Chapter Five:

Strategy Formulation (Strategy Analysis and Choice)

5.1 Business level strategic analysis
5.2 Corporate level strategic analysis
5.3 Industry and competitor analysis
 5.1 Business Level Strategic Analysis of a Company
• In selecting business-level strategy, the firm should determine:
• Who will be served? Refers to types of customers
• What needs those target customers have that the firm will satisfy?
Refers to the benefits & features of products.
• How those needs will be satisfied? Refers to core competencies.

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 cont’d …

Note:
• Only firms who diligently perform these can expect to meet & hopefully
exceed customers’ expectations across time.

• The firm’s relationship with its customers is strengthened when it is

committed to offering them superior value

• In turn, receiving superior value enhances customers’ loyalty to the firm

– helps to develop a new competitive advantage

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 cont’d …
Business-level strategy:
• Is a deliberate choice about how a firm will perform the value chain’s
primary & support activities in ways that create unique value
• Reflects where & how the firm has an advantage over its rivals
• Is intended to create differences b/n the firm’s position relative those of
its rivals

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 cont’d …
• Thus, the essence of a firm’s business-level strategy is choosing to:
o Perform activities differently than rivals – to achieve lowest cost; or
o Perform different (valuable) activities – being able to differentiate
• Hence, competitive advantage is achieved within some scope – firms
should prefer one of the two.

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 Business-level strategy
The Five business-level Strategies
Competitive Advantage
Competitive Scope

Lower Cost Uniqueness

(Market Target)

Broad Target Cost L/Ship Differentiation

Integrated Cost L/ship

/ Differentiation

Focused Cost Focused

Narrow Target
L/ship Differentiation

6
 The Five Business – Level Competitive Strategies

• The two basic types of competitive advantages a firm can posses are low
cost and differentiation.
- they are important to cope with the five forces based on an industry
structure
• The two basic types of competitive advantage combined with the
competitive scope lead to three generic strategies for achieving above-
average performance.
• These are cost leadership, differentiation & focus.

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 cont’d …
• The focus strategy again has two variants: cost focus & differentiation
focus.
• Thus, a focus strategy is an integrated set of actions designed to produce
& deliver goods/services that serve the needs of a particular competitive
segment.
• Hence, the five Business Level strategies are:
o Cost leadership
o Differentiation
o Focused cost leadership
o Focused differentiation
o Integrated cost leadership & differentiation
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 cont’d …
• Cost leadership: lowest cost to produce acceptable features to all
customers.

• Differentiation: differentiated features rather than low cost for

customers who value differentiation.
• Focused cost leadership: refers to targeting those specific customers
with low cost
• Focused differentiation: refers to targeting those specific customers
with a differentiated product
• Integrated cost leadership & differentiation: according to Porter, this
strategy was referred initially as “stuck in the middle”
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 cont’d …

Note:
• None of the five business-level strategies is inherently or universally superior
to others
• The effectiveness of each strategy is contingent both on the opportunities &
threats in a firm’s external environment & on the possibilities provided by
the firm’s unique resources & capabilities (core competencies)
• It is critical, therefore, for the firm to select an appropriate strategy in light
of its external conditions & competencies.

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 1. Cost Leadership Strategy
Definition
• A cost leadership strategy is an integrated set of actions designed to
produce or deliver goods or services at the lowest cost relative to
competitors, with features that are acceptable to customers. That is:
 Lowest competitive price
 Features acceptable to many customers
 Relativey standardised products

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 cont’d …
• Cost saving actions required by this strategy:
o Building efficient scale facilities
o Tightly controlling production costs and overhead.
o Simplifying production processes and building efficient manufacturing
facilities.
o Minimising costs of sales, R & D and service
o Monitoring costs of activities provided by outsiders
o Gaining a unique access to a large source of lower cost materials.
o Making optimal outsourcing
o Vertical integration decisions
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 Cost Leadership Strategy and the Five Competitive
Forces
Economies of Scope
• Economies of scope occur through a firm’s ability to spread costs
associated with one element of the value chain across multiple products,
thereby reducing costs.
• For example, Sharp achieves economies of scope through spreading the
costs of running their distribution networks etc across a range of
products.

