# Strategy Formulation

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## 🧭 Table of Contents
[TOC]

# 🖊️ Video Lessons

## 🧩 M15L1 - Lesson Overview

++Strategy Formulation++ - the act of defining and selecting the most appropriate courses of action to achieve the strategic goals of the organization
* turns Analysis into Initiatives for development

**Lesson Objectives**
* Examine importance of and primary drivers of firm growth
* Analyze and evaluate corporate growth strategies including:
* Concentration
* Vertical Integration
* Horizontal Integration
* Diversification
* Describe how industry affects business strategies
* Advantages and disadvantages of Porter's Generic Strategies
* Contrast Red vs. Blue Ocean Strategies (most organization compete in Red Oceans)

**Strategy Scope**
* ++Business Level Strategy++ - Single Product Market, Focus on Competitive Advantage (i.e. Micro)
* ++Corporate Level Strategy++ - Multiple Industries and Markets Simultaneously. Focus on Firm Scope and Resource Allocation (i.e. Macro)

---

## 🧩 M15L2 - Growth, Stability, and Renewal

++Growth Strategy++ - a strategy in which the business expands the number of industries, markets, or geographies served; or expands the products or product lines offered in either the current market or new markets

### 🔸 Stability Strategy

++Stability Strategy++ - a strategy characterized by an absence of significant change; maintain competitive advantage or remain in competitive parity. Characteristics include:
* Continue to service the same markets with the same products
* Pursuing the same objectives but with a strategic thrust on incremental improvement of financial performance

Reasons for choosing a Stability Strategy:
* External environment is stable and the firm wants to focus efforts on improving efficiency
* Uncertain environment leads to management adopting a "wait and see" approach
* The firm has finished a period of rapid growth and needs to consolidate its gains
* Management expects to enter a period of economic recession and high capital costs
* Industry is mature with few or no growth prospects AND the business is in a comfortable position

**Examples**


### 🔸 Renewal Strategy

++Renewal Strategy++ - a strategy characterized by an absence of significant change.

Reasons for choosing a Renewal Strategy:
* Reducing size in response to a declining environment
* Sub-Strategies:
* ++Retrenchment++ - a short run strategy used to address minor performance issues; helps stabilize operations, revitalize resources and compete again
* ++Turnaround++ - a strategy to address serious performance issues; this can include bankruptcy

Types of Bankruptcy
* Chapter 7 Bankruptcy involves liquidating the assets of the business; NOT a Turnaround Strategy
* Chapter 11 Bankruptcy allows the firm to reorganize its capital structure and allows the business to stay alive

**Examples**


### 🔸 Growth Strategy

++Growth Strategy++ - a strategy in which the business expands the number of industries, markets, or geographies served; or expands the products or product lines offered in either the current market or new markets

Growth is Important because:
* Higher firm profits and greater returns for investors
* Drives more economies of scale and lowers operating costs
* Signals firm as industry leader
* Can mask weaknesses in other parts of the business
* Attracts better management and employee talent
* Can be a significant motivator

**Examples**


**Growth Strategies**

++Concentration++ - firm focuses on single market or product; allows the company to invest more resources in production and marketing in that one area, but risk losses in the event of a drop in demand or increase in the level of competition

++Vertical Integration++ - firm acquires business operations within the same production; can be forward or backward. The firm owns multiple stages in the vertical industry chain: Supply Chain, Manufacturing, Distribution, Retail, etc.

++Horizontal Integration++ - merger or acquisition of companies at the same stage of production in the same industry. When all producers of a good or service merge it's a Monopoly. When a few competitors merge or some remain, it's an Oligopoly.

++Diversification++ - firm enters an industry or market different from it's core business(es). Increase variety of a firm's products, markets, industries and/or geographic regions

---

## 🧩 M15L3 - (Corporate Strategy) Firm Scope and Resource Allocation

The two most critical sets of decisions made in corporate strategy are the firm scope and resource allocation across business units.

### 🔸 Three Dimensions of Firm Scope

**Vertical Integration**

Issue: What components of the industry value chain does the firm want to own or control?


