competitive advantage?

ANS: The best answers will develop the theme that the EdFex outsourcing
arrangement is truly likely to be win-win. With the arrangement in place, Heartsong is
able to devote its financial, human capital, and managerial resources to basic R&D
and quality precision manufacturing; and, EdFex does what it does best in logistics.
Moreover, it is hard to contemplate that EdFex would ever think of entering the heart
valve industry - thus, EdFex does not pose a direct threat as a future competitor. It
does however pose an indirect threat to Heartsong to the extent it can hold the firm
hostage, and extract exorbitant fees for its logistic services.

4. (Refer to Case Scenario 1) If Heartsong LLC is to continue extending its competitive

advantage in high-quality, leading-edge artificial heart valves, it must keep the
inventorying, warehousing, and delivery of its heart valves in-house rather than
outsourcing these activities.

ANS: False

5. (Refer to Case Scenario 1) Heartsong should not outsource its inventorying,

warehousing, and delivery of its valves to EdFex since EdFex poses a direct threat as
a future competitor.

ANS: False
 Case Scenario 2: ERP Inc.
ERPI is a leading provider of enterprise integration software (EIS). EIS allows a firm
to connect and integrate processes across all aspects of its business, regardless of
where they are located around the world. ERPI is a product-focused company,
whereas most competitors in its market space, like Oracle, operate as “solutions
companies.” Oracle and Microsoft have begun to devote considerable resources to the
development of and acquisition of products to compete in the EIS space. Despite
these recent threats, one benefit of its product-focused strategy is that ERPI’s
proprietary product is generally recognized as being 200% to 300% better than
competitors’ software. ERPI estimates it will take 2 to 3 years for competitors to
develop the capabilities needed to bring a competing product to market. ERPI invests
a considerable percentage of its profits in basic R&D to support its core products. As
evidence of this, among its competitors the firm maintains the largest in-house
programming staff dedicated solely to the development of advanced enterprise
integration software. Installation and related consulting for EIS typically cost between
$100 and $200 million, with the ERPI software component accounting for about 20%
of the installed cost (the remaining 80% is spent on the actual installation, not
counting the value of the customer’s time). ERPI’s target market consists of the
world’s largest manufacturing and industrial firms and it currently enjoys a 60 percent
market share.

6. (Refer to Case Scenario 2) How valuable, rare, costly to imitate, and nonsubstitutable
are ERPI’s capabilities?

ANS: The best answers will simply walk through the respective columns in Table 3.5
and reach the conclusion that, at least in the near term, ERPI has a sustainable
competitive advantage. Its EIS software is valuable given that it is 200% to 300%
better than competitors’ products. It is similarly rare and nonsubstitutable since it is
proprietary, and currently has a two-year lead on the alternatives. A similar rationale
can be invoked to support the argument that ERPI’s capabilities in software
programming are going to be costly to imitate. A competitor would have to hire a
similar workforce or acquire a company that currently occupies the same market
space. This strong position is further bolstered by the fact that a large percentage of
the market is voting with its feet in favor of ERPI.

7. (Refer to Case Scenario 2) How sustainable is ERPI’s competitive advantage?

ANS: The best answers will build on the basic notions developed in response to
question 4. Students will argue that ERPI’s competitive advantage is sustainable as
long as its technology continues to define the leading edge of EIS products and that
substitute solutions do not encroach much on its two-year lead. However, and as is
consistent with most high-technology markets, as students pick apart ERPI’s
capabilities following the categories in Table 3.5 they should begin to see that
sustained competitive advantage in this particular market space may be difficult,
particularly given the presence of large, aggressive competitors like Oracle and
Microsoft, which are intent on gaining a presence in the EIS market.
 8. (Refer to Case Scenario 2) Imagine that ERPI’s historic growth strategy has focused
on making one sale and then moving on to the next target company. After several
years of building market share using this approach, what new resources has ERPI
developed?

ANS: This question asks students to take a more dynamic perspective of potentially
valuable resources that companies and their customers create together, but that the
company itself can exploit (a perfect example of a co-specialized asset). The best
answers will begin by observing that if ERPI has focused historically on transactions
(making the sale), then it has given little explicit consideration to customers as long-
term relationships beyond the need to provide technical support (lifetime value of a
customer beyond the first sale). Shifting attention to ERPI installations as
relationships suggests that the company now has a customer list to die for. This list is
especially valuable since (1) the target companies have invested upwards of $200
million in ERPI proprietary systems and, (2) once installed, given the pervasive
nature of EIS systems, those target firms are unlikely to simply switch to another
system.

9. (Refer to Case Scenario 2) Which of the following best describes ERPI?

a. ERPI is at a competitive disadvantage.
b. ERPI is at a competitive parity.
c. ERPI is has a temporary competitive advantage.
d. ERPI is has a sustainable competitive advantage.

ANS: d

10. (Refer to Case Scenario 2) Which of the following represents the maximum level of
performance ERPI should expect to achieve?
a. Below-average returns.
b. Average returns.
c. Average to above average returns.
d. Above average returns.

ANS: c

11. (Refer to Case Scenario 2) If the time for the competitor to produce a product similar
to ERPI’s were 2-3 months instead of 2-3 years, which portion of your assessment of
ERPI’s capabilities would change?
a. Valuable
b. Rare
c. Costly-to-imitate
d. None of these would change

ANS: b

Case Scenario 3: B.B. Mangler.

B.B. Mangler is a top U.S. business-to-business distributor of maintenance, repair,
and service equipment, components, and supplies such as compressors, motors, signs,
lighting and welding equipment, and hand and power tools. Customers include
contractors, service and maintenance shops, manufacturers, hotels, government, and
 health care and educational facilities. Mangler’s industry is typically referred to as
MRO, which is an acronym for maintenance, repair, and supplies. Mangler states its
strategy as having the “capacity to quickly offer an unmatched breadth of lowest total
cost MRO solutions to business.” Mangler’s GoMRO sourcing center for indirect spot
buys locates products through its unique database of 8,000 suppliers and 5 million
products. Mangler also dominates the North American market in terms of its sheer
local physical presence. It has 388 physical branches in the U.S. largest cities,
including Puerto Rico (90% of sales), 184 in Canada, and five in Mexico. This
physical presence also has garnered them a reputation for excellent, dependable
service in their target markets, which in turn translates into a vast and loyal clientele.

12. (Refer to Case Scenario 3) Mangler’s physical locations are best an example of
a. a core competency.
b. a capability.
c. an intangible resource.
d. a tangible resource.

ANS: d

13. (Refer to Case Scenario 3) Mangler’s reputation among its customers is an example of
a. a core competency
b. a capability
c. an intangible resource
d. a tangible resource

ANS: c

14. (Refer to Case Scenario 3) The Internet threatens to displace physical locations as a
basis for competitive advantage. If Mangler’s vast network of branch offices were an
integral part of its core competencies, what might the branches become if the basis for
competitive advantage in the MRO industry moves to the Internet?
a. a core rigidity
b. a capability
c. an intangible resource
d. a tangible resource

ANS: a

Chapter 4 – Biz level strategy

1. Define strategy and business-level strategy. What is the difference between these
two concepts?

ANS: In general, a strategy consists of the choices an organization makes in an

attempt to gain strategic competitiveness and earn above-average returns. The
organization’s strategic choices are influenced by threats and opportunities in the
external environment and by the nation and quality of its internal resources,
capabilities, and core competencies. The strategy reflects the firm’s vision and
mission. Business-level strategy is concerned with a particular product market.
Business-level strategy is an integrated and coordinated set of commitments and
actions the firm uses to gain a competitive advantage in a particular product market. It
 is the organization’s core strategy. Every firm, no matter how small, will have at least
one business-level strategy. A diversified firm will have several types of corporate-
level strategies as well as a separate business-level strategy in each product market
area in which the company competes. The essence of a firm’s business level strategy
is choosing to perform activities differently or to perform different activities than
competitors.

2. When a firm chooses a business-level strategy, it must answer the questions “Who?
What? and How?” What are these questions and why are they important?

ANS: The firm must decide (1) who are the customers who will be served, (2) what
needs do the target customers have that must be satisfied, and (3) how will those
needs be satisfied by the firm. The choice of target customer (who) usually involves
segmenting the market to cluster people with similar needs into groups. The target
customers’ needs drive “what” benefits and features the firm’s product will have. This
involves a choice and balance between cost and differentiation of the product. Finally,
firms use their core competencies (how) to implement value-creating strategies and
satisfy customers’ needs.

3. Discuss how a cost leadership strategy can allow a firm to earn above-average returns
in spite of strong competitive forces. Address each of the five competitive forces.

ANS: 1) Rivalry: Having the low cost position serves as a valuable defense against
rivals. Because of the cost leader’s advantageous position, especially in logistics,
rivals cannot reduce their costs lower than the cost leaders’, and so they cannot earn
above-average returns. 2) Buyers: The cost leadership strategy also protects against
the power of customers. Powerful customers can drive prices lower, but they are not
likely to be driven below that of the next-most-efficient industry competitor. Prices
below this would cause the next-most-efficient competitor to leave the market,
leaving the cost leader in a stronger position relative to the buyer. 3) Suppliers: The
cost leadership strategy also allows a firm to better absorb any cost increases forced
on it by powerful suppliers, because the cost leader has greater margins than its
competitors. In fact, a cost leader may be able to force its suppliers to keep prices low
for them. 4) Entrants: The cost leadership strategy also discourages new entrants
because the new entrant must be willing to accept no better than average returns until
they gain the experience and core competencies required to approach the efficiency of
the cost leader. 5) Substitutes: For substitutes to be used, they must not only perform a
similar function but also be cheaper than the cost leader’s product. When faced with
substitute products, the cost leader can reduce its price.

4. Describe the risks of a differentiation strategy.

ANS: The risks of a differentiation strategy include the fact that the price differential
between the low cost producer and the differentiated firm’s product may be too high
for the customer. The differentiated products may exceed the customers’ needs.
Additionally, differentiation may cease to provide value for which customers are
willing to pay. This can occur if rivals imitate the firm’s product and offer it at a
lower price. A third risk is that customer learning can narrow the customer’s
perception of the value of the firm’s differentiated product. If customers have positive
experience with low-cost products, they may decide the additional cost for the
 differentiated product is too high. Finally, counterfeit products are a risk to a
differentiation strategy if these products provide the same differentiated features to
customers at significantly reduced prices.

5. How do focused differentiation and focused cost-leadership strategies differ from

their non-focused counterparts?

ANS: Focus strategies target specific industry segments or niche rather than the entire
market. The market can be segmented into 1) a particular buyer group, 2) a different
part of a product line, or 3) different geographic areas. The firm using a focus strategy
hopes to meet the needs of a particular target market better than firms with a more
broad-based approach. Or, they hope to meet needs of a market niche that has been
overlooked or neglected by broad-based rivals.

6. Describe the additional risks undertaken by firms pursuing a focus strategy.

ANS: Focus firms face three additional risks beyond the general risks of industry-
wide strategies. First, a competitor may be able to focus on a more narrowly defined
competitive segment and "outfocus" the focuser. Second, a firm competing on an
industry-wide basis may decide the targeted market segment is attractive and worthy
of competitive pursuit. Finally, the needs of the firm’s customer group may become
more similar to the needs of industry-wide customers as a whole, thereby eliminating
the advantages of a focus strategy.

7. Describe the advantages of integrating cost leadership and differentiation strategies.

ANS: Customers have increasingly high expectations for products, wanting products
that are both low-priced and differentiated. So a number of firms are trying to
simultaneously follow both a cost leadership and a differentiation strategy. This
requires the firm to perform the primary and support activities required of both
strategies, which is challenging. Successful integration of strategies allows firms to
adapt quickly to environmental changes, and learn new technologies. The firm gains
more skills which makes it more flexible. Evidence suggests that successful use of
integrated strategies is related to above-average returns. A number of firms such as
Target Stores and European-based Zara owe their success to the integrated cost
leadership/differentiation strategy.

8. What are the risks of an integrated cost leadership/differentiation strategy?

ANS: Integrated strategies present risks that go beyond those that arise from the
pursuit of any single strategy by itself. Principal among these risks is that a firm
becomes "stuck in the middle." In such a situation a firm fails to implement either the
differentiation or the cost leadership strategy effectively. The firm will not be able to
earn above-average returns, and without favorable conditions, it will earn below-
average returns. Recent research suggests that firms using either cost leadership or
differentiation often outperform firms attempting to use a “hybrid” strategy (i.e.,
integrated cost leadership/differentiation). This research suggests the risks associated
with the integrated strategy.
CASE

Case Scenario 1: International Cow Packers.

International Cow Packers (ICP) is a $12 billion meat processor (slaughter,
processing, and packing). Founded in 1943, ICP has grown to become the largest beef
and pork processor in the United States (revenues come 90% from beef and 10% from
pork) and also has a growing export market to Japan. The company follows a focused
cost-leadership strategy, delivering USDA-graded meats primarily to the institutional
(schools, prisons, hospitals) and supermarket channels. ICP’s entire value chain is
organized to deliver volume product at the industry’s lowest per-unit cost. Its supplier
industries, primarily cattle and swine feedlots, have relatively little power since prices
for these raw materials are determined in the commodity markets. While entry
barriers to the industry are high due to high minimum start-up costs, industry rivalry
is extremely intense - primarily due to the fact that three large companies (including
ICP) control 80% of the market for processed meats. The threat of substitutes is high
with an increasing trend for consumers to favor poultry and other non-beef proteins.
Buyers are also powerful since supermarkets are relatively concentrated at a regional
level and end-consumers have ample choices.

