Business Finance – Accounting assignment

Case Instructions, Guidelines & Preparation

Remember, the case is graded per the rubric. The BoD would want your recommendations with the proper support. Any analysis details should be covered in an appendix. Do not go to the Internet to find, for example, a SWOT or external analysis analysis and use it for your case. Do your own research and develop your own strategic analysis.

In doing your case you will need a minimum of five references outside the case I give you. Use current business websites to find out about recent developments. Certainly do not use websites that develop term papers or do strategy analysis on this case and publish them. This could lead to charges of plagiarism and the associated consequences.

The case study analysis allows you to apply your knowledge to the real world. Your goal is to identify the major problem confronting the subject company and provide a strategic solution for the problem. You will need to collect data and interpret it. You must also isolate the critical issues that the company faces. Remember that in the words of Lord Kelvin, “anything that cannot be expressed in numbers represents knowledge that is of a poor and uncertain kind.”

After identifying the critical issues you can generate alternatives to address the company’s competitive situation. Evaluating these alternatives allows an organization to select one course of action. With a course of action defined the strategic manager can then provide a plan for implementation this is what you are to do on the case studies. Always refer to the rubric for the critical points to cover.

The format for the case study should be as follows.

APA cover page,
One-page, single spaced Executive Summary for the case as noted below. This is a summary of your report and, therefore, must be done after you finish the report. This one-page report must use headings and subheadings indicated in the following format to identify the critical issues. Begin with your understanding of the situation in a problem statement. Follow this with a concise presentation of your analysis and the alternatives you see. Recommend one course of action and support that recommendation with facts and other information, such as competitor’s moves. The last item is presents a plan for implementation –a sentence or two is sufficient. A sample of the Executive Summary is available with all this material.
Body of your report (4-5 Pages). The summary page should encapsulate your understanding to the problems facing the company, a brief summary of the strategic analysis, financial analysis, the alternatives considered and a single recommendation with an implementation plan.

After the executive summary page, you are to use standard APA formatting for a 5-page report. Tables, charts, graphs, etc. are to be put in the appendix and referenced from the body of your paper. Deductions may be taken for papers where the body is longer than five pages. Remember, in management you must get your thoughts across quickly if you expect your work to be read. Long reports generally wind up in a stack awaiting reading at some future date (which never comes).

Case Study Report Format:

Your report must include:

NSU Cover page (1 page in length). It will present the name of the case and the author(s) of the report.
Executive Summary (1 page in length).

The Executive Summary is a concise overview of the report. The Case Study Report should be written from the perspective of an outside consultant, writing to the Board of Directors of the firm. It notes the essential points of the report and must have the following sections:

Problem Statement: State the main problem facing the firm (or industry) in one, succinct sentence.
Analysis: Summarize the main findings of your analysis. You may use bullet points, bold, italics – any means to convey and highlight the key factors you have determined based on your analysis. Don’t repeat items from the body of your report like the SWOT. Summarize the major issues.
Alternatives: State briefly (one sentence or a bullet point each) 2 or 3 alternative courses of action that could be implemented
Recommendation: Choose one course of action and support your choice.
Implementation: Briefly (1 or 2 sentences are sufficient) present how the plan would be implemented. This tests the viability of the choice. For example, your plan would demonstrate that the company has the people, financial resources and time to implement your recommendation.

These bullets should appear in your paper. The following is a precise format for the Case Study.

Formatting for Executive Summary:

Single-space
One inch all margins
Use bullet points, lists, or other means to convey information briefly. Further explanation can be found in the main body of the report.
Use headings and subheadings to organize the material in an easy to read and understandable manner that highlights the essential points of your analysis.
Do not include a summary or overview of the firm in your report. The Board of Directors are knowledgeable and need no background presented.

The body of your paper should be in standard APA format, double-spaced, with appropriate references, but not exceeding five pages. You may attach Appendices for tables, charts, anything useful that is referred to in body of the case report.

Remember that cases are graded per the rubric. The Case Study rubric can be found here or in the in the Course Instruction Tab and should be added at the end of your submission.

Case Study Preparation

The preparation of the case in this course is different than the cases you have written in the past. These will require substantial investigation into case company’s strategies, competitive positions and actions, problems being faced, the company financials, ratios and trends. The case study is about a real company’s current position in the industry, the external competitive environment, the current strategies being used, and recommendations for strategies the company should use going forward. The case should identify a problem faced by the company, using the strategic management tools highlighted in the text and a quantitative analysis. You then generate realistic solutions, evaluate and select one, and then provide recommendations and the timeline to implement your recommendations. Remember that you are working to understand the company’s current strategy and future direction that offers a solution to the problem of meeting the company’s shareholder requirements. Again, remember that you are fulfilling the requirements of the rubric for the cases.

By analogy, in the BSG you have a set of prescribed goals to attain and a set of reports issued weekly to assist you in understanding how your company is doing relative to the competition and giving you an opportunity to revise your operational plans for the next period. However, in the Vail Resortss case you have to look at a company’s performance over the past few years and understand how their performance is changing and identify underlying problems. You are to identify trends in performance, problem areas, and how the company is performing using all of the tools that you have learned throughout your MBA program. Remember that you are working to meet or exceed the shareholder expectations.

The perspective for your report analysis should be directed to the company’s Board of Directors (BoD). Remember that the BoD is familiar with the company’s history, its management structure and the strategies deployed in the past. Recycling old history about the formation of the company, its previous management, etc. will not be looked upon favorably by the BOD (or your instructor). Remember that your case study must be brought up to date with the most current 10K report or financial information. Get at the critical issues and report on them. Remember that in business, situations do not come with a set of questions. The questions sometimes have to be generated and then researched to find solutions to those questions. Success in the case is important to your final grade in that the case constitutes 10% of your course grade.

Vail Resorts Individual Case

The case will build on previous work in the course so your report will include:

Analyzing the internal environment (Chapter 3)
Analyzing the external environment (Chapter 4) and a few more considerations from the later chapters.
More comprehensive examination of the financial situation of the company (Chapter 4)
Consideration of other strategy choices (Chapter 6), or competing internationally (Chapter 7) or adding a diversification strategy (Chapter 8).

With your knowledge of these later chapters, your strategic recommendation for Vail Resortss can be more sophisticated than the basic five generic business strategies. Use the material in Chapters 6 -9 to develop strategic solutions that can involve global expansion, mergers and acquisitions, alliances, backward or forward integration.

For the financial analysis:

Present one or more ratios to represent each of the four areas of financial analysis:

Profitability (more than Gross Profit Margin)

Liquidity

Leverage (what I call Risk)

Activity (what I call Efficiency)

Then, present a minimum ½ page discussion of the company’s financial situation, using ratios to evaluate the company’s profitability, liquidity, leverage and activity.

Of course, most of these ratios are meaningless by themselves; they only have meaning as a comparison. You must therefore compare the Vail Resortss ratios to one of three choices:

Where the company is now versus where it has been over time (last two years), or
The industry averages for the ratios, or
A significant rival’s ratios

The ratios and financial information should be in the Appendix so you have all the five pages of the report for your analysis and recommendation. The financial analysis should be a significant part of your internal analysis – What could be more important about a company’s strengths and weaknesses?

You are a consultant hired by the executive leadership of Vail Resortss’s. Based on your analysis, you recommend to the company’s leadership what they should do strategically. Then, support your strategic recommendation. Why is it the best solution to the significant problem you have identified? Your recommendation should have as foundation at least 1-2 internal factors and at least 1 -2 external factors. You can mix and match – what strengths should Vail Resortss’s use to take advantage of an opportunity; or what opportunity should they take to solve one of its weaknesses. What strengths could the company use to mitigate a threat; or what weaknesses must the company address so they do not fall victim to the threats facing the industry?

Yes – this is a SWOT analysis. And the true payoff of SWOT analysis is learning enough to develop a strong strategic approach to gaining competitive advantage.

Rubric

Performance Criteria

Basic

Developing

Proficient

Accomplished

Exemplary

States Problem Effectively

Does not identify the problem.

(0 pts)

Identifies a symptom.

(4 pts)

Identifies a significant problem.

(6 pts)

Identifies a critical problem.

(8pts)

Effectively identifies the crucial problem

(10pts)

Analyzes the Situation using Tools and Concepts of Strategic Management

Does not present analysis.

(0 pts)

Vaguely analyzes material.

(12 pts)

Generally analyzes the situation.

(16 pts)

Analyzes some key strategic factors.

(24 pts)

Insightfully analyzes key strategic factors.

(30 pts)

Analyzes Quantitative Factors

Does not present quantitative analysis.

(0 pts)

Presents irrelevant quantitative analysis.

(4pts)

Generally analyzes the situation.
(6 pts)

Analyzes some key quantitative measures.

(8pts)

Insightfully analyzes key quantitative measures.

(10pts)

Generates Realistic Strategic alternative Solutions

Provides no realistic strategic solutions.

(0 pts)

Provides ambiguous strategic solutions.

(4 pts)

Provides strategic solutions.

(6 pts)

Provides realistic strategic solutions.

(8 pts)

Provides realistic strategic solutions related to the problem.

(10 pts)

Evaluates Solutions/Selects Optimal

Selects without evaluation.

(0pts)

Selects with little evaluation.

(8 pts)

Evaluates alternatives and selects one.

(12 pts)

Evaluates alternatives and explains rationale for selection.

(16pts)

Evaluates alternatives, provides rationale, and selects optimal Strategic solution for the main problem.

(20 pts)

Generates an Implementation Plan

Provides no plan.

(0pt)

Provides cursory plan.

(4 pts)

Provides an implementation plan.

(6 pts)

Provides realistic implementation plan.

(8pts)

Provides implementation plan considering major factors.

(10 pts)

Writes at the Graduate Level

Does not use designated format or standard.

(0 pt)

Uses designated format, but does not write clearly or in an organized fashion.

(4 pts)

Uses designated format, style, grammar, punctuation, and references.

(6 pts)

Uses designated format and writes at the graduate level.

(8 pts)

Uses designated format and writes at the publishable level.

(10 pts)

tho07361_case25_C363-C374.indd 363 01/08/24 11:17 AM

VAIL RESORTS’ FAMILY
OF WINTER RESORTS
VR’s family of winter resorts includes (a) 10 North
American year-round destination facilities, (b) 24
regional “urban” winter resorts located near major
U.S. cities, which combine to form a feeder system for
customer visits to its more remote destination resorts,
and (c) a growing list of global destination resorts
located in Australia and Switzerland. Locations of
the facilities are shown in Exhibit 1.

The firm’s North American destination resorts
included combinations of owned properties (mostly
in the villages) and long-term leases from both the
U.S. Forest Service and private landowners for
the mountain ski terrain. All these sites included
centrally located retail and commercial structures
contained in “ski-in ski-out” villages, embossed with
quaint hotels and hotel/convention centers, some
golf courses, and other unique entertainment facili-
ties. Each resort was different in theme and atmo-
sphere, but all ascribe to Vail Resorts’ reputation for
quality service, all-season excellence, and trademark
in providing a unique upscale experience to discern-
ing vacationers.

The firm’s marquis resort was Vail, known by its
slogan: “Like Nowhere Else on Earth.” The resort

Vail Resorts, Inc. in 2023

Herman L. Boschken
San Jose State University

Vail Resorts (VR) celebrated its 60th
anniversary season in 2022 and had achieved
an esteemed reputation and commanding

presence in the North American winter resort indus-
try. But, in some ways, the company was approach-
ing a crossroads in both strategy and context. Unlike
the earlier years when linear growth pursuits were the
norm, VR was facing new and more difficult choices,
many posing significant conflicts in resort activities
and tradeoffs in corporate strategic direction.

Vail Resorts was also facing some difficult indus-
try and environmental challenges that had been
evolving for several years. The most significant of
these included and aging U.S. population leading to
decreased demand for skiing and a growing number
of injuries on the slopes originating from the reck-
lessness of some snowboarders. In addition, industry
rivals were upping the ante by bringing forth stun-
ning new designs and making vast new investments
in on-mountain and village facilities. Several consoli-
dations and mergers had reduced the field of large
multiresort providers to the Big Four—Vail Resorts,
Aspen Skiing Company (SKICO), Alterra, and
POWDR. Also of concern were climate effects on
production and maintenance of resort ski operations,
as well as feeding longer term variability and uncer-
tainty in skier expectations.

Going into the 2023–2024 ski season, Vail
Resorts would continue to focus on the implementa-
tion of its strategy to best sustain its position in the
North American winter resort industry.

CASE 25

Copyright 2023 by Herman L. Boschken. All rights reserved. This case
was originally developed in cooperation with the senior management of
Vail Resorts, Inc.

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C-364 PART 2 Cases in Crafting and Executing Strategy

EXHIBIT 1 Vail Resorts’ Family of Ski Resorts

Region Resort

Pacific Northwest Whistler Blackcom
Stevens Pass

Tahoe Heavenly
Northstar
Kirkwood

Rockies Park City
Crested Butte
Beaver Creek
Vail
Breckenridge
Keystone

Northeast Stowe
Attitash
Wildcat
Mount Sunapee
Croched Mountain
Okemo
Mount Snow
Hunter Mountain

Mid-Atlantic Jack Frost
Big Boulder
Roundtop
Whitetail
Liberty Mountain

Midwest Alpine Valley
Brandywine
Boston Mills
Mad River Mountain
Mt. Brighton
Paoli Peaks
Wilmot
Hidden Valley
Afton Alps
Snow Creek

Australia Perisher
Falls Creek
Hotham

Source: Vail Resorts, Inc., 2021 10-K Report

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CASE 25 Vail Resorts, Inc. in 2023 C-365

1,800 acres of skiable terrain with exceptional variety
for families having different levels of skiing ability. Its
“Birds of Prey” downhill course was recognized by
World-Cup skiers as the most challenging in North
America. Its 250-acre McCoy Park offers gentle-
sloping terrain, dedicated exclusively to beginner and
low-intermediate skiers.

Located off I-70, about an hour east of Vail
and Beaver Creek along the Continental Divide,
are VR’s other two Colorado destination facilities.
Opening as a ski resort in 1961, the largest of these
was Breckenridge, consisting of a vast range of tree-
less peaks anchored by a historical western mining
town. Although slightly rebranded to fit VR’s multi-
generational family clientele, this resort community’s
reputation had emphasized the youthful exuberance
of singles and couples seeking an active social life. As
a consequence, it had more bars (totaling over 50)
but fewer restaurants than Vail and over 100 shops.
In addition, the town had a performing-arts theater,
museums, a golf course, and a large convention cen-
ter. It had overnight accommodations for 25,000
people.

The clientele of this historically preserved year-
around resort often cites the unique “sense of place
and fabled Main Street experience” as a prime reason
for coming. Added to the town’s ambiance was a new
“second” village completed in 2010 and situated on
the mountain above the town. It was connected to
the town by an enclosed gondola. Free buses also cir-
culate throughout the resort. The resort’s mountain
contains 2,358 acres of skiable terrain and caters to
all levels of skier proficiency at many of Colorado’s
highest elevations.

VR’s fourth all-season destination resort in
Colorado was Keystone. Like Beaver Creek in origin
and family focus, its off-mountain village facilities
were crafted along meadowland as a free-standing
planned unit development. Opened in 1970, the
resort had steadily expanded over the years but
had acquired a reputation for putting guests close
to nature. Its trademark, “Nature of the Rockies,”
indicates more rustic facilities and accommodations
than VR’s other destination resorts. It contains two
villages—the original Keystone Village and the newer
River Run surrounded by residential areas contain-
ing homes and condominiums.

The resort had accommodations for about 5,000
people and includes about 50 shops and restaurants,
a convention center for 1,800 people, and a PGA golf

was among the three largest single-site ski resorts in
North America. With major design facelifts over the
years, its village nevertheless retains the appearance
and ambiance of a traditional European alpine set-
ting. Paralleling the interstate, the resort provides all
the conveniences of a large rural town. It had two
primary pedestrian-only village centers, connected to
each other and the town’s outer areas (some of which
are four miles up or down the freeway) by a compli-
mentary bus system.

The town of Vail boasted accommodations for
over 30,000 people and contains over 100 restau-
rants and bars, 225 shops and markets, two skating
arenas, outdoor amphitheater, a PGA golf course,
regional hospital, transportation center, schools,
and a library. It was the primary or second home to
professionals and executives from numerous blue-
chip companies, high-tech firms, and Wall Street
investment houses, most representing the “movers
and shakers” of globalization. As a group, this clien-
tele prefers anonymity outside of their professional
careers and had chosen Vail because of the resort’s
relaxed but discrete atmosphere.

The resort had developed over 5,000 skiable
acres within its permitted 12,500-acre terrain. Skiing
was provided on both sides of a seven-mile ridge
paralleling its villages, and in an adjacent back-bowl
called Blue Ski Basin. Vertical drop (a measure of
terrain steepness and ski-run length) was 3,450 feet
and the longest run was 4.5 miles.

Ten miles west of Vail and located three miles off
the interstate was the firm’s smaller but most upscale
Colorado resort, Beaver Creek. The resort actually
contains three separate villages at different points
along the base of the mountain. Originally conceived
as Colorado’s location for the 1976 Olympics (which
was aborted by a state referendum), the core village
opened in 1980 as a state-of-the-art CAD-designed
facility with European alpine elegance and environ-
mental sophistication tucked into a tiny valley and
meadow.

With emphasis on exclusivity, first-class accom-
modations, and “family friendliness,” the resort
sports over 25 restaurants, 70 shops, an outdoor ice-
skating arena, the Hyatt Regency and Conference
Center, the Vilar Performing Arts Center, a
Ritz-Carlton, and overnight capacity for 6,000 people
(more accommodations are available in the town of
Avon, about three miles down mountain from Beaver
Creek). On the mountain, Beaver Creek provides

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C-366 PART 2 Cases in Crafting and Executing Strategy

Nevertheless, unlike most of the other overlap-
ping segments of leisure, recreation and entertain-
ment, the ski resort industry segment (esp. NAICS
721110 and 713920) had faced strong headwinds.
As reflected in Exhibit 2, the long-term trend in
customer demand, as measured by U.S. skier/
snowboarder visits per day, had been persistently flat
for more than two decades. Within regions where VR
had destination facilities, the trends mostly reflect
the flattening nationwide demand. Even During the
initial two years of the COVID pandemic, demand
varied downward temporarily and then recovered by
2022 to its long-term flat demand levels.

Traditionally, customers in the destination
recreational-resort industry (of which skiing was but
one subtype) have been distinguished in the popula-
tion by income, age, and family status (i.e., married/
unmarried, with/without children). These factors
often differentiated people inclined toward large
scale or mass recreational services coupled with
lesser expensive accommodations (like the destina-
tion profile of Disney World) from people seeking a
more exclusive and intimate resort setting featuring
high-value or high-status vacation venues (like those
provided by VR’s destination resorts).

In the case of destination ski resorts, a greater
variety of demographic factors was weighing-in as
determinants of customer demand during the first
two decades of the 21st century. In addition to
traditional ones mentioned above, more recent fac-
tors included age distribution (generational dynam-
ics), education level attained (i.e., college degree vs.
nondegree), occupational status (i.e., professional/

course. Additional housing and amenities are located
about two miles away in the town of Dillon. With
3,148 acres of skiable terrain, Keystone developed
its ski mountain with an emphasis on intermediate
skiers but provided skier access to very steep ter-
rain at an adjacent ski area not owned by VR, called
Arapahoe Basin.

THE WINTER RESORT
INDUSTRY
With an emphasis on skiing and mountain recreation,
Vail Resorts operates its core business primarily in
the “destination” segment of the recreation-resort
industry. As part of the sprawling leisure, recreation
and entertainment industry (i.e., NAICS 71 and 72,
esp. 713, and 721), this destination segment was
itself an agglomeration of subparts having no exact
boundaries. According to the U.S. Department of
Commerce, recreation resorts also overlap other
related industries composed of such segments
as amusement parks (e.g., Disney), gaming (e.g.,
Harrah’s Entertainment), cruises (e.g., Carnival/
Princess Cruise Lines), and sporting events (e.g., the
NFL and NBA). In this ill-defined setting, competi-
tion therefore includes a vast assemblage of directly
competing and partially substitutable products and
services. Moreover, with loosely segmented markets,
strategic opportunities tend to be more elusive and
potentially conflicting in that they consist of differ-
ent but partially overlapping customer profiles and
product-market relationships.

1998/99

1999/00

2000/0

2001/0

2002/03

2003/04

2004/05

2005/06

2006/07

2007/0
8

2008/09

2009/10

2010
/11

2011/
12

2012/13

2013/14

2014/15

2015/16

2016/17

2017/
18

2018/19

2019/20

2020/21

2021/2
2

10
20
30
40
50
60
70

TOT US ROCKY MTN PACIFIC WEST

EXHIBIT 2 Annual U.S. Skier/Snowboarder Visits, 1997–2022 (in millions)

Data Source: National Ski Areas Association, Vail Resorts

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CASE 25 Vail Resorts, Inc. in 2023 C-367

the structure of competition already had been chang-
ing in dramatic ways. For example, a shift had taken
place from a market environment ruled by year- over-
year growth in skier demand and positive-sum behav-
ior among industry competitors, to one dominated
by flat demand, zero-sum gaming, and strategic alli-
ances pertaining to jointly-sponsored ski-lift passes,
which in 2022, was extended to several European
partnerships.

While competitors continued to devise pro-
grams to grow the overall-industry skier population,
most recognized their dependency on such tactics
described by VR as “attracting skiers away from
other ski resorts, fending off competitors offering
non-ski alternatives, generating loyalty incentives to
attract more revenue per skier-visits, or encouraging
more visits from each skier.” This zero-sum mindset
created what VR’s president called an “arms race”
among firms in developing on-mountain facilities,
new village venues, social-media technologies, and
skier incentive programs.

Adding to these factors was an evolving bifur-
cation of ski industry players, partly as a result of
maturing demand. For those with limited access
to capital, developing off-mountain amenities and
overnight accommodations was sacrificed to favor
on- mountain infrastructure development, such as
high-speed chair lifts, enclosed gondolas and snow-
making equipment. As a result, most of these “old
school” players became distinguished as “windshield”
resorts, principally providing day-use ski slopes with
few on-site accommodations, and usually requiring a
same-day round-trip drive from an urban home.

For resorts with deep pockets, like VR, invest-
ment in new elegant European-style villages with
“ski-in ski-out” access transformed their sites to “des-
tination resorts,” providing a complete recreation
and entertainment experience, including upscale
accommodations and “apre-skiing” activities for
people who typically fly in to stay a week or longer.
Extending upon this distinction, most of the better-
financed destination resorts also had been shifting
since the 2010s from a ski-resort image to an inte-
grated “all-season” setting, featuring winter recre-
ation as well as golf and tennis, on-mountain summer
activities, convention venues, world-class performing
arts, and international festivals.

The latest entry in this new 21st century
approach had been Palisades (formerly Squaw
Valley/Alpine), which in 2011 was sold to KSL

managerial employment vs. blue-collar/clerical jobs),
lifestyle and other psychographic characteristics
(e.g., cosmopolitan versus parochial awareness), and
family makeup (i.e., singles/couples versus families).

In the instance of age distribution, the effects
of generational evolution pose especially difficult
strategic questions going forward. Historically, ski-
ing demand and age have been correlated, with peak
skiing interest occurring among people between 18
and 45. Hence, an aging population of post-war Baby
Boomers (now mostly in their mid-60s) and late
middle-age Gen Xers were thought to be a primary
cause of the industry’s maturing demand. However, a
secondary cause can also be attributed to less physi-
cally active and less financially secure Millennials
(ages 27 to 42 in 2023), who are currently the natural
replacement stock for today’s aging skier population.
As an age group, it may be too early to predict the
impact of Gen Z.

Skiing is a rigorous and potentially dangerous
outdoor recreational activity and requires physical
stamina and a dose of youthful abandon. As baby
boomers move into their senior years and family
responsibilities become more important in determin-
ing types of vacation venues, skiing’s reputation as an
expensive, singles-oriented and physically demanding
sport may be coming up short when matching it with
future demand profiles. Many former skiers and the
like have been moving to other segments of the vaca-
tion and leisure industry where less physical activity
was required.