**Diversification**

Issue: What will be the scope of products and services offered by the firm?

++Unrelated Diversification++ - when a firm adds new or unrelated product or service lines and penetrates new markets

++Related Diversification++ - when a firm expands its activities into product or service lines that are similar or complementary to those it currently offers; Vertical Integration is a form of Related Diversification. Horizontal Integration can be a form of Related Diversification.


**Geographic**

Issue: Where should the compete geographically?

### 🔸 Structuring the Firm

Another objective of corporate strategy is defining the structure of the firm so that all of its parts create more value together than they would individually. Achievable by:
* Building strong internal competencies
* Sharing technologies & resources between business units
* Positioning themselves to raise capital more cost-effectively
* Developing and nurturing a strong corporate bond

**Example**


### 🔸 Resource (Capital) Allocation

Resource allocation is the responsibility of the highest ranking executive officer, the corporate HQ staff and the head of each of the SBUs.

The primary mechanism is the capital budgeting process and analytical tools.

The goal is the efficient use of capital and reductions in the cost of capital. Criteria and frameworks for making capital allocation decisions will typically be used.

**Example**


1970s, GE hired McKinsey consultants to develop a framework for making capital allocation decisions.

There are 3 basic strategies, color-coded:
* Green - Harvest/Divest
* Orange - Selective Investments
* Blue - High Potential

---

## 🧩 M15L4 - (Corporate Strategy) Vertical Integration

Vertical Integration is a strategy that firms use to gain control over their industry's value chain and is a key consideration when developing corporate level strategy.

Should the firm participate in one activity in one industry OR many activities in many industries?

### 🔸 Vertical Integration Issues

**Costs**

An organization should vertically integrate when:
* the cost of making the product inside the company are lower than the cost of buying that product in the market OR
* the cost of selling and distributing its own product are less than the lost profits and lack of merchandising control when using 3rd party distribution channels and retailers

**Scope of the Firm**

A firm should consider whether moving into new industries would dilute its core competencies or not.

### 🔸 Going Up and Down the Value Chain

**Forward Integration**


Reasons to Forward Integrate:
* Lack of access to current distribution channels or poor quality channels
* Distributors or retailers have attractive profit margins
* Current distributors/retailers are not reliable or unable to meet the firm's needs
* Important to interact daily with customers to develop customer insights or new product ideas

**Backward Integration**


Reasons to Backward Integrate:
* Suppler prices are not stable
* Suppliers have attractive profit margins
* Current suppliers are not reliable or cannot supply the required inputs important to the firm
* There are few suppliers and supplier bargaining power is high
* Supplier product quality is not reliable

### 🔸 Benefits and Costs


### 🔸 Virtual vs. Vertical Integration


---

## 🧩 M15L5 - (Corporate Strategy) Diversification

### 🔸 Diversification Strategies


**Products Diversification**

This strategy involves using existing or new channels of distribution to market new products to current markets.

**Geographic Diversification**

This strategy involves selling existing products or product lines to new or larger geographic locations/markets.

**Products & Geographic Diversification**

A combination of the two strategies above. Carries both product and geographic market risk. Also referred to as the "Suicide Cell".

### 🔸 Diversification Benefits

* Leverage existing capabilities over new markets; potentially increase economies of scale and economies of scope
* Pursue new growth and profit opportunities
* Spread financial risks over different products and markets
* Cross subsidize products and/or operations

### 🔸 Stages of Diversification


### 🔸 Related vs. Unrelated Diversification

++Related Diversification++ - when a firm adds related products or markets to achieve strategic fit
* Occurs when companies expand their operations beyond current markets, but are operating within existing capabilities
* Strategic fit allows an organization to achieve synergy

++Unrelated Diversification++ - where the firms expand their operations into geographies or products beyond current resources and capabilities
* Sometimes referred to as a "conglomerate strategy"

### 🔸 Diversification and Firm Performance

**Diversification Costs**

* ++Coordination Costs++ - increase in administrative problems associated with operating different businesses
* ++Influence Costs++ - if management lacks experience in the new line of business, senior corporate managers may be misled by more knowledgeable but biased business unit managers - results in less than optimal allocation of resources


Note that in the visual above, performance peaks with Related Diversification.