1. (Refer to Case Scenario 1) Is ICP’s focused low-cost strategy appropriate for its
industry? Why?

ANS: The best answers will begin by noting that ICP sells a commodity product, as
evidenced by the fact that there are only so many grades of USDA-certified beef and
pork. Since the product is an undifferentiated commodity, customers typically base
their purchasing decisions on price alone.

2. (Refer to Case Scenario 1) What risks is ICP accepting by adopting its focused low-
cost strategy?

ANS: The best answers will note that since ICP has aligned its entire value-chain
with its low-cost strategy, it has linked its own ups and downs to the ups and downs
of the beef and pork industries. Thus, like commodity prices, we can expect that ICP
will do well when general demand for beef and pork is up, and less well when such
demand is down. A more nuanced answer may also point out that ICP’s intense focus
on costs may essentially drive out any opportunities for it to develop differentiation
advantages (other than offering the lowest cost product). If competitors are able to
match ICP’s efficiency as well as build other differentiation advantages (like brand
management skills or forward integration into value-added meat products like
prepackaged meals), ICP may find itself at a competitive disadvantage in the long run.

3. (Refer to Case Scenario 1) What can ICP do to decouple itself from the ups and
downs of the pure commodity markets? What specific actions might ICP undertake?

ANS: The best answers will begin by suggesting that ICP must retain its cost
advantage while developing differentiation advantages. At a general industry level,
ICP can promote the consumption of beef and pork to counter trends away from these
meats. Specific to ICP, it can begin experimenting with value-added products like
prepackaged meals (frozen dinners, etc.). A related strategy would be the
development of organic products that do not fall within the USDA categories. Selling
 high-quality beef and pork outside of the USDA categories would be another strategy
as well. The theme across students’ recommendations should be one of developing
products that no longer have commodity-like characteristics.

4. (Refer to Case Scenario 1) The focused cost-leadership strategy followed by

International Cow Packers Inc. (ICP) is appropriate given the industry characteristics
of low supplier power, high entry barriers, intense industry rivalry, high threat of
substitutes, and powerful buyers.

ANS: T

5. (Refer to Case Scenario 1) The supplier industries of International Cow Packers

(ICP), primarily cattle and swine feedlots, are powerful because prices for these
supplies are determined in the commodity markets.

ANS: F

Case Scenario 2: Walt Disney Company.

Walt Disney Company is famed for its creativity, strong global brand, and uncanny
ability to take service and experience businesses to higher levels. In the early 1990s,
then-CEO Michael Eisner looked to the fast-food industry as a way to draw additional
attention to the Disney presence outside of its theme parks - its retail chain was highly
successful and growing rapidly. A fast-food restaurant made sense from Eisner’s
perspective since Disney’s theme parks had already mastered rapid, high-volume food
preparation, and, despite somewhat undistinguished food and high prices (or perhaps
because of), all its in-park restaurants were extremely profitable. From this
inspiration, Mickey’s Kitchen was launched. The first two locations were opened in
California and in a suburb of Chicago, adjacent to existing Disney stores. Menu items
included healthy, child-oriented fare like Jumbo Dumbo burgers and even a meatless
Mickey Burger. Eisner thought that locating each restaurant next to existing Disney
stores was sure to increase foot traffic through both venues. Less than two years later
Disney closed down the California and Chicago stores and shuttered further
expansion plans. Eisner cited overwhelming competition from McDonalds and
general oversaturation in the fast-food industry as the primary reasons for closing
down the failing Mickey’s Kitchen.

6. (Refer to Case Scenario 2) Based on your own knowledge of Disney and the
information provided in the scenario, does Disney appear to create value in its
businesses primarily through a cost-leadership or through a differentiation strategy?

ANS: The best answers will begin by noting that Disney, via Mickey Mouse, is
probably one of the world’s most recognized brands. This unique asset complements a
differentiation strategy well. Students may further remark that, while Disney may
seek efficiencies in all of its operations, ticket prices for the theme parks don’t appear
to be a particular bargain, and that Disney never seems to promote its products based
on their cost. This is illustrated by the point that the in-park restaurants charged high
prices.

7. (Refer to Case Scenario 2) What resources and value-chain activities did Disney try to
leverage through the opening of Mickey’s Kitchen?
 ANS: It appears that Disney was hoping for a differentiation advantage through (1)
the image of Mickey Mouse, (2) its service management expertise, particularly in
food service, and (3) locations next to its already successful chain of retail outlets.

8. (Refer to Case Scenario 2) Why do you think that Mickey’s Kitchen failed?

ANS: The best answers will begin with the observation that it’s hard to imagine that
Mickey’s Kitchen could create the differentiated Disney experience and margins at
fast-food prices. The discussion can then be extended to note that Disney did deploy a
set of resources that were valuable, rare, costly to imitate, and nonsubstitutable, but it
did so in the fast-food industry where consumers make choices based primarily on
price. Thus, Disney’s particular resources generated differentiation advantages, but
not the needed cost advantages. It also can be pointed out that Disney’s theme park
restaurants have likely done well because guests of the park are a captive audience
and have few food choice alternatives unless they opt to leave its park or properties.

9. (Refer to Case Scenario 2) Mickey’s Kitchens was successful primarily because it

was able to create a differentiated Disney experience that drew customers away from
other fast-food restaurants such as McDonald’s.

ANS: F

Case Scenario 3: Abrahamson’s Jewelers.

Through its sole location in an affluent suburb of San Francisco, Abrahamson’s
Jewelers has established a strong niche market in the upscale jewelry store segment.
Abrahamson’s was founded in 1871 and is currently owned and operated by John
Wickersham, who bought the firm from its namesake founders in 1985. Wickersham
joined the firm as a trainee out of high school, completed his gemology training, and
several years later took ownership with the financial help of his parents. That debt has
long been paid off and business has thrived. When he first acquired the business,
Abrahamson’s offered a full range of jewelry and gift items from watches to wedding
sets to silverware to clocks. This broad range of products was mirrored by a broad
price range-$10,000 Rolex watches were sold next to $50 Seiko watches. While some
jewelry was custom designed and manufactured, most of the products were “case
ready,” meaning they were sourced from large jewelry and silver manufacturers from
around the world. Over the last 15 years, Wickersham has narrowed the company’s
product offering considerably to focus only on high-end watches like Rolex and
Piaget, custom jewelry, and estate jewelry. Wickersham stresses that this is an
appropriate focus for his business since each of the products lends itself to
relationship selling, and price rarely comes into the discussion. Despite the narrower
offering moreover, Abrahamson’s floor space has doubled, and clients are intensely
loyal to the good taste, design skills, and personal service level provided by Mr.
Wickersham.

10. (Refer to Case Scenario 3) What generic business strategy best describes
Abrahamson’s? Why?

ANS: The best answers will observe that all the features of this case point to a
focused differentiation strategy. The company is focused both in terms of product
 offering and geography. Purchase decisions are based primarily on a relationship with
Mr. Wickersham and unique products, not on price.

11. (Refer to Case Scenario 3) While Abrahamson’s is doing well, Mr. Wickersham
would like to grow his business beyond the present location. He believes that growth
may bring greater profitability, as well as employment avenues for his only child, who
will soon be finishing high school. What recommendations do you have for Mr.
Wickersham regarding his growth choices?

ANS: The objective here is to get students to see the limits to growth presented by
Abrahamson’s current strategy and key resources. This scenario also provides a nice
opportunity to link a company’s strategy and resource base with a key individual - in
this instance, Mr. Wickersham. The best answers will start by walking through a
particular expansion plan and then noting how the company’s resources do and do not
support that plan. For instance, one obvious avenue is to open additional locations.
Such an avenue would likely leverage Wickersham’s contacts and expertise in
sourcing raw materials, as well as providing a greater market to exploit his
representation and contracts with watch firms like Rolex and Piaget. A second avenue
would be to leverage Wickersham’s design skills to go into the wholesale jewelry
business. The risk underlying both of these growth avenues is that it may spread Mr.
Wickersham too thin: as the scenario clearly suggests, his personal knowledge and
relationships (and time) are central to Abrahamson’s current success.

12. (Refer to Case Scenario 3) Would you recommend that Mr. Wickersham embark on
an Internet sales strategy for his company?

ANS: The best answers will note that some aspect of the Internet may be valuable for
Abrahamson’s, but that his current resource base does not lend itself well to an
Internet sales vehicle. Customers typically expect that products sourced and sold
online will be cheaper than through traditional retail channels, even for high-end
items like watches (for instance, have students do a Web search for Rolex watches).
Abrahamson’s is not poised to, nor does it seem inclined to, compete on price. In
terms of customer relations, however, Abrahamson’s could use some form of Internet
presence to show its customers a broader variety of products in its already narrow
line. They could also perhaps see prior design work to help them better imagine what
a custom-designed piece might look like. Particularly for the estate sales,
Abrahamson’s could link its inventory to larger, reputable online estate-sale houses -
thus giving its customers the benefit of local relationships with the power of the
Internet’s worldwide markets. Finally, use of the Internet for maintaining contact with
existing customers would enhance its relationship with and knowledge of them.

13. (Refer to Case Scenario 3) With its sole location in an affluent suburb of San
Francisco and a narrow product offering of only high-end watches, custom jewelry,
and estate sales, Abrahamson’s Jewelers is most likely following a differentation
strategy.

ANS: F

Chapter 5 – Competitive Rivalry and Dynamics

1. Define competitors, competitive rivalry, competitive behavior, and competitive
dynamics.

ANS: Competitors are firms competing in the same market, offering similar products,
and targeting similar customers. Competitive rivalry is the ongoing set of competitive
actions and competitive responses occurring between competitors as they compete
against each other for an advantageous market position. For the individual firm, the
set of competitive actions and responses it takes while engaged in competitive rivalry
is called competitive behavior. Competitive dynamics is the set of actions and
responses taken by all firms that are competitors within a particular market.

2. What is market commonality? What is resource similarity? How are these concepts
combined to identify the level of competition between two firms?

ANS: Market commonality is concerned with the number of markets with which the
firm and a competitor are jointly involved and the degree of importance of the
individual markets to each. When firms produce similar products and compete for the
same customers, the competitive rivalry is likely to be high. Firms competing against
one another in several or many markets engage in multimarket competition. Research
suggests that a firm with greater multimarket contact is less likely to initiate an attack,
but more likely to respond when attacked. In general, multimarket competition
reduces competitive rivalry but some firms will still compete when the potential
rewards (e.g., potential market share gain) are high.

Resource similarity is the extent to which the firm’s tangible and intangible resources
are comparable to a competitor’s in terms of both type and amount. Firms with
resource similarity are likely to have similar strengths and weaknesses and to use
similar strategies.

The combination of high or low market commonality and high or low resource
similarity identifies whether firms are competitors. Firms having both high market
commonality and high resource similarity are direct and mutually acknowledged
competitors. If firms share few markets and have little similarity in resources they are
not direct and mutually acknowledged competitors.

3. Define awareness, motivation and ability in reference to competitive behavior.

ANS: Awareness, motivation and ability are the drivers of competitive behavior.
They influence the firm’s actions toward and responses to competitors. Awareness is
the extent to which competitors recognize the degree of their mutual interdependence
that results from market commonality and resource similarity. Awareness affects the
extent to which the firm understands the consequences of its competitive actions and
responses. Awareness is greatest when firms have highly similar resources.
Motivation concerns the firm’s incentive to take action against a competitor or to
respond to a competitor’s attack. If the firm doesn’t believe that attacking its
competitors will improve its position, it will not act. If the firm does not believe a
competitor’s action will result in losses for it, it will not have motivation to respond.
High market commonality gives firms more motivation to attack and to respond to
competitors’ actions than when market commonality is low. Ability relates to each
 firm’s resources and the flexibility these resources provide. When a firm faces a
competitor with similar resources, careful study of a possible attack is essential
because a competitor with similar resources is likely to respond to competitive attack.
When the resources between two competitors are very dissimilar, the weaker firm will
delay in responding to an attack by the stronger firm.

4. Define competitive actions and responses and explain the two types of competitive
actions and responses.

ANS: A competitive action is a strategic or tactical action the firm takes to build or
defend its competitive advantages and improve its market position. A competitive
response is a strategic or tactical action the firm takes to counter the effects of a
competitor’s competitive action. A strategic action or strategic response is a market-
based move that involves a significant commitment of organizational resources and is
difficult to implement or reverse. A tactical action or tactical response is a market-
based move that is taken to fine-tune a strategy. It involves fewer resources and is
relatively easy to implement and reverse. Strategic actions tend to receive strategic
responses. Tactical actions tend to receive tactical responses because they are easy to
put into place. Strategic actions elicit fewer total competitive responses than do
tactical actions. Responses to strategic actions will be slower than will responses to
tactical actions because competitors need time to observe whether the strategic action
will be successful. But, if a competitor’s action threatens a large number of a firm’s
customers, the firm will react strongly regardless of whether the competitor’s action is
strategic or tactical.

5. What are the advantages and disadvantages of being a first mover, second mover, and
late mover?

ANS: First movers can gain market share, customer loyalty, and high revenues by
being the first in the market. But, first movers also take more risk because it is
difficult to judge the returns the firm will earn from product innovations. Moreover, if
the first mover is successful, other firms will enter its arena. First movers tend to have
a significant amount of organizational slack to fund research and development.
Second movers imitate the first movers, after they have studied the first mover’s
successes and mistakes. Consequently second movers can develop more efficient
processes and technologies than first movers, which results in lower costs. Late
movers react to the first and second movers’ actions after a long delay. A late mover
may be able to earn average returns if it has learned how to create at least as much
value for customers as the value created by the first and second movers. In general,
late movers are relatively ineffective.