Competition Among Winter
Resorts in North America
In 2023, there were about 760 ski areas in North
America of which 462 were located in the U.S. Most
were small day-use “windshield” operations located
near metropolitan areas. The rest, fewer than 30,
could be classified as destination resorts. In com-
bined industry figures (both windshield and destina-
tion) for the 2021–22 season, the United States had
60.7 million skier visits, and for all of North America,
the total was 80.0 million. VR’s share of these totals
was 25.3 percent and 19.5 percent, respectively.

Looking forward, interaction among industry
rivals (especially in contriving new winter experi-
ences and imagining new customer profiles), was
likely to intensify competition and keep the winter
resort industry in flux. Indeed, by the mid-2000s,

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C-368 PART 2 Cases in Crafting and Executing Strategy

single-resort operators. Vail Resorts was the largest
player on the Pacific, holding 25.4 percent of the
region’s 11.6 million skier visits, but more than 60
percent of its destination visits in the 2021–22 sea-
son. Direct competitors in the California destina-
tion ski resort market included Palisades Tahoe and
Mammoth Mountain (both owned by Alterra).

The current market structure of destination ski-
resort competitors came about in the years between
2005 and 2020, when a rash of consolidations and
mergers reduced the field to a new “big four” (VR,
Alterra, SKICO, and POWDR) and a few small
specialized firms. Due to mismanagement and over-
spending on development projects during the first
decade of the 2000s, one firm (American Ski) was
reduced to a small player, another (Intrawest) was
forced into bankruptcy and subsequently acquired
by Alterra, and another previously smaller firm
(POWDR Corp) entered the “Big 4” elite standing.
POWDR subsequently lost its major assets in Park
City to VR, leaving the industry’s market power
mostly to VR and newcomer Alterra (the SKICO/
KSL joint venture). With few exceptions, other firms
that remain outside the big-four are operators of
day-use windshield resorts, which have lower capital
costs and offer few off-mountain amenities, activities
and accommodations. Exceptions to this included
destination providers Sinclair Oil (Sun Valley, Idaho)
and Telluride Ski and Golf.

Consolidation and Increasing Rivalry
in the Winter Resorts Industry
During this period of industry consolidation, the
technology-driven “arms race” in new capital-
vintensive development sharpened the destination
focus on such areas as (1) thematically planned vil-
lages at the ski-mountain base, (2) costly snowmak-
ing equipment to guarantee visitors a quality skiing
experience regardless of the vagaries of natural pre-
cipitation, (3) luxurious on-mountain restaurants to
meet the cosmopolitan tastes of “high-end” skiers,
and (4) mountaintop nonski recreation parks for
tubing, ski biking, and other variant outdoor recre-
ational activities.

However, even with these significant arms-race
investments, the skier destination segment was not
experiencing a corresponding response from the
demand side of the market. Indeed, most of the big-
four firms (and smaller ones as well) were showing

Partners (owned in part by former VR executives).
With a well-publicized “retro-fit” strategy designed to
join the “world class” destination market, KSL subse-
quently formed a joint venture with Aspen’s SKICO
to create a new firm called Alterra. By late 2016, the
resort had received final government approvals for
a massive $1 billion redevelopment with a 25-year
build-out horizon. Focus of the makeover was on
(1) connecting the previously separate resorts with a
high-speed aerial tram, completed in 2022 and (2) a
village expansion from 15 acres currently to over 100
acres, with visions of many new accommodations and
entertainment venues. Phase 1 of the new Palisades
was opened during the 2022–2023 ski season.

In contrast to windshield resorts which are ubiq-
uitous across North America and make up most of
the ski industry in site numbers and skier visits, the
destination ski industry was more geographically
confined to four “production” areas. These included
the Rocky Mountains (Colorado, Utah, Idaho, and
Montana), the California Sierras, southern Canada,
and New England (especially Vermont and Maine).
With destination resorts having the most market
reach demographically and geographically, the
Rockies claim to be the location of the best known
and most visited because of its central and scenic
locations, situated between population corridors on
the east and west coasts.

Within the Rocky Mountain region, Vail Resorts
held a 32.3 percent market share of the 25.3 million
skier visits (combined destination and windshield) in
the 2021–22 ski season. In the Colorado subset, VR
accumulated more than a 50 percent share of the des-
tination skier market, competing with the Aspen Ski
Company (aka SKICO, which owned the Aspen-3
mountains and Snowmass, all proximally located in
the Roaring Forks Valley), Alterra (which owned
Steamboat and managed Winter Park), POWDR
(which owned Copper), and several smaller destina-
tion operators, such as Telluride Golf & Ski. In the
Utah subset, VR held the vast majority of the destina-
tion market with its Park City/Canons complex.

Beyond Colorado, the “big four” destination-
resort firms held widely distributed operations, with
most located in the Rockies, Pacific Northwest,
the California Sierras, Northeastern U.S., and
in Southern Canada (mostly Quebec and British
Columbia). On the Pacific Coast, ski resorts draw
fewer out-of-state destination visitors than Colorado,
and industry competition tended to include smaller

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CASE 25 Vail Resorts, Inc. in 2023 C-369

To a great extent, the firm’s persistent market
dominance was attributable to the fact that VR was the
only firm in the industry able to achieve a “cooperative”
administrative control over all aspects of its destination
resort context (i.e., mountain activities, local accom-
modations, village concessions, entertainment venues,
airline and ground transportation), even though much
of it was owned or managed by a host of other firms
acting as an integrated network of “co- producers.” As a
result of its management of these multiple-partner stra-
tegic alliances, VR stands out among its competition
in creating a superbly- packaged seamless destination
product for the customer. Increasingly, its peripheral
feeder system of urban resorts was adding value as well
to the EPIC whole.

In addition to its domestic-market skiers, Vail
Resorts was also looking to global markets as an
important source of new growth. Although 80 per-
cent of the world’s skiers live outside the United
States (mainly in Canada, Europe, Oceania, Japan,
parts of South America, and increasingly China), the
firm’s customer mix typically includes only about
12 percent foreign visitors. Since the turn of the cen-
tury, VR pursued an ongoing but as yet unfulfilled
goal of raising that figure to 15 percent.

The firm’s global reach was marked by three
of its resorts hosting past Winter Olympics.

continuing decline and further pressure to consoli-
date. In the case of VR, the flat market conditions
would also have likely stunted its growth potential
had it not been for the firm’s acquisitions and promo-
tion programs, especially its EPIC program. Indeed,
the VR threat of preeminence in this period of stag-
nating demand and intensified rivalry led Alterra to
introduce IKON to mimic the enlarged product-line
image of VR’s EPIC.

Moreover, destination-resort visitors were
becoming choosier about the price-to-value of individ-
ual resorts. It had become clear that most destination
visitors sought additional “creature comforts” both
on and off the mountain, and were willing to pay for
exceptional luxury where quality was assured. VR’s
industry leadership in moving toward this high-end
market was reflected in Exhibit 3, which compares
a selection of destination-resorts according to each
resort’s annual skier visits during the 2021–2022
ski season (calculated as one skier or snowboarder
purchasing a lift ticket for one day). Consistent with
this data, most of VR’s resorts have ranked for many
years in the industry’s top 10 by annual ski magazine
surveys. Upon the firm’s acquisitions in 2017 of Park
City and then of Whistler, VR solidified its position
in holding the three most popular destination ski
resorts in North America.

WHISTLE
R (V

PA
RK CTY (V

VAIL
MTN (V

BREKNRDG (V
R)

MAMMOTH (A
LT

ERRA)

KEYSTO
NE (V

BEAVER CRK (V
R)

WIN
TER PA

RK (A
LT

ERRA)

COPPER (P
OWDR)

HEAVENLY
(V

STEAMBOAT (A
LT

ERRA)

PA
LIS

ADES (A
LT

ERRA)

NORTHSTA
R (V

SNOMASS (S
KICO)

ASPEN/3 (S
KICO)

TELL
URIDE (T

G&S)

SUN VLY
(S

IN
CLA

IR)

KIRKWOOD (V
R)

CRESTED BUTTE (V
R)

0.5

1.5

2.5

EXHIBIT 3 Most Visited Destination Ski Resorts in North America, 2021–2022
Season (Annual Skier/Snowboarder Visits, in millions)

Data Source: National Ski Areas Association, Individual Resorts.

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C-370 PART 2 Cases in Crafting and Executing Strategy

Much of the public’s awareness of a human-
altered and degraded environment came from indi-
vidual experiences and personal knowledge of losses
in biodiversity, growing pollution and threats of
global warming. But some attention was also height-
ened by protests made directly against targeted firms,
some involving “eco-terrorism.” Most in the industry
have been the subject of environmental litigation,
varying degrees of non-violent demonstrations and
media attention.

VAIL RESORTS’ STRATEGY
AND PERFORMANCE
Vail Resorts’ mission recognized the linkage between
employees and the guest experience and stated “Our
mission is simple—to create the experience of a life-
time for our employees, so they can, in turn, provide
exceptional experiences for our guests. Along with
this declaration, five policy guidelines drove the
firm’s strategic-action agenda:

1. Create new attractions to enhance consumer
appeal.

2. Broaden VR’s participation in varied guest experi-
ences (produce more services previously provided
by co-producers).

3. Provide value through our passion for quality.
4. Leverage our strong market position.
5. Capitalize on industry consolidation

opportunities.

Nearly all of these alluded to a need for new ways
to improve integration of resort services and a devel-
opment strategy involving significant on-mountain
expansion and new venturing in the firm’s destina-
tion ski-in/ski-out villages. Succeeding Aron in 2006,
CEO Katz continued to reaffirm and embellish this
action agenda. Indeed, much of this agenda remains
intact going into the 2020s.

Financial performance
Vail Resorts was a mid-size corporation with
$6.3 billion in assets and annual revenues of
$2.5 billion in 2022—see Exhibit 4. The firm reports
results according to three market segments it

Augmenting this world status, it maintains an aggres-
sive international marketing program. In part, VR
expedites this program by annually hosting one
or more of the several World Cup ski events held
throughout the world. In addition, it had managed
to acquire the rights about once a decade as the
exclusive host of the World Ski Championships,
which culminates the World Cup series every two
years and was the worldwide equivalent to football’s
Super Bowl. Most recently, VR hosted the 2016
Championships at Vail and Beaver Creek, and fol-
lowed this event with a worldwide “prestige and pro-
motion” campaign promoting its North American
destination resorts. Going forward, growth potential
in international demand may come more from Asia
(especially China) than from its historical draw in
the Western Hemisphere.

The effort to promote its global markets, how-
ever, was partially blunted by continuing terrorist con-
cerns worldwide and subsequent stringent security
measures following September 11, 2001. The rise of
global terrorism served not only to create resistance
from a foreign market but also to cause a restructur-
ing of destination ski-resort competition. In addition,
the more recent COVID pandemic terrorism and gun
violence added uncertainties to international travel
and further resistance to intercontinental jaunts. The
long-term outlook for a worldwide market demand
remains unclear, partially due to these factors but
also due to employment-based service disruptions,
continually fluctuating foreign exchange rates, and
persistent “nationalist” issues in a nascent global
economy.

In addition to the industry characteristics
described above, the ski resort business also had
become more complex due to a growing environ-
mental ethic among recreation and leisure customers
concerned about biodiversity and ecological sus-
tainability. Since landmark legislation in the 1970s,
environmental awareness had not only become insti-
tutionalized (by the inception of new laws, organiza-
tions and processes), but also acquired much broader
appeal culturally, especially among younger people.
The impact of respectability for environmental sus-
tainability was especially felt by firms dealing with
or affecting natural resources, a prime example of
which are ski-resort operators.

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CASE 25 Vail Resorts, Inc. in 2023 C-371

EXHIBIT 4 Selected Financial Data for Vail Resorts, Inc., 2000, 2005, 2010,
2015, 2018–2022 ($ in millions, except per share data)

Fiscal Year Ended July 31: 2022 2021 2020 2019 2018 2015 2010 2005 2000

Statement of Operations:

Revenue

From Mountain $ 2,213.1 $ 1,689.9 $ 1,710.4 $ 1,956.2 $ 1,722.9 $ 1,104.0 $ 638.5 $ 540.9 $ 373.8

From Lodging 312.1 218.1 248.4 314.7 284.6 254.6 195.3 196.4 116.6

From Real Estate 0.7 1.8 4.8 0.7 4.0 41.3 61.0 72.8 48.7

Total Revenue 2,525.9 1,909.7 1,963.7 2,271.6 2,011.6 1,400.0 894.8 810.1 531.1

Operating Expenses
(excl. D&A)

For Mountain 1,181.0 1,146.2 1,212.1 1,279.6 1,132.8 777.1 456.0 392.0 284.1

For Lodging 509.9 223.8 245.1 289.6 259.6 232.9 192.9 177.5 103.6

For Real Estate 5.9 6.7 9.2 5.6 3.5 48.4 71.4 58.3 42.1

Total Operating
Expenses 1,696.8 1,376.7 1,466.4 1,571.7 1,396.0 1,058.4 720.3 627.8 298.8

Net Operating Income $ 829.1 $ 533.0 $ 497.3 $ 699.9 $ 615.6 $ 341.6 $ 174.5 $ 182.3 $ 101.3

Gross Operating Margin

For Mountain 46.6% 32.2% 29.1% 34.6% 34.2% 29.6% 28.5% 27.5% 24.0%

For Lodging 0.0% (0.1)% 0.0% 8.0% 8.8% 8.5% 1.2% 9.6% 11.1%

For Real Estate (742.9)% (272.2)% (91.6)% (700.0)% 12.5% (17.2)% (17.0)% 19.9% 13.6%

Net Income $368.3 $124.5 $109.1 $323.5 $401.3 $114.8 $30.4 $23.1 $10.0

Annual Capital Expenditures
(Operations) $193 $115 $172 $192 $141 $124 $130 $80 $57

Cash Flows

Net Cash From
Operations $710.5 $525.3 $395.0 $634.2 $551.6 $303.7 $36.0 $148.2 $110.7

Net Cash Increase/
(Decrease) $(132.5) $856.5 $283.7 $(66.7) $60.8 $(8.9) $(54.6) $90.3 $(9.5)

Balance Sheet Data

Total Assets $6,318.0 $6,251.1 $5,244.2 $4,426.1 $4,065.0 $2,487.3 $1,922.8 $1,525.9 $1,135.6

Long-Term Debt 2,670.3 2,850.3 2,450.8 1,576.3 1,272.7 814.5 526.7 521.7 394.2

Stockholders’ Equity 1,612.4 1,594.6 1,316.7 1,500.6 1,589.4 866.6 788.8 540.5 475.8

(continued )

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C-372 PART 2 Cases in Crafting and Executing Strategy

Fiscal Year Ended July 31: 2022 2021 2020 2019 2018 2015 2010 2005 2000

CEO Monetized Compensation
(salary + other comp, in $000)

Adam Aron, CEO
(1997–2006) – – – – – – – $ 1,848.6 $ 686.3

Rob Katz, CEO
(2007–2021) – $ 3,814.8 $ 2,789.9 $ 3,624.7 $ 7,995.0 $ 5,344.4 $ 2,999.4 – –

Kirsten Lynch
(since Nov. 2021) $ 6,610.0 – – – – – – – –

Average Stock Price
Per Share $240 $315 $212 $218 $250 $109 $43 $24 $23

Cash Dividend Per Share $5.58 none $5.28 $6.46 $5.05 $2.08 none none none

Data Source: Vail Resorts Annual 10-K Reports, 2000–2022.

identifies as mountain, lodging, and real estate. Its 10
destination resorts account for more than 80 percent
of VR’s revenues, with the remainder sourced from
its 24 urban windshield resorts, its three Australian
winter-destination resorts, and the Grand Tetons
Summer Resort. Its most recent acquisition in the
Swiss Alps occurred late in 2022, and therefore
financial results for it that year were not reported.

The firm’s financial results are greatly attribut-
able to management’s long-term strategic choices,
as well as dynamic market conditions and growing
weather uncertainties. Nevertheless, total revenues
have improved more than five-fold over the last
two decades, due principally to robust on-mountain
sources as well as (1) the addition of new sources
of off-mountain operating revenues (especially lodg-
ing), (2) the initiation of summer-season activities
(reflecting movement to an “all-season” strategy),
and (3) success of its EPIC program in integrating
VR’s customer image across its destination resorts
and its North American feeder-network of urban
windshield resorts.

Regarding a desire to spread financial risk, VR
continues to diversify its product line. Historically,
more than 95 percent of its revenues came from
the five-month ski season. With implementation
of its “all-season” strategy at its various ski resorts
and expansion of activities at summer resorts like its
Grand Tetons facilities, the winter contribution had
been reduced to about 70 percent of total operating
sources.

Although real estate sales make little direct con-
tribution to VR’s total revenues, they nevertheless are

important to the firm’s growth strategy because they
feed future resort revenues by expanding the visitor bed
base (especially from rental units known as “hot beds”).
As a destination-resort provider, the firm depends on
growth in total capacity of overnight accommoda-
tions and the occupancy rate. The hot-bed concept
encourages rentals which maximize occupancy with-
out requiring the resort owner to put up capital for bed
capacity. VR’s lodging control was maintained instead
by dominating the guest reservation and hospitality
systems which it operates on a fee basis.

For public firms, a comprehensive indicator of
managerial success in implementing a well-designed
strategy was usually found in the firm’s long-term
stock price. In VR’s case, the picture had been an
evolving work-in-progress, as shown in Exhibit 8.
During the formative years of Aron’s term as CEO,
the firm designed much of the substance of its strat-
egy that remains in place today. However, it wasn’t
until Katz took it to the next level, integrating all the
pieces which Aron had put in play, that the results
became publically recognized. Hence, the stock’s
current price, representing an eight-fold increase
since 2010 was best understood as a reflection of
their dual efforts.

STRATEGY IMPLEMENTATION
AT VAIL RESORTS
With Vail Resorts’ commitment in the mid-2000s
to an all-season growth strategy, the ensuing years
unleashed a cascade of managerial events and

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CASE 25 Vail Resorts, Inc. in 2023 C-373

Over the years, the progression of reorganiza-
tions created new corporate needs and expectations
in human resource management. Driving these was
the adoption of a new personnel credo:

At Vail Resorts, we believe in Customer-Focused
Teamwork striving to Continuously Improve our
Process Management skills through Fact-Based
Decision Making to Enhance Customer Satisfaction
and Retention and Shareholder Value (i.e., company
profits).

As part of implementing this managerial credo,
the firm engaged in ongoing talent searches for more
and different professional expertise, which would
require new approaches to motivating, retaining, and
directing the best managerial employees. In recent
years, the firm would also make dramatic improve-
ments in employee productivity at both management
and nonmanagement levels. To control the more
complex information flows, VR created a new posi-
tion of chief information officer, which oversees
MIS, web design, and the firm’s cyber-technology
subsidiary, called RTP.

VAIL RESORTS IN MID-2023
Over the last decade, however, the substantial corpo-
rate growth came with a “changing of the old guard.”
Attendant with CEO Aron’s departure in 2006, other
key executives also moved on, including Daly, the
firm’s original president (who went on to become a
two-term mayor of the Town of Vail), one COO (lost
to Telluride), several presidents of the Mountain
Segment, one vice president of Vail operations (lost
to KSL), three corporate CFOs (not counting one
lateral transfer), four marketing vice presidents, three
heads of lodging, and countless numbers of less
senior executives. In 2006, a decision was also made
to sever its corporate-level community ties to the
Vail Valley by relocating its headquarters from Avon
(near Vail) to Broomfield Hills (a Denver suburb).

The Katz leadership team would continue imple-
mentation of much of Aron’s strategy by further
leveraging off its earlier acquisitions, picking the
fruits of industry consolidation, and investing heav-
ily in resort development. Emphasizing continuity
in the firm’s strategy, Katz would ask rhetorically:
“Why Vail Resorts?” On behalf of five stakehold-
ers, he defined as “our guests, our employees, our
communities, our natural environment, and our

consequences. Indeed, the sheer complexity of com-
bining and integrating internal capital investments
and acquisition resources made necessary a massive
reorganization of authority and a huge increase in the
number of employees. Even though happening over 20
years, the changes in scale included a tripling of the
firm’s employment base by 2021. At seasonal peak,
VR employs over 40,200 seasonal people on top of
its permanent year-round employment base of 6,100.

As a result, the original organization structure
progressively underwent a transformation that took
into account the massive increase in the diversity of
new resources, product-markets, managerial cultures,
personalities, and expertise. VR was organized with
a mix of structural forms including functional hierar-
chy, several kinds of divisions, and a partial matrix.
A major accomplishment of the reorganization
was separating management of the ski resorts and
other product lines from general management func-
tions. These production units were then divided into
three activity segments, identified as “Mountain,”
“Lodging,” and “Real Estate.”

To preserve the simultaneous organizational
needs for differentiation of organizational specializa-
tions and integration of authorities engendered by
the firm’s synergistic complexities, three structural
components were put in place. First, at the core of
the business, each ski resort was given a separate pro-
duction authority headed by a chief operating officer
(COO). This meant each had control over the man-
agement detail of designing and operating everything
from grooming schedules, to customer reception
activities, to ski-school programs, to food services,
to purchasing and maintenance. Although market-
ing was shown as a corporate function, the firm uses
a “brand management” scheme built around each
resort operating as a distinct brand within the VR
family of iconic products.

Second, to ensure consistency with Vail Resorts’
overall corporate quality and image, each resort COO
reports to the Mountain Segment vice president, who
acts as a “peak coordinator” in making companywide
policies pertaining to overall corporate production
issues. Third, a partial matrix was set up consisting
of the individual resorts and five corporatewide func-
tions (highlighted on the organization chart in bold).
For example, each resort had a marketing brand
manager who simultaneously reports to their respec-
tive resort COO and to the senior vice-president for
marketing at the corporate level.

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C-374 PART 2 Cases in Crafting and Executing Strategy

agitation and conflict at many of the firm’s 24 feeder
resorts, some observers were wondering whether the
unfinished business of implementing the EPIC strat-
egy lay principally with brand management or with
an entrepreneurial approach to resort operations and
local personnel. Equally concerning was whether the
recent growth had made VR more “corporate” in
focus, and further detached from its “ski town” local
communities.

shareholders,” he reiterated a long-standing theme
of offering extraordinary resorts and exceptional
experiences.

This vision continued into mid-2023 even
though Katz transitioned in 2021 from VR’s CEO
to “Executive Chairperson of the Board,” leaving the
CEO role to his protégé, Kirsten Lynch, who as senior
vice president of marketing, had spearheaded the
firm’s EPIC brand. However, given the considerable

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XXX– Case Study

Executive Summary

Problem Statement

Present a significant problem you have identified after analyzing the situation; it should

be concise and, if not addressed, something that has the potential to prevent the company from

being successful. One sentence is enough. Ask the question “Why” to make sure it is a root

cause and not a symptom of a deeper problem.

Analysis

In this section you present a few points of analysis. Since there are many factors to con-

sider, you would only present here the most significant of the many points of analysis you have

in the full report.

• These factors would be the ones that led to your identification of a significant problem.

• The factors presented here would help a reader understand why your recommendation is the

best.

• For Case One you are dealing only with external analysis – the macro-environment and the

industry.

• For Case Two and Case Three you will be presenting key points of external and internal

(company-related) analysis.

• Using bullet points, color, formatting will make the report more executive reader-friendly.

Alternatives

• Briefly present a possible alternative strategic action the company could take.

• Briefly present another possible alternative strategic action the company could take.

• In some instances, you might even want to present a third alternative

Recommendation

Based on your analysis and the problem you have identified, you will want to present

your recommendation. It will be one of the alternatives above. Then you should add a few

comments as to why it is the best course of action, based on your analysis and the problem. Of

course, your report will have far more detail and explanation – but this page will serve to sum-

marize that lengthier report and justify your recommendation. Remember, you are a consultant

and you must convince your client that you have thoroughly analyzed the situation and are pre-

senting the best course of action.

With a limit of one page to summarize the report, you would want to use most of the

page.

Implementation

Since we do not have access to internal company information, all you can present here

would be a cursory implementation plan. It should at least present material that supports the

viability of your recommendation. You should offer a few words about the company having the

time, the talent and expertise, and the financial resources to follow your recommendation – or

can acquire them.