---

## 🧩 M15L6 - (Corporate Strategy) Horizontal Integration

++Horizontal Integration++ - the process of acquiring or merging with competitors; improves the firms position in a single industry.

### 🔸 Horizontal Integration


++Merger++ - two competitors joining together to create a new combined firm; a new firm emerges from the consolidation of two firms

++Acquisition++ - typically a larger firm buys a smaller firm and combines into the larger firm; larger firm continues while the smaller firm disappears

### 🔸 When Horizontal Integration is Appropriate

* Competitor lacks key capability, product, resources or market coverage that can be more efficiently obtained by acquiring an existing competitor
* Economies of scale would have a significant effect on lowering costs
* An industry is in maturity with excess capacity

Mergers and acquisitions are popular strategies for firms that desire to overcome a competitive disadvantage or because the acquiring firm has developed superior integration capabilities and has the capital to spend.

### 🔸 Horizontal Integration Fail to create Economic Value

Not all mergers are successful, in fact, most fail. Here are a number of reasons:
* DOJ interference to prevent a monopoly
* Synergies expected either fail to materialize or don't create more value than the cost to acquire the firm
* Acquiring firm almost always overpays for the acquired firm; "goodwill" created never fully materializes

---

## 🧩 M15L7 - (Strategy Formulation) Business Level Strategies & Cost Leadership

### 🔸 Business Level (SBU) Strategy

Goal-directed actions managers take to achieve competitive advantage in a single product market.

Concerns:
* Monitoring the external environment
* Identifying opportunities and threats
* Developing products and services consistent with core business and markets
* Developing distinct capabilities and resources
* Aligning and support corporate strategic goals

**💡 Note**: SBU strategies are Concentration strategies since they are focused on growth. Growth through innovation of existing products is ++Organic Growth++ and tends to grow markets. Horizontal Integration is not organic as it does not grow the market.

### 🔸 Industry & Firm Effects Impact on Competitive Advantage


In essence, SBU strategy and business model should align with the firm's position in the market.

### 🔸 Cost Leadership Factors

Cost Leadership is about becoming the lowest cost producer in an industry. Some universal factors include:
* Input Factors - materials, labor, services, technology, intellectual property and financial capital
* Purchasing Power - drive down the prices of suppliers
* Economies of Scale - cost advantages a business can gain by increasing its production volume leading to a lower average cost per unit
* Minimum Efficient Scale - the lowest possible cost per unit


* Learning Curves - learning by doing inherently leads to greater efficiency
* Experience Curves - combines the effects of the learning curve and economies of scales

**Firms that Succeed at Cost Leadership** often have the following strengths:
* access to capital to make significant investments in technology and production assets
* design and manufacturing skill sets that provide streamlined production and product assembly
* highly automated business processes
* business activities off-loaded onto customers willing to perform these functions
* a culture of frugality

### 🔸 Cost Leadership and The Porter Five Forces Model


---

## 🧩 M15L8 - (Strategy Formulation) Business Level Strategies & Differentiation

Firms that pursue differentiation and focus strategies are much more common than firms that pursue cost leadership. There can only be one cost leader.

### 🔸 Differentiation

🎯 Goal: To add unique features that will increase the perceived value of goods or services in the minds of the buyer so that they're willing to pay a higher price. Achieved by one or more of the following:
* Product design
* Complements
* Mass customization
* Customer service
* Customer experience

Firms tend to concentrate on two primary drivers: a dominant and a differentiator.