6. What factors contribute to the likelihood of a response to a competitive action?

ANS: In general, a firm is more likely to respond to a competitive action if: (1) the
action leads to better use of the competitor’s capabilities to gain or produce stronger
competitive advantage or to improve its market position, (2) the action damages the
firm’s ability to use its capabilities to create or maintain an advantage, or (3) the
firm’s market position becomes less defensible. In addition, a firm is more likely to
respond to a competitor’s tactical action, rather than to a competitor’s strategic action.
Strategic actions involve a significant commitment of resources and are difficult to
 implement and reverse, as well as requiring time to put into place. In contrast, tactical
actions can be implemented quickly and are quickly reversed, and are relatively less
costly than strategic actions. A firm is also more likely to respond to a competitor’s
action when the competitor is the market leader - a firm that has the reputation for
above-average returns. Successful actions by competitors are likely to be quickly
imitated, even if not initiated by a market leader. Actions by price predators are
usually not responded to, nor are actions by firms with reputations for risky, complex,
and unpredictable behavior. Finally, competitors with high market dependence are
likely to respond strongly to attacks threatening their market position.

7. Define slow-cycle, fast-cycle and standard cycle markets.

ANS: In slow-cycle markets, the firm’s competitive advantage is shielded from

imitation for long periods of time and imitation is costly. Competitive advantages are
sustainable in slow-cycle markets. Successful firms in slow-cycle markets have
difficult-to-understand and costly-to-imitate advantages resulting from unique
historical conditions, causal ambiguity and/or social complexity. These conditions can
include copyrights, patents, and ownership of an information resource. Firms in slow-
cycle markets focus on protecting their competitive advantages and exploiting them as
long as possible. In fast-cycle markets, imitation happens quickly. Competitive
advantages are not sustainable. Reverse engineering and quick technology diffusion
facilitate rapid imitation. In fast-cycle markets, innovation is critical and firms avoid
“loyalty” to any product. Firms must focus on rapidly and continuously developing
new competitive advantages, because prices fall quickly and firms need to profit
rapidly from innovations, and move on to the next product. Fast-cycle markets are
volatile and the pace of innovation is frenzied. In standard-cycle markets, the firm’s
competitive advantages are moderately shielded from imitation and imitation is
moderately costly. Competitive advantages are partially sustainable if the firm can
continuously upgrade the quality of its capabilities making its competitive advantage
dynamic. Typically, these markets have large firms seeking high market share,
striving for customer brand loyalty, and controlling their operations to give customers
consistent experiences. Economies of scale are necessary for survival. Competition
for market share is intense and is often based on incremental innovation in a product
rather than radical innovation.

CASE

Case Scenario 1: Romulac, Inc.

Romulac Inc. (RI), a subsidiary of a large successful manufacturing conglomerate,
supplies a key component in the assembly of residential cooling systems (air
conditioning units, etc.). There has been tremendous consolidation in RI’s industry, to
the point where only five suppliers of this particular component account for nearly
90% of U.S. industry sales. Paralleling this trend, its customers - comprised of makers
of branded residential air conditioning units like Carrier and Trane - have seen similar
levels of consolidation in their own industry. Half of these firms produce all their
components in-house, while the balance purchases them from specialized component
manufacturers like RI. RI’s business is extremely capital intensive, and their 40%
share of the market allows them to also be the most profitable domestic player. Strong
competitors exist in Europe and Asia. Although like RI, these foreign players’
strongholds are their home regions, with negligible presence outside of the region.
 Some of the larger Asian manufacturers have signaled an interest in more
aggressively pursuing the lucrative U.S. market. RI is presently considering a $400
million dollar investment in a new plant, which will create a component that is much
quieter, more efficient, and is likely to satisfy future regulatory standards. While the
core technology for the new component is very old, RI’s engineering and design skills
have allowed them to retain their low cost-advantage, even though the component will
represent a significant improvement over products currently provided by its
competition.

1. (Refer to Case Scenario 1) Develop an argument as to why RI should try to be a first-

mover with this new technology.

ANS: The best answers will begin by suggesting that RI move quickly to retain its
dominant market share, particularly since the technology itself is not new, and
competitors may easily develop their own efficient designs. A more subtle argument
is that RI has an opportunity to set a new industry standard, and as the leader, may
likely gain even greater market share.

2. (Refer to Case Scenario 1) Develop an argument as to why RI should hold back and
be a second mover with the new technology.

ANS: The best answers will observe that RI cannot predict with certainty that its new
technology will be cheaper, or as cheap to produce. Thus, a primary risk is that RI
invests in the plant, the industry moves to the new technology, but the technology is
actually more costly to produce - in this way, RI may cannibalize its existing low-cost
position with a higher-cost one. By waiting, RI can learn from its competitors’
mistakes. A secondary risk is that competitors will learn from RI’s initial mistakes,
and be able to offer the new technology for considerably lower cost. The nightmare
scenario here is that the industry moves to the new technology, RI has a higher cost
position, and overseas competitors steal domestic market using the new technology,
which they have learned to manufacture at a lower cost. Thus, RI could avoid this
latter risk by again waiting out the competition.

3. (Refer to Case Scenario 1) As one of RI’s direct competitors, how would you try to
predict what it will do with regard to the new technology?

ANS: The best responses can begin by pointing to three main characteristics that are
likely to heavily influence RI’s choices. The ways these factors bode in favor and
against the move should be discussed. First, RI is both large and a dominant player in
this market. Second, RI is very profitable and such profitability is a direct
consequence of its large market share. Finally, RI is the subsidiary of a large
successful conglomerate - students would want to point out that the new technology
will require a large corporate commitment ($400 million). A related issue is whether
the corporate parent considers itself to be primarily a first or second mover in its
competitive interactions.

4. (Refer to Case Scenario 1) Assume that you are a consultant and have been asked by
the management at Romulac Inc. whether it should be a first mover with the new
component technology.
 Romulac is leaning towards being a first mover because the general evidence is that
first movers have greater survival rates than later market entrants. Is this true or
false?

ANS: F

Case Scenario 2: Plasco.

Plasco is a $3 billion U.S.-based manufacturer of flexible plastic products like trash
cans, reheatable and freezable food containers, and a broad range of other plastic
storage containers designed for home and office use. Historically, Plasco has been the
category killer for most of its products and has devoted tremendous resources to new
product development on an ongoing basis - this research intensity has allowed the
company to release, on average, a new product every day over the past five years.
Despite its past strength and high brand awareness, Plasco’s profitability has been
eroded by dramatic increases in the cost of plastic resin, the primary input into its
plastic products. Moreover, the retail channel has experienced rapid consolidation
resulting in a shift in the balance of power from branded manufacturers like Plasco, to
strong retailers like Wal-Mart, who in turn have been unwilling to help Plasco absorb
the higher resin costs. Enhancing Wal-Mart’s power is the fact that it can always turn
to alternative high-volume sources of consumer plastic products like Sterlite. Further
hampering Plasco’s recovery is the emergence of feisty little foreign competitors like
Zig Industries, a $250 million Israeli firm that has begun to take part of Plasco’s
market share in plastic toolboxes. Ironically, Plasco was the first company to offer
plastic toolboxes some 20 years ago. This innovation changed the market dramatically
and Plasco’s first mover strategy rewarded it with a rapidly growing new segment and
a dominant market position. Today, Plasco’s toolboxes are viewed as rather boring,
while Zig’s products are ingeniously designed to catch the customer’s eye in the aisle
(better merchandising the product) and capture their interest (and pocketbook) with
many new and novel features. Zig is also able to provide this new line of toolboxes at
between 10% to 15% less than Plasco.

5. (Refer to Case Scenario 2) Is Wal-Mart a competitor or a customer of Plasco?

ANS: The best answers will start by summarizing that Wal-Mart is both a customer
and a competitor. It is a customer in the sense that it is a primary outlet for Plasco’s
products. Wal-Mart is a competitor from the standpoint that Wal-Mart has control
over Plasco’s profitability and, in a sense, is competing for a portion of the profit pool
in Plasco’s industry as well.

6. (Refer to Case Scenario 2) Is the toolbox business a slow-, standard-, or fast-cycle

business?

ANS: The best answers will suggest that the cycle characteristics of the toolbox
market appear to have shifted over time. Before Plasco entered the business, metal
toolboxes were the norm and this was likely to be characterized as standard to slow in
terms of its cycle speed. The metal toolbox market was probably an oligopolistic one,
dominated by a few profitable players. With the entrance of Plasco and its plastic
toolboxes, the cycle speed among metal toolbox manufacturers increased, where they
no longer dominated the industry. Plasco’s innovative product plus its unique capacity
(at the time) to produce a durable plastic toolbox probably turned its segment into a
 slow-cycle market (with Plasco enjoying a near monopoly position), while the metal
toolbox took on standard- to fast-cycle market characteristics. With the new entrance
of Zig into plastic toolboxes, this segment is now likely to be characterized as
standard to fast cycle - plastic technologies aren’t proprietary and designs are readily
copied by competitors.

7. (Refer to Case Scenario 2) How can a small player like Zig be such a successful
competitor against a large, established firm like Plasco?

ANS: The value of this question is that it forces students to consider how changes in
both a focal industry and its upstream industry may affect competition. The best
answers can begin by noting that the market for plastic toolboxes is probably pretty
large (tools, cosmetics, fishing gear, toys, etc), especially on a global basis. Couple
this observation with the fact that there are a number of mega-retailers who would
find this to be a necessary product to stock on their shelves. Thus, this market
segment is nearly an industry in and of itself and a small focused player could gain
economies of scale in manufacturing as well as distribution and marketing to the
staple, volume retailers like Wal-Mart, Home Depot, and Carrefour. Finally, Plasco
was apparently treating the plastic toolbox market as a stable one, leaving it less likely
to invest much of any additional resources into further innovation. This creates a
window of opportunity for a nimble, aggressive, focused and talented new entrant like
Zig.

8. (Refer to Case Scenario 2) Although Plasco was the first mover in plastic toolboxes
several years ago, its competitor Zig has gained market share by building brand
loyalty to its boxes which are viewed as more attractive and have novel features. The
characteristics of this market are most similar to a standard-cycle market.

ANS: T

Case Scenario 3: The Pet Food Industry.

The pet food industry is comprised primarily of six market segments: dry dog food,
dry cat food, moist dog food, moist cat food, canned dog food, and canned cat food.
Five large firms dominate the market and each has some market share in all segments,
and the leading share in at least one segment. The largest firm participates solely in
the pet food industry, while the next four firms are actually subsidiaries of some of
the world’s largest food and consumer products companies. Top management of these
larger firms have made public statements that suggest they each see themselves as
future leaders of the pet food industry. All five have acquired comparable skills in
terms of manufacturing and marketing. Two small firms also participate in the
industry, but these players are relatively weak and compete in just two of the six
segments; the pet food industry is the only industry in which they operate. Inputs to
the industry are basic commodities and there is no real threat of substitute products
except across segments and price points. The industry is growing slowly, barely
keeping up with the rate of inflation. Barriers to entry are enormous when pet food
companies can gain scale economies in production coupled with aggressive
marketing, though even then these coordinated actions may only yield average
industry profitability. Any firm can increase its market share only to the extent that
another firm’s share is decreased.
 9. (Refer to Case Scenario 3) The pet food industry is best characterized as an example
of
a. slow-cycle markets.
b. standard-cycle markets.
c. fast-cycle markets.
d. neither slow-cycle, standard-cycle, nor fast-cycle markets.

ANS: b

10. (Refer to Case Scenario 3) The pet food industry provides an example of
a. market commonality.
b. resource similarity.
c. multimarket competition.
d. market commonality, resource similarity, and multimarket competition.

ANS: d

11. (Refer to Case Scenario 3) Members of the pet food industry are likely to experience
a. no competition.
b. little competition.
c. moderate competition.
d. extensive competition.

ANS: D

Chapter 6 – Corporate Level Strategy

1. Differentiate between corporate-level and business-level strategies and give examples

of each.

ANS: A business-level strategy determines how a firm will compete in a single

industry or product market. When a firm diversifies beyond a single industry it uses a
corporate-level strategy. A diversified company has two levels of strategy: business-
level and corporate-level. Each business unit has a business level strategy. The
corporate strategy is concerned with: 1) what businesses the firm should be in and 2)
how the corporate office should manage the group of businesses. The top
management of diversified companies views the firm’s businesses as a portfolio of
core competencies that will generate above-average returns by creating value. An
example of a business-level strategy would be whether the firm targets the mass
market and competes on price, or whether it competes on the basis of uniqueness. An
example of a corporate-level strategy would be whether the firm should sell off a
poorly performing subsidiary.

2. What are the five categories of businesses based on level of diversification?

ANS: The five categories of businesses determined by level of diversification are as

follows: (1) Single business (more than 95% of revenues from a single business), (2)
Dominant business (between 70% and 95% of revenue from a single business), (3)
Related constrained (a diversified organization earning less than 70% of revenue from
the dominant business, and all the component businesses share product, technological,
 and distribution linkages), (4) Related linked (a diversified organization earning less
than 70% of revenues from the dominant business with only limited links among the
component businesses), and (5) Unrelated (diversified organizations earning less than
70% of revenues from the dominant business with no common links among the
businesses).