Nova Southeastern University

H. Wayne Huizenga College of Business and Entrepreneurship

Assignment for Course: MGT-5170: Applying Strategy for Managers

Submitted to: Dr. Jason Cavich

Submitted by:

Date of Submission: April 23, 2023

Title of Assignment: Uber Case

CERTIFICATION OF AUTHORSHIP: I certify that I am the author of this paper and that any assistance I received in its preparation is fully acknowledged and disclosed in the paper. I have also cited any sources from which I used data, ideas of words, whether quoted directly or paraphrased. I also certify that this paper was prepared by me specifically for this course.

Student’s Signatures:

******************************************************************************

Instructor’s Grade on Assignment:

Instructor’s Comments:

Executive Summary

Problem Statement

Uber’s main problem is the ongoing debate and legal issues around how its drivers are classed and whether they should be treated as workers or independent contractors, especially in California with the passage of AB5.

Analysis

· With negative net profit margins and a negative return on assets in 2017 and 2019 and positive net profit margins and return on assets in 2018, Uber’s profitability has fluctuated over the past three years.

· Although Uber has high liquidity ratios, it has become more dependent on debt financing and has not produced enough operating revenue to meet its interest costs.

· Uber’s advantages include a substantial market share in the US, good liquidity ratios, and efficient receivables management.

Weaknesses

are negative net profit margins, large debt-to-equity ratios, and a low return on assets.

Threats

to Uber include ongoing legal challenges over driver classification and cyberattacks, while opportunities include reentering the Southeast Asian market and expanding its food delivery services to include restaurants.

Alternatives

· Enter new markets to increase worldwide reach.

· By starting a food delivery business or providing logistics and courier services, Uber can go beyond only providing ride-hailing services.

· Spend money on R&D to create new technology, such as driverless vehicles or sustainable transportation solutions, and focus on innovation.

Recommendation

The recommended strategy for Uber is to diversify its offerings beyond ride-hailing by branching into new industries like food delivery, logistics, and courier services, to reduce its reliance on the ride-hailing sector and discover new revenue streams.

Implementation

Implementation of the recommended strategy will require investment in research and development, marketing, and customer support for the additional services.

Problem Statement
Uber’s main problem is the ongoing debate and legal issues around how its drivers are classed and whether they should be treated as workers or independent contractors, especially in California with the passage of AB5.

Financial Analysis

According to the examined financial ratios, Uber’s profitability has changed during the last three years. In 2019 and 2017, the company’s net income margin, which measures the profit it makes for every dollar of revenue, was negative, but in 2018, it was positive. The return on assets (ROA) was likewise negative in 2019 and 2017, demonstrating that the business was not using its resources to produce profits. However, the company had a positive return on assets in 2018. These variances in profitability are probably brought on by the company’s significant expenditure on growing operations and advancing technologies.

Uber is in a good situation in terms of liquidity. The company has regularly had a current ratio above 1, indicating that it has adequate current assets to cover its current obligations and its capacity to satisfy its short-term liabilities. Furthermore, the business has increased its working capital, or the sum of money accessible for regular business activities. This demonstrates how well the company is handling its current assets and liabilities. Uber’s leverage ratios, on the other hand, have been inconsistent. Over the previous three years, the company’s reliance on debt financing has increased, as indicated by the debt-to-equity ratio. This suggests that the business depends more on debt financing to fund its operations, which raises the possibility of financial difficulty if it cannot produce enough cash flow to pay off its debts.

The company’s ability to pay interest on its debt has been measured by the times’ interest earned ratio, which has been negative for the last three years. This shows the company is not producing enough operational revenue to cover its interest costs. Uber has maintained a high accounts receivable turnover ratio, showing that the company successfully obtains client payments. The average collection time has constantly been 30 days, which indicates effective receivables management.

Analyzing the Internal Environment

Strengths

· Large market share: Uber has a market share of 74% in the US, while Lyft, its primary competitor, holds 26% of the market (Thorbecke, 2023). Uber’s market share has been increasing while Lyft has been losing them. In 2020, Uber held 62% of the market share, with the remaining 38% held by Lyft (Thorbecke, 2023).

· High liquidity ratios: Uber’s high liquidity ratios is a prominent strength for the company. The company has regularly maintained a current ratio above 1, indicating that it has adequate current assets to cover its current liabilities. Uber’s working capital has increased over the years, demonstrating that it has sufficient current assets to meet its immediate obligations.

Weaknesses

· Negative Net Profit Margin: Uber has repeatedly reported negative net profit margins, with 2019’s lowest performance at –60.13%. This suggests that the business’s expenses exceed its revenue. The business has made significant investments in growth and expansion, which has affected its profitability.

· High Debt-to-Equity Ratio: High Debt-to-Equity Ratio: Over the past three years, Uber’s debt-to-equity ratio has risen, reaching 1.19 in 2019. A high debt-to-equity ratio shows that a business significantly relies on borrowing money to fund its operations, which raises financial risk.

· Negative Return on Assets (ROA): Uber has reported negative ROA in two of the three years examined, with the worst performance coming in 2019 at -26.78%. This suggests that the business is not making enough money from its assets.

Analyzing the External Environment

Opportunities

· Reentering the South East Asian market: In 2018, Uber ceased its operations in several South East Asian countries and sold much of its business to competitors there (Goel, 2018). With less competition and a monopoly in the ride-hailing business due to Uber’s leaving, customers are experiencing subpar service and higher costs (Goel, 2018). Due to its enormous population, expanding middle class, rising use of smartphones, and adoption of electronic payment systems, the Southeast Asian market represents a significant opportunity for Uber.

· Uber Eats had a market share of 23% in March 2023 (Perri, 2023). Expanding their meal delivery services to include their restaurants may present a chance for forward integration. Uber might connect their delivery services with the restaurant’s ordering system and provide clients with a seamless dining experience by acquiring or collaborating with well-known restaurant chains.

Threats

· The ongoing legal disputes with authorities and drivers in several locations, which contest the company’s designation of its drivers as independent contractors instead of employees, pose one of the most significant risks to the business. The UK Supreme Court decision that Uber drivers should be treated as “workers” with the right to benefits like minimum wage and holiday pay is a significant setback for the corporation (Reuters, 2021). The California appeals court recently voted in favor of ride-hailing companies (Rana, 2023), but Uber remains vulnerable to lawsuits and frequent protests.

· Uber is susceptible to cyberattacks affecting its users’ privacy and data. In 2022, the company suffered a major cyber attack, a breach on its computer network that might have exposed many of its internal systems (Conger & Roose, 2022). A perpetrator shared screenshots of email, cloud storage, and code repositories. Uber may have given the hacker complete access throughout the attack. As a result, several internal communications and engineering systems were taken offline as the firm looked into the scope of the incident (Conger & Roose, 2022).

Strategy Alternatives

1. International competition: Uber’s strategy is to expand globally by entering new markets. Although the business is currently well-established in many nations, there are still a lot of undiscovered places where Uber may extend its offerings. Uber may improve its market share and revenue sources by going global, which will lessen its reliance on a small number of markets.

2. Strategy for diversification: Uber may want to expand beyond providing ride-hailing services. The business could, for instance, enter the food delivery industry or offer logistics and courier services. Uber will be able to investigate new revenue streams thanks to this diversification approach and lessen its reliance on the ride-hailing industry, which is dealing with escalating competition and regulatory issues.

3. Concentrate on innovation: Uber may keep spending money on R&D to develop new technology to enhance its offerings and give customers a better experience. This can involve creating autonomous vehicles or collaborating with other businesses to offer sustainable, eco-friendly transportation options.

Recommended Strategy

I recommend that Uber concentrates on diversification to lessen its reliance on the ride-hailing sector, which deals with escalating competition and regulatory difficulties. Uber may develop new revenue streams and discover new markets by branching into new industries like food delivery, logistics, and courier services. Additionally, this will allow the business to stand out from its rivals and lessen its exposure to legal and regulatory problems in the ride-hailing sector. Additionally, this plan is consistent with Uber’s earlier initiatives to expand its clientele, such as purchasing Postmates and creating Uber Eats.

Implementation of the Recommended Strategy

If Uber chooses a diversification approach, it may begin by locating potential markets or products to enhance its ride-hailing operation. For instance, the food delivery sector makes sense, given that Uber already runs Uber Eats. It may need to work with additional restaurants, create a more effective delivery system, and enhance the ordering functionality of the app to expand its capabilities in this area. Offering logistics and courier services is another way to diversify, and this could involve forming alliances with small and medium-sized firms that need dependable and effective delivery services. This might increase the company’s revenue streams and lessen its reliance on the ride-hailing sector. Uber would need to devote enough resources to research and development, marketing, and customer support for the additional services to adopt a diversification plan successfully.

References

Conger, K. & Roose, K. (2022).
Uber Investigating Breach of Its Computer Systems. NY Times. Retrieved from

Goel, V. (2018, October 28).
Uber’s Exit From Southeast Asia Upsets Regulators and Drivers. NY Times. Retrieved from

Perri, J. (2023, April 14).
Which company is winning the restaurant food delivery war? Bloomberg Second Measure. Retrieved from

Which company is winning the restaurant food delivery war?

Rana, P. (2023).
Uber, Lyft Score Victory as California Court Affirms Right to Treat Drivers as Contractors. The Wall Street Journal. Retrieved from

https://www.wsj.com/articles/uber-lyft-score-victory-as-california-court-affirms-right-to-treat-drivers-as-contractors-642bdd67

Reuters. (2021, February 19).
Factbox: Uber’s legal challenges around the world.

https://www.reuters.com/business/legal/ubers-legal-challenges-around-world-2021-02-19/

Thorbecke, C. (2023, March 29).
How Uber left Lyft in the dust. CNN. Retrieved from

https://www.cnn.com/2023/03/29/tech/lyft-leadership-change/index.html

Appendix: Financial Ratio Calculations

Profitability Ratios

Return of Asset = Net Income / Total Assets

2019: –8,506,000/31,761,000 = –26.78%

2018: 997,000/23,988,000 = 4.16%

2017: –4,033,000/15,426,000 = –26.14%

Net Profit Margin = Net Income / Total Revenue

2019: –8,506,000/14,147,000 = –60.13%

2018: 997,000/11,720,000 = 8.51%

2017: –4,033,000/7,932,000 = –50.84%

Liquidity Ratios

Current Ratio = Current Assets / Current Liabilities

2019: 13,925,000/5,639,000 = 2.47

2018: 8,658,000/5,313,000 = 1.63

2017: 6,837,000/3,847,000 = 1.78

Working Capital = Current Assets – Current Liabilities

2019: 13,925,000 – 5,639,000 = 8,286,000

2018: 8,658,000 – 5,313,000 = 3,345,000

2017: 6,837,000 – 3,847,000 = 2,990,000

Leverage Ratios:

Debt to Equity Ratio = Total Debt / Total Equity

2019: 16,889,000/14,190,000 = 1.19

2018: 13,655,000/10,333,000 = 1.32

2017: 23,983,000/–8,557,000 = –2.80

Times Interest Earned = Operating Income / Interest Expense

2019: –8,596,000/559,000 = –15.38

2018: –3,033,000/648,000 = –4.68

2017: –4,080,000/479,000 = –8.52

Activity Ratios:

Accounts Receivable Turnover Ratio = Total Revenue / Net Receivables

2019: 14,147,000/1,214,000 = 11.65

2018: 11,270,000/919,000 = 12.26

2017: 7,932,000/739,000 = 10.73

Average Collection Period = 365 / Accounts Receivable Turnover Ratio

2019: 365/11.65 = 31.33 days

2018: 365/12.26 = 29.77 days

2017: 365/10.73 = 34.02 days

Nova Southeastern University

H. Wayne Huizenga College of Business and Entrepreneurship

Assignment for Course: MGT-51

0: Applying Strategy for Managers

Submitted to: Dr. Jason Cavich

Submitted by:

Date of Submission: April 23, 2024

Title of Assignment: Macy’s Case

Student’s Signatures:

******************************************************************************

Instructor’s Grade on Assignment:

Instructor’s Comments:

Executive Summary

Problem Statement

Macy’s, Inc. faces the challenge of sustaining its recent performance improvement amidst a rapidly evolving retail landscape exacerbated by the COVID-19 pandemic. Despite the initial success of its Polaris turnaround strategy, the company must address stagnant revenue growth, lingering weaknesses in its brick-and-mortar business model, and the persistent threat of online retail competition.

Analysis

· Macy’s revenue declined sharply to $1

.1 billion in

2020

due to the COVID-19 pandemic, exacerbating its ongoing struggle to adapt to online retail.

· The Polaris turnaround strategy, initiated in 2020 under CEO Jeff Gennette, focused on six key pillars: winning with fashion and style, delivering clear value, excelling in digital shopping, enhancing store experience, modernizing the supply chain, and enabling transformation.

· Despite challenges, Macy’s rebounded in

2021

with increased online purchases and a strong performance in brick-and-mortar stores.

· Target Corporation and Nordstrom Inc. have adapted to the changing retail landscape through innovative strategies such as same-day fulfillment capabilities, store remodeling, and digital sales platforms.

Alternatives

1. Invest more heavily in digital shopping platforms and omnichannel capabilities to meet the growing demand for online shopping.

2. Further enhance the in-store experience through strategic partnerships, brand collaborations, and store redesigns to attract more customers.

3. Explore diversification strategies to expand into new product categories or invest in emerging markets to broaden the company’s revenue streams.

Recommendation

Macy’s should prioritize the continued implementation of its Polaris strategy, emphasizing excelling in digital shopping and enhancing the in-store experience. By leveraging technology and data analytics to understand consumer behavior and preferences better, Macy’s can create personalized shopping experiences and improve customer loyalty.

Implementation

Macy’s should allocate resources to upgrade its digital platforms, optimize the mobile shopping experience, and expand omnichannel capabilities. Additionally, the company should invest in employee training and development to ensure high-quality customer service in-store. Regular performance monitoring and adjustments to the strategy will be necessary to adapt to evolving market trends and consumer preferences.

Problem Statement

Financial Analysis

Macy’s experienced a decline in revenues from a peak of $28.1 billion in fiscal 2015 to $18.1 billion in fiscal 2020 due to the impact of the COVID-19 pandemic (Gamble & Badal, 2022). However, with the implementation of the Polaris strategy, the company rebounded, and its 2021 performance showed promising signs, including a sharp % increase in online sales by 45% compared to

2019

. The company expects digital sales to reach $10 billion by the end of 2022 (Gamble & Badal, 2022). Despite these improvements, Macy’s shares at $19.02 are still trading significantly below their peak in 2015 (Yahoo Finance, 2024). The potential takeover bid by Arkhouse Management and Brigade Capital Management has raised concerns about the future of Macy’s under new leadership led by Tony Spring. Potentially leading to shareholder pressure for action (Loeb, 2024).

An analysis of Macy’s profitability metrics reveals a fluctuation pattern, indicating that the current strategic approach has yet to achieve consistent success. Notably, the Net Profit margins for consecutive years exhibit significant variability, starting at

2.23%

in 2019, plunging to

-22.07%

in 2020, and rebounding to

5.65%

in 2021 (Gamble & Badal, 2022). In contrast, the Gross Profit margin shows a more stable trend, maintaining

40.87%

32.11%

, and

40.11%

for 2021, 2020, and 2019 respectively. This discrepancy between Net profit and Gross Profit suggests that Macy’s overhead costs are substantially higher, estimated at least 30%. The considerable expense of approximately $3.5 million on restructuring, impairment, and store closures in 2020 significantly impacted Net Income, consequently eroding market share. Reflecting on the return on equity, 2020 recorded a staggering

-156.44%

, while 2021 showed improvement at

39.49%

. Ideally, a return on equity falls within the range of 15% to 20%; thus, a negative value in 2020 was anticipated. Additionally, in 2021, the return on asset (ROA) stood at 8%, categorized as ‘good’ rather than ‘great’ considering Macy’s extensive history spanning nearly two centuries (Birken & Curry, 2021).

Turning to liquidity ratios, particularly the quick ratio, it becomes evident that Macy’s ability to meet short-term obligations is precarious. With quick ratios of

0.44

in 2021 and

0.45

in 2020, figures below 1 imply difficulty in paying short-term debts, potentially resulting in higher interest rates on borrowing.

Regarding the debt metrics, Macy’s debt ratio was 36% in 2021 and 45% in 2020, with corresponding debt-to-equity ratios of

1.77

and

3.15

, respectively. While a debt-to-equity ratio of 3.15 indicates heavier reliance on debt financing, concerns arise regarding the company’s ability to service its debts, especially given the low quick ratio. Gallo (2015) suggests ratios between 2 and 5 are suitable for publicly traded companies like Macy’s, although the general guideline advises staying within the 1 to 1.5 range.

Finally, examining the

Asset Turnover

ratio, which is significant for portfolio investors, Macy’s recorded a figure of

1.43

, indicating moderate efficiency in utilizing assets to generate sales. However, in the retail industry, where a turnover of 2.5 or higher is considered favorable, Macy’s performance falls short, suggesting potential inefficiencies in inventory management (Patin et al., 2020).

Internal Environment Analysis

Strengths

· Macy’s enduring brand presence since its inception in 1830 instills trust and recognition among consumers, fostering a sense of reliability and authenticity in the marketplace.

· With a diverse retailing portfolio encompassing Macy’s department stores, Bloomingdale’s luxury chain, Bluemercury beauty boutiques, and robust online divisions, Macy’s demonstrates resilience and adaptability to cater to varying consumer preferences and shopping behaviors (Gamble & Badal, 2022).

· Macy’s has demonstrated effective strategic planning by implementing the Polaris strategy, which has yielded notable improvements in digital sales.

Weaknesses

· Before implementing the Polaris strategy, Macy’s faced prolonged periods of stagnant revenue growth, indicating a lack of agility in responding to market shifts and consumer demands.

· Macy’s has encountered significant hurdles in transitioning its traditional brick-and-mortar operations to the online retail landscape, potentially missing out on opportunities for market expansion and customer engagement in the digital sphere (Lee, 2024).

· Over its history, Macy’s has grappled with challenges in optimizing its merchandising strategy to meet evolving consumer preferences and delivering consistently satisfactory customer experiences across its stores, hindering long-term customer loyalty and satisfaction.

External Environment Analysis

Opportunities

· The escalating trend of digital shopping presents a lucrative opportunity for Macy’s to capitalize on evolving consumer preferences for online convenience. Leveraging its established brand presence, Macy’s could capture a larger share of the digital market.

· Macy’s has significant potential to expand its online sales and digital channels further, leveraging technological advancements and innovative strategies to enhance customer engagement and drive revenue growth in the digital sphere.

· Macy’s can explore opportunities for strategic partnerships and collaborations with industry players, influencers, and technology providers to enrich the customer experience, offering unique and compelling offerings that differentiate Macy’s from competitors and resonate with modern consumers.

Threats

· There is intense competition from online retailers like Amazon and discount retailers like Walmart and Target.

· The department store segment of the retail industry is experiencing a decline, exacerbated by changing consumer shopping habits and preferences favoring alternative retail formats (Lee, 2024).

· Uncertainties due to ongoing shifts in consumer demographics and preferences.

Strategy Alternatives

1. Double down on digital transformation: Invest further in enhancing the online shopping experience, expanding digital channels, and leveraging data analytics to personalize customer interactions.

2. Reinvent brick-and-mortar experience: Innovate store layouts, introduce experiential elements, and forge strategic partnerships to revitalize in-store foot traffic and enhance customer engagement (Loeb, 2024).

3. Diversify product offerings and brands: Expand private label brands, collaborate with exclusive partners, and explore new product categories to attract a broader customer base and differentiate from competitors.

Recommended Strategy

The recommended strategy for Macy’s is to prioritize digital transformation while simultaneously reinventing the brick-and-mortar experience. This entails continued investment in enhancing online channels, leveraging data analytics for personalized marketing, and improving logistics for seamless digital order fulfillment. Simultaneously, Macy’s should innovate its physical stores by introducing experiential elements, strategic partnerships, and a curated product mix to create compelling reasons for customers to visit.

Implementation of the Recommended Strategy

Based on a thorough analysis, Macy’s should focus on digital transformation while innovating its brick-and-mortar stores. Leveraging its strong brand presence and successful Polaris strategy, Macy’s can expand online sales, capitalizing on the growing trend of digital shopping. Meanwhile, addressing historical weaknesses like challenges transitioning to online retail, Macy’s should revamp in-store experiences with innovative layouts and strategic partnerships. By enhancing digital infrastructure and creating compelling in-store experiences, Macy’s can ensure sustained success in an evolving retail landscape while continuously monitoring market trends and performance metrics for adaptation.

References

Birken, E. G., & Curry, B. (2021). Understanding

Return on Assets

(ROA).
Forbes.

https://www.forbes.com/advisor/investing/roa-return-on-assets/#:~:text=What%20Is%20a%20Good%20ROA,the%20same%20industry%20and%20sectr

Gallo, A. (2015). A Refresher on Debt-to-Equity Ratio.
Harvard Business Review.

https://hbr.org/2015/07/a-refresher-on-debt-to-equity-ratio

Gamble, J. E., Badal, A. (2022). Macy’s, Inc. in 2022: Has the Implementation of its Polaris Strategy Produced a Successful Turnaround? Mc Graw Hill: Essentials of Strategic Management: The Quest for Competitive Advantage.

https://www.mheducation.com/content/dam/mhe/highered/documents/product/strategic-management/author-vetted-cases-gamble-8e

Kapner, S. (2024, February 27). Macy’s to Close 150 Stores, Puts San Francisco Flagship Up for Sale New CEO Tony Spring wants department-store chain to give customers a chance to ‘shop the way they want’.
The Wall Street Journal.

https://www.wsj.com/business/retail/macys-closing-stores-earnings-report-83721a8d

Lee, J. (2024, April 5). The Hot Sale Going on at Department Stores: Their Shares

Private buyers might have more stomach for the struggling retail sector than jaded stock investors.
The Wall Street Journal.

https://www.wsj.com/business/retail/the-hot-sale-going-on-at-department-stores-their-shares-bf5c01ca

Loeb, W. (2024). How Will Macy’s Survive – A Sign of Hard Times For Department Stores.
Forbes.

https://www.forbes.com/sites/walterloeb/2024/04/01/how-will-macys-survivea-sign-of-hard-times-for-department-stores/?sh=2fc288ae52cc

Patin, J. C., Rahman, M., & Mustafa, M. (2020). Impact of Total Asset

Turnover Ratio

s on Equity Returns: Dynamic Panel Data Analyses. Journal of Accounting, Business and Management (JABM), 27(1), 19-29.

http://dx.doi.org/10.31966/jabminternational.v27i1.559

Yahoo Finance (2024, April 22).

https://finance.yahoo.com/quote/M/history?period1=1556061866&period2=1713914631

Appendix: Financial Ratio Calculations

				2021	2020	2019
PROFITABILITY RATIOS
Net Profit Margin	5.65%	-22.07%	2.23%
Gross Profit Margin	40.87%	32.11%	40.11%
Operating Profit Margin	7.38%	-26.47%	2.87%
Return on Assets	8.10%
Return on Equity	39.49%	-156.44%
LIQUIDITY RATIOS
Current Ratio	1.25	1.15
Quick Ratio	0.44	0.45
LEVERAGE RATIOS
Debt Ratio	36.34%	45.43%
Debt to Equity	1.77	3.15
EFFICIENCY RATIOS
Inventory Ratio	3.67
Turnover Ratio	2.90
Asset Turnover	1.43
Days’ Sales in Inventory	7	8

36Chapter 3 Evaluating a Company’s External Environment

Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.

Strategy: Core Concepts and Analytical Approaches

An e-book marketed by McGraw Hill LLC

Arthur A. Thompson, The University of Alabama 8th Edition, 2025–2026

Chapter 3
Evaluating a Company’s
External Environment

Analysis is the critical starting point of strategic thinking.
—Kenichi Ohmae, consultant and author

It’s critical for companies to adapt their strategies to an evolving external environment.
—Amanda Wagner, CEO of Immunitas Therapeutics

Things are always different—the art is figuring out which differences matter.
—Laszlo Birinyi, investments manager

In essence, the job of a strategist is to understand and cope with competition.
—Michael E. Porter, Harvard Business School professor

In order to wisely chart a company’s strategic course, managers must first develop a deep understanding of the
company’s present situation. Two facets of a company’s situation are especially relevant: (1) the company’s
external environment—most notably, the industry and competitive environment in which the company

operates and the forces acting to reshape this environment, and (2) the company’s internal environment—
particularly its resources and capabilities and its ability to compete successfully against rivals.