### 🔸 Differentiating Firm's Strengths

Firms that compete based on differentiation need the following strengths:
* Deep understanding of target market - unique insights into customer needs and preferences
* Highly skilled and creative product development and marketing teams
* Powerful sales message and supporting sales structure
* Reputation for innovation and quality
* Capital to finance innovation activities
* Strong, positive brand image

### 🔸 Differentiation and The Porter Five Forces Model


---

## 🧩 M15L9 - (Strategy Formulation) Business Level Strategies & Market Focus

**💡 Note**: Focus strategy is a cost leadership strategy or differentiation strategy applied to a specific market niche.

### 🔸 Market Focus

🎯 Goal: To differentiate itself by more specifically on meeting unique customer needs or by achieving lower costs within limited markets.


### 🔸 Advantages & Disadvantages


### 🔸 Focus and The Porter Five Forces Model


---

## 🧩 M15L10 - (Strategy Formulation) Combination & Blue Ocean Strategies and the Productivity Frontier P1


**💡 Note**: None of the generic strategies are inherently superior.

Success of a strategy is dependent on two factors:
* How well the strategy leverages the firm's internal strengths, specifically core competencies and strategic resources
* How well it helps the firm exploit external opportunities while minimizing the risk associated with the firm's external threats

In most situations, firms must add value through differentiation while controlling cost.

Firms that attempt to achieve both cost leadership and differentiation often find themselves "stuck in the middle" and under perform.

🎯 Goal: to provide unique value in an efficient manner.

### 🔸 Drivers for Increase Value and Lower Cost

**Focus on the Objective**

A successful combination strategy requires trade-offs between differentiation and cost leadership. Of note, a firm does NOT need to be the best in both but rather to optimize the difference between value created and the cost incurred.

**Focus on Quality**

Firms can produce products with quality in mind while also reducing cost to produce that level of quality (LEAN).

**Economies of Scale & Scope Help**

An example of economies of scope is the ability to leverage existing distribution channels for a new product or service at little or not incremental cost to the firm.

**Innovation is Necessary**

Incremental improvements in efficiency or significant improvement through business process reengineering can be used to resolve the trade-offs when firms are pursuing a combination strategy.

---

## 🧩 M15L11 - (Strategy Formulation) Combination & Blue Ocean Strategies and the Productivity Frontier P2

### 🔸 Blue Ocean Strategy


++Blue Ocean Strategy++ - a business level strategy that successfully combines differentiation and cost leadership activities using Value Innovation to reconcile the inherent trade-offs in those two distinct business strategies and supporting business models.
* Ignore Competition and Porter's Structural Characteristics Forces which shape Red Oceans (highly contested markets)
* Seek out or invent new Blue Oceans of untapped market opportunity

### 🔸Achieving a Combination Strategy with Value Innovation

Both a Blue Ocean Strategy in a new market and a Combination Strategy in an existing market, if successfully implemented, will result in offering a differentiated product at a low cost.

Both strategy's objective is to provide the customer more value than the cost leader but at a similar price OR allow the firm the ability to underprice a differentiator yet still delivers equivalent or near equivalent value to the customer.

**Blue Ocean Four Actions Framework**

Four key questions:
* What factors should be raised well above the industry's standard?
* What factors were a result of competing against other industries and can be reduced?
* Which factors that the industry has long competed on should be eliminated? and
* Which factors should be created that the industry has never offered?


**Cirque du Soleil Example**


### 🔸 Risks of Blue Ocean


### 🔸 Productivity Frontier


++Productivity Frontier++ - the theoretical limit of the cost-value relationship; captures the sum of all existing best practices at any given time.

---

## 🧩 M15L12 - Tesla Motor Example

---

# ❓ Self-Assessment Questions

1. Which ONE of the following is NOT a growth strategy?

*Divestiture*

2. These strategies address which businesses the firm will be in and how capital will be allocated among those businesses.

*Corporate*

3. A business sets a 10% per annum growth objective over a 5 year planning horizon. The CEO intends to accomplish this growth through taking additional market share from competitors by improving product packaging and aggressively advertising. This is an example of an inorganic growth strategy.

*False*

4. In order for a firm to formulate an effective business level strategy, it is important to remember that competitive advantage is determined by:

*The characteristics of both the industry and the firm*

5. (True/False). If a firm has no single line of business that represents 70% or more of the firms total revenues the firm is considered to be diversified.