3. Describe the primary reasons a firm pursues increased diversification.

ANS: Firms typically diversify to increase the firm’s value by improving its overall
performance. Value-creating diversification occurs through related or unrelated
diversification when the strategy allows the company’s business units to increase
revenues or reduce costs while implementing business level strategies. Alternatively,
a firm may diversify to gain market power over competitors. Value-neutral
diversification may occur in response to governmental policies, firm performance
problems, or uncertainties about future cash flows. Finally, managers may have
selfish motives to diversify, such as increased compensation or personal reduced
employment risk. These selfish motivations may actually erode the firm’s
competitiveness, and can be value-reducing diversifications.

4. Describe how diversified firms can use activity sharing and transfer of core
competencies to create value.

ANS: In related diversification, a firm seeks to exploit economies of scope between

its business units. Economies of scope are cost savings created by transferring some
of its capabilities and competencies developed in another business to a new business.
Firms create value through economies of scope two ways: the sharing of activities
(operational relatedness) and the transferring of core competencies (corporate
relatedness). Both primary and support activities may be shared, including marketing
and production. This activity sharing can result in cost reductions and improve
financial returns. The sharing of core competencies allows the firm to create value
two ways: 1) it eliminates the need for the second unit to allocate resources to develop
the competence, and 2) transferring intangible resources internally makes it hard for
competitors to understand and to imitate the resource.

5. What are the two ways that an unrelated diversification strategy can create value?

ANS: Unrelated diversification can create value through two types of financial
economies (cost savings). 1) Unrelated diversified firms can more efficiently allocate
capital among the component businesses than can the external financial market. This
is possible because the corporate-level management has more complete information
about the performance of the component businesses and it can also discipline under-
performing management teams. 2) Unrelated diversified firms can also create value
by purchasing other businesses at low prices, restructuring them, and reselling them at
a higher price. This practice is most successful with mature, low-technology
businesses, rather than high-technology or service businesses, which are more
dependent on employees who may leave.

6. What is the effect of a firm’s low performance on the pursuit of diversification?

ANS: High corporate performance eliminates the need for diversification. Some
 research shows that low returns are related to greater levels of diversification. Firms
plagued by poor performance often diversify in an effort to become more profitable.
But, continued poor performance following diversification may slow the pace of
diversification and may lead to divestitures and a focus on the core business. In
addition, firms that are more broadly diversified compared to their competitors may
have lower overall performance. Figure 6.3 shows that the related constrained
diversification strategy is the highest performing strategy. So poor performing firms
that intend to diversify should look at purchasing businesses that would be suitable for
this strategy rather than moving into unrelated diversification or retaining a dominant
business strategy.

7. What are the managerial motives to diversify?

ANS: A top-level manager may be motivated to pursue diversification because

diversification leads to greater job security for executives. In general, greater amounts
of diversification reduce managerial risk because if a particular business fails, the top
executive remains employed by the corporation. In addition, diversification increases
firm size, and firm size has a direct effect on executive compensation. Moreover,
managing a highly diversified firm is more difficult; thus, managerial compensation is
generally higher in such a firm. Consequently, executives may have selfish motives to
diversify the company in ways which may actually reduce corporate competitiveness.

CASE
Case Scenario 1: Syco.
Syco is a diversified company that has six primary lines of business. Fifty percent of
its revenues and 18 percent of its profits come from retailing. Most of its retail outlets
are discount department stores that serve as anchor tenants for large suburban
shopping malls. The remaining businesses are broken out as follows: Insurance
accounts for 30 percent of revenues and 50 percent of profits; consumer credit card
operations are 6 percent of sales and 17 percent of profits; 5 percent of revenues and 6
percent of profits come from its stock brokerage business; commercial and residential
real estate operations generate 4 percent of sales and 8 percent of profits; finally, 5
percent of revenues and 1 percent of profits come from its online portal business. The
company’s management states that all these businesses are essential to its competitive
future.

1. (Refer to Case Scenario 1) Why might there be so much variability among the
proportion of sales versus profitability contributed by each of the businesses? Does
this mean that Syco is more successful in its insurance business than in its retail
business?

ANS: The best answers to this question will start out by noting that industries vary in
their profit structures. That is the margins in retailing are typically very low, while
those in insurance are relatively much higher. Beyond this, the statement tells us
nothing about how well Syco is actually doing in each business, since you would need
to compare business-level performance against that of competitors on a business-by-
business basis. [Note to the instructor: The above scenario is based loosely on Sears in
the mid-1980s. At that time its lines of business were Sears Department Store,
Allstate Insurance, Discover Card, Dean Witter Stock Brokerage, Coldwell Banker
Real Estate Brokers, and Prodigy Online. Sears eventually divested all but its
 department stores and, at one time, was near bankruptcy under the weight of its
diverse operations and failing retail business (under-maintained mall properties
became a core rigidity).]

2. Part 1: (Refer to Case Scenario 1) Develop a logical argument that would lead you to
describe Syco’s diversification type as related linked and another logical argument
that Syco’s diversification type is related constrained. For both the related linked and
for the related constrained arguments, what product, technological, or distribution
activities might link these businesses together?

Part 2: Would you describe either of the logical arguments you developed in response
to Part 1 as a good corporate strategy?

ANS: Part 1: The purpose of this exercise is to give students an opportunity to view
the diversified firm from the perspective of the top management team. The best
answers will start with related linked strategies and note that superficial linkages can
be provided by global brandings (i.e., all businesses under one name), one-stop
shopping (i.e., all businesses under one roof), and shared accounting systems (i.e.,
centralized accounting, cash allocation, and planning). The best answers to the related
constrained questions will offer more complex linkages beyond those noted above
like shared customer lists, active cross-selling, and rotation of key personnel. Because
the businesses are so different, however, the students should begin to see that more
complex linkages may be difficult to achieve.

Part 2: Based on the challenges of developing answers for Part 1, this question forces
students to stand back and criticize the strategies that they created. Since there are
many possible approaches to Part 1, it should become clear to students that each of
these competing arguments has significant drawbacks. Ultimately, students should
reach the point where they may agree that offering a bundle of services is desirable,
although there is no reason that Syco has to own all of these offerings. This discussion
also provides a nice way to foreshadow the role and importance of strategic alliances
which are covered in Chapter 9.

3. (Refer to Case Scenario 1) What diversification strategy best describes Syco?

Assume that retailing, insurance, consumer credit card, stock brokerages, and online
portal businesses allow for some transfer of knowledge about consumer behavior
including buying and bill-paying habits.
a. related constrained diversification strategy
b. related linked diversification strategy
c. unrelated diversification strategy
d. combination diversification strategy

ANS: B

Case Scenario 2: Jewell Company.

Jewell Company (JC) is a $2 billion diversified manufacturer and marketer of simple
household items, cookware, and hardware. In the early 1950s, JC’s business consisted
solely of manufactured curtain rods that were sold through hardware stores and
retailers like Sears. Since the 1960s however, the company has diversified extensively
through acquisition into such businesses as paintbrushes, writing pens, pots and pans,
 and hairbrushes. Over 90 percent of its growth can be attributed to these many small
acquisitions, whose performance it improved tremendously through aggressive
restructuring and its corporate emphasis on cost-cutting and cost controls. While JC’s
sixteen different lines of business may appear quite different, they all share the
common characteristics of being staple manufactured items and sold primarily
through volume retail channels like Wal-Mart, Target, and Kmart. Because JC
operates each line of business autonomously (separate manufacturing, R&D, and
selling responsibilities for each line), it is perhaps best described as pursuing a related
linked diversification strategy. The common linkages are both internal (accounting
systems, product merchandising skills, and acquisition competency) and external
(distribution channel of volume retailers). JC is presently contemplating the
acquisition of Plastico, a $3 billion U.S.-based manufacturer of flexible plastic
products like trash cans, reheatable and freezable food containers, and a broad range
of other plastic storage containers designed for home and office use. While Plastico
has been highly innovative (over 80% of its growth has come from internal new
product development), it has had difficulty controlling costs and is losing ground
against powerful customers like Wal-Mart. JC believes that the market power it
wields with retailers like Wal-Mart will help it turn Plastico’s prospects around.

4. (Refer to Case Scenario 2) How might JC's related diversification strategy result in
economies of scope and market power?

ANS: For the question of efficiencies, the best answers will observe that JC is able to
leverage its accounting systems, product merchandising skills, acquisition
competency, and distribution channel of volume retailers across all its businesses
(economies of scope). These scope economies, in turn, provide JC the opportunity to
build scale economies in these resources and value chain activities. The market power
dimension comes into play in terms of the scope economies it realizes within the
channel - for instance, JC’s multi-product portfolio is likely to give it more power
with regard to Wal-Mart than would be possessed by a single product firm like
Plastico.

5. (Refer to Case Scenario 2) Why would the acquisition of Plastico be good for JC?

ANS: The best answers will note that JC has likely created some market power with
respect to the large retailers so another staple consumer product makes sense. JC can
leverage its existing market presence, selling contacts, distribution system, and
merchandising skills for plastic consumer products as well. And since Plastico is
having trouble controlling its costs, JC can bring to it more sophisticated financial
management skills and accounting systems.

6. (Refer to Case Scenario 2) What difficulties might you expect JC to encounter related
to its acquisition of Plastico?

ANS: The best answers will begin by quickly noting that Plastico is much bigger than
JC, which itself is likely to create problems (a nice lead-in to chapter 7, Merger and
Acquisition Strategies). And while JC has grown through acquisition, it has primarily
made small ones, which suggests that the firm may be ill-prepared for the enormous
challenge of taking control of such a large firm. And even though Plastico appears to
be in trouble controlling costs, a more subtle observation is that JC’s cost control
 emphasis may be too extreme for Plastico’s historic competency in innovation and,
ultimately, undermine this valuable resource.

7. (Refer to Case Scenario 2) If Jewell Company is able to transfer its competence in

cost-cuting and cost controls to Plastico (which has had difficulty controlling costs), it
will have achieved the primary means whereby a related linked diversification
strategy creates value.

ANS: T

Case Scenario 3: Walt Disney Company.

Walt Disney Company is famed for its creativity, strong global brand, and uncanny
ability to take service and experience businesses to a higher level. In the 1970s, the
company realized nearly 90% of its revenues from its cartoons and the Disneyland
theme park in Anaheim, CA. By the beginning of the 21st Century, Disney had not
only opened up more parks and ramped up its output of animated films, it had also
diversified into many businesses well beyond its traditional core of high-quality
cartoon animation and theme parks. For instance, the Disney empire diversified
vertically and horizontally into retail (The Disney Store, since licensed to The
Children’s Place), cruise lines, theaters, motels, and the Disney Press. It also moved
into new product offerings such as sports franchises, TV networks (ABC and ESPN)
and stations, Miramax, Broadway shows (Beauty and the Beast), and vacation clubs.
International growth included EuroDisney and Hong Kong Disney and new releases
of TV shows, videos, and movies worldwide. Indeed, while many of Disney’s
businesses had some tie to Mickey Mouse, only about 28% of total revenues now
came directly from its parks.

8. (Refer to Case Scenario 3) What level and type of diversification best characterized
Disney in the 1970s?
a. dominant business
b. related constrained
c. related linked
d. unrelated

ANS: A

9. (Refer to Case Scenario 3) What level and type of diversification best characterized
Disney at the beginning of the 21st Century?
a. dominant business
b. related constrained
c. related linked
d. unrelated

ANS: B

10. (Refer to Case Scenario 3) Assume that Disney can benefit from both operational and
corporate relatedness. Which of the following corporate core competencies would
provide Disney the greatest opportunity to create value across all or most of its many
businesses?
a. leading-edge animation and live-action film production skills
 b. ability to manage creativity and service excellence within financial constraints
c. ability to generate and manage cash-flow surpluses efficiently
d. strong general managers and general management skills

ANS: B

Chapter 7 – Strategic acquisitions and restructuring

1. How have changing conditions in the external environment influenced the type of M
& A activity firms pursue?

ANS: During the recent financial crisis, tightening credit markets made it more
difficult for firms to complete megadeals (those costing $10 billion or more). As a
result, many acquirers focused on smaller targets with a niche focus that
complemented their existing businesses. In addition, the relatively weak U.S. dollar
increased the interest of firms from other nations to acquire U.S. companies.

2. How difficult is it for merger and acquisition strategies to create value and which
firms benefit the most from M & A activity?

ANS: Evidence suggests that using merger and acquisition strategies to create value
is challenging. This is particularly true for acquiring firms in that some research
results indicate that shareholders of acquired firms often earn above-average returns
from acquisitions while shareholders of acquiring firms typically earn returns that are
close to zero. In addition, in approximately two-thirds of all acquisitions, the
acquiring firm’s stock price falls immediately after the intended transaction is
announced. This negative response reflects investor’s skepticism about the likelihood
that the acquirer will be able to achieve the synergies required to justify the premium.