Insightful diagnosis of a company’s external and internal environment is a prerequisite for managers to succeed
in crafting a strategy that is an excellent fit with the company’s situation, is capable of building a competitive
advantage, and has good prospects for boosting company performance—the three tests of a winning strategy.
As depicted in Figure 3.1, the task of crafting a strategy begins with appraisals of the company’s external and
internal environments (as a basis for deciding upon a long-term direction and developing a strategic vision),
moves toward an evaluation of the most promising alternative strategies and business models, and culminates in
choosing a specific strategy.

This chapter presents the concepts and analytical tools for zeroing in on those aspects of a single-business
company’s external environment that should be considered in making strategic choices. Attention centers on
identifying and assessing the factors that are causing potentially important changes in the company’s “macro-
environment,” conditions in the specific industry and competitive arena in which the company operates, the
drivers of market change in that arena, the market positions and likely actions of rival companies, and the factors
that determine competitive success. In Chapter 4, we explore the analytical methods of evaluating a company’s
internal circumstances and competitive capabilities.

Chapter 3 • Evaluating a Company’s External Environment 37

Copyright © 2025 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.

Figure 3.1 From Analyzing the Company’s Situation to Choosing a Strateg

Form a
strategic
vision of

where the
company

needs to head

Analyzing a
company’s

external
environment

Analyzing a
company’s

internal
environment

Identify
promising
strategic
options
for the

company

Select the
best

strategy
and

business
model for

the company

The Strategically Relevant Factors Influencing a Company’s
External Environment

A single-business company’s external environment includes the immediate industry and competitive environment
in which it operates plus a broader “macro-environment” (see the outer ring of Figure 3.2). This macro-
environment consists of six different types of components: political factors; economic conditions in the firm’s
general environment (local, country, regional, worldwide); sociocultural forces; technological factors; factors
concerning the natural environ ment; and legal/regulatory conditions. An analysis of the how ongoing changes
in these external factors can have strategically relevant impacts on a company and conditions in its immediate
industry and competitive environment is often referred to as PESTEL analysis, an acronym that serves as
a reminder of the six types of external factors that need to be evaluated (Political, Economic, Sociocultural,
Technological, Environmental, and Legal/regulatory). Each of PESTEL components has the potential to affect
a firm’s industry and competitive environment (the inner ring of Figure 3.2) in ways that are important enough
and strategically relevant enough to require corrective adjustments in a company’s strategic vision, mission,
performance objectives, strategy, and even its business model.

Changes in the six macro-economic factors can occur with or without warning. Often, there are multiple signs
that certain outer-ring macro-environmental factors are undergoing change. The changes can unfold slowly or
quickly. Frequently, it can be difficult to quickly and accurately discern what the resulting influences will be and
how big the ultimate impact of these influences will be. Changes typically affect different industries in different
ways and to different degrees ranging from very little (if any at all) to moderate to major. Consequently, it is
important for senior-level managers to closely monitor their company’s macro-environment and stay on top of
new developments. Changes in those factors with a potentially big impact plainly deserve the closest attention,
but changes in factors that initially appear to have a small impact merit a watchful eye since their level of impact
may change. Diligently monitoring the macro-environment and assessing the impact and influence of outer ring
developments is a necessary but not sufficient function of top management—the managerial goal must be to
understand the changes at work well enough to know whether and when to make desirable or needed corrective
adjustments in the company’s long-term direction, objectives, strategy, and, possibly, its business model.

Chapter 3 • Evaluating a Company’s External Environment 38

Copyright © 2025 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.

Figure 3.2 The Components of a Company’s Macro-environment

Political

Factors

Economic
Conditions

Technological
Factors

Sociocultural
Forces

Environmental
Forces

Legal/
Regulatory

Factors

Im
mediate Industry and Competitive Environment

Factors
affecting future

competitive
success

The
industry’s

profit outlook

Industry
growth rate

Market
demand-supply

conditions

Competitive
pressures

COMPANY

Forces driving
changes in
the industry

The market
positions and

likely actions of
rival firms

Table 3.1 provides brief descriptions of the six PESTEL factors that comprise the outer ring of the macro-
environment, along with examples of the industries or business situations that changes in each of these factors
can affect.

There are numerous instances where changes in the macro-environment require industries and companies to
undertake strategic changes. When new or different new federal banking regulations pertaining to lending risk
and lending requirements are announced and take effect, the affected banks must rapidly adapt their strategies
and lending practices to be in compliance. Tobacco products firms have had to adapt to anti-smoking ordinances,
the imposition of higher taxes on tobacco products, and the cultural stigma attached to public use of tobacco
products. The homebuilding industry must adapt to such macro-influences as increases or decreases in household
incomes and buying power, changes in mortgage interest rates, shifting preferences of families for renting versus
owning a home, shifts in buyer preferences for homes of various sizes and styles, and changing preferences for
particular kinds of home features—homebuilders watch such developments and trends closely, making frequent
adjustments in home sizes, styles, features, and prices. Companies in the food processing industry must assess the
impact and influence of changing consumer attitudes toward processed foods laden with chemical ingredients,
growing consumer preferences for natural and organic foods, and heightened public concerns about nutrition,
healthy-eating, and obesity/diabetes risks—and adapt their long-term direction, performance targets, business
model, and strategies in ways they deem appropriate.

Chapter 3 • Evaluating a Company’s External Environment 39

Copyright © 2025 by Arthur A. Thompson. All rights reserved.
Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.

However, the factors and forces in a company’s external environment having the biggest strategy-shaping impact
typically pertain to the company’s own industry and competitive environment—these include industry growth,
competitive pressures, anticipated actions of rivals, forces driving industry change, the key factors for future
competitive success, and the industry’s outlook for profitability (as depicted in the inner ring of Figure 3.2).
Consequently, the primary role of this chapter is to present a revealing discussion and analysis of the factors
shaping a company’s industry and competitive environment.

Table 3.1 The Six Outer-Ring Components of a Company’s Macro-Environment

Component Description

Political
factors

Pertinent political factors include (1) the degree to which the political climate is friendly or hostile to
certain business or industries, (2) whether the political majority favors or opposes raising/lowering
taxes or increasing/decreasing government spending or using import tariffs to protect domestic
companies from what is deemed as unfair trade conditions, (3) the extent to which politicians are
inclined to grant subsidies to companies/industries deemed worthy of special government support
such as electric vehicles, solar and wind energy, and the installation of 5G wireless services in rural
areas, and (4) the degree of political interest in breaking up businesses deemed to be too large or
too powerful. Some political policies affect certain types of industries more than others. Examples
include climate change and energy policy, which clearly affect the producers and users of fossil
fuels, business investment in carbon-reducing technologies and equipment, government subsidies
for purchasing electric vehicles, and the recent attempts by some state governments to ban the
purchases of new natural gas appliances for residential use and ban gas ranges in restaurants.

Economic
conditions

The relevant factors here are the general economic climate and such specifics as the rate of
economic growth, trends in per capita income and discretionary income, the inflation rate, the
unemployment rate, interest rates and the availability of credit, consumer confidence, currency
exchange rates, trade deficits or surpluses, and conditions in the stock market, bond market, and
the real estate market. Industries like steel, construction, and buildings materials benefit from big
increases in government spending on infrastructure (roads, bridges, airports, hospitals, schools) and
a booming economy that features construction of new manufacturing plants, commercial buildings,
and apartment complexes. Discount retailers and budget-priced restaurants benefit when general
economic conditions weaken, as consumers become more price conscious and careful about how
much they spend.

Sociocultural
forces

Sociocultural forces concern the nature and range of values, attitudes, beliefs, cultural influences,
and lifestyles that impact demand for particular goods and services, as well as demographic factors
such as population size, growth rate, and age distribution. Sociocultural forces vary by locale and
change over time. An example of sociocultural influences is the trend toward healthier lifestyles,
which can shift spending toward exercise equipment and health clubs and away from snack foods.
The demographic effect of people living longer lives is having a huge impact on the health care,
recreation, travel, hospitality, and entertainment industries. Growing consumer preferences for
healthy, less-calorific menu choices that include vegetarian and gluten-free selections, organic
and pasture-fed meats, plant-based meat products, and organic and/or locally grown fruits and
vegetables are prompting fine dining and other restaurants to adapt their menus, recipes, and
cooking practices.

Technological
factors

The most important technological factors concern the pace of technological change and so-called
breakthrough technical innovations that have the potential for wide-ranging effects on society, such
as artificial intelligence, genetic engineering, self-driving vehicles, LED lighting technology, the
rapiding expanding capabilities of robots, and wireless broadband speeds. Technological changes
can spawn the birth of altogether new industries (online retailing, drones, connected wearable
devices, streamed entertainment), disrupt others (cloud computing, mobile payments, 3-D printing,
big data solutions), and render others obsolete (VCRs, fax machines, incandescent light bulbs, digital
cameras).

Chapter 3 • Evaluating a Company’s External Environment 40

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Environmental
factors

The relevance of environmental considerations stems from the fact that some industries contribute
more significantly than others to air and/or water pollution, or to the depletion of irreplaceable
natural resources, or to inefficient energy/resource usage, or are closely associated with other types
of environmentally damaging activities (unsustainable agricultural practices, the creation of waste
products that are not recyclable or biodegradable). Growing numbers of companies worldwide,
in response to stricter environmental regulations and also to mounting public concerns about the
effects of climate change, are implementing actions to operate in a more environmentally and
ecologically responsible manner.

Legal and
regulatory
factors

These factors include the laws and regulations with which companies must comply, such as
consumer privacy regulations, labor laws, antitrust laws, health care insurance requirements, and
occupational health and safety regulation. Some factors, such as financial services regulation, are
industry-specific. Others affect certain types of industries more than others. For example, minimum
wage legislation largely impacts low wage industries (such fast food restaurants, janitorial services,
and service workers in hospitals) that employ substantial numbers of relatively unskilled workers.
Companies in heavy construction, meat-packing, and steelmaking, where many jobs are hazardous
or carry high risk of injury, are much more impacted by occupational safety regulations than are
companies in industries such as retailing or software programming.

Assessing a Company’s Industry and Competitive Environment
To gain deep understanding of a company’s industry and competitive environment, managers do not need to
gather all the information they can find and spend lots of time digesting it. Rather, the task can be focused on
using some well-defined concepts and analytical tools to get clear answers to six questions:

1. What competitive forces do industry members face, and how strong are they?

2. What forces are driving changes in the industry, and what impact will these changes have on competitive
intensity and industry profitability?

3. What market positions do industry rivals occupy—who is strongly positioned and who is not?

4. What strategic moves are rivals likely to make next?

5. What are the key factors for future competitive success?

6. Is the industry outlook conducive to good profitability?

Analysis-based answers to these questions provide managers with the essential understanding needed to craft
a strategy that fits the company’s external situation. The remainder of this chapter is devoted to describing the
methods of obtaining solid answers to these six questions and explaining how the nature of a company’s industry
and competitive environment has direct bearing on company managers’ strategic choices.

Question 1: What Competitive Forces Do Industry Members
Face and How Strong Are They?

The character, mix, and subtleties of the competitive forces operating in a company’s industry are never the same
from one industry to another. The most powerful and widely used tool for systematically diagnosing the principal
competitive pressures in a market and assessing the strength and importance of each is the five forces model of
competition.1 This model, depicted in Figure 3.3, holds that the competitive pressures on within an industry come
from five sources:

1. Competitive pressures stemming from the market maneuvering and strategy initiatives of industry rivals
to enhance buyer appeal for their products, boost profitability, and win a competitive edge.

2. Competitive pressures stemming from the threat of new entrants into the market.

Chapter 3 • Evaluating a Company’s External Environment 41

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3. Competitive pressures from companies in other industries selling substitute products.

4. Competitive pressures stemming from the exercise of supplier bargaining power.

5. Competitive pressures stemming from the exercise of buyer (or customer) bargaining power.

Using the five forces model to determine the collective nature and strength of competitive pressures in a given
industry involves building the picture of competition in three steps:

l Step 1: Identify the specific competitive pressures associated with each of the five forces.

l Step 2: Evaluate how strong the pressures comprising each of the five forces are (fierce, strong, moderate
to normal, or weak).

l Step 3: Determine whether the collective strength of the five competitive forces presents industry
members with reasonable profit-making opportunity.

Figure 3.3 The Five Forces Model of Competition: A Key Analytical Tool

Firms in Other
Industries O�ering

Substitute Products

Suppliers of
Raw Materials,

Parts,
Components,

or Other
Resources

Inputs

Rivalry among
Competing Sellers
Competitive pressures

created by the
maneuvers of rival

sellers to win increased
sales and market share

and build/strengthen
competitive
advantage

Competitive pressures coming from
the market attempts of outsiders to

win buyers over to their products

Competitive
pressures
stemming

from supplier
bargaining

power

Buyers

Competitive
pressures
stemming

from
buyer

bargaining
power

Potential New
Entrants

Competitive pressures coming from
the threat of entry of new rivals

Source: Adapted from Michael E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 57, no. 2 (March–April
1979), pp. 137–145; Michael E. Porter, “The Five Competitive Forces that Shape Strategy,” Harvard Business Review 86, no. 1 (January
2008), pp. 80–86.

Chapter 3 • Evaluating a Company’s External Environment 42

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Competitive Pressures Created by the Rivalry among Competing

Sellers

The strongest of the five competitive forces is nearly always the market maneuvering for buyer patronage that
goes on among rival sellers of a product or service. In effect, a market is a competitive battlefield where the
contest among competitors is ongoing and dynamic. Each competing company endeavors to deploy whatever
means in its business arsenal it believes will attract and retain buyers, enhance its competitive strength vis-à-vis
rivals, and yield good profits. The challenge is to craft a competitive strategy that, at the very least, allows a
company to hold its own against rivals and that, ideally, produces a competitive edge over many, if not all, rivals.
But when one industry competitor makes a new strategic move or boosts its competitive efforts in ways that yields
good results, its rivals typically respond with offensive or defensive countermoves of their own. This pattern of
action and reaction, move and countermove, adjust and readjust produces a continually evolving competitive
landscape where the market battle ebbs and flows, sometimes takes unpredictable twists and turns, and produces
winners and losers. But the winners—the current market leaders—have no guarantees of continued leadership;
their competitive success in the marketplace is no more durable than the power of their latest competitive efforts
to fend off the latest competitive efforts of ambitious challengers. In every industry, the ongoing competitive
jockeying of rivals leads to some companies gaining or losing momentum in the marketplace based on the
success or failure of their latest competitive efforts and maneuvering in the marketplace.2

Figure 3.4 shows the competitive weapons that firms often employ in battling rivals and indicates the factors that
influence the intensity of their rivalry. A brief discussion of the factors that influence the tempo of rivalry among
industry competitors is in order:3

l Rivalry intensifies when competing sellers are active in launching fresh actions to boost their market
standing and business performance; conversely, rivalry is weaker when competing sellers seldom make
aggressive moves to boost their sales/market shares by taking customers and sales away from rivals. One
indicator of active rivalry is lively price competition, a condition that puts pressure on industry members
to drive costs out of the business and threatens the survival of high-cost companies. Another indicator
of active rivalry is rapid introduction of next-generation products—when one or more rivals frequently
introduce new or improved products, competitors that lack good product innovation capabilities feel
considerable competitive heat to get their own new and improved products into the marketplace quickly.
Other indicators of active rivalry among industry members include:

n Whether several/many industry members are racing to differentiate their products from rivals by
offering better performance features, higher quality, improved customer service, or a wider product
selection.

n How frequently some/many rivals resort to such marketing tactics as special sales promotions,
heavy advertising, rebates, or low-interest-rate financing to drum up additional sales.

n How actively some/many industry members are pursuing efforts to build stronger dealer networks
or expand their presence in foreign markets or otherwise expand their distribution capabilities.

n How hard one or more companies are striving to gain a market edge over rivals by developing new
or enhanced resource strengths and competitive capabilities that rivals are hard-pressed to match.

Normally, competitive maneuvering among rival sellers is active because every competitor has a strong
incentive to initiate fresh actions that hold promise for increasing buyer appeal for its products/services
and boosting its profitability.

l Rivalry is usually weaker when buyer demand is growing rapidly, and stronger when buyer demand is
growing slowly or even falling. Rapidly expanding buyer demand produces enough new business for all
industry members to grow without resorting to aggressive efforts to steal sales from rivals. But in markets
where growth is only 1 to 2 percent or certainly when buyer demand is shrinking, companies anxious
(or sometimes desperate) to gain more business are prone to initiate aggressive price discounting, sales
promotions, or other tactics to boost their sales volumes at the expense of rivals. Aggressive moves to

Chapter 3 • Evaluating a Company’s External Environment 43

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draw customers away from rivals always heighten competitive pressures and can often ignite a fierce
industrywide battle for market share.

l Rivalry increases as it becomes less costly for buyers to switch brands and decreases as buyers’ costs
to switch brands become more expensive or otherwise troublesome. The less costly it is for buyers to
switch their purchases from the seller of one brand to the seller of another brand, the easier it is for
sellers to steal customers away from rivals. But the higher the costs buyers incur to switch brands,
the less prone they are to brand switching. Even if consumers view one or more rival brands as more
attractive, they may not be inclined to switch because of the added time and inconvenience that may be
involved or the psychological anguish of abandoning a long-used brand. Distributors and retailers may
not switch to the brands of rival manufacturers because they are hesitant to sever longstanding supplier
relationships, incur any technical support costs or retraining expenses in making the switchover, go to
the trouble of testing the quality and reliability of the rival brand, or devote resources to marketing the
new brand (especially if the brand is lesser known). Consequently, unless buyers are dissatisfied with
the brand they are presently purchasing, high switching costs weaken the rivalry among competing
sellers.

l Rivalry increases as the products of rival sellers become less differentiated and weakens as the products of
industry rivals become more strongly differentiated. When the offerings of rivals are identical or weakly
differentiated (because the brands of different sellers have identical or very comparable attributes),
buyers have less reason to be brand loyal—when one brand is mostly like another, buyers can shop the
market for the best deal and switch brands at will. On the other hand, strongly differentiated product
offerings among rivals breed high brand loyalty—because many buyers are attached to the attributes
of their preferred brand as opposed to the attributes of rival brands. Strong brand attachments make it
tougher for sellers to draw customers away from rivals. Unless meaningful numbers of buyers are open
to considering whatever new or different product attributes rivals are offering, the high degrees of brand
loyalty that accompany strong product differentiation work against fierce rivalry among competing
sellers. The degree of product differentiation also affects switching costs. When rivals’ offerings are
identical or weakly differentiated, it is usually easy and inexpensive for buyers to switch their purchases
from one rival to another. Strongly differentiated products raise the probability that buyers will find
it costly, inconvenient, or annoying to switch to brands with different and potentially less satisfying
features.

l Rivalry is more intense when industry members have too much inventory or significant amounts of idle
production capacity, especially if the industry’s product entails high storage costs or high fixed costs.
Competitive pressures among rival sellers build quickly whenever a market is oversupplied (because
many rivals have excessive inventories and/or industry-wide production capacity significantly exceeds
market demand for the product). Efforts on the part of sellers to rid themselves of unwanted inventories
or find ways to use idle production capacity creates a “buyer’s market” that not only prompts rival
sellers to pursue various volume-boosting sales tactics (for example, price discounts, extra advertising,
rebates, and favorable credit terms) but also empowers buyers to insist on a lower price and other
favorable purchase terms or else take their business elsewhere—all of which intensifies rivalry. And if
fixed costs account for a large fraction of total cost, industry members with significant amounts of idle
production capacity (which raises fixed costs per unit sold and squeezes profit margins) are pressured
by eroding profitability to cut prices and/or institute other volume-boosting competitive tactics—so as
to spread the burdensome total fixed costs over a bigger unit sales volume, lower overall cost per unit
sold, and therefore improve profit margins.

l Rivalry tends to be more intense when a product is costly to hold in inventory, perishable, or seasonal.
This is because industry rivals have potent incentives to employ volume-boosting tactics to avoid high
inventory storage costs, to rid themselves of perishable items before they spoil, and to clear out seasonal
items before the end of the selling season.

Chapter 3 • Evaluating a Company’s External Environment 44

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l Rivalry usually becomes more intense as competitors become more equal in size and capability, and as
the number of competitors increases. When rivals are of comparable size and competitive strength, they
can usually compete on a fairly equal footing—an evenly matched contest tends to be fiercer than where
one or more industry members have commanding market shares and substantially greater resources and
capabilities than their much smaller rivals. A bigger number of competitors typically strengthens rivalry
because the presence of more sellers raises the likelihood that fresh, creative strategic initiatives will be
launched rather frequently, thereby prompting countermoves by rivals and precipitating a livelier market
contest than might otherwise occur. However, as the number of competitors in the marketplace becomes
progressively larger—so that big sales and market share gains flowing from successful strategic moves
by any one company ripple out to have a lesser impact on the businesses of its many rivals—head-to-
head rivalry becomes weaker. Why? Because in an industry with a large number of rivals (say, more than
20 or 30), each rival soon learns that the actions of a single rival to boost its sales and improve its market
position usually turns out to have only a small or tolerable effect on its own business—the absence of
an imperative to respond to the moves of each rival weakens the intensity of head-to-head battles for
market share. Furthermore, rivalry tends to grow weaker as the number of industry members declines
from 5 to 4 to 3 to just 2. This is because in a market with few rivals, each competitor soon learns
that an offensive to grow its sales and market share will be viewed by rivals as a hostile move to steal
their customers. Actions that have an immediate adverse impact on rivals’ sales and profits will almost
certainly provoke vigorous retaliation, potentially triggering a ferocious and costly competitive battle.
Companies that have only a few strong rivals thus come to understand the merits of restrained efforts
to wrest sales and market share from competitors as opposed to undertaking hard-hitting offensives
that escalate into a price war or that force industry members to sharply increase their expenditures
for advertising, sales promotions, and other inducements to secure and retain customers. Deep price
discounting and a marketing arms race nearly always erode the profits of every industry participant.

l Rivalry increases when one or more competitors become dissatisfied with their sales volumes and launch
offensives to steal business away from rivals. Firms in financial trouble or desperate for more customers
often employ sales-boosting turnaround strategies that intensify rivalry. Aggressive rivals seeking to be
a market leader or simply gain a bigger market share frequently initiate strategic offensives that turn
competitive pressures up a notch. On occasion, rivalry intensifies because one or two industry members
achieve game-changing technological breakthroughs and/or develop innovative new products that prove
wildly popular, enabling them to capture significantly bigger sales volumes and market shares. In such
cases, industry members that unexpectedly begin to lose many customers must scramble quickly to stay
in the game; they either have to launch effective counterstrategies or become also-rans.

l Rivalry increases when strong companies outside the industry acquire weak firms in the industry and
launch aggressive, well-funded moves to transform their newly acquired competitors into strong market
contenders. A concerted effort to turn a weak rival into a formidable competitor nearly always entails
launching well-financed strategic initiatives to dramatically improve the competitor’s product offering,
excite buyer interest, and win a much bigger market share. Such actions quickly catch the attention of
all industry participants and, should such actions of the aggressor prove successful, prompts them to
counter with fresh strategic offensive and defensive moves of their own.

l Rivalry often becomes more intense—as well as more volatile and unpredictable—when competitors have
diverse views about where the industry is headed and/or have sharply differing long-term directions,
objectives, strategies, and competitive capabilities and/or have production facilities in different countries
with different production costs. In industries where future market conditions are murky or fast changing,
differing views of rivals about where the industry is headed and the resulting differing views about how
best to attract and retain customers typically sparks a spirited competitive battle for sales and market
share. In globally competitive markets, attempts by cross-border rivals to gain stronger footholds in
each other’s domestic markets typically boost the intensity of rivalry, especially when the aggressors
have lower costs or products with more attractive features. Furthermore, a diverse group of sellers often
contains one or more mavericks willing to try novel, high-risk, or rule-breaking market approaches, thus
generating a livelier competitive environment that can produce surprising twists and turns.