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 Cont’d …
Accumulated Experience
• As a person or a firm gains experience in completing a task, they
become more efficient at doing it.
• This process can occur through:
• learning or experience
• technical progress
Potential entrants
• A Firm can frighten off potential new entrants due to:
o Their need to enter on a large scale in order to be cost competitive
o The time it takes to move down the learning curve
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 cont’d …

Bargaining power of suppliers & buyers

• Can mitigate suppliers’ power by:
o Being able to absorb cost increases due to low cost position
o Being able to make very large purchases to reduce the chance of
suppliers to use their power.
• Can mitigate buyers’ power by:
o Driving/heavy prices far below competitors and causing them to
exit, thus shifting the power of the buyers back to the firm.

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 Cont’d …
 Product substitutes & rivalry among existing competitors
• Cost leader is well positioned to:
o Make investments to be first to create substitutes
o Buy patents developed by potential substitutes
o Lower prices in order to maintain value position

• Due to cost leader’s advantageous position:

o Rivals hesitate to compete on the basis of price
o Lack of price competition leads to greater profits

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 Competitive Risks of the Cost Leadership Strategy
• Processes used to produce & distribute goods or services may become
obsolete due to competitors’ innovations.
• Focus on cost reductions may occur at the expense of customers’
perceptions of differentiation encouraging them to purchase competitors’
products & services.
• Competitors, using their own core competencies, may learn to successfully
imitate the cost leader’s strategy.

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 2. Differentiation Strategy
Definition
• A differentiation strategy is an integrated set of actions designed to
produce goods or services that customers perceive as being different
in ways that are important to them.
• The firm produces non-standardized products for customers who value
differentiated features more than they value low cost.
• Continuous success with the differentiation strategy results when the
firm consistently upgrades differentiated features that customers
value, without significant cost increases.
• The ability to sell goods or services at a price that substantially exceeds
the cost of creating its differentiated features allows the firm to
outperform rivals and earn above-average returns 18
 Examples of Approaches for Differentiation
o Products with unusual features
o Responsive customer service
o Rapid product innovation and technological leadership
o Perceived prestige and status
o Different tastes
o Engineering design and performance
 A firm’s value chain can be analyzed to determine whether the firm is
able to link the activities required to create value by using the
differentiation strategy.

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 Differentiation Strategy and the Five Competitive Forces
 Potential entrants
• Can defend against new entrants because:
– entrants’ new products must surpass proven products
– entrants’ new products must be at least equal to performance of proven
products, but offered at lower prices

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 cont’d …

Bargaining power of suppliers and buyers

• Can mitigate suppliers’ power by:
o Absorbing price increases due to higher margins
o Passing along higher supplier prices because buyers are loyal to
differentiated brand
• Can mitigate buyers’ power by:
• Well differentiated products reduce customer sensitivity to price
increases

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 cont’d …
Product substitutes and rivalry among existing
competitors
• Well positioned relative to substitutes because:
o Brand loyalty to a differentiated product tends to reduce customers’
testing of new products or switching brands
• Well positioned relative to competitors because:
o Brand loyalty to a differentiated product tends to offset price
competition

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 Competitive Risks of the Differentiation Strategy
• The price differential between the differentiator’s product and the
cost leader’s product becomes too large
• Differentiation ceases to provide value for which customers are willing
to pay
• Experience narrows customers’ perceptions of the value of a
product’s differentiated features
• Counterfeit goods replicate differentiated features of the firm’s
products at significantly reduced prices

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 3. Focus Strategy
Definition
• A focus strategy is an integrated set of actions designed to
produce or deliver goods or services that serve the needs of a
particular competitive segment.
• Firms choose a focus strategy when they want their core
competencies to serve the needs of a particular industry segment or
niche at the exclusion of others.

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 cont’d …
• Examples of specific market segments that can be targeted by a focus
strategy:
o Particular buyer group (e.g. youths or senior citizens)
o Different segments of a product line (e.g. professional craftsmen
versus do-it-yourselves)
o Different geographic markets

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 cont’d …
• Types of focused strategies:
o Focused cost leadership strategy
o Focused differentiation strategy
• To implement a focus strategy, the firm must be able to complete
various primary and support value chain activities in a competitively
superior manner, in order to develop and sustain a competitive
advantage and earn above-average returns
• Competitor firms may overlook small niches
• The firm lacks resources needed to compete in the broader market,
but serves a narrow segment more effectively than industry-wide
competitors.
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 Competitive Risks of the Focus Strategies

• The focuser firm may be ‘out focused’ by its competitors

• A firm competing on an industry-wide basis decides to pursue the
niche market of the focuser firm.
• Customer preferences in the niche market may change to more
closely resemble those of the broader market. As a result, the
advantages of a focus strategy are either reduced or eliminated.