3. Identify and explain the seven reasons firms engage in an acquisition strategy.

ANS: (1) Increased market power. Market power allows a firm to sell its goods or
services above competitive levels or when the costs of its primary or support activities
are below those of its competitors. Market power is derived from the size of the firm
and the firm’s resources and capabilities to compete in the marketplace. Firms use
horizontal, vertical, and related acquisitions to increase their size and market power.
(2) Overcoming entry barriers. Firms can gain immediate access to a market by
purchasing a firm with an established product that has consumer loyalty. Acquiring
firms can also overcome economies of scale entry barriers through buying a firm that
has already successfully achieved economies of scale. In addition, acquisitions can
often overcome barriers to entry into international markets. (3) Reducing the cost of
new product development and increasing speed to market. Developing new products
and ventures internally can be very costly and time consuming without any guarantee
of success. Acquiring firms with products new to the acquiring firm avoids the risk
and cost of internal innovation. In addition, acquisitions provide more predictable
returns on investments than internal new product development. Acquisitions are a
much quicker path than internal development to enter a new market, and they are a
means of gaining new capabilities for the acquiring firm. (4) Lower risk compared to
developing new products internally. Acquisitions are a means to avoid internal
ventures (and R&D investments), which many managers perceive to be highly risky.
 However, substituting acquisitions for innovation may leave the acquiring firm
without the skills to innovate internally. (5) Increased diversification. Firms can
diversify their portfolio of business through acquiring other firms. It is easier and
quicker to buy firms with different product lines than to develop new product lines
independently. (6) Reshaping the firm’s competitive scope. Firms can move more
easily into new markets as a way to decrease their dependence on a market or product
line that has high levels of competition. (7) Learning and developing new capabilities.
By gaining access to new knowledge, acquisitions can help companies gain
capabilities and technologies they do not possess. Acquisitions can reduce inertia and
help a firm remain agile.

4. Describe the seven problems in achieving a successful acquisition.

ANS: Acquisition strategies present many potential problems. (1) Integration

difficulties. It may be difficult to effectively integrate the acquiring and acquired firms
due to differences in corporate culture, financial and control systems, management
styles, and status of executives in the combined firms. Turnover of key personnel
from the acquired firm is particularly negative. (2) Inadequate evaluation of target.
Due diligence assesses where, when, and how management can drive real
performance gains through an acquisition. Acquirers that fail to perform effective due
diligence are likely to pay too much for the target firm. (3) Large or extraordinary
debt. Acquiring firms frequently incur high debt to finance the acquisition. High debt
may prevent the investment in activities such as research and development, training of
employees and marketing that are required for long-term success. High debt also
increases the risk of bankruptcy and can lead to downgrading of the firm’s credit
rating. (4) Inability to achieve synergy. Private synergy occurs when the acquiring and
target firms’ assets are complementary in unique ways, making this synergy difficult
for rivals to understand and imitate. Private synergy is difficult to create. Transaction
costs are incurred when firms seek private synergy through acquisitions. Direct
transaction costs include legal fees and investment banker charges. Indirect
transaction costs include managerial time to evaluate target firms, time to complete
negotiations, and the loss of key managers and employees following an acquisition.
Firms often underestimate the indirect transaction costs of an acquisition. (5) Too
much diversification. A high level of diversification can have a negative effect on the
firm’s long-term performance. For example, the scope created by diversification often
causes managers to rely on financial controls rather than strategic controls because the
managers cannot completely understand the business units’ objectives and strategies.
The focus on financial controls creates a short-term outlook among managers and
they forego long-term investments. Additionally, acquisitions can become a substitute
for innovation, which can be negative in the long run. (6) Managers overly focused on
acquisitions. Firms that become heavily involved in acquisition activity often create
an internal environment in which managers devote increasing amounts of their time
and energy to analyzing and completing additional acquisitions. This detracts from
other important activities, such as identifying and taking advantage of other
opportunities and interacting with importance external stakeholders. Moreover, during
an acquisition, the managers of the target firm are hesitant to make decisions with
long-term consequences until the negotiations are completed. (7) Growing too large.
Acquisitions may lead to a combined firm that is too large, requiring extensive use of
bureaucratic controls. This leads to rigidity and lack of innovation, and can negatively
affect performance. Very large size may exceed the efficiencies gained from
 economies of scale and the benefits of the additional market power that comes with
size.

5. Describe how an acquisition program can result in managerial time and energy
absorption.

ANS: Typically, a substantial amount of managerial time and energy is required for
acquisition strategies if they are to contribute to a firm’s strategic competitiveness.
Activities with which managers become involved include those of searching for
viable acquisition candidates, completing effective due diligence processes, preparing
for negotiations and managing the integration process after the acquisition is
completed. Company experience shows that participating in and overseeing the
acquisition activities can divert managerial attention from other matters that are linked
with long-term competitive success (e.g., identifying and acting on other
opportunities, interacting effectively with external stakeholders).

6. What are the attributes of a successful acquisition program?

ANS: Acquisitions can contribute to a firm’s competitiveness if they have the

following attributes: (1) The acquired firm has assets or resources that are
complementary to the acquiring firm’s core business. (2) The acquisition is friendly.
(3) The acquiring firm conducts effective due diligence to select target firms and
evaluates the target firm’s health (financial, cultural, and human resources). (4) The
acquiring firm has financial slack. (5) The merged firm maintains low to moderate
debt. (6) The acquiring firm has sustained and consistent emphasis on R&D and
innovation. (7) The acquiring firm manages change well and is flexible and adaptable.

7. What is restructuring and what are its common forms?

ANS: Restructuring refers to changes in a firm’s portfolio of businesses and/or

financial structure. There are three general forms of restructuring: (1) Downsizing
involves reducing the number of employees, which may include decreasing the
number of operating units. (2) Downscoping entails divesting, spinning-off, or
eliminating businesses that are not related to the core business. It allows the firm to
focus on its core business. (3) A leveraged buyout occurs when a party (managers,
employees, or an external party) buys all the assets of a (publicly traded) business,
takes it private, and finances the buyout with debt. Once the transaction is complete,
the company’s stock is no longer publicly traded.

8. What are the differences between downscoping and downsizing and why are each
used?

ANS: Downsizing is a reduction in the number of employees. It may or may not

change the composition of businesses in the company’s portfolio. In contrast, the goal
of downscoping is to reduce the firm’s level of diversification. Downsizing is often
used when the acquiring form paid too high a premium to acquire the target firm or
where the acquisition created a situation in which the newly formed form had
duplicate organizational functions such as sales or manufacturing. Downscoping is
accomplished by divesting unrelated businesses. Downscoping is used to make the
firm less diversified and allow its top-level managers to focus on a few core
 businesses. A firm that downscopes often also downsizes at the same time.

9. What is an LBO and what have been the results of such activities?

ANS: Leveraged buyouts (LBOs) are a restructuring strategy. Through a leveraged

buyout, a (publicly-traded) firm is purchased so that it can be taken private. In this
manner, the company’s stock is no longer publicly traded. LBOs usually are financed
largely through debt, and the new owners usually sell off a number of assets. There
are three types of LBOs: management buyouts (MBOs), employee buyouts (EBOs),
and whole-firm buyouts. Because they provide managerial incentives, MBOs have
been the most successful of the three leveraged buyout types. MBOs tend to result in
downscoping, an increased strategic focus, and improved performance.

10. What are the results of the three forms of restructuring?

ANS: Downsizing usually does not lead to higher firm performance. The stock
markets tend to evaluate downsizing negatively, as investors assume downsizing is a
result of problems within the firm. In addition, the laid-off employees represent a
significant loss of knowledge to the firm, making it less competitive. The main
positive outcome of downsizing is accidental, since many laid-off employees become
entrepreneurs, starting up new businesses. In contrast, downscoping generally
improves firm performance through reducing debt costs and concentrating on the
firm’s core businesses. LBOs have mixed outcomes. The resulting large debt
increases the financial risk and may end in bankruptcy. The managers of the bought-
out firm often have a short-term and risk-averse focus because the acquiring firm
intends to sell it within five to eight years. This prevents investment in R&D and
other actions that would improve the firm’s core competence. But, if the firms have
an entrepreneurial mindset, buyouts can lead to greater innovation if the debt load is
not too large.

Case Scenario 1: Syco Inc. (SI).

Syco, Inc. (SI) was founded the late 1800s and grew through acquisition from being
primarily a large discount retailer into a highly diversified firm. Beyond retailing (still
SI’s dominant business), by the middle of the 1990s its lines of business included
significant market positions in insurance, consumer credit cards, stock brokerage,
commercial and residential real estate brokerage, and an online Internet portal. Each
of the non-retail businesses was average in its relative industry performance.
Consistent with the decentralized structure at SI and arms-length corporate oversight,
each of these businesses was also rapidly developing their own unique brands and
customer following. However, within a short period of time it became apparent that
the retail business was failing. SI’s vast mall-based department store holdings were
suffering from deferred maintenance and merchandising that did not appear to be
popular with its once large consumer base. At the same time, highly efficient and
focused low-cost competitors like Wal-Mart were beginning to take significant
market share from SI. On the verge of bankruptcy by early 2000, SI’s management
chose to sell off its insurance, real estate and stock brokerage units; it also spun off its
credit card and portal businesses in separate public offerings.
1. (Refer to Case Scenario 1) Why do you suppose SI entered the non-retail businesses
through acquisition? Is this a cheaper route than starting up these businesses from
scratch?

ANS: The best answers may begin by noting that SI had no real prior experience in
these non-retail businesses so they needed to either buy the relevant operations and
skills or start them up from scratch. Absent such experience it is considerably more
expedient to enter these businesses through acquisition, since they are likely to be
able to acquire both the business and an experienced management team. The second
question gets to the fact that SI would also likely have to pay a premium for the
acquired firms since it brought no industry-specific knowledge to the bargaining
table.

2. Part 1: (Refer to Case Scenario 1) Why do you suppose that SI sold off or spun-off its
non-retail businesses?

Part 2: What should SI do after selling off the non-retail businesses?

ANS: Part 1: The best answers will note that SI was probably in too many and too
many different businesses. Each of these businesses had to compete in their respective
industries while at the same time dealing with SI’s corporate ownership. By getting
out of the non-retail business, SI is able to get back to its roots in retail. While of
course speculative, students can debate whether or not SI chose the right business to
focus its future on. From a resource-based perspective, retail had the strongest history,
which would likely give SI the richest and most defensible set of valuable, rare, and
costly to imitate resources in the retailing business.

Part 2: This is a natural follow-on to Part 1 above. Students could begin this answer
by suggesting that SI’s diversification strategy diverted its attention from the needs of
its core retailing business. Future efforts should be directed toward turning the
retailing business around and aggressively trying to outmaneuver emerging and
existing retailing competitors. The instructor can use this dialogue to point out that
after establishing a strong industry position, SI probably viewed its retailing business
as stable and unthreatened, and thus used it as means of financing its broad
diversification efforts. In contrast, emerging companies like Wal-Mart viewed
retailing as a growth vehicle and developed novel and lower cost structures which
eventually undermined the advantages established earlier by SI.

3. (Refer to Case Scenario 1) Syco’s acquisition strategy was appropriate since it would
allow the firm to have market power over its competitors.

ANS: F

Case Scenario 2: Raptec

Raptec was incorporated in 1991 and went public on the Nasdaq Stock Market in
1996. Raptec’s strategy is to become the global leader in innovative storage solutions.
Raptec is an S&P 500 and a Nasdaq Stock Market 100 member. The company’s
hardware and software solutions for eBusiness and Internet applications move,
manage, and protect critical data and digital content. Raptec operates in three
principal business segments: Direct Attached Storage (“DAS”), Storage Networking
 Solutions (“SNS”) and Software. These hardware and software products are found in
high-performance networks, servers, workstations, and desktops from the world’s
leading OEMs, and are sold through distribution channels to Internet service
providers, enterprises, medium and small businesses, and consumers. Since the time it
went public, Raptec has experienced rapid growth and consistently profitable
operations. In early 2007, the company announced its plan to spin-off the software
segment, subsequently incorporated as Axio, Inc., in the form of a fully independent
and separate company. Software was Raptec’s most profitable and fastest growing
segment. By mid-2007 Raptec had completed the initial public offering of
approximately 15% of Axio’s stock, and then distributed the remaining Axio stock to
Raptec’s stockholders in a tax-free distribution.

4. (Refer to Case Scenario 2) Why would a successful firm like Raptec spin off its most
promising business?

ANS: The best answers will begin by noting that both hardware and software are
industries characterized by fast cycle times, which requires management to be both
focused and nimble. With this background, students can then argue that the spin-off
provides the management teams of Raptec and the newly formed Axio with greater
focus (on hardware and software respectively), better alignment of employee
incentives, and greater managerial accountability. The spin-off also provides Axio
direct access to capital markets.

5. (Refer to Case Scenario 2) Prior to the spin-off, how would you go about identifying
the respective boundaries of the Raptec and Axio businesses?

ANS: The purpose of this question is to point out how blurry the lines may be
between businesses in a diversified firm - the best answers will revolve around this
point. While Raptec operated in three business segments, this does not guarantee that
each operated as independent organizations within Raptec. In fact, Raptec likely
benefited from tremendous operational and market synergies among its three primary
lines of business, and such synergies are typically accomplished through formal
coordination and integration mechanisms like organizational structure, systems, and
processes. A useful analogy here can be drawn to Palm, Inc., and its PDA product the
Palm Pilot. Given that consumers view the Palm PDA as a monolithic product (they
don't think of it as separate hardware and software), where would you begin to draw
the dividing line if Palm wanted to split up its hardware and software businesses?

6. (Refer to Case Scenario 2) What risks does Raptec run in spinning off Axio?

ANS: The best answers will point out that the spin-off strategy makes sense only to
the extent that the benefits described in the answer to question 1 considerably
outweigh the costs arising from breaking up the firm and its lost opportunities for
within-firm synergies. If Raptec has been successful because of its ability to uniquely
couple hardware and software, along with the fact that it possesses inside knowledge
about the technological advances in each business, then breaking up the firm may
actually break-up and destroy a potential core competency. Also, once a firm has
broken itself up into distinct legal entities there is nothing to prevent one of the
players from preying on the others’ most profitable related businesses. For instance,
Axio may start moving into parts of the hardware business that, from its inside
 experience with Raptec, it knows are highly profitable when combined with Axio’s
proprietary software.