Chapter 3 • Evaluating a Company’s External Environment 45

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The above factors, taken as whole, determine how strong this competitive force is. Rivalry can be characterized
as cutthroat or brutal when competitors engage in protracted price wars or regularly undertake other aggressive
strategic moves that prove mutually destructive to profitability and inflict lower profits or even losses on most
industry members. Rivalry can be considered fierce to strong when the battle for sales and market share is so

Figure 3.4 The “Weapons” That Can Be Used to Battle Rivals and the Factors
Affecting the Strength of Rivalry

Rivalry is generally stronger when:
l Competing sellers are active in making fresh moves to improve their market

standing and business performance.
l Buyer demand is growing slowly.
l Buyers incur low costs in switching to rival brands.
l The products of rival sellers are essentially identical or else weakly

differentiated, resulting in little or no buyer brand loyalty.
l Sellers have idle capacity and/or excess inventory.
l The industry’s product is costly to hold in inventory, perishable, or seasonal.
l The number of rivals increases and/or rivals are of roughly equal size and

competitive capability.
l One or more rivals are dissatisfied with their business performance and are

making aggressive moves to attract more customers.
l Outsiders have recently acquired weak competitors and are spending

heavily to turn them into major contenders.
l Rivals have diverse industry outlooks, objectives, or strategies and/or have

production facilities in countries where production costs are materially
different.

Rivalry is generally weaker when:
l Industry members infrequently launch aggressive actions to take sales and

market share away from rivals.
l Buyer demand is growing rapidly.
l Buyer costs to switch to rival brands are high.
l The products of rival sellers are strongly differentiated and the loyalty of

buyers to their preferred brand is high.
l There are so many rivals that any one company’s actions have

little direct impact on the businesses of rivals.
l Sellers have small inventories and/or little idle capacity.
l Rivals have low fixed costs and low inventory storage costs.
l A few large sellers have the majority of sales and dominant

market shares.
l Rivals have similar costs and similar industry outlooks—there are no industry

mavericks to disrupt the status quo.

Rivalry among
Competing Sellers

How strong are the
competitive pressures

stemming from the
maneuvers of rivals
to win higher sales
and market shares

and build/strengthen
competitive advantages?

Typical “Weapons” for Battling Rivals and Attracting Buyers
l Reducing price; granting discounts to win the

business of particular buyers
l Introducing more or different features
l Innovating to improve product performance and

quality
l Running ads to inform buyers of new or special

features and/or to strengthen brand awareness
and brand image

l Having periodic sales promotions, holding
clearance sales, advertising items on sale

l Improving selection of models/styles
l Building a bigger/better dealer network
l Offering low interest rate financing
l Offering coupons
l Improving customer service
l Allowing buyers to customize what they purchase
l Improving warranties
l Providing quicker or cheaper delivery
l Developing competitively valuable capabilities

rivals don’t have

Chapter 3 • Evaluating a Company’s External Environment 46

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Competitive Pressures Associated with the Threat of New

Entrants

A looming threat that outsiders will enter an industry intensifies the competitive pressures on existing industry
members. New entry threatens the positions of current industry participants. Newcomers give buyers an additional
choice of which brands to purchase, add to the industry’s supply capabilities in the case of manufacturers, and
expand the number of head-to-head rivals. New entrants can be expected to compete aggressively to gain a
market foothold and then further expand their customer base, oftentimes taking sales and market share away
from current industry members. Financially-strong newcomers with either proven competitive capabilities (or
the ability to acquire them) may well evolve into formidable competitors, thus putting added competitive pressure
on current industry members. To counter credible threats of entry, some/many industry members may decide to
initiate defensive strategies (like announcing selective price cuts, boosting advertising, announcing intentions to
accelerate new product introductions, and so on) to deter new entry and signal their intent to make it harder for
new entrants to be competitively successful.

Just how serious the threat of entry is in a particular market depends on (1) whether entry barriers are high or
low, (2) the expected reaction of existing industry members to the entry of newcomers, (3) the size of the pool
of likely entry candidates and the degree to which they have the resources and capabilities to become formidable
competitors, and (4) the attractiveness of the industry to newcomers (see Figure 3.5).

Figure 3.5 Factors Affecting the Threat of Entry

Entry threats are stronger when:
l Entry barriers are low or can be readily hurdled by entry candidates

with adequate resources.
l Potential entrants do not expect that industry members are likely or

able to strongly contest the entry of newcomers.
l The pool of entry candidates is large and some have adequate

resources to overcome entry barriers and combat defensive actions
of existing industry members.

l Existing industry members are looking to expand their market reach
by entering product segments or geographic areas where they
currently do not have a presence.

l Buyer demand is growing rapidly.
l Newcomers view the industry as attractive because of its strong

growth potential and/or their prospects of earning good profits.

Entry threats are weaker when:
l Entry barriers are high.
l Entry candidates expect that industry members will strongly contest

the efforts of newcomers to gain a market foothold.
l The pool of likely entry candidates is small.
l Buyer demand is growing slowly or is stagnant.
l The industry’s outlook is risky or uncertain or offers limited profit

opportunities for newcomers.
l Frequently tough industry conditions make it hard for current

industry members to consistently earn a decent profit—a condition
that makes the industry unattractive to newcomers.

Rivalry
among

Competing
Sellers

How strong are the
competitive pressures

associated with the entry
threat from new rivals?

Potential
New

Entrants

vigorous that profit margins are eroded and industry profitability drops to unattractively low levels. Rivalry
is moderate or normal when the maneuvering among industry members, while lively and healthy, still allows
most industry members to earn acceptable profits. Rivalry is weak when most companies in the industry are
relatively well satisfied with their sales growth and market shares, rarely undertake offensives to steal customers
away from one another, and—because of weak cross-company competition—earn consistently good profits and
returns on investment.

Chapter 3 • Evaluating a Company’s External Environment 47

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Whether Entry Barriers Are High or Low. The strength of the threat of entry is governed to a large degree
by whether potential new entrants face high or low entry barriers. High barriers reduce the threat of potential
entry, whereas low barriers enable easier entry. The most widely encountered barriers that entry candidates must
hurdle include:4

l The cost advantages enjoyed by industry incumbents. Existing industry members frequently have been
able to reduce unit costs to levels that are hard for a newcomer to replicate. The cost advantages of
industry incumbents can stem from (1) scale economies in production, distribution, or other activities,
(2) the learning-based cost savings that accrue from experience in performing certain activities such as
manufacturing or new product development or inventory management, (3) cost-savings accruing from
patents or proprietary technology, (4) partnerships with the best and cheapest suppliers of raw materials
and components, (5) favorable locations, and (6) low fixed costs (because they have older facilities
that have been mostly depreciated). The bigger the cost advantages of industry incumbents, the riskier
it becomes for outsiders to attempt entry (since they will have to accept thinner profit margins or even
losses until the cost disadvantages can be overcome).

l Strong brand preferences and high degrees of customer loyalty. The stronger the attachments of buyers
to established brands, the harder it is for a newcomer to break into the marketplace. In such cases, a
new entrant must have the financial resources to spend enough on advertising and sales promotion to
overcome customer loyalties and build its own clientele. Establishing brand recognition and building
customer loyalty can be a slow and costly process. In addition, if it is difficult or costly for a customer to
switch to a new brand, a new entrant must persuade buyers that its brand is worth the switching costs. To
overcome switching-cost barriers, new entrants may have to offer buyers a discounted price or an extra
margin of quality or service. All this can mean lower expected profit margins for new entrants, which
increases the risk to startup companies who are dependent on sizable early profits to support their new
investments.

l High capital requirements. The larger the total dollar investment needed to enter the market successfully,
the more limited the pool of potential entrants. The most obvious capital requirements for new entrants
relate to manufacturing facilities and equipment, introductory advertising and sales promotion
campaigns, working capital to finance inventories and customer credit, and sufficient cash to cover all
kinds of startup costs that must be paid before sizable revenues materialize.

l The difficulties of building a network of distributors or retailers and securing adequate space on
retailers’ shelves. A potential entrant can face numerous distribution channel challenges. Wholesale
distributors may be reluctant to take on a product that lacks buyer recognition. Retail dealers must
be recruited and convinced to give a new brand ample display space and an adequate trial period.
When existing sellers have strong, well-functioning distributor–dealer networks, a newcomer has an
uphill struggle in squeezing its way into existing distribution channels. Potential entrants sometimes
have to “buy” their way into wholesale or retail channels by cutting their prices to provide dealers and
distributors with higher markups and profit margins, or by giving them big advertising and promotional
allowances. As a consequence, a potential entrant’s profits may be squeezed unless and until its product
gains enough consumer acceptance that distributors and retailers are anxious to carry it.

l Restrictive or costly regulatory policies. Government agencies can limit or even bar entry by requiring
licenses and permits. Entry into industries like cable TV, telecommunications, electric and gas utilities,
radio and television broadcasting, liquor retailing, and railroads is government-controlled. In international
markets, host governments commonly limit foreign entry and must approve all foreign investment
applications. Government-mandated safety regulations and environmental pollution standards are entry
barriers because they raise entry costs. Recently-enacted banking regulations in many countries have
made entry particularly difficult for small new bank startups—complying with all the new regulations
along with the various rigors of competing against existing banks requires very deep pockets.

Chapter 3 • Evaluating a Company’s External Environment 48

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l Tariffs and international trade restrictions. National governments commonly use tariffs and various
kinds of burdensome trade restrictions to raise entry barriers for foreign firms and protect domestic
producers from outside competition.

Whether an industry’s entry barriers ought to be considered high or low depends on the resources and
competencies possessed by potential entrants. Small startup enterprises may find the prevailing entry barriers
insurmountable. However, current industry participants looking to expand their market reach by entering new
segments or geographic areas where they currently have no market presence normally have the resources to
overcome the existing entry barriers without much difficulty. Likewise, outsiders with sizable financial resources,
proven competitive capabilities, and a recognized brand name may be able to hurdle an industry’s entry barriers
rather easily. For example, when Honda opted to enter the U.S. lawnmower market in competition against Toro,
Snapper, Craftsman, John Deere, and others, it was easily able to hurdle entry barriers that would have been
formidable to other newcomers because it had longstanding expertise in gasoline engines, and its well-known
reputation for quality and durability in automobiles gave it instant credibility with homeowners. Honda had
to spend relatively little on advertising to attract lawnmower buyers and gain a market foothold. Distributors
and dealers were quite willing to handle the Honda lawnmower line, and Honda had ample capital to build a
U.S. assembly plant. Similarly, Samsung’s brand reputation in televisions, DVD players, and other electronics
products gave it strong credibility in entering the market for smart phones—Samsung’s Galaxy smartphones are
now a formidable rival of Apple’s iPhone.

However, it is important to understand that the barriers to entering an industry can become stronger or weaker
over time. Changing industry circumstances can cause one or more entry barriers to become easier to hurdle
(maybe even disappear) or harder to hurdle, thus raising or lowering the threat of entry. For example, in the
pharmaceutical industry the expiration of a key patent on a widely-prescribed drug greatly lowers an important
entry barrier and virtually guarantees that one or more drug makers will enter with generic offerings of their own.
When companies win new patents on their technological discoveries or develop proprietary low-cost production
techniques, entry barriers rise significantly. Regulatory changes can raise entry barriers when new regulations
impose significant cost and compliance burdens on industry members and lower entry barriers when rules and
regulations become more relaxed.

The Expected Reaction of Industry Members in Defending against New Entry A second factor
affecting the threat of entry relates to the ability and willingness of industry incumbents to launch strong defensive
maneuvers to maintain their positions and make it harder for a newcomer to compete successfully and profitably.
Entry candidates may have second thoughts about attempting entry if they conclude that existing firms will
mount well-funded campaigns to hamper (or even defeat) a newcomer’s strategy to gain a market foothold big
enough to compete successfully; such campaigns can include reducing prices, offering special price discounts
to the very customers a newcomer is seeking to attract, stepping up advertising expenditures, running frequent
sales promotions, adding attractive new product features (to match or beat the newcomer’s product offering),
increasing spending on R&D to speed the introduction of new and improved products, or providing additional
services to customers. Strong expectations on the part of new entrants that some or many important industry
incumbents will strongly contest a newcomer’s entry raise a new entrant’s costs and risks, perhaps by enough to
dissuade some/many entry candidates from going forward. Microsoft can be counted on to fiercely defend the
position that Windows enjoys in computer operating systems and that Microsoft Office has in office productivity
software. The world’s leading motor vehicle producers (General Motors, Ford, BMW, Volkswagen, Toyota,
Daimler Benz, and Jeep) are mounting strong defensive actions to contest the strategic intent and strategic
actions of Tesla and Chinese makers of electric vehicles (particularly BYD) to be high-volume players in the
market for electric vehicles.

However, there are occasions when industry incumbents have nothing in their competitive arsenal that is
formidable enough to either discourage entry or put obstacles in a newcomer’s path that will defeat its strategic
efforts to become a viable competitor. In the restaurant industry, for example, existing restaurants in a given
geographic market have few actions they can take to discourage a new restaurant from opening or to block it

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from attracting enough patrons to be profitable. A fierce global competitor like Nike has not prevented relative
newcomer Under Armour from rapidly growing its international sales and market share in sports apparel. Amazon.
com, despite its competitively formidable size, attractively low prices, wide selection, fast delivery, and well-
regarded reputation, lacks the ability to prevent other online retailers whose merchandise lineups include items
comparable to items found on Amazon’s website from building a profitable customer base—rather, the number
of online retailers is growing and the sales of many different online retailers are growing at double-digit rates.

Furthermore, there are occasions when industry incumbents can be expected to refrain from taking or initiating
any actions specifically aimed at contesting a newcomer’s entry. In large industries, entry by small startup
enterprises normally poses no immediate or direct competitive threat to industry incumbents and their entry is
not likely to provoke defensive actions. For instance, a new online retailer with sales prospects of maybe $10–
$20 million annually can reasonably expect to escape competitive retaliation from Amazon.com. The less that a
newcomer’s entry will adversely impact the sales and profitability of industry incumbents, the more reasonable
it is for potential entrants to expect industry incumbents to ignore the entry of newcomers (in the sense of not
making new competitive moves to combat the newcomer’s efforts to attract customers and become profitable).

The Pool of Likely Entry Candidates and Their Resources and Competitive Capabilities. A third
factor relates to the size of the pool of likely entry candidates and the competitively valuable resources at their
command. As a rule, the bigger the pool of entry candidates, the stronger the threat of potential entry. This is
especially true when some entry candidates have ample resources to hurdle existing entry barriers and may
also have competitively valuable skills and resource strengths to become formidable contenders for market
leadership. However, in many industries the strongest entry threat frequently comes not from companies outside
the industry but from existing industry members seeking to expand by entering market segments or geographic
areas where they currently do not have a market presence. Companies already well established in certain product
categories or geographic areas usually possess the resources, competencies, and competitive capabilities to
hurdle the barriers of entering a different market segment or new geographic area.

Industry Attractiveness Factors The fourth and final factor shaping whether the threat of entry is strong
or weak is how attractive the growth and profit prospects are for new entrants. Rapidly growing market demand
and high potential profits act as magnets, growing the pool of entry candidates and motivating potential entrants
to commit the resources needed to hurdle entry barriers.5 When the growth opportunities and profit prospects
of new entrants are sufficiently attractive, entry barriers are
unlikely to be an effective entry deterrent. At most, they
limit the pool of candidate entrants to enterprises with the
requisite resources and competencies to compete head-to-
head with incumbent firms. In contrast, when an industry’s
growth prospects are minimal, if its outlook is risky/
uncertain, or if industry members often struggle to earn a
decent profit (because the industry is plagued by intense
competition or other profit-limiting conditions), the pool
of potential entrants shrinks—there is seldom any good
business reason for a company to enter an industry or a market segment if its prospects for good long-term
profitability are poor.

Therefore, a very revealing indicator of whether potential entry is a strong or weak competitive force in the
marketplace is to inquire if the industry’s growth and profit prospects are strongly attractive to potential entry
candidates. When the answer is no, potential entry is a weak competitive force. When the answer is yes and there
are entry candidates with sufficient (maybe even competitively powerful) expertise and resources to contend with
entry barriers and retaliatory moves by industry incumbents, then the looming entry threat definitely intensifies
competitive pressure on current industry members.

CORE CONCEPT
The threat of entry is stronger when entry barriers
are low, when incumbent firms are unable or
unwilling to vigorously contest a newcomer’s
entry, when there’s a sizable pool of entry
candidates, and when the industry’s outlook is
highly attractive to outsiders.

Chapter 3 • Evaluating a Company’s External Environment 50

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Competitive Pressures from the Sellers of Substitute Products
Companies in one industry come under competitive pressure from the actions of companies in a closely adjoining
industry whenever buyers view the products of the two industries as good substitutes. For instance, the producers
of wine face competitive pressures from the makers of beer and hard liquors (bourbon, vodka, tequila, rum, etc.).
The producers of sugar experience competitive pressures from the producers of sugar substitutes (high-fructose
corn syrup, agave syrup, and artificial sweeteners). Internet providers of news-related information have put
brutal competitive pressure on the publishers of newspapers. Contact lens are a substitute for eyeglasses. The
makers of smart phones, by building ever better cameras into their cell phones, have reduced the demand for all
other types of cameras to an irrelevant market niche and made smart phones the device of choice for picture-
taking. New types of diabetes control are becoming an attractive substitute for daily insulin shots. Plant-based
meats are a substitute for animal meat. These examples should make it clear that the term substitute products (or
just substitutes) refers specifically to products in different industry categories that perform the same or similar
functions for consumers or meet similar consumer needs; different brands of a product/service within a given
industry are not considered to be substitute products but rather the brand alternatives of rivals competing head-
to-head within same industry category.

As depicted in Figure 3.6, three factors determine whether the competitive pressures from substitute products
are strong, moderate, or weak:

1. Whether substitutes are readily available and attractively priced. The presence of readily available and
attractively priced substitutes creates competitive pressure by placing a ceiling on the prices industry
members can charge without giving customers an incentive to switch to substitutes and risking sales
erosion.6 This price ceiling, at the same time, puts a lid on the profits that industry members can earn
unless they find ways to cut costs.

2. Whether buyers view the substitutes as comparable or better in terms of quality, performance, and other
relevant attributes. The availability of substitutes inevitably invites buyers to compare performance,
features, ease of use, and other attributes besides price. The users of paper cartons constantly weigh
the performance trade-offs with plastic containers and metal cans. Movie enthusiasts are increasingly
weighing whether to go to movie theaters to watch newly released movies or wait till they can watch
the same movies streamed to their home TV by streamed entertainment providers or cable firms. Strong
competition from the providers of appealing substitutes pressures industry participants to incorporate
new features and attributes that make their product offerings more competitive and more or less equally
attractive to buyers.

3. Whether the costs that buyers incur in switching to the substitutes are low or high. Low switching costs
make it easier for the sellers of attractive substitutes to lure buyers to their offering; high switching costs
deter buyers from purchasing substitute products.7

As a rule, the lower the price of readily available substitutes, the higher their quality and performance, and the
lower the user’s switching costs, the more intense the competitive pressures posed by the sellers of substitute
products. Three reliable market indicators of the competitive strength of substitute products include (1) whether
the sales of substitutes are growing faster than the sales of the industry being analyzed (a sign that the sellers
of substitutes may be drawing customers away from the industry in question); (2) whether the producers of
substitutes are investing in added capacity and market coverage; and (3) whether the producers of substitutes are
earning progressively higher profits.

Chapter 3 • Evaluating a Company’s External Environment 51

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Figure 3.6 Factors Affecting Competition from Substitute Products

Competitive pressures from substitutes are stronger when:
l Good substitutes are readily available or new ones are emerging.
l Substitutes are attractively priced.
l Substitutes have comparable or better performance features.
l Buyers have low costs in switching to substitutes.
l Buyers are growing more comfortable with using substitutes.

Competitive pressures from substitutes are weaker when:
l Good substitutes are not readily available or don’t exist.
l Substitutes are higher priced relative to the value they

deliver to buyers.
l Substitutes lack comparable or better performance features.
l Buyers have high costs in switching to substitutes.

Firms in Other
Industries Offering

Substitute
Products

How strong are competitive
pressures coming from

the attempts of companies
outside the industry
to win buyers over
to their products?

Rivalry
among

Competing
Sellers

Signs that Competition from Substitutes Is Strong
l Sales of substitutes are growing faster than sales of the industry

being analyzed (an indication that the sellers of substitutes are
stealing the industry’s customers away).

l Producers of substitutes are investing in new capacity and
expanding their market coverage.

l Profits of the producers of substitutes are rising.

Competitive Pressures Stemming from Supplier Bargaining Power
Whether the suppliers of industry members represent a strong, moderate, or weak competitive force depends
on how much bargaining power suppliers have to influence the terms and conditions of supply in their favor.
Powerful or influential suppliers can be a source of competitive pressure because of their ability to charge industry
members higher prices and/or make it difficult or costly for industry members to switch to other suppliers.

A number of circumstances determine the nature and strength of supplier bargaining power:8

l Whether certain needed inputs are in short supply. Suppliers of items in short supply have some degree
of pricing power, whereas a surge in the available supply of particular items greatly weakens supplier
pricing power and bargaining leverage.

l Whether certain suppliers provide a differentiated input that enhances the performance or quality of
the industry’s product. The more valuable a particular input is in terms of enhancing the performance or
quality of industry members’ products, the more bargaining leverage and pricing power such suppliers
have.

l Whether certain suppliers provide equipment or services that deliver valuable cost-saving efficiencies
to industry members in operating their production processes. Suppliers who provide cost-saving
equipment or other valuable or necessary production-related services are likely to possess bargaining
leverage and be in a position both to resist requests for concessions from industry members and to
charge higher prices than they might otherwise be able to charge. Industry members that do not source
from such suppliers may find themselves at a cost disadvantage and thus under competitive pressure
to buy the cost-saving equipment or services of these suppliers (on terms that are favorable to the
suppliers).

Chapter 3 • Evaluating a Company’s External Environment 52

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l Whether the item being supplied is a standard item or commodity that is readily available from a host
of suppliers at the going market price. The suppliers of commodities (like copper or steel reinforcing
rods or shipping cartons) are in a weak position to demand a premium price or insist on other favorable
terms because industry members can readily obtain essentially the same item at the same price from any
of several other suppliers eager to win their business, perhaps dividing their purchases among two or
more suppliers to promote lively competition for orders. The suppliers of commodity items have market
power only when supplies become so tight that industry members agree to pay more to have their orders
filled and delivered on time.

l Whether it is difficult or costly for industry members to switch their purchases from one supplier to
another or to switch to attractive substitute inputs. High switching costs convey strong bargaining
power to suppliers, whereas low switching costs and ready availability of good substitute inputs weaken
the bargaining power of suppliers. The lack of good substitute inputs enhances supplier bargaining
power, whereas the availability of good substitute inputs weakens supplier bargaining power. Soft
drink bottlers, for example, can counter the bargaining power of aluminum can suppliers by shifting or
threatening to shift to greater use of plastic containers and introducing new sizes or plastic containers
and/or more attractive plastic container designs.

l Whether industry members are major customers of suppliers. As a rule, suppliers have less bargaining
leverage when their sales to members of this one industry constitute a big percentage of their total sales.
In such cases, the well-being of suppliers is closely tied to the well-being of their major customers.
Suppliers have a big incentive to protect and enhance the competitiveness of their major customers via
reasonable prices, exceptional quality, and ongoing advances in the technology of the items supplied.

l Whether suppliers provide an item that accounts for a sizable fraction of the costs of the industry’s
product. The bigger the cost of a particular part or component, the harder it is for suppliers to boost
their prices because such higher prices result in big increases in unit costs and total costs for industry
members—cost increases that may adversely affect their competitiveness and long-term well-being. In
such cases, suppliers must be cautious about charging prices that damage the business performance of
their customers, and they can expect industry members to bargain hard in resisting the price increases
of such suppliers. On the other hand, when suppliers’ product or service accounts for a small or tiny
fraction of industry members’ unit costs and total costs, suppliers have added power over the price and
other terms of supply; this is especially true when industry members are not major customers of these
suppliers and their purchases generate only small revenues.

l Whether only a few suppliers are regarded as the best or preferred sources of a particular item. Highly
regarded suppliers with strong demand for the items they supply generally have sufficient bargaining
power to deny industry members’ requests for lower prices or other concessions, and they may also
have the clout to charge higher prices when they make innovative improvements in the items they
supply. Nonetheless, the bargaining power of preferred suppliers can erode substantially if their profits
are suffering and they need to boost sales. Moreover, the larger the number of acceptable suppliers that
industry members have to purchase from, the weaker the bargaining power of any one supplier, even if
they enjoy preferred status.

l Whether industry members have sound business reasons to integrate backward and self-manufacture
items they have been buying from suppliers. The make-or-buy issue generally boils down to whether
suppliers who specialize in the production of a particular part or component and who make them in
volume for many different customers have the expertise and scale economies to supply as good or better
components at a lower cost than industry members could achieve via self-manufacture. Frequently, it
is difficult for industry members to self-manufacture parts and components more economically than
they can obtain them from suppliers who specialize in making such items. For instance, most producers
of outdoor power equipment (such as lawn mowers, rotary tillers, and leaf blowers) find it cheaper
to source the small engines they need from outside manufacturers who specialize in small engine

Chapter 3 • Evaluating a Company’s External Environment 53

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manufacture rather than make their own engines; this is often because the quantity of engines they need
is too small to justify the investment in production facilities, master the production process, and capture
scale economies. Specialists in small engine manufacture, by supplying many kinds of engines to the
whole power equipment industry, can obtain a big enough sales volume to fully realize scale economies,
become proficient in all the manufacturing techniques, keep unit costs low, while also spending enough
on product R&D to periodically introduce cutting-edge next-generation versions of their product. As a
rule, suppliers are safe from the threat of self-manufacture by their customers until the volume of parts
a customer needs becomes large enough for the customer to justify backward integration into self-
manufacture of the component.

l Whether suppliers have the resources and profit incentive to integrate forward into the business of the
customers they are supplying. In instances where such is the case, suppliers have strong bargaining
leverage because industry members may be willing to pay such suppliers a higher price to keep them
from entering their business and potentially becoming a formidable rival.