*True*

6. Which of the following makes up the three main types of "grand" strategies? Typically grand strategies are driven by goals and objectives set at the corporate level.

*Growth, stability, renewal*

7. Consider both statements regarding combination strategies. Statement 1. Combination strategies are often difficult because they are inherently contradictory. Statement 2. The goals of a combination strategy is to provide unique value in an efficient manner.

*Both statements are true*

8. What is the productivity frontier?

*The best possible strategic positions that a firm can take relating to value and low cost. The frontier is drawn as a concave curve*

9. ______ drivers are as important to a differentiation strategy as ______ drivers are to a cost leadership strategy.

*value, cost*

10. Firms that have 1) access to leading scientific research, 2) a highly skilled and creative product development team, 3) a strong sales team and creative marketing, and 4) a reputation for quality and innovation are likely to be pursuing a _________ positioning strategy. If there are more than one correct answer, check all the answers you believe are right.

*differentiation strategy broadly across the market & differentiation strategy focused in a niche market*

11. The firm that consistently charges the lowest price for a product/quality category relative to the competition will always be following a cost leadership strategy.

*False*

12. AMBAC Financial has been forced into bankruptcy primarily because of credit risks taken in the sub-prime market and loan origination costs that are higher than the industry average. AMBAC hopes to emerge from bankruptcy as a smaller but more financially sound firm, with a redesigned and less costly set of business processes. AMBAC's strategy is an example of a:

*Turnaround strategy*

13. Being "stuck in the middle" means a firm has tried to implement both a differentiation and low cost producer strategy concurrently but has not succeed in either.

*True*

14. A Blue Ocean Strategy is a business level strategy that successfully combines differentiation and cost leadership activities using value innovation to reconcile the inherent trade-offs.

*True*

15. A big risk in pursuing a cost leadership strategy is that a firm's cost advantage may be jeopardized by a new production or distribution technology.

*True*

16. In forward vertical integration a company becomes its own:

*distributor*

17. Which ONE of the following is not a potential benefit of a vertical integration strategy?

*Eliminating a direct competitor*

18. Developing new product lines related to the core business, extending existing product lines, and marketing campaigns targeted towards existing customers are all examples of _________ strategies.

*Concentration*

19. (True/False) Influence costs are a source of costs for both Related and Unrelated Diversification.

*True*

20. In forward vertical integration the company becomes its own:

*distributor*

21. Which strategy is a potential result of a make vs. buy analysis?

*Backward vertical integration*

22. A diversified corporation is likely to have:

*Multiple competitive strategies*

23. For questions 23 - 26 imagine that you are the CEO of Taco Rocket, a new and successful chain of 18 Mexican fast-food restaurants. The success that you have experienced in the last five years has you thinking of what to do with the business next.

Up to now your success has been based on selling tacos and burritos at a price that others cannot match. Your business is pursuing which of Porter's strategies?

*A cost leadership/niche strategy*

24. You are thinking of buying a tortilla factory in a nearby state. This action would be an example of:

*a backward vertical integration strategy*

25. Continuing with Taco Rocket...

Recently Taco Rocket has considered buying a local competitor, Hacienda Joes. The two would combine under the Taco Rocket name. This is an example of which of the following:

*Horizontal integration strategy*

26. Continuing with Taco Rocket...

Your brother-in-law approaches you about buying his solar panel installation business. If you proceeded with his proposal this would be an example of:

*Unrelated diversification*

27. Which ONE of the following would NOT be an output of a corporate strategy?

*The decision to lower prices on a product that facing intense competition*

28. These strategies address which markets a firm will compete in and which markets that the firm is in but plans to exit.

*Corporate*

29. A main tenant of red ocean strategy is to ignore competition and Porter forces.

*False*

30. Which of the below statements is true of horizontal integration?

*Horizontal integration is accomplished through mergers or acquisitions of competitors.*

31. Holding everything else constant, horizontal integration results in less competition than vertical integration.

*True*