7. (Refer to Case Scenario 2) Leveraged buyouts such as the Axio spinoff is a form of
restructuring strategy that is only used to correct for managerial mistakes or because
the firm’s managers were making decisions that only served their own interests rather
than those of the shareholders.

ANS: F

Case Scenario 3: Barracuda Inc.

Barracuda Inc. has diversified beyond its early base as a lamp fixture manufacturer
into multiple hardware and plumbing fixture products that it sells to professionals
(i.e., plumbers and electricians) and through the large volume do-it-yourself (DIY)
stores like The Home Depot and Lowe’s. While this successful growth has been
achieved primarily through acquisition, the company tends to let the acquired
businesses run independently. It has done so by looking to fragmented industries to
acquire small firms with efficient operations and good management teams. It then
grows these businesses through a combination of internal cash flow and debt, and
directs new sales to the professional and DIY channels. Barracuda has been
particularly successful in the faucet segment, which it practically reinvented though
such technological innovations as the washerless faucet, and marketing innovations
like branding and good-better-best merchandising. Barracuda has leveraged this
merchandising strategy across its businesses and, coupled with the explosive growth
of the DIY channel, is spectacularly profitable with a net profit after tax (NPAT) of
18%. The firm’s management is looking to broaden its revenue base and has
identified the home furnishings business as sharing many characteristics with faucets,
prior to Barracuda’s entry into faucets. It plans to enter this industry through large-
scale acquisitions. The landscape of the U.S. home furnishings manufacturing
industry consists of many players, none with controlling share, and serious issues of
overcapacity. There are presently 2500 home furnishings firms, and only 600 of those
have over 15 employees. Average NPAT is between 4 and 5%, which also reflects the
fact that few firms have good managers. While the industry is still primarily
comprised of single-business family-run firms, which manufacture furniture
domestically, imports are increasing at a fairly rapid rate. Some of the European
imports are leaders in contemporary design. Relatively large established firms are also
diversifying into the home furnishings industry via acquisition. Supplier firms to the
home furnishings industry are in relatively concentrated industries (like lumber, steel,
and textiles), and therefore typically offer fewer accommodations to the small
furniture manufacturers. Retailers, the intermediate customer of the home furnishings
industry, are becoming increasingly concentrated and the few large, successful
furniture companies actually have their own stores or have dedicated showrooms in
the larger department stores. Customers have many products to choose from, at many
different price points, and few home furnishing products beyond those of the larger
companies have established brands. Also, customers can switch easily among high
and low-priced furniture and other discretionary expenditures (spanning plasma TVs
to the choice of postponing any furniture purchase entirely).

8. (Refer to Case Scenario 3) Why would Barracuda consider acquisition as its preferred
mode of entry into furniture?
 ANS: The best answers will identify several factors, including but not limited to the
observation that the company has grown primarily through acquisition. Thus,
acquisition is Barracuda’s preferred growth strategy. Also, since the industry is
fragmented and suffering from over-capacity, the company may be able to buy up
several firms much more cheaply than it would cost to start up a furniture company
from scratch. Finally, Barracuda’s management may view the lack of brand awareness
and low average industry profitability as a sign that it can create the same success it
has reaped in the plumbing goods sector.

9. (Refer to Case Scenario 3) Given the history of Barracuda, what guidelines would you
suggest to management regarding their acquisition strategy in the home furnishings
industry?

ANS: If Barracuda is to repeat its prior success then the best answers will suggest that
it should look to companies with stronger management teams and product portfolios
that could benefit from an aggressive branding strategy. Also, since most of the
incumbent firms don’t appear to have much power over supplier industries, any
acquisition strategy should consider building up scale in a particular segment so that
suppliers then have more incentive to offer better terms, prices, selection, and delivery
of raw materials. Also, to the extent possible, Barracuda should seek out furniture
companies whose products it can sell through its existing channels like cabinetry or
knock-down furniture.

10. (Refer to Case Scenario 3) Given Barracuda’s history, what threats does Barracuda
face in entering the furniture industry through acquisition?

ANS: The best answers here should probably start out by noting that a strategy that
worked in one context (faucets) is not typically likely to work in another. At the very
least, furniture and faucets have different physical characteristics and price points. A
couch is much bigger than a faucet, and hence requires different logistics and
merchandising practices. Good-better-best in faucets can mean a spread of perhaps
$100 between the top and bottom quality product; such a spread for furniture can
amount to thousands of dollars. Beyond the product, Barracuda has typically left its
acquisitions alone under the guidance of good management. If it cannot acquire firms
with these managers in place, which the scenario suggests, then it will likely need to
take a more hands on role in either direct management or the replacement of
management in an industry in which it has little experience. Finally, this industry is
presently not very profitable and Barracuda will have to change this profit structure in
order for this move to extend its current high margins.

11. (Refer to Case Scenario 3) Barracuda’s acquisitions have been driven by the need to
increase market power and hence have been mostly horizontal and vertical
acquisitions.

ANS: F
 Chapter 8 – Global Strategy

1. What are the incentives for firms to use international strategies? What are the three
basic benefits firms can derive by moving into international markets?

ANS: One reason is to extend the life cycle of the firm’s products. Gaining access to
needed and potentially scarce resources is another reason. There is also pressure for
global integration of operations, driven by growing universal product demand.
Companies also want to take advantage of opportunities to better use rapidly
developing technologies such as the Internet and mobile applications which permit
greater integration of trade, capital, and culture. Finally, the potential of large
demand for goods and services for people in emerging markets is an important
incentive.

When firms successfully move into international markets, they can experience:
increased market size, economies of scale and learning, and location advantages.

2. What are the three basic benefits of international strategies?

ANS: Firms derive three basic benefits by successfully using international strategies:
(1) increased market size, (2) economies of scale and learning, and (3) advantages of
location. Increased market size is achieved by expansion beyond the firm’s home
country. International expansion increases the number of potential customers a firm
may serve. Starbucks is a firm that has increased its market size through international
expansion (Opening Case). Other firms such as Coca Cola and PepsiCo have moved
into international markets primarily because of limited growth opportunities in their
domestic markets. Economies of scale and learning is a second benefit. Leveraging a
technology beyond the home country allows for more units to be sold and initial
investments recovered more quickly. Rivals Airbus and Boeing have multiple
manufacturing facilities and outsource some activities in order to gain scale
advantages. Lastly, advantages of location can be realized through
internationalization. These advantages include access to low-cost labor, critical
resources, or customers.

3. Discuss the three international corporate-level strategies. On what factors are these
strategies based?

ANS: International corporate strategy focuses on the scope of a firm’s operations

through both product and geographic diversification. The three basic international
corporate-level strategies vary on the need for local responsiveness to the market and
the need for global integration. The multidomestic strategy focuses on competition
within each country in which the firm operates. Firms employing a multidomestic
strategy decentralize strategic and operating decisions to the strategic business units
operating in each country so business units can customize their goods and services to
the local market. The use of global integration in this strategy is low. The global
strategy assumes more standardization of product demand across country boundaries.
Therefore, competitive strategy is centralized and controlled by the home office,
placing high emphasis on global integration of operations. The strategic business units
in each country are interdependent and the home office integrates these businesses.
The firm offers standardized products across country markets. It emphasizes
 economies of scale and the opportunity to use innovations developed in one nation to
other markets. The transnational strategy seeks to achieve both global efficiency
(through global integration) and local responsiveness. This strategy is difficult to
implement. One goal requires global coordination while the other requires local
flexibility. Flexible coordination builds a shared vision and individual commitment
through an integrated network. The effective implementation of the transnational
strategy often produces higher performance than either of the other corporate-level
strategies.

4. Identify and describe the modes of entering international markets. What are their
advantages and disadvantages?

ANS: Firms may enter international markets in any of five ways: exporting, licensing,
forming strategic alliances, making acquisitions, and establishing new, wholly owned
subsidiaries (greenfield ventures). Most firms, particularly small ones, begin with
exporting (marketing and distributing their products abroad). This involves high
transportation costs and possibly tariffs. An exporter has less control over the
marketing and distribution of the product than in other methods of entering the
international market. In addition, the exporter must pay the distributor or allow the
distributor to add to the product price in order to offset its costs and earn a profit. In
addition, the strength of the dollar against foreign currencies is a constant uncertainty.
But, the advantages are that the company does not have the expense of establishing
operations in the host countries. The Internet makes exporting easier than in previous
times. Licensing (selling the manufacturing and distribution rights to a foreign firm) is
also popular with smaller firms. The licenser is paid a royalty on each unit sold by the
licensee. The licensee takes the risks and makes the financial investments in
manufacturing and distributing the product. It is the least costly way of entering
international markets. It allows a firm to expand returns based on a previous
innovation. But there are disadvantages. Licensing provides the lowest returns,
because they must be shared between the licensee and the licensor. Licensing gives
the licenser less control over the manufacturing and marketing process. There is the
risk that the licensee will learn the technology and become a competitor when the
original license expires. If the licenser later wishes to use a different ownership
arrangement, the licensing arrangement make create some inflexibility.

Strategic alliances involve sharing risks and resources with another firm in the host-
country. The host country partner knows the local conditions; the expanding firm has
the technology or other capabilities. Both partners typically enter an alliance in order
to learn new capabilities. The partnership allows the entering firm to gain access to a
new market and avoid paying tariffs. The host-country firm gains access to new
technology and innovative products. Equity-based alliances are more likely to
produce positive gains. Alliances work best in the face of high uncertainty and where
cooperation is needed between partners and strategic flexibility is important. But,
many alliances fail due to incompatibility and conflict between the partners. Cross-
border acquisitions provide quick access to a new market, but they are expensive and
involve complex negotiations. Cross-border acquisitions have all the problems of
domestic acquisitions with the complication of a different culture, legal system and
regulatory requirements. Acquisitions are expensive and usually involve debt-
financing. The most expensive and risky means of entering a new international market
is through the establishment of a new, wholly owned subsidiary or greenfield venture.
 Alternatively, it provides the advantages of maximum control for the firm and, if
successful, potentially the greatest returns as well. This alternative is suitable for
firms with strong intangible capabilities and/or proprietary technology. The risks are
high because of the challenges of operating in an unfamiliar environment. The
company must build new manufacturing facilities, establish distribution networks, and
learn and implement new marketing strategies.

5. Discuss the effect of international diversification on a firm’s returns.

ANS: Research shows that returns vary as the level of diversification increases. At
first, returns decrease, then as the firm learns to manage the diversification, returns
increase. But, as diversification increases past some point, returns level off and
become negative. Firms that are broadly diversified in international markets usually
receive the most positive stock returns, especially when they diversify geographically
into core business areas. International diversification can lead to economies of scale
and experience, location advantages, increased market size, and the potential to
stabilize returns (which reduces the firm’s overall risk). International diversification
improves a firm’s ability to increase returns from innovation before competitors can
overcome the initial competitive advantage. In addition, as firms move into
international markets, they are exposed to new products and processes that stimulate
further innovation. The amount of international diversification that can be managed
varies from firm to firm and according to the abilities of the firm’s managers. The
problems of central coordination and integration are mitigated if the firm diversifies
into more friendly countries that are geographically and culturally close.

6. Identify and describe the major risks of international diversification.

ANS: International diversification carries multiple risks. The major risks are political
and economic. Political risks are related to governmental instability and to war.
Instability in a government creates economic risks and uncertainty created by
government regulation. Governmental instability can result in the existence of many
potentially conflicting legal authorities, corruption, and the risk of nationalization of
company assets. Economic risks are related to political risks. Economic risks include
the increased trend of counterfeit products and the lack of global policing of these
products. Another economic risk is the perceived security risk of a foreign firm
acquiring firms that have key natural resources or firms that may be considered
strategic in regard to intellectual property. In addition, differences in and fluctuations
of the value of different currencies is another economic risk. The security risk created
by terrorism prevents U.S. firms from investing in some regions. The relative strength
or weakness of the dollar affects international firms’ competitiveness in certain
markets and their returns.

Case Scenario 1: Blast Furnace, Inc., (BFI)

Blast Furnace, Inc., (BFI) provides customized development of automated rich-media
applications, and scalable solutions that allow media and entertainment companies, as
well as enterprises and government organizations, to deploy, manage and distribute
video content on IP-based networks. The company was founded in 1997 and went
public in 2004; its stock trades on the NASDAQ under the ticker BLST. While
providing solutions to a variety of firms and industries in North America, BFI has
experienced its fastest growth with the security products that it designs and sells to the
 U.S. government and U.S. government agencies. This growth is based on its propriety
VUE software, which is a complete identification solution for capturing, analyzing,
and managing multi-biometric information. Proprietary analysis algorithms aggregate
and cross-compare multiple biometrics to increase accuracy and lessen dependence on
single identification techniques. Additionally, specialized encoding techniques reduce
file size and increase analysis and response times. VUE supports a wide range of
applications ranging from ID issuance and verification to gated entry screening for
border patrol, airports, government buildings, and corporations. Essentially, VUE is
able to sift through massive amounts of digitized multimedia files to create a unified
ID dossier of an individual and then identify those individuals rapidly anywhere in the
data. Such a capability is of great interest to security organizations, particularly since
the World Trade Center bombing, because it allows the user to identify suspects
within minutes on a real-time basis anywhere digitized media is being created (like
that created by the hidden and visible surveillance cameras in airline terminals, banks,
ATMs, and other public locations). Once a suspect is entered into the system, the
software is capable of scanning all data sources automatically and without stop. For
two years, BFI has had this market to itself but now two new entrants, a Belgian start-
up and the subsidiary of a Finnish telecom firm, are staking out positions in large non-
U.S. markets like Europe and Asia. BFI’s management fears that if it limits its efforts
to North America, then these aggressive competitors may eventually develop
strongholds in other markets from which they can launch successful attacks on BFI’s
home turf.