Figure 3.7 summarizes the conditions that tend to make supplier bargaining power strong or weak.

Figure 3.7 Factors Affecting the Bargaining Power of Suppliers

Supplier bargaining power is stronger when:
l A needed input is in short supply.
l Certain suppliers either have a differentiated

input that enhances the quality or performance of
sellers’ products or provide equipment/services
that deliver valuable cost-saving efficiencies.

l Industry members incur high costs in switching
to alternative suppliers.

l There are no good substitutes for certain
products/services being supplied.

l Suppliers are not dependent on industry
members for a large portion of their revenues.

l Suppliers provide an item that accounts for
a small fraction of the costs of the industry’s
product.

l There are only a few “preferred” suppliers of a
particular input.

l Some suppliers are a threat to integrate forward
into the business of industry members and
perhaps become a powerful rival.

Supplier bargaining power is weaker when:
l There are ample supplies of a needed input.
l The item being supplied is a “commodity” obtainable

from many different suppliers at the going market
price.

l Industry members incur low costs in switching to
alternative suppliers.

l Good substitutes exist for the products/services of
suppliers.

l Industry members are major customers and
continuing to secure their business is important to
suppliers’ well-being.

l Suppliers provide an item that accounts for a sizable
fraction of the costs of the industry’s product.

l Industry members can purchase what they need from
any of many different “good to acceptable” suppliers.

l Industry members are a threat to integrate
backward into the business of suppliers and to
self-manufacture their own requirements.

Rivalry among
Competing

Sellers

How strong are the
competitive pressures

stemming from supplier
bargaining power?

Suppliers of Raw
Materials, Parts,

Components, or Other
Resource Inputs

Competitive Pressures Stemming from Buyer Bargaining Power
Whether buyers are able to exert strong competitive pressures on industry members depends on (1) the degree
to which some or many buyers have sufficient bargaining power to obtain price concessions and other favorable
purchase terms and (2) the extent to which buyers are price-sensitive. Buyers with strong bargaining power are
a source of competitive pressure because they are in position to push hard for price concessions, better payment
terms, additional features and services, and/or other special treatment that typically squeeze industry members’

Chapter 3 • Evaluating a Company’s External Environment 54

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profit margins. High levels of buyer price sensitivity are a source of competitive pressure because large numbers
of price sensitive buyers place limits on seller ability to raise prices without suffering declining unit sales and
revenue erosion.

The Factors Affecting Whether Buyers Have Strong or Weak Bargaining Power As with suppliers,
the leverage that buyers have in negotiating favorable terms can range from weak to strong. Individual consumers
seldom have much bargaining power in negotiating price concessions or other favorable terms with sellers; the
primary exceptions involve situations in which price haggling is customary, such as the purchase of new and
used motor vehicles, homes, and other big-ticket items like luxury watches, jewelry, works of art, and pleasure
boats. For most consumer products and services, individual buyers have negligible bargaining leverage because
they purchase in small quantities and often irregularly—their option is to pay a seller’s posted price or take their
business elsewhere. Small businesses usually have weak bargaining power because of the small-size orders they
place with sellers. Many relatively small wholesalers and retailers that have very little buyer bargaining power
acting on their own join buying groups to pool their purchasing power and approach manufacturers for better
terms than could be gotten individually.

Understandably, large retail chains like Walmart, Best Buy, Walgreens, The Home Depot, and Kroger typically
have considerable bargaining power in purchasing products from manufacturers not only because they buy in
large quantities but also because of manufacturers’ need for broad retail exposure and the most appealing shelf
locations. Retailers may stock two or three competing brands
of a product but rarely all competing brands, so competition
among rival manufacturers for visibility on the shelves of
popular multistore retailers gives such retailers significant
bargaining strength. Major supermarket chains like Kroger,
Albertson’s (also the owner of Safeway and eleven other
supermarket brands), and Publix have sufficient bargaining
power to demand promotional allowances and lump-sum
payments (called slotting fees) from food products manufacturers in return for stocking certain brands or putting
them in the best shelf locations. Motor vehicle manufacturers have strong bargaining power in negotiating to
buy original equipment tires from Goodyear, Michelin, Bridgestone/Firestone, Continental, and Pirelli partly
because they buy in large quantities and partly because tire makers believe they gain an advantage in supplying
replacement tires to vehicle owners if their tire brand is original equipment on the vehicle. On occasions,
“prestige” buyers have a degree of clout in negotiating with sellers because a seller’s reputation is enhanced by
having prestige buyers on its customer list.

Even if buyers do not purchase in large quantities or provide sellers better market exposure or an enhanced
reputation, their bargaining strength increases in the following circumstances:9

l When buyer demand is weak in relation to the available supply and industry members are eager to sell
more units. Weak or declining demand and the resulting excess supply create a “buyers’ market” where
bargain-hunting buyers have leverage in pressing industry members for better deals and special treatment.
Conversely, strong or rapidly growing market demand creates a “sellers’ market” characterized by tight
supplies or shortages—conditions that put buyers in a weak position to wring concessions from industry
members.

l When industry members’ products are standardized “commodities” or else weakly differentiated.
In such instances, buyer loyalty to any one brand is low, and buyers tend to shop for the best price,
which usually spurs price competition among industry members. However, buyer bargaining power
declines as the products/services of industry members become strongly differentiated—the bigger the
differences among the features, performance, and quality of rival brands, the more buyers come to prefer
the brand most suitable to their preferences and pocketbook. Strong buyer attachment to a favorite brand
diminishes buyer bargaining power, particularly when an industry member knows full well that buyers
recognize the superiority of its product offering.

Buyers’ bargaining power is stronger when they
are few in number and purchase in large volumes.
The larger buyers’ purchases, the more important
their business is to sellers and the more likely
that sellers will grant them concessions or special
treatment.

Chapter 3 • Evaluating a Company’s External Environment 55

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l When buyers have low costs in switching to competing brands or substitutes. Buyers who can readily
switch brands or source from several competing sellers have more negotiating leverage than buyers who
have high switching costs or strong loyalty to a particular brand.

l When the number of buyers is small or retaining a particular buyer’s business is important to a seller.
The smaller the number of buyers, the harder it is for industry members to find alternative buyers when a
customer is lost to a rival. The prospect of losing a customer not easily replaced often makes an industry
member willing to grant concessions of one kind or another to retain the customer’s business.

l When buyers are well informed and have compared the product offerings of industry members regarding
prices, product features, quality, buyer reviews, and other pertinent factors. The more information buyers
have about the comparative product offerings of industry members, the better bargaining position they
are in. The mushrooming availability of product information at online websites enables businesses and
individuals to compare different products and locate industry members with the best deals. Armed with
this information, bargain-hunting businesses can contact one or more low-priced industry members and
try to wrangle an even better deal. Similarly, individuals can use information gleaned from the Internet
to bargain with local retailers, a technique that works well when it comes to buying new and used motor
vehicles and other big-ticket items.

l When buyers pose a credible threat of integrating backward into the business of sellers. Retailers gain
bargaining power in negotiating with the makers of popular name brand products by stocking and
promoting their own private-label brands alongside manufacturers’ brands. Beer producers like Anheuser
Busch InBev SA/NV (whose brands include Budweiser, Coors, Miller, Molson, and Heineken) have
integrated backward into metal can manufacturing to gain bargaining power in obtaining the balance of
their beer containers from can and bottle manufacturers. But such buyer bargaining power evaporates
when there is no credible threat of buyers integrating backward into the business of sellers/industry
members.

l When buyers have discretion to delay their purchases or perhaps not make a purchase at all. Consumers
often have the option to delay purchases of durable goods (cars, major appliances, a home addition) or
discretionary goods (hot tubs, home entertainment centers) if they are unhappy with the prices offered.
If college students believe the prices of new textbooks are too high, they can purchase used textbooks
or rent them or buy lower-priced digital ebooks, or share hard-copy texts with friends. Business buyers
may be able to defer spending for new equipment, software upgrades, or maintenance services. Such
options put pressure on industry members to grant concessions to prospective buyers to keep their sales
numbers from dropping off.

Strong Buyer Price Sensitivity Creates Competitive Pressures Low-income and budget-constrained
consumers are almost always price sensitive; bargain-hunting consumers are highly price sensitive by nature.
Most consumers grow more price sensitive as the price tag of an item becomes a bigger fraction of their spending
budget. Business buyers besieged by weak sales, intense competition, and other factors squeezing their profit
margins are price sensitive. Price sensitivity also grows among all businesses as the cost of an item becomes a
bigger fraction of their cost structure. Rising prices of frequently purchased items heightens the price sensitivity
of all types of buyers.

Widespread or rapidly growing price sensitivity among buyers creates competitive pressures on industry
members in two ways: (1) it limits their ability to charge prices that buyers perceive as “too high” and (2) it
constrains industry member ability to raise prices. Price-related competitive pressures on industry members
escalate further if buyer concerns about overly high prices spark a falloff in demand for the industry’s product/
service—buyers having a hard time making ends meet may decide to reduce or defer their purchases or switch to
cheaper-priced substitutes. Business customers suffering weak sales or profitability problems may communicate
their unhappiness over prices directly to industry members and announce their intention to curtail purchases or
switch to lower-priced substitutes.

Chapter 3 • Evaluating a Company’s External Environment 56

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Collective action on the part of growing numbers of individuals, households, and businesses to curtail purchases
escalates competitive pressure on industry members, sometimes exponentially, and can become a potent
competitive force. Fear of a potential sales decline or the harsh winds of an actual sales decline can prompt
industry members to act on their own to trim prices or grant other more favorable purchase terms to buyers.
In such circumstances, buyer bargaining power increases, and industry members anxious to grow their sales
volumes become more willing to bargain with buyers over price and other terms of sale.

Figure 3.8 highlights the circumstances causing buyer bargaining power to be strong or weak.

Figure 3.8 Factors Affecting the Bargaining Power of Buyers

Buyer bargaining power is stronger when:
l Large-volume purchases enable buyers to gain

special treatment.
l A buyer’s identity adds prestige to the seller’s list of

customers.
l Supplies of the product are greater than buyer

demand.
l There are only a few buyers, so each one’s business

is important to sellers.
l Buyers have low costs in switching to competing

brands or substitute products.
l The products of industry members are

“commodities” or else weakly differentiated.
l Buyers are well informed about the product offerings

of industry members.
l Buyers can postpone purchases if they do not like

the deals sellers are offering.
l Some buyers are a threat to integrate backward into

the business of sellers and become an important
competitor.

l Buyers are highly price sensitive.

Buyer bargaining power is weaker when:
l Buyers purchase the item in small quantities.
l Buyers have insufficient “prestige” to command

special treatment.
l Strong buyer demand creates tight supply

conditions or shortages.
l There are so many buyers that any one buyer’s

purchases account for a tiny fraction of total
industry sales.

l Buyers have high costs in switching to competing
brands or substitute products.

l The products of industry members are strongly
differentiated.

l Buyers have limited information about the product
offerings of industry members.

l Buyers cannot easily postpone purchases.
l There is no credible threat of buyers integrating

backward into the business of industry members.
l Buyer price sensitivity is relatively low.

Buyers
How strong are the competitive

pressures stemming from
buyer bargaining power?

Rivalry Among
Competing Sellers

Is the Collective Strength of the Five Competitive Forces Conducive
to Good Profitability?
Assessing whether each of the five competitive forces gives rise to strong, moderate, or weak competitive
pressures sets the stage for evaluating whether the collective strength of the five forces is conducive to good
profitability. Can companies in this industry reasonably expect to earn decent profits in light of the prevailing
competitive forces? Are competitive forces sufficiently powerful to undermine industry profitability? Or, is the
state of competition in the industry weaker than “normal,” thus opening opportunities for industry members to
earn very attractive profits?

As a rule, the stronger the collective impact of the five
competitive forces, the lower the combined profitability
of industry participants. The most extreme case of a
“competitively unattractive” industry occurs when all five
forces are producing strong competitive pressures: rivalry

The stronger the forces of competition, the harder
it becomes for industry members to earn attractive
profits.

Chapter 3 • Evaluating a Company’s External Environment 57

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among sellers is vigorous, low entry barriers allow new rivals to gain a market foothold, competition from
substitutes is intense, and both suppliers and buyers are able to exercise considerable bargaining leverage. Fierce
to strong competitive pressures coming from all five directions nearly always drive industry profitability to
unacceptably low levels, frequently producing losses for many industry members and forcing competitively weak
businesses to go out of business. But an industry can be competitively unattractive without all five competitive
forces being strong. Intense competitive pressures from just two or three (maybe even just one) of the five forces
may suffice to destroy the conditions for good profitability, and prompt struggling companies to exit the business.
Especially intense competitive conditions seem to be the norm in tire manufacturing, apparel, and commercial
airlines—all three industries have long been characterized by historically thin profit margins.

In contrast, when the collective impact of the five competitive forces is moderate to weak, an industry is
competitively attractive in the sense that industry members can reasonably expect to earn good profits and
a nice return on investment. The ideal competitive environment for earning superior profits is one in which
both suppliers and customers are in weak bargaining positions, there are no good substitutes, high barriers
block further entry, and rivalry among present sellers generates only moderate competitive pressures. Weak
competition is the best of all possible worlds for also-ran companies because even they can usually eke out a
decent profit—if a company can’t make a decent profit when competition is weak, then its business outlook is
indeed grim.

In most industries, the collective strength of the five competitive forces is somewhere near the middle of the
two extremes of intense and weak, typically ranging from slightly stronger than normal to slightly weaker than
normal and typically allowing well-managed companies with sound strategies to earn acceptable or better profits.

Matching Company Strategy to Competitive Conditions Working through the five forces model step by
step not only aids strategy-makers in assessing whether the intensity of competition allows good profitability but
also promotes sound strategic thinking about how to better match company strategy to the specific competitive
character of the marketplace. Effectively matching a
company’s strategy to prevailing competitive conditions
has two aspects:

1. Pursuing avenues that shield the firm from as many
of the different competitive pressures as possible.

2. Initiating actions calculated to produce sustainable competitive advantage, thereby shifting competition
in the company’s favor, putting added competitive pressure on rivals, and perhaps even defining the
business model for the industry.

But making headway on these two fronts first requires identifying competitive pressures, gauging the relative
strength of each of the five competitive forces, and gaining a deep enough understanding of the state of competition
in the industry to know which strategy buttons to push.

Question 2: What Factors Are Driving Industry Change
and What Impact Will They Have?

While it is critical to understand the nature, intensity, and fluidity of competitive forces in an industry, there
are also other types of factors that gradually or speedily alter industry conditions in ways important enough to
require a strategic response from participating firms. The popular hypothesis that industries go through a life
cycle of takeoff, rapid growth, early maturity and slowing growth, market saturation, and stagnation or decline
is but one aspect of industry change—many other new developments and emerging trends cause industry change
besides an industry’s so-called normal progression through the life cycle.10

A company’s strategy is increasingly effective the
more it provides some insulation from competitive
pressures and shifts the competitive battle in the
company’s favor.

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The Concept of Driving Forces
Industry environments are dynamic and, in most all cases, contain forces that are enticing or pressuring certain
industry participants (competitors, customers, suppliers) to alter their actions in important ways.11 The most
powerful of the change agents are called driving forces because they have the biggest influences in reshaping
the industry landscape and altering competitive conditions. Some driving forces originate in the outer ring of the
company’s macro-environment (see Figure 3.2), but most originate in the company’s more immediate industry
and competitive environment.

Driving-forces analysis has three steps: (1) identifying what the driving forces are, (2) assessing whether the
drivers of change are, on the whole, acting to make the industry more or less attractive, and (3) determining
what strategy changes are needed to prepare for the impacts of the driving forces. All three steps merit further
discussion.

Identifying an Industry’s Driving Forces
Many developments can affect an industry powerfully enough to qualify as driving forces. Some drivers of
change are unique and specific to a particular industry situation, but most drivers of industry and competitive
change fall into one of the following categories:12

l Changes in an industry’s long-term growth rate.
Faster industry growth triggers a race among
established firms and newcomers to capture the
new sales opportunities; ambitious companies
with trailing market shares may see the upturn in
buyer demand as a golden opportunity to launch
offensive strategies to broaden their customer
base and move up several notches in the industry
standings. Slower industry growth nearly always
intensifies rivalry as firms anxious to grow rapidly
pursue ways to take sales and market share
away from rivals. Other industry members may
respond to a growth slowdown by merging with or
acquiring other industry members. Should industry sales stagnate or enter into long-term decline, some
competitively weak and/or growth-oriented companies may opt to exit the industry by selling their
operations to those industry members who elect to stick it out. When demand for an industry’s product
continues to shrink, the remaining industry members will likely be forced to close inefficient plants and
retrench to a smaller production base. Hence, whether an industry’s growth rate turns up or down, starts
to stagnate, or becomes negative, the usual outcome is a much-changed competitive landscape.

l Increasing globalization. Competition begins to shift from primarily a regional or national focus to an
international or global focus when industry members begin seeking out customers in foreign markets
or when production activities begin to migrate to countries where costs are lowest. Globalization of
competition really starts to take hold when one or more ambitious companies precipitate a race for
worldwide market leadership by launching initiatives to expand into more and more country markets.
Globalization can also be precipitated by the blossoming of consumer demand in more and more
countries and by government actions in certain countries to reduce trade barriers or open up once-closed
markets to foreign competitors, as is occurring in many parts of Europe, Latin America, and Asia.
Significant differences in labor costs among countries give manufacturers a strong incentive to locate
plants for labor-intensive products in low-wage countries and use these plants to supply market demand
across the world. Wages in China, India, Vietnam, Mexico, and Brazil, for example, are much lower
than those in the United States, Germany, and Japan. The forces of globalization are sometimes such
a strong driver that companies find it highly advantageous, if not necessary, to spread their operating
reach into more and more country markets. Globalization is very much a driver of industry change in

CORE CONCEPT
Industry conditions change because important
forces are driving industry participants
(competitors, customers, or suppliers) to alter their
actions. The driving forces in an industry are the
major underlying causes of changing industry and
competitive conditions—they have the biggest
influence on how the industry landscape will
be altered. Some driving forces originate in the
outer ring of the macro-environment, and some
originate in the inner ring.

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industries like motor vehicles (especially electric vehicles), steel, petroleum, electronics, smart phones,
video games, public accounting, commercial aircraft, subscription-based streamed entertainment, social
media, and pharmaceuticals.

l Emerging new Internet capabilities and applications. Mushrooming use of high-speed Internet service
and Voice-over-Internet-Protocol (VoIP) technology, growing use of online shopping, and the exploding
popularity of Internet applications (“apps”) have been major drivers of change in industry after industry.
The ability of companies to reach consumers via the Internet increases their geographic reach, brings
more sellers into head-to-head competition, and often escalates rivalry by pitting pure online sellers
against combination brick-and-click sellers and against pure brick-and-mortar sellers. The Internet gives
buyers an unprecedented ability to research competitors’ product offerings and shop the market for the
best value. Widespread use of e-mail has forever eroded the business of providing fax services and the
first-class mail delivery revenues of governmental postal services worldwide. Videoconferencing via
the Internet erodes the demand for business travel. Online course offerings are profoundly affecting
higher education. The growing number of online news sources is destroying the newspaper business.
The availability of telehealth capabilities, where patients have online conferences with their doctors or
other types of healthcare providers, alters the need for visits to doctor offices and, coupled with the ease
of transferring digitized medical records, widens the options people have for obtaining the advice and
care of medical specialists. The “Internet of things” now features faster speeds, dazzling applications,
and billions of connected gadgets performing an array of functions, thus driving a changing competitive
landscape in numerous industries. But Internet-related impacts vary from industry to industry. The
challenges here are to assess precisely how fast-emerging uses of new Internet capabilities are altering a
particular company’s industry and to factor these impacts into the company’s strategy-making equation.

l Changes in who buys the product and how buyers use it. Shifts in buyer demographics and the ways
products are used can greatly alter industry and competitive conditions. Longer life expectancies are
driving demand growth in health care, prescription drugs, and assisted living residences. Growing
percentages of relatively well-to-do retirees are driving demand growth in cosmetic surgery, vacation
travel, and assisted living residences. The growing popularity of streamed entertainment has impacted
the businesses of broadband providers, cable providers, television broadcasters, and the long-term
growth prospects of the most popular streamed entertainment providers.

l Product innovation. Competition in an industry is always affected by rivals racing to be first to introduce
some new product or product enhancement, one after another. An ongoing stream of product innovations
tends to alter the pattern of competition in an industry by attracting more first-time buyers, rejuvenating
industry growth, and/or creating wider or narrower product differentiation among rival sellers. The
exploding use of Zoom’s video conferencing software is having a big impact on business travel,
attendance at conferences and conventions, and how companies call on customers, meet with vendors,
and hold internal meetings. Recently developed software using artificial intelligence enables scanning
thousands of potential cancer-treating therapies to reliably identify which drug combinations will have
the desired impact on cancer cells; this begin allows drug researchers to quickly begin clinical trials of
high potential therapies, avoid the time and expense of conducting clinical trials that yield poor results,
and get effective new drug treatments into the marketplace much sooner, thereby revolutionizing how
new drugs are discovered and brought to market. Artificial intelligence is impacting the future of many
industries, enabling wider use of robotics to perform many types of epetitive tasks, and speeding the
development of self-driving vehicles. New cutting-edge 3D printing technology is revolutionizing how
products are manufactured, permitting fast designs, rapid prototyping, strong parts and components,
printing on demand, customization, minimal waste, and cost-effective operation for manufacturers
of all sizes. In recent years, product innovation has been a key driving force in such industries as
semiconductors, lightbulbs, golf clubs, performance fabrics for sports apparel, good-for-you food
products, and small home appliances—witness the introduction of air fryers, pressure cookers like the
Instant Pot, next-generation non-stick cookware, and a host of new types of kitchen gadgets.