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 4. Integrated Cost Leadership /Differentiation
Strategy
• A firm that successfully uses the integrated cost
leadership/differentiation strategy should be in a better position to:
o Adapt quickly to environmental changes
o Learn new skills and technologies more quickly
o Effectively leverage its core competencies while competing against
its rivals
• A commitment to strategic flexibility is necessary for successful use of
this strategy

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 Competitive Risks of the Integrated strategy
• Often involves compromises
o Becoming neither the lowest cost nor the most differentiated firm
• Becoming ‘stuck in the middle’
o Lacking the strong commitment and expertise that accompanies firms
following either a cost leadership or a differentiated strategy
o Earning below-average returns
o Competing at a disadvantage
• Even so, the integrated strategy is an appropriate choice for firms
possessing the core competencies to produce somewhat differentiated
products at relatively low prices

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5.2 Corporate level strategic analysis
 Corporate - Level Strategy
• A corporate-level strategy is an action taken to gain a competitive
advantage through the selection & management of a mix of businesses
competing in several industries or product markets.
• A corporate-level strategy is concerned with two key questions:
• What business should the firm be in?
• How should the corporate office manage its group of businesses?

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 cont’d …
• Corporate strategies are often called grand/master strategies
• These grand strategies (major Corporate Strategies) can be:
o Growth strategy - expand the company's activities.
o Stability strategy - make no change to the company’s current
activities
o Defensive strategy – reduce the company’s levels of activities

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 1 Growth Strategy
• Growth Strategy involves the attainment of specific growth objectives
by increasing the level of a firm’s operations.
• Typical growth objectives for businesses include:
o Increase in sales revenues
o Increase in earnings or profits
o Other performance measures

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 Concentration Strategy

• Concentration strategy will be appropriate when the company

concentrates on the current business.
• The firm directs its resources to the profitable growth of a
single product, in a single market, with a single technology.

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 Concentration Strategy cont’d …

• Advantages:
• Based on known competencies & same experience
• Lowest in risk & additional resources
• Disadvantages:
• Steady but slow increases in growth & profitability
• Narrow range of investment options

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 Concentration Strategy cont’d …

• In general, firms that use this strategy gain competitive advantage in

production skill, marketing know-how & reputation in the market place
• In fact, it refers to marketing present products with only cosmetic
modifications
• Thus, concentration focuses on:
• Increasing present customers’ rate of usage
• Attracting competitors’ customers through price cuts
• Attracting non-users through advertising, price incentives etc.

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Concentration Strategy cont’d …
• There are two options that involve moderate cost & risk. They are:
• market development &
• product development
• Market development is selling present products in new markets –
additional regional, national & international expansions.
• Attracting other market segments through:
o Developing product versions to appeal to other segments
o Entering other channels of distribution
o Advertising in other media
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 Cont’d…
• Product development is developing new products for present markets.
This involves:
• Developing new product features:
o Modifying (change color, form, shape, etc.)
o Magnify & minify
o Rearrange (layout, patterns, etc.)
• Developing additional models & sizes (product proliferation)

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 cont’d …
• Thus, it involves substantial modification of existing products or creation
of new but related items that can be marketed to current customers
through established channels.

• The idea is to attract satisfied customers to new products as a result of

their positive experience with company’s initial offering.

• The product development strategy is often adopted either to prolong

the life cycle of current products or to take advantage of favorable
reputation & brand name.

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 Innovation Strategy
• Innovation strategy refers to original or novel ideas when firms shift from
market & product development as the basis for profitability.
• Thus, the main philosophy of innovation strategy is creating a new
product life cycle, thereby making any similar existing products obsolete.
• However, innovation is costly & risky – few innovative ideas prove
profitable because R&D, marketing, & other costs are extremely high.