1. (Refer to Case Scenario 1) Should BFI expand its operations outside of North
America?

ANS: The best answers will note that BFI does not have to be a global firm, but that
its future growth may be stifled if it chooses to focus only on the North American
market. A good discussion can be developed around whether or not a patient BFI can
eventually take over weaker competitors that spread themselves too thinly, too
quickly (i.e., rapid geographic expansion). While BFI may have a product with global
potential, students will want to be certain that it also has the managerial and financial
capital to undertake a global move. A mid-range recommendation might be for BFI to
further entrench itself in the North American market (increase its market penetration),
while seeking a partner or acquisition candidate abroad in those markets that offer the
greatest potential in terms of growth and customer synergies.

2. (Refer to Case Scenario 1) Assume that BFI has chosen international expansion. How
quickly should it move? Which activities would you recommend BFI to
internationalize first?

ANS: As suggested above, the best answers will also note that even if BFI decides
diversify internationally, it does not have to entirely recreate itself overseas overnight.
Students can flush out the value chain components that lend themselves most to near-
term internationalization - like sales, marketing, installation, and technical support.
Other value chain components like basic R&D may never need to be internationalized
unless there is a clear benefit in terms of learning, or some form of scale or scope
economies. The answers to this question lead naturally to question three.
3. (Refer to Case Scenario 1) How would you evaluate which country or countries BFI
should enter first?

ANS: Again, the best answers to this question will flesh out a number of options,
which in turn give rise to a good discussion of what resources and capabilities BFI
would need to possess to pull these off. For instance, BFI could initially move to its
competitors’ markets and perhaps undermine their current strongholds. Alternately,
BFI could move to the largest potential markets - perhaps Japan and Germany for
instance. Finally, BFI could leverage its domestic ties to move to their overseas
locations. For example, BFI could internationalize by following the U.S. government
to consulates, embassies, and military bases overseas.

4. (Refer to Case Scenario 1) If BFI engages in international diversification, it can

expect that its returns decrease initially but then increase quickly as it learns how to
manage under conditions of greater geographic diversity.

ANS: True

Case Scenario 2: Heartsong LLC. Heartsong LLC is a designer and manufacturer of

replacement heart valves based in Peoria, Illinois. While a relatively small company
in the medical devices field, it has established a worldwide reputation as the provider
of choice of high-quality, leading-edge artificial heart valves. Most of its products are
sold to large regional hospital systems and research hospitals around the world,
though primarily to customers in the U.S. and Europe. Specialty heart centers are
another emerging, but fast-growing market for its valves. Heartsong has recently
embarked on an expansion strategy that requires it to increase its volume, which in
turn will demand more component parts than it can source domestically - both from
an economic and volume standpoint. The firm has determined that such growth is
only viable if it produces these parts itself overseas for a lower cost, or outsources the
production entirely to a joint venture it establishes with a local manufacturer, which
could both produce the parts more cheaply and in higher volumes. It is considering
starting up an owned production facility in Luxembourg, or seeking a joint venture
with a precision manufacturer in China.

5. (Refer to Case Scenario 2) What opportunities and threats might Heartsong be

exposing itself to via the Luxembourg expansion proposal?

ANS: The best answers will note that an owned production facility will give
Heartsong the greatest control over its designs, propriety technologies, and quality.
Also, Luxembourg is close to major European markets and, it is more culturally and
socio-economically similar to the U.S. than is China. The drawbacks however are
significant as well. These include the large start-up costs, time required before initial
production runs, a new location far from home, and the large capital expenditures
likely to be needed to fund such owned expansion.

6. (Refer to Case Scenario 2) What opportunities and threats might Heartsong be

exposing itself to via the China expansion proposal?

ANS: This solution fits well because it requires little capital investment by Heartsong
(relative to the Luxembourg option) and its management will not be stretched further
 by the need to run another production facility. The drawbacks of this option are also
significant in that any joint venture would expose proprietary production processes to
theft, and China provides a very different cultural context than that experienced in
Peoria. Finally, it does not appear that Heartsong currently sells many heart valves in
China. This could be an opportunity or a weakness if such a market is economically
infeasible.

7. (Refer to Case Scenario 2) Which option would you recommend?

ANS: The best answers will note that (by design) neither solution is ideal and that
Heartsong may be best served by pursuing some combination of the two; for instance,
entering into a joint-venture with a European manufacturer where Heartsong
outsources some critical components that can be produced for a lower cost while
retaining production of those components that require proprietary processes. Since the
parts are likely to be small, Heartsong can then assemble these as needed in the
European market.

8. (Refer to Case Scenario 2) The advantages of a joint venture with a precision

manufacturer in China is shared costs, shared resources, and shared risks, but there
may be problems integrating the two corporate cultures.

ANS: True

Case Scenario 3: Compliance, Inc.

Compliance, Inc., (CI) conducts clinical human and animal trials for the
pharmaceutical and biotechnology industries. Revenues are split evenly between early
and late drug development services. In the area of early drug development, CI
offerings include analytical, bioanalytical, antibody, clinical pharmacology (Phases I-
IIa), toxicology, and drug metabolism services. Late development services include
central diagnostics, central lab, clinical development (Phases IIb- IIIa), periapproval
(Phases IIIb-IV), and pharmacogenomics. The bulk of its business is conducted in
Europe and the U.S. (10 and 17 subsidiaries, respectively); CI also has subsidiaries in
Africa, Latin America, Asia, and Australia. While now an independent public
company, CI was once itself a subsidiary of Corning International. Corning built up
CI through over 40 acquisitions, hoping to extend its strength in medical testing
glassware into the medical services business. At the time Corning made its
acquisitions, the clinical testing industry was geographically fragmented, owing
largely to the fact that various parts of the world had their own strong local
pharmaceutical companies and distinct regulatory environments. Perhaps for that
reason Corning, and now CI, has retained the autonomous character of each country’s
businesses. However, globalization of the regulatory environment (both global and
local standards), globalization of the biotechnology firms (increasing the geographic
scope of their operations), and tremendous consolidation in the pharmaceutical
industry (reducing the number of pharmaceutical industry participants to only a
handful of major global companies) is causing CI to question its decentralized
strategy.

9. (Refer to Case Scenario 3) What benefits might CI expect from using an international
strategy?
a. increased market size
 b. economies of scale and learning
c. competitive advantage through location
d. increased market size, economies of scale and learning, and competitive
advantage through location.

ANS: d

10. (Refer to Case Scenario 3) What type of international strategy is CI currently

pursuing?
a. multidomestic
b. global
c. transnational
d. regional

ANS: a

11. (Based on Case Scenario 3) What type of international strategy should CI pursue?
a. multidomestic
b. global
c. transnational
d. regional

ANS: C

Chpater 9 – Cooperative implications for strategy

129. Identify and define the different types of strategic alliances.

ANS: Strategic alliances are cooperative strategies between firms whereby resources
and capabilities are combined to create a competitive advantage. All strategic
alliances require firms to exchange and share resources and capabilities to co-develop
or distribute goods or services. The three basic types of strategic alliances are: (1)
joint ventures, where a legally independent company is created by at least two other
firms, with each firm usually owning an equal percentage of the new company; 2)
equity strategic alliances, whereby partners own different percentages of equity in the
new company they have formed; and (3) nonequity strategic alliances, which are
contractual relationships between firms to share some of their resources and
capabilities. The firms do not establish a separate organization, nor do they take an
equity position. Because of this, nonequity strategic alliances are less formal and
demand fewer partner commitments than joint ventures and equity strategic alliances.
Typical forms are licensing agreements, distribution agreements and supply contracts.

130. Explain the rationales for a cooperative strategy under each of the three types of basic
market situations (i.e., slow, standard, and fast cycles).

ANS: In slow-cycle markets (markets that are near-monopolies), firms cooperate with
others to gain entry into restricted markets or to establish franchises in new markets.
Slow-cycle markets are rare and diminishing. Cooperative strategies can help firms in
(presently) slow-cycle markets make the transition from this relatively sheltered
existence to a more competitive environment. In standard-cycle markets (which are
 often large and oriented toward economies of scale), firms try to gain access to
partners with complementary resources and capabilities. Through the alliance, the
firms try to increase economies of scale and market power. In fast-cycle markets
(characterized by instability, unpredictability, and complexity), sustained competitive
advantages are rare, so firms must constantly seek new sources of competitive
advantage. In fast-cycle markets, alliances between firms with excess resources and
capabilities and firms with promising capabilities who lack resources help both firms
to rapidly enter new markets.

131. Identify the four types of business-level cooperative strategies and the advantages and
disadvantages of each.

ANS: Through vertical and horizontal complementary alliances, companies combine

their resources and capabilities in ways that create value. Vertical complementary
strategic alliances result when firms creating value in different parts of the value
chain combine their assets to create a competitive advantage. Vertical complementary
strategies have the greatest probability of being successful compared with other types
of cooperative strategies. But firms using this type of alliance need to be wise in how
much technology they share with their partners. Vertical complementary alliances rely
heavily on trust between partners to succeed. Horizontal complementary strategic
alliances are developed when firms in the same stage of the value chain combine their
assets to create additional value. Usually they are formed to improve long-term
product development and distribution opportunities. Horizontal complementary
strategies can be unstable because they often join highly rivalrous competitors. In
addition, even though partners may make similar investments, they rarely benefit
equally from the alliance.

The competition response strategy involves alliances formed to react to competitors’

actions. Usually they respond to strategic, rather than tactical, actions because the
alliances are difficult to reverse and expensive to operate. The uncertainty-reducing
strategy is used to hedge against risk and uncertainty, such as when entering new
product markets or in emerging economies. Both of these strategies are less effective
in the long-run than the complementary alliances which are focused on creating value.

Competition reducing (collusive) strategies are often illegal. There are two types of
collusive competition reducing strategies: explicit collusion and tacit collusion.
Explicit collusion exists when firms directly negotiate production output and pricing
agreements to reduce competition. These are illegal in the U.S. and in most developed
economies. Tacit collusion exists when several firms in an industry indirectly
coordinate their production and pricing decisions by observing each other’s
competitive actions and responses. Both types of collusion result in lower production
levels and higher prices for consumers.

132. Identify the three types of corporate-level cooperative strategies.

ANS: A diversifying strategic alliance allows firms to share some of their resources
and capabilities to diversify into new product or market areas. A synergistic strategic
alliance allows firms to share some of their resources and capabilities to create
economies of scope. These alliances create synergy across multiple functions or
multiple businesses between partner firms. Franchising is a strategy in which the
 franchisor uses a contractual relationship to describe and control the sharing of its
resources and capabilities with franchisees. A franchise is a contract between two
independent organizations whereby the franchisor grants the right to the franchisee to
sell the franchisor’s product or do business under its trademarks in a given location
for a specified period of time.

133. Why are cooperative strategies often used when firms pursue international strategies?
What are the advantages and disadvantages of international cooperative strategies?

ANS: A cross-border strategic alliance is an international cooperative strategy in

which firms headquartered in different nations combine some of their resources and
capabilities to create a competitive advantage. The typical reasons follow: 1) In
general, multinational firms outperform firms operating only on a domestic basis.
Firms may be able to leverage core competencies developed domestically in other
countries. 2) Limited domestic growth opportunities push firms into international
expansion. 3) Some governments require local ownership in order for foreign firms to
invest in businesses in their countries, which requires foreign firms to ally with local
firms. 4) Local partners often have significantly more information about factors
contributing to competitive success such as local markets, sources of capital, legal
procedures, and politics, which makes an alliance useful for a foreign firm. 5) Cross-
border alliances can help firms transform themselves or better use their competitive
advantages surfacing in the global economy. On the negative side, cross-border
alliances are more complex and risky than domestic strategic alliances.

134. Identify and define the two different types of network strategies.

ANS: A network cooperative strategy is a cooperative strategy wherein several firms

form multiple partnerships to achieve shared objectives. Stable alliance networks
(primarily found in mature industries) usually involve exploitation of economies of
scale or scope. In this type of network, the firms try to extend their competitive
advantages to other settings while continuing to profit from operations in their core
industries. Dynamic alliance networks (witnessed mainly in rapidly changing
industries) are used to help a firm keep up when technologies shift rapidly by
stimulating product innovation and successful market entries. Dynamic alliance
networks explore new ideas and typically generate frequent product innovations with
short product life cycles.

135. Identify the competitive risks associated with cooperative strategies.

ANS: Cooperative strategies are not risk free strategy choices; as many as 70% fail. If
a contract is not developed appropriately and fails to avert opportunistic behavior, or
if a potential partner firm misrepresents its competencies or fails to make available
promised complementary resources, failure is likely. Furthermore, a firm may make
investments that are specific to the alliance while the partner does not. This puts the
investing firm at a disadvantage in terms of return on investment. The core of many
failures is the lack of trustworthiness of the partner(s) who act opportunistically.
136. Describe the two strategic management approaches to managing alliances.

ANS: The ability to effectively manage competitive strategies can be one of a firm’s
core competencies. There are two basic approaches to managing competitive
alliances. Cost minimization leads firms to develop protective formal contracts and
effective monitoring systems to manage alliances. Its focus is to prevent opportunistic
behavior by the partner(s). Opportunity maximization is intended to maximize value
creation opportunities. It is less formal and places fewer constraints on partner
behaviors. But, identifying trustworthy partners is the key to this second approach. If
(well-founded) trust is present, monitoring costs are lowered and opportunities will be
maximized. Trust is more difficult to establish between international partners.
Ironically, the cost minimization approach is more expensive to implement and to use
than the opportunity maximization approach.