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l Technological change and manufacturing process innovation. Technological advances in manufacturing
equipment and the development of new manufacturing processes can cause disruptive change in an
industry by making it possible to produce dramatically new and better products at lower cost and
sometimes opening up whole new industry frontiers. Rapidly advancing self-driving technology is
disrupting the motor vehicle industry, enabling such companies as Google and chip-maker Nvidia to
enter the industry. Stem cell research holds promise for finding ways to cure or treat an array of diseases.
Advancing robotics technology and 3D printing technology (often called additive manufacturing) are
big drivers of manufacturing process innovation, enabling most small-scale manufacturers to compete
cost effectively with large scale producers.

l Marketing innovation. When firms are successful in introducing new ways to market their products,
they can spark a burst of buyer interest, widen industry demand, increase product differentiation, and
lower unit costs—any or all of which can alter the competitive positions of rival firms and force strategy
revisions. Growing popularity of online shopping is shaking up the retailing industry, depressing buyer
traffic at shopping malls and altering the mix of sales through various distribution channels. Increasing
numbers of music artists are marketing their recordings at their own websites rather than entering into
contracts with recording studios. The growing propensity of advertisers to place a bigger percentage
of their ads on social media sites like Facebook and Twitter is shaking up the advertising industry.
Companies that once advertised heavily in newspapers and magazines have found they can get a bigger
sales impact by shifting their advertising dollars to online sites, using highly targeted pay-per-click
marketing, where they pay a fee each time one of their ads is clicked. For example, if an online shopper
has just visited Wayfair’s website and browsed through Wayfair’s faux flowers offerings and bedroom
furniture products, it is a simple matter when the same shopper moves on to another website for Wayfair
to have banner ads for the products the shopper just viewed on Wayfair’s site to appear on other visited
that same day and the next several days. Hundreds of thousands of companies have recently begun
making heavy use of pay-per-click marketing.

l Entry or exit of major firms. The entry of one or more foreign companies into a geographic market
once dominated by domestic firms nearly always shakes up competitive conditions. Likewise, when an
established domestic firm from another industry attempts entry either by acquisition or by launching its
own startup venture, it usually applies its skills and resources in some innovative fashion that pushes
competition in new directions. Entry by a major firm thus often produces a new ball game, not only
with new key players but also with new rules for competing. Similarly, a major firm’s exit changes the
competitive structure by reducing the number of market leaders (perhaps increasing the dominance of
the leaders who remain) and causing a rush to capture the exiting firm’s customers.

l Diffusion of technical know-how across more companies and more countries. As knowledge about
how to perform a particular activity or execute a particular manufacturing technology spreads, the
competitive advantage held by firms originally possessing this know-how erodes. Knowledge diffusion
occurs through scientific journals, trade publications, onsite plant tours, word of mouth among suppliers
and customers, worker migration, and Internet sources. In recent years, rapid technology transfer across
national boundaries has been a prime factor in causing industries to become more globally competitive.

l Changes in cost and efficiency. Widening or shrinking differences in the costs among key competitors
tend to dramatically alter the state of competition. Lower production costs and longer-life products have
allowed the makers of super-efficient fluorescent-based spiral lightbulbs and LED bulbs to cut deeply
into the sales of incandescent lightbulbs. Lower-cost e-books are cutting into sales of costlier hardcover
books as increasing numbers of consumers have laptops, iPads, Kindles, and other brands of tablets.
Lower cost and higher efficiency solar roof panels have heightened homeowner interest in solar roof
installations. Lower cost batteries and longer driving distances between charges have enhanced buyer
interest purchasing an electric vehicle in countries all across the world..

l Growing buyer preferences for differentiated products instead of a commodity product (or for a more
standardized product instead of strongly differentiated products). When buyer tastes and preferences

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start to diverge, sellers can win a loyal following by introducing products that stand apart from those of
rival brands. In recent years, beer drinkers have grown less loyal to traditional brands; many are shifting
to “boutique” beers with distinctive tastes. Leading beer manufacturers have responded by introducing
new distinctive-tasting brands of their own. The consequently larger number of brands and varieties has
made competition livelier. When a shift from standardized to differentiated products occurs, the driver
of change is the contest among rivals to cleverly out-differentiate one another.

Sometimes, however, buyers decide that a standardized budget-priced product suits their requirements
as well as or better than a premium-priced product with lots of snappy features and personalized services.
Pronounced shifts toward greater product standardization (as in grocery items where the difference
between brand-name products and private-label products is frequently miniscule) usually spawn lively
price competition and force rival sellers to lower their costs to maintain profitability. The lesson here
is that competition is driven partly by whether the market forces in motion are acting to increase or
decrease product differentiation.

l Reductions in uncertainty and business risk. Many companies are hesitant to enter industries with
uncertain futures or high levels of business risk, and firms already in these industries may be cautious
about making aggressive capital investments to expand—often because it is unclear how much time and
money it will take to overcome various technological hurdles and achieve acceptable production costs
(as is the case in the solar power industry). Likewise, firms entering foreign markets where demand
is just emerging or where political conditions are volatile may be cautious and limit their downside
exposure by using less risky strategies. Over time, however, diminishing risk levels and uncertainty in
an industry tend to stimulate new entry and capital investments by growth-minded companies seeking
new opportunities, thus dramatically intensifying competitive pressures.

l Regulatory influences and government policy changes. Government regulatory actions can often
mandate significant changes in industry practices and strategic approaches—as has occurred in the
world’s banking industry since 2008. In the United States, a deluge of much stricter banking regulations
during the Obama Administration profoundly altered the operations of banks of all sizes; but starting
in 2017 there were sweeping efforts during the Trump Administration to undo or modify the thousands
of banking rules and regulatory requirements imposed during 2008–2016. New rules and regulations
pertaining to government-sponsored and/or government-mandated health insurance programs are potent
driving forces in the health care industry. It is common practice across the world for governments to
grant subsidies or tax breaks to industries whose products they deem worthy of governmental support
(like electric vehicles and solar energy) and to impose higher taxes or burdensome regulation on those
industries whose products they deem harmful (like cigarettes and fossil fuel production),. In industries
with big volumes of international trade, governments can drive competitive changes by opening their
domestic markets to desirable foreign imports or by erecting tariff barriers and other trade restrictions
to protect domestic companies from foreign competitors. The Trump Administration used the threat/
imposition of high tariffs on various imported products as a bargaining tactic to incentivize governments
across the world to eliminate existing trade inequities, lower the barriers to imports from the United
States, and establish “fair trade” arrangements affecting many industries and product categories in many
countries.

l Changing societal concerns, attitudes, and lifestyles. Emerging social issues, as well as changing
attitudes and lifestyles, can be powerful instigators of industry change. Growing public concern about
climate change has emerged as a major driver of change in the energy industry. The trend to more casual
business dress has dramatically affected the apparel industry. Greater affinity for having household pets
has driven growth across the whole pet industry. Shifting societal concerns, attitudes, and lifestyles
alter the pattern of competition, usually favoring those players that respond quickly and creatively with
products targeted to the new trends and conditions.

That there are so many different potential driving forces explains why a full understanding of all types of change
drivers is a fundamental part of industry analysis. However, labeling every change or trend as a driving force

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must be resisted; no more than three or four are likely to be true driving forces powerful enough to reshape a
particular industry’s landscape in significant ways. The important first task of identifying the in a particular
industry is to evaluate the forces of change carefully enough to separate the forces likely to produce important
changes from those likely to have modest or little impact.

Assessing the Impact of the Driving Forces
Just identifying the driving forces in an industry is not sufficient, however. The second, and more important, step
in driving-forces analysis is to determine whether the prevailing driving forces are, on the whole, acting to make
the industry environment more or less attractive. Answers to three questions are needed:

1. Are the driving forces, on balance, acting to cause
demand for the industry’s product to increase or
decrease?

2. Is the collective impact of the driving forces
making competition more or less intense?

3. Will the combined impacts of the driving forces
lead to higher or lower industry profitability?

Getting a handle on the collective impact of the driving forces usually requires looking at the likely effects of
each force separately since the driving forces may not all be pushing change in the same direction. For example,
two driving forces may be spurring demand for the industry’s product, while one driving force may be curtailing
demand. Whether the net effect on industry demand is up or down hinges on which driving forces are the more
powerful.

Adjusting Strategy to Prepare for the Impacts of Driving Forces
The third step of driving-forces analysis—where the real payoff for strategy-making comes—is for managers to
draw some conclusions about what strategy adjustments will be needed to deal with the impacts of the driving
forces. But taking the “right” actions to prepare for the
industry and competitive changes being wrought by the
driving forces first requires accurate diagnosis of the forces
driving industry change and the impacts these forces will
have on both the industry environment and the company’s
business. To the extent that managers are unclear about the
drivers of industry change and their impacts, or if their views are off-base, the chances of making astute and timely
strategy adjustments are slim. So, driving-forces analysis is not something to take lightly; it is a valuable tool for
managers to use in thinking strategically about where the industry is headed and preparing for the changes ahead.

Question 3: What Market Positions Do Rivals Occupy—
Who Is Strongly Positioned and Who Is Not?

Some industry rivals occupy stronger (or at least distinguishably different) market positions than others, having
opted to incorporate product features that appeal to different
types of buyers, or charge widely differing prices for
products with widely differing quality and/or performance,
or emphasize different distribution channels, or compete in
different geographic areas, and so on. Understanding which
companies are strongly positioned and which are weakly
positioned is an integral part of analyzing an industry’s
competitive structure. The best technique for revealing the market positions of industry competitors is strategic
group mapping.13

The most important part of driving-forces analysis
is to determine whether the collective impact of
the driving forces will be to increase or decrease
market demand, make competition more or less
intense, and lead to higher or lower industry
profitability.

The real payoff of driving-forces analysis is to help
managers understand what strategy changes are
needed to prepare for the impacts of the driving
forces.

CORE CONCEPT
Strategic group mapping is a technique for
displaying the different market positions that rival
firms occupy in the industry.

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Using Strategic Group Maps to Assess the Market Positions of Key Competitors
A strategic group consists of those industry members with similar competitive approaches and positions in
the overall market.14 Companies in the same strategic group can resemble one another in any of several ways:
they may have comparable product-line breadth, have similarly-priced products with similar performance and
quality, emphasize the same distribution channels, use essentially the same product attributes to appeal to similar
types of buyers, depend on identical technological approaches, compete in much the same geographic areas,
or offer buyers similar services and technical assistance.15
An industry contains only one strategic group when all
sellers compete in much the same market space, employing
much the same strategies and using much the same product
attributes to appeal to much the same types of buyers. At the
other extreme, an industry may contain as many strategic
groups as there are competitors when each rival pursues a
distinctly different competitive approach, strives to attract
different types of buyers with distinctly different product offerings, and thus occupies a distinctly different market
position. The number of strategic groups in an industry and their respective market positions can be displayed
on a strategic group map.

The procedure for drawing a strategic group map is straightforward:

l Identify the competitive characteristics that differentiate firms in the industry. Typical variables are price/
quality range (high, medium, low), geographic coverage (local, regional, national, global), product-line
breadth (wide, narrow), degree of service offered (no-frills, limited, full), use of distribution channels
(one, some, all), and degree of vertical integration (none, partial, full).

l Plot the firms on a two-variable map using pairs of these differentiating characteristics.

l Assign firms that are located close together on the two-dimensional map to the same strategic group.

l Draw circles around each strategic group, making the circles proportional to the size of the group’s share
of total industry sales revenues.

This produces a two-dimensional diagram like the one shown in Figure 3.9.

Several guidelines need to be observed in mapping the positions of strategic groups in the industry’s overall
market space.16 First, the two variables selected as axes for the map should not be highly correlated. If they
are, the circles on the map will fall along a diagonal and reveal nothing more about the relative positions
of competitors than would be revealed by comparing the rivals on just one of the variables. For instance, if
companies with broad product lines use multiple distribution channels while companies with narrow lines use a
single distribution channel, then looking at broad versus narrow product lines reveals just as much about who is
positioned where as does looking at single versus multiple distribution channels—rendering one of the variables
redundant. Second, the two variables chosen as axes should be ones where there are big differences in the
competitive characteristics and positioning among the rivals—when rivals differ on both variables, the locations
of the rivals will be scattered, thus showing how they are positioned differently. Third, the variables used as axes
do not have to be quantitative or continuous; rather they can be defined as distinct conditions like use of only one
distribution channel (Internet sales at the company’s website), use of two distribution channels (company-owned
retail stores and Internet sales), use of three distribution channels (independent wholesale distributors, big-box
discount retailers, and Internet sales at the company’s website), and use of multiple distribution channels (four
or more). Fourth, drawing the sizes of the circles on the map proportional to the combined sales of the firms in
each strategic group allows the map to reflect the relative market shares that each strategic group commands.
Fifth, if three or more variables are good candidates for being chosen as axes for the map, it is wise to draw two
or more maps to give different exposures to the competitive positioning relationships present in the industry’s
structure—there is not necessarily any one best map for portraying how competing firms are positioned.

CORE CONCEPT
A strategic group is a cluster of industry rivals
that employ similar competitive approaches, have
product offerings that appeal to similar types of
buyers, and thus occupy similar market positions.

Chapter 3 • Evaluating a Company’s External Environment 64

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Figure 3.9 Comparative Market Positions of Selected Retail Chains:
An Example of a Strategic Group Map

Many Localities

Geographic Coverage

Pr
ic

e/
Q

ua
lit

High

Low

Few Localities

Neiman
Marcus,

Saks Fifth
Avenue

Macy’s,
Nordstrom,

Dillard’s,
Belk

Target

Walmart

Gap,
Old Navy,
Victoria’s

Secret

Kohl’s,
Ross Stores,
JC Penney

T.J. Maxx,
Tuesday
Morning

Gucci, Chanel, Prada,
Hermes, Burberry,

Louis Vitton

Polo-Ralph Lauren,
Coach

Note: Circles are drawn roughly proportional to the total revenues of the retailers shown in each strategic
group.

What Can Be Learned from Strategic Group Maps?
Strategic group maps are revealing in several respects. The most important information revealed is which industry
members are close rivals and which are distant rivals.
Firms in the same strategic group are the closest rivals; the
next closest rivals are in the immediately adjacent groups.
Often, firms in strategic groups that are far apart on the map
hardly compete at all. For instance, Walmart’s clientele,
merchandise selection, and pricing points are much too
different to justify calling them close competitors of Neiman Marcus, Saks Fifth Avenue, or Gucci.

The second thing to be gleaned from strategic group mapping is that not all positions on the map are equally
attractive.17 Two reasons account for why some positions can be more attractive than others:18

Strategic group maps reveal which companies
are close competitors and which are distant
competitors.

Chapter 3 • Evaluating a Company’s External Environment 65

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1. Prevailing competitive pressures and industry driving forces favor some strategic groups and hurt others.
Discerning which strategic groups are advantaged and disadvantaged requires scrutinizing the map in
light of what has also been learned from the prior analysis of competitive forces and driving forces. Quite
often the strength of competition varies from group to group—there’s little reason to believe that all firms
in an industry feel the same degrees of competitive
pressure, since their strategies and market positions
may well differ in important respects. For instance,
the competitive battle between Walmart and Target
is of a different character and intensity than the
rivalry among Gucci, Chanel, Fendi, and other
high-end fashion retailers. Likewise, industry
driving forces can boost the business outlook for
some strategic groups and adversely impact the
business prospects of others. Firms in strategic groups that are being adversely impacted by intense
competitive pressures or driving forces may try to shift to a more favorably situated group if they
can hurdle the barriers to enter the target strategic group. If certain firms are known to be trying to
change their competitive positions on the map, then attaching arrows to the circles showing the targeted
direction helps clarify the picture of competitive maneuvering among rivals.

2. Profit prospects vary from strategic group to strategic group. The profit prospects of firms in different
strategic groups can vary from good to ho-hum to poor because of differing growth rates in buyer
demand for the market segments each group serves, differing degrees of competitive rivalry within
strategic groups (due perhaps to variations in entry barriers, product/brand differentiation, and customer
loyalty), differing degrees of exposure to competition from substitute products outside the industry,
differing degrees of supplier or buyer bargaining power from group to group, and differing impacts from
the industry’s driving forces.

Thus, part of strategic group map analysis always entails drawing conclusions about where on the map is the
“best” place to be and why. Which companies/strategic groups are destined to prosper because of their positions?
Which companies/strategic groups seem destined to struggle because of their positions? What accounts for why
some parts of the map are better than others? Do big white spaces on the map correctly imply that these spaces
are not attractive positions to be in or might one or more industry members be able to profitably create and
capture new demand by moving into a particular white space?

Question 4: What Strategic Moves Are Rivals Likely to Make Next?
Unless a company pays attention to competitors’ strategies and situations and has some inkling of what moves
they will be making, it ends up flying blind into competitive battle. As in sports, scouting the opposition and
trying to prepare for the actions close rivals are likely to take is essential to competing effectively against them.
Gathering competitive intelligence about rivals’ strategies, their financial performance, their resource strengths
and weaknesses, the actions and plans they have announced, and the thinking and leadership styles of their top
executives is valuable for predicting or anticipating the strategic moves competitors are likely to make next. The
more a company can get into the minds of the managers of rival companies and anticipate rivals’ moves, the better
able it is to be ready with defensive countermoves, to craft
its own strategic moves with some confidence about what
market maneuvers to expect from rivals, and to capitalize
on opportunities stemming from competitors’ missteps or
strategy flaws. Failure to study rival companies well enough
to accurately anticipate some of their probable competitive
moves makes it (highly?) likely that a company will suffer
unexpected declines in sales and profits because it is caught flat-footed or “surprised” by aggressive moves on
the part of one or more rivals to grow sales and market share and thereby boost their profitability and overall
performance.

CORE CONCEPT
Some strategic groups are more favorably
positioned than others because they confront
weaker competitive forces and/or because they
stand to be favorably impacted by the industry’s
driving forces.

Closely monitoring the actions of competitors and
preparing a defense against their expected next
moves reduces the risk of being caught napping
and suffering a damaging loss of sales and profits.

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Good clues about what actions a specific company is likely to undertake can often be gleaned from how well it
is faring in the marketplace, the problems or weaknesses it needs to address, and how much pressure it is under
to improve its financial and overall business performance.19
Rivals with good financial performance are likely to continue
their present strategy with only minor fine-tuning. Poorly
performing rivals are virtually certain to make fresh strategic
moves. Ambitious rivals looking to move up in the industry
ranks are strong candidates for launching new strategic
offensives to pursue emerging market opportunities and
exploit the vulnerabilities of weaker rivals. Other sources of
clues about what actions a rival may take include company
press releases, management letters to shareholders, recent
top management presentations management has recently
made to securities analysts, interviews of top executive by the business media, and such public documents as
annual reports and 10-K filings.

Company managers can pose several useful questions to help predict the likely actions of important rivals:

l Which competitors have strategies that are producing good results—and thus are likely to make only
minor strategic adjustments (other than increasing expenditures for one or more strategy elements in
order to further boost their competitiveness and performance)?

l Which competitors are losing ground in the marketplace or otherwise struggling to come up with a
good strategy—and thus are strong candidates for altering their prices, improving the appeal of their
product offerings, perhaps moving to a different part of the strategic group map, and otherwise adjusting
important elements of their strategy?

l Which competitors are poised to gain market share, and which ones seem destined to lose ground?

l Which competitors are likely to rank among the industry leaders five years from now? Do one or more
up-and-coming competitors have powerful strategies and sufficient resource capabilities to overtake the
current industry leader?

l Which rivals badly need to increase their unit sales and market share? What strategic options are they
most likely to pursue: lowering prices, adding new models and styles, expanding their dealer networks,
entering additional geographic markets, boosting advertising to build better brand-name awareness,
acquiring a weaker competitor, or placing more emphasis on direct sales to consumers via online sales
at their websites?

l Which rivals are likely to enter new geographic markets or make major moves to substantially increase
their sales and market share in a particular geographic region?

l Which rivals are strong candidates to expand their product offerings and enter new product segments
where they do not currently have a presence?

l Which rivals are good candidates to be acquired? Which rivals (or an outsider with competitively
valuable capabilities) might well acquire one or more industry rivals?

To succeed in predicting a competitor’s next moves, company strategists need to have a good feel for each
rival’s situation, how its managers think, and what the rival’s best strategic options are. Many companies have
competitive intelligence units that sift through the available information to construct up-to-date strategic profiles
of rival firms. Doing the necessary detective work can be tedious and time-consuming, but scouting competitors
well enough to anticipate their next moves allows a company’s strategy-makers to prepare effective countermoves
(perhaps to even beat a rival to the punch) and to take rivals’ probable actions into account in crafting their own
company’s best course of action.

Perhaps the most frequent reason why a company
gets outcompeted by what it considers the
“surprising” actions of rivals goes directly to the
failure of its management to do a competent
job of studying the situation of certain rivals
and recognizing their need to undertake certain
actions in the marketplace to improve their market
share and profitability.

Chapter 3 • Evaluating a Company’s External Environment 67

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Question 5: What Are the Key Factors for Future
Competitive Success?

An industry’s key success factors (KSFs) are those competitive factors that most affect industry members’
ability to prosper in the marketplace—the particular strategy elements, product attributes, resource strengths,
competitive capabilities, and market achievements that spell the difference between being a strong competitor
and a weak competitor—and sometimes between profit and
loss. KSFs by their very nature are so important to future
competitive success that all firms in the industry must pay
close attention to them or risk becoming a weak competitor
and industry laggard. To indicate the significance of KSFs
another way, how well a company’s product offering,
resources, and capabilities measure up against an industry’s
KSFs determines just how financially and competitively
successful that company will be. Identifying KSFs, in light
of the prevailing and anticipated industry and competitive conditions, is therefore always a top-priority analytical
and strategy-making consideration. Company strategists need to understand the industry landscape well enough
to separate the factors most important to competitive success from those that are less important.

KSFs vary from industry to industry, and even from time to time within the same industry, as driving forces and
competitive conditions change. In the case of manufacturers of national and international brands of beer, the
KSFs are full utilization of brewing capacity (to keep the fixed costs of manufacturing low), a strong network
of wholesale distributors (to get the company’s brand stocked and favorably presented in retail outlets, bars,
restaurants, and sports arenas where beer is sold), and clever advertising and branding capabilities (to induce
beer drinkers to buy the company’s brand and thereby pull beer sales through the established wholesale/retail
channels). In apparel manufacturing, the KSFs are appealing designs and color combinations (to create buyer
interest) and low-cost manufacturing efficiency (to permit attractive retail pricing and ample profit margins).

Regardless of the circumstances, an industry’s key success factors can be identified by asking three questions:

l On what basis do buyers of the industry’s product or service choose between the competing brands of
sellers? That is, what product or service attributes are crucial from the standpoint of buyers?

l Given the nature of competitive rivalry and the competitive forces prevailing in the marketplace, what
resources and competitive capabilities must a company have to be competitively successful?

l What shortcomings are almost certain to put a company at a significant competitive disadvantage?

Only rarely are there more than five key factors for future competitive success. And even among these, two or
three usually outrank the others in importance. Managers should therefore bear in mind the purpose of identifying
KSFs—to determine which factors are most important to future competitive success—and resist the temptation
to label a factor that has only minor importance as a KSF. To compile a list of every factor that matters even
a little bit defeats the purpose of concentrating management attention on the factors truly critical to long-term
competitive success.

Correctly diagnosing an industry’s KSFs also raises a company’s chances of crafting a sound strategy. The goal
of company strategists should be to design a strategy that not
only enables the company to compare favorably vis-à-vis
rivals on each and every one of the industry’s future KSFs
but that also aims at being distinctly better than rivals on one
(or possibly two) of the KSFs—being distinctly better than
rivals on one or two key success factors tends to translate
into competitive advantage.20 The competitive advantage
potential of such an approach to crafting a company’s strategy stands in sharp contrast to what happens when

CORE CONCEPT
Key success factors are the strategy elements,
product attributes, resource strengths, competitive
capabilities, and market achievements with the
greatest impact on future competitive success in
the marketplace.

To be a winner, a company’s strategy must
compare favorably with rivals on all industry KSFs
and be competitively superior on one, maybe two,
of the industry’s KSFs.

Chapter 3 • Evaluating a Company’s External Environment 68

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company executives misdiagnose industry KSFs or discount their strategic importance. When a strategy falls far
short of delivering competitive parity on the industry’s KSFs, the company is destined to be a weak competitor
and earn below-average profits. When a company’s strategy puts a company somewhere in the middle of the
pack of rivals relative to industry KSFs, its overall performance will likely approximate the industry average.
Hence, making sure the company’s strategy contains top-priority strategic actions aimed at comparing favorably
with rivals on each and every KSF—and then going a step further to achieve competitive superiority on at least
one KSF—is a powerful and rewarding approach to crafting a company’s strategy.

Question 6: Is the Industry Outlook Conducive
to Good Profitability?