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 Integration Strategy
• Integration strategy focuses on moving to different industry level,
different product & technology but the basic market remains the same.
• There are two types of integrative growths:
o Vertical integration
o Horizontal integration

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 Integration Strategy cont’d …
Vertical Integration
• Vertical Integration involves extending an organization’s present
business in two possible directions.
• Forward integration moves the organization into distributing its
own products or services .
• Backward integration moves an organization into supplying some or
all of the products or services used in producing its present
products or services.

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 Integration Strategy cont’d …

Horizontal integration
• Horizontal integration occurs when an organization adds one or more
businesses that produce similar products or services and that are
operating at the same stage in the product market chain.
• Almost all horizontal integration is accomplished by buying another
organization in the same business.

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 Diversification
• The entry of a firm or business unit into new lines of activity, either by
processes of internal business development or acquisition, which entail
changes in its administrative structure, systems and other management
processes
• Diversification growth strategy is classified into two categories:
1. Concentric (Related)
2. Conglomerate (Unrelated)

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 1. Concentric (Related) Diversification

• Diversifying into a different industry but one that’s related in some ways
to the organization’s current operations
• Search for strategic “synergy”, which is the performance of the whole is
greater than the sum of the parts.
• The idea that 2 + 2 = 5
• Synergy happens because of the interactions and the interrelatedness of
the combined operations and the sharing of resources, capabilities, &
distinctive competencies

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 Concentric (Related) Diversification cont’d…

• Related diversification could be achieved through economies of scope &

market power
• Firms that have selected related diversification as their corporate-level
strategy seek to exploit economies of scope between business units and
get market power.
• Economies of scope are cost savings attributed to transferring the
capabilities and competencies developed in one business to a new
business

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 Concentric (Related) Diversification cont’d…
• Economies of scope refers to sharing activities & transferring of core
competencies: operational & corporate relatedness.
• Value is created from economies of scope through operational
relatedness and corporate relatedness.

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Concentric (Related) Diversification cont’d …
• Market power exists when a firm is able to:
o Sell its products above the existing competitive level
o Reduce the costs of its primary & support activities below the
competitive level
o Blocking competitors through multi-point competition
• Market power could be gained through:
o Multi point competition
o Vertical integration

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 Concentric (Related) Diversification cont’d …

Multi-point competition exists when:

• Two or more diversified firms compete in the same product areas or
geographic markets
• Multipoint competition will not create potential gains when there is
excessive competitive activity
• Therefore, firms develop mutual forbearance to create value by
engaging in less competitive rivalry

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Concentric (Related) Diversification cont’d …
Vertical integration
• Exists when a firm produces its own inputs (backward integration)
or owns its source of distribution of outputs (forward integration)
• A firm pursuing vertical integration usually is motivated to
strengthen its position in its core business by gaining market power
over competitors

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2. Conglomerate (Unrelated) Diversification
• Diversifying into completely different industry from the firm’s current
operations
• Firm move into industries where there is
• No strategic fit to be exploited
• No meaningful value chain relationships
• No unifying strategic theme
• The Approach is venture into any business with good profitability
prospects

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cont’d …

• Unrelated diversification could be achieved through financial economies

• These are cost savings realized through improved allocations of financial
resources and based on investments inside or outside the firm.
Value is created through two types:
• Efficient internal capital allocations
o Development of a portfolio of businesses with different risk profiles
thereby reducing the business risk for the total corporation
• Purchasing other corporations and restructuring their assets
o Buying and selling businesses in the external market with the intent
of increasing the total value of the firm.
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 Major Reasons for Diversification
• Antitrust regulation
• Tax laws
• Low performance
• Uncertain future cash flows
• Risk reduction for firm
• Tangible resources
• Intangible resources
• Managerial motives for diversification may lead to value reduction
• Diversifying managerial employment risk
• Increasing managerial compensation
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 2 Stability Strategy
• It is also called neutral strategy: occurs when an organization is satisfied
with its current situation & wants to maintain the status quo.
• Reasons for using stability strategy:
• The company is doing well
• The management wants to avoid additional hassles associated with
growth
• Resources has been exhausted because of earlier growth strategies

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 Defensive Strategies

• Defensive Strategies most often used as a short-term solution to:

• Reverse a negative trend
• Overcome a crisis or problem situation
• It could be classified into decline & closure strategies

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 Defensive Strategies cont’d …
Reasons:
The company faced financial problems – certain parts of the organization
are doing poorly
The company forecasts hard times ahead related to:
Challenges from new competitors & products
Changes in government regulations
Owners are tired of the business or have to have an opportunity to profit
substantially by selling