Case Scenario 1: Norning International

Norning International (NI) states that both its past successes and future growth
strategies are based on an evolving network of wholly owned businesses and joint
ventures around its core competency in glass making. Through their alliances and
owned divisions they compete in four global business sectors: Specialty Glass and
Materials (including materials for HDTV and LCD displays), Consumer Housewares
(including microwavable dishware), Laboratory Sciences Products and Services (test
tubes, testing equipment, and drug trials testing), and Communications (fiber optics
and related technologies). Per the company’s annual report, “binding all four sectors
together is the glue of a commitment to leading edge glass making technologies,
shared resources, and dedication to total quality.” Each sector is composed of
divisions, subsidiaries and alliances. However, the central role played by alliances is
demonstrated by the fact that the combined revenue of its 30-some alliances is more
than double that of NI on its own. Most of the alliances provide NI with access to
particular geographic markets, industries, or channels, although an increasing number
of alliances involve both market access and technological development.

137. (Refer to Case Scenario 1) Why would a company like NI place such emphasis on
alliances as a growth vehicle?

ANS: The best answers will observe that simultaneously increasing technological
intensity while developing a more powerful market presence is likely to demand
access to research, manufacturing, and marketing resources that are substantially in
excess of those that exist (or can be developed quickly) in one company. It is also
unlikely that NI has a monopoly on leading edge glass-making technology, and that
partnerships may give it access to technologies even more advanced than those it
currently possesses. Moreover, if NI is able to retain its focus and leading edge
expertise in advanced glass-making technologies, while at the same time realize
repeated successes and technological breakthroughs via alliances, then its ability to
partner and manage multiple alliances may truly become a strategic asset.

138. (Refer to Case Scenario 1) What risks arise from a strategy based on such a “network
of alliances”?

ANS: The best answers will start by noting that NI’s historic success (via its core
competency in glass making) is likely to have been based in a strong commitment to
 basic research and development. Multiple partnerships, in and of themselves, can lead
to the dilution of management's attention and investment in this core, or lead to a less
well defined core. Given that such basic R&D is the “glue” holding NI together, such
dilution may make that glue at the hub of its strategy wheel come unstuck.
Exacerbating this threat is the possibility that NI’s fascination with alliances may
become a crutch where alliances displace its internal strengths and become an end in
and of themselves. Alliance partners are also a threat to the extent they are able to
learn more from NI about its technologies, and eventually undermine or leapfrog NI
technological competitive advantages.

139. (Refer to Case Scenario 1) NI appears to be managing a large number of alliances.

What criteria should it use to exit particular alliances?

ANS: The best answers will develop a set of company rules of thumb for exiting
alliances, and even some of NI’s owned businesses. For instance, given the
fundamental role played by the need to emphasize basic R&D in advanced glass-
making technologies, students may first start by observing that NI should likely exit
those businesses that are highly service-based (like some of its laboratory services
businesses), or do not require leading edge glass-making expertise (like consumer
glass-based products), since neither of these businesses require or contribute to NI’s
understanding of new glass-making technologies. Consequently, NI should exit the
alliances related to those particular segments because they don’t help to reinvigorate
its technological core. Beyond this rule of thumb, students may then push NI to exit
those alliances where there is the least opportunity to learn from its partners, and
again reinvigorate and further enhance its core in advanced glass making.

140. (Refer to Case Scenario 1). Norning International (NI) is following a network
cooperative strategy. This strategy should work best in linking together
geographically disperse markets where no one form serves as the leader of the
network.

ANS: False

Case Scenario 2: ERP Inc

ERP, Inc., (ERPI) is a leading provider of enterprise integration software (EIS). EIS
essentially allows a firm to connect and integrate processes across all aspects of its
business. To fuel its dramatic growth, ERPI has focused its organization entirely on
product development (software programming for a suite of EIS products) and selling
(making the sale and then moving onto a new target), while outsourcing the
installation and consulting aspects to the world’s largest accounting firms. This also
makes ERPI basically a “product company,” whereas most competitors like Oracle
and PeopleSoft in its market space operate as “solutions companies.” One benefit of
this focused strategy is that ERPI’s product is generally recognized as being 200% to
300% better than competitors’ software, and thus adopters are thus likely to have a
one to two year advantage. In further contrast to the competition, ERPI has used its
partnerships with the accounting firms to deliver a turn-key solution, and has focused
this solution on a market comprised of the world’s largest, global manufacturers and
consumer product companies. The accounting firms, in turn, coordinate a
comprehensive collection of hardware, operating systems, and complementary
software firms. Installation and related consulting for EIS typically cost between $100
 and $200 million, with the ERPI software component accounting for only about 20%
of the installed cost (the remaining 80% is spent on the actual installation, not
counting the value of the customer’s time). To incentivize the accounting firms to
help sell its product (since, at least initially, the accounting firms had better
reputations and controlled access to the target customers), ERPI told its partners that
it will never enter the installations and consulting side of the business (aside from
installation and consulting that ERPI does as part of its software support). Dangling
such a large carrot in front of the accounting firms provided the continuing benefit of
encouraging their continued support of ERPI with their customers.

141. (Refer to Case Scenario 2) Given that software systems like EIS are very complex,
and quality is largely a function of the related installation and consulting processes,
how can ERPI control quality and ultimately protect the reputation of its product (and
its name) when it has ultimately outsourced installation to its partners?

ANS: The best answers will include a menu of actions that ERPI can take, starting
first with the observation that ERPI is being very generous to the accounting firms
and that such firms stand to lose considerable revenues if they are not involved in
EIS-related installations and consulting. From that base, students should begin talk
about the challenge of building open communications, trust, competency, and
accountability with the partners. The first step, a detailed operating contract, will set
the groundwork for open communications. It should spell out the quality expectations
of the partner as well as the conditions upon which ERPI has the right to terminate the
partner’s representation. On the trust side, ERPI can give its partners inside
information on its technological breakthroughs so they can keep abreast and have a
competitive advantage regarding innovations in the pipeline. They should also adhere
to their promise that they will not encroach on the installation and consulting business
side for the target firms (world’s largest, global manufacturers, and consumer product
companies). In terms of competency, ERPI can provide initial training and
certification of partner consultants; they can then provide ongoing continuing
education for both the consultants and the clients as a service (not a profit center). The
accountability side is also well served by the certification, since non-certified
consultants cannot represent ERPI software. A second control would be a quality
audit function on each installation (feasible, since the installations are both huge and
relatively few), and cancel the partners’ right to install ERPI products if they fail the
audits.

142. (Refer to Case Scenario 2) After managing this network of alliances for several years,
what new strategic assets has ERPI developed?

ANS: This is a challenging question for students because it forces them to take a
more dynamic perspective of potentially valuable resources that companies and their
customers create together, but that the company itself can exploit (a perfect example
of a co-specialized asset). The best answers will begin by observing that ERPI has
focused historically on transactions (making the sale), instead of relationships
(lifetime value of a customer beyond the first sale). Shifting attention to ERPI
installations as relationships suggests that the company now has a customer list to die
for - this list is especially valuable since (1) the target companies have invested
upwards of $200 million in ERPI proprietary systems and, (2) once installed, given
the pervasive nature of EIS systems, those target firms are unlikely to simply switch
 to another system.

143. (Refer to Case Scenario 2) Imagine that ERPI has saturated the large-firm market for
its products, competitors are undermining its technological advantage, and ERPI
needs to look to new markets for revenue. Its CEO has suggested that it start selling
its software down-market to middle-market companies, and at the same time enter the
consulting and installation side of the business for this target market. What are the
risks and opportunities of such a strategy?

ANS: The best answers will start by pointing out that ERPI’s prior competitive
advantage has relied on a high degree of trust with its partners, particularly its
agreement not to encroach on the accounting firms’ lucrative installation and
consulting practices. To the extent the large accounting firms serve middle market
firms, this violation of trust may undermine the strength of ERPI’s core business
market position. A secondary risk is, by converting a cost center (software support
and service) to a profit center, ERPI is actually diversifying into a new set of
industries (installation and consulting), and it will now face a slew of competent,
defensive competitors who have long occupied these market spaces. In terms of
opportunities, it is reasonable to assert that the large accounting firms have typically
not played a large role in the middle market, and have even had difficulty entering
those markets when they tried. ERPI could position its strategy in cooperation with
the large accounting firms to jointly enter and dominate the markets comprised of the
largest middle-market firms.

144. (Refer to Case Scenario 2) The approach used to manage the ERPI network of
alliances is closest to an opportunity-maximization approach which makes it possible
which for the partners to explore how their resources and capabilities can be shared in
multiple value-creating ways.

ANS: True. The relationship among the alliance partners is based on trust
(exemplified by ERPI’s promise not to enter the installation and consulting aspects of
the business) rather than contracts.

Case Scenario 3: Bunnywac.

Bunnywac is a global producer and seller of batteries for consumer electronics
products (radios, flashlights, toys, etc.), and competes primarily with its larger rivals
by providing battery products equal in performance at a lower price. The worldwide
battery industry suffers from issues of overcapacity and commoditization, brand
segmentation and proliferation, the growing strength of global retailers, and the low-
cost threat of new entrants from Asia. Thus, the ability to provide dependable
batteries at a very low cost is essential to survival in this industry. Bunnywac has
grown quickly into one of the leading players in the battery industry primary through
horizontal acquisitions financed by a recent successful IPO, and is now counted
among the top four companies in North and Latin America. Its presence in Europe
and Latin America is negligible. While its market presence and brand is generally
strong and market share is growing, Bunnywac has entered into an alliance to obtain
the core technologies of its batteries. Bunnywac does not actually own the technology
that makes its batteries work. This approach has provided Bunnywac a cost advantage
since it has not had to invest in basic R&D and has very little R&D infrastructure.
This technology is licensed from Mats (which has 200 engineers dedicated to moving
 the technology forward), one of Japan’s largest technology-based holding companies
(like Sharp or Canon). Mats also sells batteries under the Pandemonium brand and
commands over 50% of the market share of Asian countries. Mats’ market share in
other global markets is negligible and its efforts at growing its branded battery share
in the North America, Latin America, and Europe has been severely frustrated in
recent years. While Mats is very large compared to Bunnywac, the battery technology
and battery business are relatively tiny relative to Mats’ other technology-based
businesses. Bunnywac’s decade-long licensing agreement with Mats for the essential
battery technology expires in one year; there are no obvious substitute providers of
this technology.

145. (Refer to Case Scenario 3) What should be Bunnywac’s primary concerns about its
lapsing technology contract with Mats?

ANS: The best discussions will draw out near and longer-term concerns for
Bunnywac’s prospects, as well as speculation as to Mats’ long-term strategic intent.
Near-term, Bunnywac needs to have access to a reasonably priced technology if it is
to continue competing on a low-cost basis. Also, since it is a public company, the
capital markets are likely to begin showing concern for Bunnywac’s prospects if no
replacement technologies are identified, which in turn will hamper the firm’s ability
to grow further through acquisition. Medium-term, if a new contract is negotiated,
Bunnywac needs to be concerned with the price it will now pay, since Mats can be
construed to be in the more advantageous bargaining position. If Bunnywac is
determined to remain independent, then it should only pay such higher costs if it has a
parallel near-term strategy of developing its own technological competencies (which
are admittedly very hard and costly to develop) or another source for the technology
at a lower price and on a long-term basis. Finally (and perhaps first!), Bunnywac
needs to assess Mats’ strategic intent with regard to Bunnywac. Does Mats view, and
is hence positioning for, Bunnywac as (a) a valued-long term partner, (b) a potential
future competitor, or (c) a near-term cheap acquisition target as a vehicle for gaining a
quick foothold in the branded battery markets?

146. (Refer to Case Scenario 3) What should Bunnywac’s strategy be with regard to the
lapsing technology contract?

ANS: Following the discussion of its concerns, the best answers will have several
possible steps. The first step should be for Bunnywac to determine Mats’ long-term
strategic intent. Is Mats primarily interested in retaining the technology? Would they
sell the technology outright? Is their primary intent to forward integrate into all global
markets through their own or acquired brands? These answers determine whether or
not Mats’ intent is to see Bunnywac as a viable, independent avenue for its
technologies, or simply as a potential future competitor, or something in between. For
instance, if Mats sees Bunnywac as adding value in terms of brand and channel
management capabilities, but is not interested in extending the technology alliance,
then perhaps Bunnywac may actually consider negotiating its own sale to Mats while
its value is still relatively high.

147. (Refer to Case Scenario 3) What type of business-level cooperative strategy is

primarily exemplified by Bunnywac’s technology licensing arrangement with Mats?
a. vertical business-level complementary strategic alliance
 b. horizontal business-level complementary strategic alliance
c. competition reducing business-level strategic alliance
d. competition response business-level strategic alliance

ANS: A. Vertical fits best since Bunnywac is accessing a basic technology, its raw
materials per se, and then adding value to them through its production, marketing,
distribution, and brand building.

148. (Refer to Case Scenario 3)

The cooperative strategy in which Bunnywac licenses technology from Mats is
common among technology-based firms and is an example of an equity alliance.

ANS: False. The chapter gives licensing arrangements, distribution agreements, and
supply contracts as examples of nonequity alliances. Licensing arrangements are
common among technology-based companies such as Hewlett-Packard which licenses
its intellectual property to other firms.