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 Decline strategy
• Decline strategy includes:
• Retrenchment/cut production costs
• Harvesting,
• Turn around and
• Divestiture
• Retrenchment strategy will be used when the company wants to reduce
its operations – primarily, by reducing product lines.
• The main purpose of retrenchment is economizing through cutting
production costs

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 Decline Strategies cont’d …
• Harvesting occurs when future growth appears doubtful or not cost
effective – the main reason could be because of new competition or
changes in consumer preferences
• In this case the firm limits additional investment & expenses but
maximizes short-term profit & cash flow through maintaining market
share over the short-run
o Cutting back employee compensation or benefits
o Replacing higher-paid employees with lower-paid employees
o Leasing rather than buying equipment
o Cutting back marketing expenses
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 Decline Strategies cont’d …
• Divestiture strategy occurs when an organization sells or divests itself
of a business or part of a business – if the previous diversification is
not successful
• Moreover, when the firm is highly indebted – it might prefer to survive
by selling some of its businesses by raising sufficient capital to:
• Increase the performance of the remaining businesses
• Settle its debt

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 Closure Strategies
• Closure strategy consists of liquidation & filing of bankruptcy
• Liquidation occurs when an entire company is either sold or dissolved
either by choice or force
• When by choice, it can be because the owners are tired of the
business or near retirement; the organization’s future prospect is not
good and sell at this time
• When by force, the decision often occurs because of a deteriorated
financial condition

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5.3 Industry and Competitor Analysis

61
 The Industry Environment
• Analysis of the industry environment is focused on the factors &
conditions influencing the firm’s profitability in the industry.
• Compared to the general environment, the industry environment has
a more direct effect on the firm’s strategic competitiveness &
capability of earning above-average returns

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 cont’d …
It refers to the analysis of:
• Industry trends as a whole;
• Competition within the industry;
• Technologies employed;
• What it takes to succeed – the key success factors (KSF);
• Comparing the firm, its products, its systems, its technology etc., with
other firms in the industry.

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 Nature and Degree of Competition

• The nature and degree of competition in an industry hinge on five

forces:
1. The threat of new entrants
2. The bargaining power of suppliers
3. The bargaining power of buyers
4. The threat from substitute products
5. Rivalry (competition) among existing firms

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 Nature cont’d …
How Competitive Forces Shape Strategy?
• The essence of strategy formulation is coping with competition.
Competition exists in the fight for market share.
• Therefore, competition in an industry is rooted in its underlying
economics, and competitive forces.
• In light of this, customers, suppliers, potential entrants, and substitute
products are all competitors that may be more or less prominent or active
depending on the industry type.
• Thus, the collective strength of these forces determines the ultimate profit
potential of an industry.

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cont’d …
• The weaker the forces collectively the greater the opportunity for superior
performance in the industry would be.
• Thus, to cope with them the strategist must delve below the surface and
analyze the sources of competition. For example:
• What makes the industry vulnerable to entry?
• What determines the bargaining power of suppliers?

66
 cont’d …
• Knowledge of these underlying sources of competitive pressure
provides the groundwork for a strategic plan of action to:
• Highlight the critical strengths and weaknesses of the company
• Animate the positioning of the company in its industry
• Clarify the areas where strategic changes may yield the greatest
payoff
• Highlight the industry trends as either opportunities or threats

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1. Threat of Entry
There are six major sources of barriers to entry:
1. Economies of scale (saving the cost of production through mass
production)
2. Product differentiation
3. Capital requirements
4. Cost disadvantages
5. Access to distribution channels
6. Government policy

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Threat of Entry cont’d …

Economies of scale:
• Deter entry by forcing the aspirant either to come in on large scale or
accept a cost disadvantage.
• Scale of economies in production, research, marketing, and service are
probably the key barriers to entry in the industry.

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Threat of Entry cont’d …
Product differentiation:
• Brand identification creates a barrier by forcing entrants to spend
heavily to overcome customer loyalty.
• Factors fostering brand identification are being first in the industry,
advertising, customer service, and product differences.
• Product differentiation is perhaps the most important barrier in soft
drinks, cosmetics, and investment banking.

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 Threat of Entry cont’d …
Capital requirements:
• The need to invest large financial resources in order to compete
creates a barrier to entry.
• Capital is necessary not only for fixed facilities but also for customer
credit, inventories, and absorbing start-up loses.
• The huge capital requirements in certain fields, such as computer
manufacturing and mineral extraction, limit other entrants.

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Threat of Entry cont’d …
Cost disadvantages independent of scale:
• Entrenched companies may have cost advantages not available to
potential rivals, no matter what their size and economies of scale.
• These advantages can stem from the effects of:
• the learning curve, and proprietary technology,
• access to the best raw material sources,
• assets purchased at pre-inflation prices,
• government subsidies, favorable location, and
• official rights (patents)

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 Threat of Entry cont’d …

Access to distribution channels:

• Affects new entrants since the new product must displace others via price
breaks, promotions, and intense selling efforts.
• When there are limited wholesale or retail channels and the existing
competitors occupied them, entry into the industry will be tougher.

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 Threat of Entry cont’d …

Government policy:
• The government can limit or even foreclose entry to industries with
such controls as license requirements and limits on access to raw
materials.
• The government also can play a major indirect role by effecting entry
barriers through controls such as air and water pollution standards and
safety regulations.

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 2. The bargaining power of suppliers
• Suppliers can exert bargaining power on participants in an industry by
raising prices or reducing the quality of purchased goods and services
affecting the profitability of the industry.

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 3. The bargaining power of Buyers
• Customers can force down prices, demand higher quality or more
service, and play competitors off against each other – all at the
expense of industry profits.
• The product buyers’ purchase from the industry is standard or
undifferentiated.
• In this situation, the buyers are always sure that they can find
alternative suppliers, may play one company against another.

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 4. The threat from Substitute Products

• The threat of substitute products increases when:

• The substitute product’s price is lower
• Substitute product’s quality and performance are equal to or
greater than the existing product

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5. Rivalry among Competing Firms
Industry rivalry increases when:
• There are numerous or equally balanced competitors
• Industry growth slows or declines
• There are high fixed costs or high storage costs
• There is a lack of differentiation opportunities or
• When high exit barriers prevent competitors from leaving the industry

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 Interpreting Industry Analyses

Low entry barriers

Suppliers & buyers Unattractive

have strong positions
industry
Strong threats from
substitute products

Intense rivalry
Low profit
among competitors potential

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Interpreting Industry Analyses cont’d …

High entry barriers

Suppliers & buyers Attractive

have weak positions
industry
Few threats from
substitute products

Moderate rivalry High profit

among competitors
potential

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Competitor Analysis

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 Competitor Analysis
• Competitor analysis focuses on each company against which a firm
directly competes.
• Analysis of competitors is focused on predicting the dynamics of
competitors' actions, responses & intentions.
• Competing firms are keenly interested in understanding each other’s
objectives, strategies, assumptions and capabilities.
• Furthermore, intense rivalry creates a strong need to understand
competitors.

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 Competitor Analysis cont’d …
In a competitor analysis, the firm seeks to understand:
• What drives the competitor, as shown by its future objectives.
 What the competitor is doing and can do, as revealed by its current
strategy.
 What the competitor believes about its own firm and the industry, as
shown by its assumptions.
 What the competitor’s capabilities are, as shown by its strengths and
weaknesses.

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Competitor analysis components

84
Competitor Analysis cont’d …
• Competitor intelligence is used to get data and information about
competing firms.
• Competitor intelligence is the set of data and information the firm
gathers to better understand and better anticipate competitor’s
objectives, strategies, assumptions and capabilities.
• Information about these different dimensions helps the firm to
prepare an anticipated response profile for each competitor.
• Thus, the result of an effective competitor analysis helps a firm to
understand, interpret and predict its competitors’ actions and
responses.

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 Competitor Array
One common and useful technique is constructing a competitor array.
The steps include:
1. Define your industry - scope and nature of the industry
2. Determine who your competitors are
3. Determine who your customers are and what benefits they expect
4. Determine what the key success factors are in your industry
5. Rank the key success factors by giving each one a weighting - The sum
of all the weightings must add up to one.
6. Rate each competitor on each of the key success factors

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 Competitor Array cont’d …
7. Multiply each cell in the matrix by the factor weighting.
8. Sum columns for a weighted assessment of the overall strength of
each competitor relative to each other

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