The final step in evaluating the industry and competitive environment is to use the preceding analysis to decide
whether the outlook for the industry presents the company with good prospects for attractive profitability and
growth. The important factors on which to base such a conclusion include:

l Whether the industry and the company are being favorably or unfavorably impacted by macro-
environmental factors.

l The industry’s growth potential.

l The anticipated strength of competitive forces—the overriding issue here is whether competitive forces
seem likely to intensify and squeeze industry profitability to subpar levels or whether the company
should be able to earn good profits despite the expected strength of competitive forces.

l Whether and to what degree industry profitability will be favorably or unfavorably affected by the
industry’s driving forces.

l Whether the company is strongly or weakly positioned on the industry’s strategic group map.

l How well the company’s strategy, product offering, and capabilities stack up against industry KSFs.

l The degrees of risk and uncertainty in the industry’s future.

As a general proposition, the anticipated industry environment is fundamentally attractive if it presents a company
with good opportunity for above-average profitability; the industry outlook is fundamentally unattractive if a
company’s profit prospects are unappealingly low.

However, it is a mistake to view future conditions in a particular industry as being equally attractive or unattractive
to all industry participants and all potential entrants.21 For instance, even though analysis reveals numerous
factors that make an industry’s outlook unattractive, a favorably situated and competitively capable company
may nonetheless see ample opportunity to capitalize on the
vulnerabilities of weaker rivals and significantly grow its
revenues and profits. And even if an industry is deemed to
have appealing potential for growth and profitability, a weak
competitor may conclude that having to fight a steep uphill
battle against much stronger rivals holds little promise
of eventual market success or even average profitability.
Similarly, some industry outsiders may conclude that they have the resources and capabilities to readily hurdle
the barriers to entering an attractive industry, while other outsiders conclude that the same industry is unattractive
because of the difficulty of challenging current market leaders with their particular resources and competencies
and/or because of the better opportunities they have elsewhere.

When a company decides an industry is fundamentally attractive, a strong case can be made that it should
invest aggressively to capture the opportunities it sees and to improve its long-term competitive position in the

CORE CONCEPT
The degree to which an industry’s outlook is
attractive or unattractive is not the same for all
industry participants and all potential entrants.

Chapter 3 • Evaluating a Company’s External Environment 69

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business. When a strong competitor concludes an industry is relatively unattractive and lacking in opportunity, it
may elect to simply protect its present position, investing cautiously, if at all, and look for opportunities in other
industries. A competitively weak company in an unattractive industry may see its best option as finding a buyer,
perhaps a rival, to acquire its business.

Key Points
Evaluating a company’s external environment involves probing for answers to seven questions:

1. To what extent are factors in the broad macro-environment acting to make the outlook for the industry
and the company more or less attractive? Industries and companies differ significantly as to how they
are affected by developments and trends in the broad macro-environment. Using PESTEL analysis
to identify which factors in the company’s macro-environment are strategically relevant and their
probable impact is the first step in understanding how attractively a company is situated in its external
environment.

2. What kinds of competitive forces are industry members facing, and how strong is each force? The
strength of competition is a composite of five forces: (1) the jockeying and market maneuvering among
industry rivals, (2) the threat of new entrants into the market, (3) the market inroads being made by the
sellers of substitutes, (4) supplier bargaining power, and (5) buyer bargaining power. All five must be
examined force by force and their collective strength evaluated. Working through the five-forces model
aids strategy-makers in crafting a strategy that is well-suited to prevailing competitive conditions and
has good prospects for producing the best possible business results.

3. What forces are driving changes in the industry, and what impact will these changes have on competitive
intensity and industry profitability? Industry and competitive conditions change because certain forces
are creating incentives or pressures for change. The most common driving forces include changes in the
long-term industry growth rate, increasing globalization, Internet-related developments, changing buyer
demographics and uses of the product, product innovation, the entry or exit of major firms, changes
in cost and efficiency, changing buyer preferences for standardized versus differentiated products or
services, regulatory influences and government policy changes, changing societal and lifestyle factors,
and reductions in uncertainty and business risk. Once an industry’s driving forces have been identified,
the analytical task becomes one of determining whether the driving forces, taken together, are acting to
make the industry environment more or less attractive. Are the driving forces causing demand for the
industry’s product to increase or decrease? Are the driving forces acting to make competition more or
less intense? Will the driving forces lead to higher or lower industry profitability?

4. What market positions do industry rivals occupy—who is strongly positioned and who is not? Strategic
group mapping is a valuable tool for understanding the similarities, differences, strengths, and weaknesses
inherent in the market positions of rival companies. Rivals in the same or nearby strategic groups are
close competitors, whereas companies in distant strategic groups usually pose little or no immediate
threat. The lesson of strategic group mapping is that some positions on the map are more favorable than
others. The profit potential of different strategic groups varies due to strengths and weaknesses in each
group’s market position. Often, industry driving forces and competitive pressures favor some strategic
groups and hurt others.

5. What strategic moves are rivals likely to make next? Scouting competitors well enough to anticipate
their actions can help a company prepare effective countermoves (perhaps even beating a rival to the
punch) and allows managers to take rivals’ probable actions into account when designing their own
company’s best course of action. Managers who fail to study competitors risk being caught unprepared
by rivals’ strategic moves.

Chapter 3 • Evaluating a Company’s External Environment 70

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6. What are the key factors for future competitive success? An industry’s key success factors (KSFs) are
the particular strategy elements, product attributes, competitive capabilities, and business outcomes that
spell the difference between being a strong competitor and a weak competitor—and sometimes between
profit and loss. KSFs are so important to competitive success that all firms in the industry must pay
close attention to them or risk becoming an industry also-ran. To be a winner, a company’s strategy must
compare favorably with rivals on all industry KSFs and be competitively superior on one, maybe two,
of the industry’s KSFs.

7. Is the industry outlook conducive to good profitability? An industry’s outlook is fundamentally
attractive if it presents a company with good opportunity for above-average profitability; its outlook is
fundamentally unattractive when a company’s profit prospects are unappealingly low. On occasion, an
industry with a bleak outlook is still very attractive to a favorably situated company with the capabilities
to take business away from weaker rivals.

Clear insightful diagnosis of a company’s external environment is an essential prerequisite to crafting strategies
that are well matched to industry and competitive conditions and, therefore, have a good chance to produce
the best possible business results. To engage in cutting-edge strategic thinking about the external environment,
managers must know what questions to pose and what analytical tools to use in answering these questions. That
is why this chapter has concentrated on suggesting the right questions to ask, explaining concepts and analytical
approaches, and indicating the kinds of things to look for.

What Is Strategy
and Why Is It Important?

What Do We Mean by “Strategy”?

Strategy and the Quest for Competitive Advantage

A Company’s Strategy is Partly Proactive and Partly Reactive

Strategy and Ethics: Passing the Test
of Moral Scrutiny

The Relationship Between a Company’s Strategy and Its Business Model

What Makes a Strategy a Winner?

Why Crafting and Executing Strategy Are Important Tasks

The Road Ahead

Key Points

Charting a Company’s Long-Term Direction: Vision, Mission,
Objectives, and Strategy

What Does the Strategy-Making,
Strategy-Executing Process Entail?

Task 1: Developing a Strategic Vision, Mission Statement, and Set of Core Values

Task 2: Setting Objectives

Task 3: Crafting A Strategy

Task 4: Implementing and Executing the Strategy

Task 5: Evaluating Performance and Initiating Corrective Adjustments

Corporate Governance: The Role of the Board of Directors in the Strategy-Making, Strategy-Executing Process

Key Points

Evaluating a Company’s
External Environment

THE STRATEGICALLY RELEVANT FACTORS
INFLUENCING A COMPANY’S EXTERNAL ENVIRONMENT

Assessing a Company’s Industry and Competitive Environment

Question 1: What Competitive Forces Do Industry
Members Face and How Strong Are They?

Question 2: What Factors Are Driving Industry Change and What Impact Will They Have?

Question 3: What Market Positions Do Rivals Occupy—Who Is Strongly Positioned and Who Is Not?

Question 4: What Strategic Moves Are Rivals Likely to Make Next?

Question 5: What Are the Key Factors for Future Competitive Success?

Question 6: Is the Industry Outlook Conducive to Good Profitability?

Key Points

Evaluating a Company’s Resources and Ability to Compete Successfully

QUESTION 1: HOW WELL IS THE COMPANY’S PRESENT STRATEGY WORKING?

QUESTION 2: WHAT ARE THE COMPANY’S IMPORTANT RESOURCES AND CAPABILITIES AND DO THEY HAVE ENOUGH COMPETITIVE POWER TO PRODUCE A COMPETITIVE ADVANTAGE OVER RIVALS?

QUESTION 3: WHAT ARE THE COMPANY’S COMPETITIVELY IMPORTANT STRENGTHS AND WEAKNESSES AND ARE THEY WELL-SUITED TO CAPTURING ITS BEST MARKET OPPORTUNITIES AND DEFENDING AGAINST EXTERNAL THREATS?

QUESTION 4: ARE THE COMPANY’S PRICES AND COSTS COMPETITIVE WITH THOSE OF KEY RIVALS, AND DOES IT HAVE AN APPEALING CUSTOMER VALUE PROPOSITION?

QUESTION 5: IS THE COMPANY COMPETITIVELY STRONGER OR WEAKER THAN KEY RIVALS?

QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS DOES TOP MANAGEMENT NEED TO ADDRESS IN CRAFTING A STRATEGY TO FIT THE SITUATION?

KEY POINTS

The Five Generic Competitive Strategy Options: Which One to Employ?

THE FIVE GENERIC COMPETITIVE STRATEGIES

BROAD LOW-COST PROVIDER STRATEGIES

BROAD DIFFERENTIATION STRATEGIES

FOCUSED (OR MARKET NICHE) STRATEGIES

BEST-COST PROVIDER STRATEGIES

SUCCESSFUL COMPETITIVE STRATEGIES ARE ALWAYS UNDERPINNED BY RESOURCES AND CAPABILITIES THAT ALLOW THE STRATEGY TO BE WELL-EXECUTED

KEY POINTS

Supplementing the Chosen Competitive Strategy—
Other Important Strategy Choices

GOING ON THE OFFENSIVE—STRATEGIC OPTIONS TO IMPROVE A COMPANY’S MARKET POSITION

DEFENSIVE STRATEGIES—PROTECTING MARKET POSITION AND COMPETITIVE ADVANTAGE

WEBSITE STRATEGIES

OUTSOURCING STRATEGIES

VERTICAL INTEGRATION STRATEGIES:
OPERATING ACROSS MORE STAGES
OF THE INDUSTRY VALUE CHAIN

STRATEGIC ALLIANCES AND PARTNERSHIPS

MERGER AND ACQUISITION STRATEGIES

CHOOSING APPROPRIATE FUNCTIONAL-AREA STRATEGIES

TIMING A COMPANY’S STRATEGIC MOVES

KEY POINTS

Strategies for Competing
Internationally or Globally

WHY COMPANIES DECIDE TO ENTER FOREIGN MARKETS

WHY COMPETING ACROSS NATIONAL BORDERS CAUSES STRATEGY MAKING TO BE MORE COMPLEX

THE CONCEPTS OF MULTICOUNTRY COMPETITION AND GLOBAL COMPETITION

STRATEGY OPTIONS FOR ESTABLISHING A COMPETITIVE PRESENCE IN FOREIGN MARKETS

COMPETING IN FOREIGN MARKETS: THE THREE COMPETITIVE STRATEGY APPROACHES

BUILDING CROSS-BORDER COMPETITIVE ADVANTAGE

PROFIT SANCTUARIES AND GLOBAL STRATEGIC OFFENSIVES

Key Points

Diversification Strategies

What Does Crafting a Diversification Strategy Entail?

CHOOSING THE DIVERSIFICATION PATH:
RELATED VS. UNRELATED BUSINESSES

EVALUATING THE STRATEGY OF A DIVERSIFIED COMPANY

KEY POINTS

Strategy, Ethics, and Social Responsibility

What Do We Mean by Business Ethics?

where do Ethical standards come from?

THE THREE CATEGORIES OF MANAGEMENT MORALITY

WHAT ARE THE DRIVERS OF UNETHICAL STRATEGIES AND BUSINESS BEHAVIOR?

WHY SHOULD COMPANY STRATEGIES BE ETHICAL?

Strategy, Social Responsibility, and Corporate Citizenship

KEY POINTS

Building an Organization
Capable of Good Strategy Execution

A FRAMEWORK FOR EXECUTING STRATEGY

BUILDING AN ORGANIZATION CAPABLE OF GOOD STRATEGY EXECUTION: THREE KEY ACTIONS

STAFFING THE ORGANIZATION

DEVELOPING AND STRENGTHENING EXECUTION-CRITICAL RESOURCES AND CAPABILITIES

STRUCTURING THE ORGANIZATION AND WORK EFFORT

KEY POINTS

Managing Internal Operations:
Actions That Promote
Good Strategy Execution

Allocating Needed Resources to Execution-Critical Activities

ENSURING THAT POLICIES AND PROCEDURES FACILITATE STRATEGY EXECUTION

ADOPTING BEST PRACTICES AND EMPLOYING PROCESS MANAGEMENT TOOLS TO IMPROVE EXECUTION

INSTALLING INFORMATION AND OPERATING SYSTEMS

TYING REWARDS AND INCENTIVES DIRECTLY TO ACHIEVING GOOD PERFORMANCE OUTCOMES

KEY POINTS

Corporate Culture and Leadership—Keys to Good Strategy Execution

INSTILLING A CORPORATE CULTURE THAT PROMOTES GOOD STRATEGY EXECUTION

LEADING THE STRATEGY EXECUTION PROCESS

KEY POINTS

71Chapter 4 Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully

Copyright © 2025 by Arthur A. Thompson. All rights reserved.
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Strategy: Core Concepts and Analytical Approaches

An e-book marketed by McGraw Hill LLC

Arthur A. Thompson, The University of Alabama 8th Edition, 2025–2026

Chapter 4
Evaluating a Company’s Resources,
Capability, and Ability to Compete
Successfully

Before executives can chart a new strategy, they must reach common understanding of the company’s
current position.
—W. Chan Kim and Renée Mauborgne

Organizations succeed in a competitive marketplace over the long run because they can do certain things
their customers value better than can their competitors.
—Robert Hayes, Gary Pisano, and David Upton

A new strategy nearly always involves acquiring new resources and capabilities.
—Laurence Capron and Will Mitchell

Chapter 3 described how to use the tools of industry and competitive analysis to assess a company’s
external environment and lay the groundwork for matching a company’s strategy to its external situation.
This chapter discusses techniques for evaluating a company’s internal situation, with emphasis on its

collection of resources and capabilities, the competitiveness of its prices and internal operating costs, and its
competitive strength versus rivals. The analytical spotlight is trained on six questions:

1. How well is the company’s present strategy working?

2. What are the company’s important resources and capabilities, and do they have enough competitive
power to produce a competitive advantage over rival companies?

4. Are the company’s prices and costs competitive with those of key rivals, and does it have an appealing
customer value proposition?

5. Is the company competitively stronger or weaker than key rivals?

6. What strategic issues and problems does top management need to address in crafting a strategy to fit the
situation?

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 72

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In probing for answers to these questions, five analytical tools—resource and capability analysis, SWOT analysis,
value chain analysis, benchmarking, and competitive strength assessment—are used. All five are valuable
techniques for revealing a company’s ability to compete successfully and for helping company managers match
their strategy to the company’s particular circumstances.

Question 1: How Well Is the Company’s Present Strategy Working?
In evaluating how well a company’s present strategy is working, one must start with a clear view of what
the strategy is. Figure 4.1 shows the key components of a single-business company’s strategy. The first thing
to examine is the company’s competitive approach. What moves has the company made recently to attract
customers and improve its market position—for instance, has it cut prices, improved the design of its product,
added new features, stepped up advertising, entered a new foreign or domestic geographic market, or merged
with a competitor? Is it striving for a competitive advantage based on low costs or an appealingly different or
better product offering? Is it concentrating on serving a broad spectrum of customers or a narrow market niche?
The company’s functional strategies in R&D, production, marketing, finance, human resources, information
technology, and so on further characterize company strategy, as do any efforts to establish competitively valuable
alliances or partnerships with other enterprises.

Figure 4.1 Identifying the Components of a Single-Business Company’s Strategy

Actions to respond to important
changes in the macro-environment
or in industry and competitive
conditions

Planned, proactive moves to attract
customers and out-compete rivals via
more appealing product attributes,
better product quality, wider selection,
lower prices, superior service, and so on

Initiatives to build competitive
advantage based on:
• Lower costs and prices

relative to rivals?
• A different or better

product offering?
• Superior ability to serve

a market niche or specific
group of buyers?

Efforts to expand or
narrow geographic
coverage

Efforts to build competitively
valuable partnerships and
strategic alliances with other
enterprises

R&D, technology,
product design
strategy

Supply chain
management
strategy

Production
strategy

Sales, marketing,
and distribution
strategies

Information
technology
strategy Human

resources
strategy

Finance
strategy

BUSINESS
STRATEGY

The actions and
approaches crafted

to compete successfully
in a particular

business

The three best indicators of how well a company’s strategy is working are (1) whether the company is achieving
its stated financial and strategic objectives, (2) whether the company is an above-average industry performer,
and (3) whether the company is gaining customers and gaining market share. Persistent shortfalls in meeting
company performance targets and mediocre performance in the marketplace relative to rivals are reliable warning

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 73

Copyright © 2025 by Arthur A. Thompson. All rights reserved.
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signs that the company has a weak strategy, suffers from poor strategy execution, or both. Specific indicators of
how well a company’s strategy is working include:

l Whether the firm’s sales are growing faster, slower, or at about the same pace as the market as a whole,
thus resulting in a rising, eroding, or stable market share.

l How well the company stacks up against rivals on product innovation, product quality, price, customer
service, and other relevant factors on which buyers base their choice of brands.

l Whether the firm’s brand image and reputation are growing stronger or weaker.

l Whether the firm’s profit margins are increasing or decreasing.

l Trends in the firm’s net profits, return on investment, and stock price and how these compare to the same
trends for other companies in the industry.

l Whether the company’s overall financial strength, credit rating, key financial and operating ratios, and
cash flows from operations are improving, remaining steady, or deteriorating.

l Evidence of internal operating improvements (fewer product defects, faster delivery times, increases in
employee productivity, a growing stream of successful product innovations, and ongoing cost savings).

The bigger the improvements in a company’s market standing and competitive strength and the stronger its
financial and operating performance, the more likely it has a well-conceived, well-executed strategy. Run-of-
the-mill market results, mediocre financial performance,
and sparse operating improvements are red flags that raise
questions about a company’s strategy and whether radical
changes in strategy or internal operations are needed.

Table 4.1 provides a compilation of the financial ratios most
commonly used to evaluate a company’s financial performance and balance sheet strength.

Table 4.1 Key Financial Ratios: How to Calculate Them and What They Mean

Ratio How Calculated What It Shows

Profitability Ratios
1. Gross profit margin Sales revenues—Cost of goods sold

Sales revenues

Shows the percentage of revenues available to cover
operating expenses and yield a profit. Higher is better
and the trend should be upward.

2. Operating profit margin
(or return on sales)

Sales revenues—Operating expenses
Sales revenues

or
Operating income

Sales revenues

Shows the profitability of current operations without
regard to interest charges and income taxes. Earnings
before interest and taxes is commonly referred to as
EBIT. Higher is better and the trend should be upward.

3. Net profit margin (or
net return on sales)

Profits after taxes
Sales revenues

Shows after-tax profits per dollar of sales. Higher is
better and the trend should be upward.

4. Total return on assets Profits after taxes + Interest
Total assets

A measure of the return on total monetary investment
in the enterprise. Interest is added to after-tax profits to
form the numerator since total assets are financed by
creditors as well as by stockholders. Higher is better
and the trend should be upward.

5. Net return on total
assets (ROA)

Profits after taxes
Total assets

A measure of the return earned by stockholders on the
firm’s total assets. Higher is better and the trend should
be upward.

Sluggish financial performance and second-rate
market accomplishments almost always signal
weak strategy, weak execution, or both.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 74

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Ratio How Calculated What It Shows
6. Return on stockholders’

equity (ROE)
Profits after taxes

Total stockholders’ equity

Shows the return stockholders are earning on their
capital investment in the enterprise. A return in the
12–15% range is “average,” and the trend should be
upward.

7. Return on invested
capital (ROIC)—
sometimes referred
to as return on capital
employed (ROCE)

Profits after taxes
Long-term debt +

Total stockholders’ equity

A measure of the return shareholders are earning
on the long-term monetary capital invested in the
enterprise. A higher return reflects greater bottom-line
effectiveness in the use of long-term capital, and the
trend should be upward.

8. Earnings per share
(EPS)

Profits after taxes
Number of shares of

common stock outstanding

Shows the earnings for each share of common stock
outstanding. The trend should be upward, and the
bigger the annual percentage gains, the better.

Liquidity Ratios
1. Current ratio Current assets

Current liabilities
Shows a firm’s ability to pay current liabilities using
assets that can be converted to cash in the near term.
Ratio should definitely be higher than 1.0; ratios of 2 or
higher are better still.

2. Working capital Current assets – Current liabilities Bigger amounts are better because the company
has more internal funds available to (1) pay its current
liabilities on a timely basis and (2) finance inventory
expansion, additional accounts receivable, and a larger
base of operations without resorting to borrowing or
raising more equity capital.

Leverage Ratios
1. Total debt-to-assets

ratio
Total liabilities
Total assets

Measures the extent to which borrowed funds (both
short-term loans and long-term debt) have been used
to finance the firm’s operations. A low fraction or ratio
is better—a high fraction indicates overuse of debt and
greater risk of bankruptcy.

2. Long-term debt-to-
capital ratio

Long-term debt
Long-term debt +

Total stockholders’ equity

An important measure of creditworthiness and balance
sheet strength. It indicates the percentage of capital
investment in the enterprise that has been financed
by both long-term lenders and stockholders. A ratio
below 0.25 is usually preferable since monies invested
by stockholders account for 75% or more of the
company’s total capital. The lower the ratio, the greater
the capacity to borrow additional funds. Debt-to-capital
ratios above 0.50 and certainly above 0.75 indicate a
heavy and perhaps excessive reliance on long-term
borrowing, lower creditworthiness, and weak balance
sheet strength.

3. Debt-to-equity ratio Total liabilities
Total stockholders’ equity

Shows the balance between debt (funds borrowed
both short term and long term) and the amount that
stockholders have invested in the enterprise. The
further the ratio is below 1.0, the greater the firm’s
ability to borrow additional funds. Ratios above 1.0 and
definitely above 2.0 put creditors at greater risk, signal
weaker balance sheet strength, and often result in
lower credit ratings.

4. Long-term debt-to-
equity ratio

Long-term debt
Total stockholders’ equity

Shows the balance between long-term debt and
stockholders’ equity in the firm’s long-term capital
structure. Low ratios indicate greater capacity to
borrow additional funds if needed.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 75

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Ratio How Calculated What It Shows

5. Times-interest-earned
(or coverage) ratio

Operating income
Interest expenses

Measures the ability to pay annual interest charges.
Lenders usually insist on a minimum ratio of 2.0, but
ratios progressively above 3.0 signal progressively
better creditworthiness.

Activity Ratios

1. Days of inventory Inventory
Cost of goods sold ÷ 365

Measures inventory management efficiency. Fewer
days of inventory are usually better.

2. Inventory turnover Cost of goods sold
Inventory

Measures the number of inventory turns per year.
Higher is better.

3. Average collection
period

Accounts receivable
Total sales ÷ 365

or
Accounts receivable
Average daily sales

Indicates the average length of time the firm must wait
after making a sale to receive cash payment. A shorter
collection time is better.

Other Important Measures of Financial Performance

1. Dividend yield on
common stock

Annual dividends per share
Current market price per share

A measure of the return that shareholders receive
in the form of dividends. A “typical” dividend yield is
2–3%. The dividend yield for fast-growth companies is
often below 1% (maybe even 0); the dividend yield for
slow-growth companies can run 4–5%.

2. Price-earnings ratio Current market price per share
Earnings per share

P-E ratios above 20 indicate strong investor
confidence in a firm’s outlook and earnings growth;
firms whose future earnings are at risk or likely to grow
slowly typically have ratios below 12.

3. Dividend payout ratio Annual dividends per share
Earnings per share

Indicates the percentage of after-tax profits paid out
as dividends.

4. Internal cash flow After-tax profits + Depreciation A quick and rough estimate of the cash a company’s
business is generating after payment of operating
expenses, interest, and taxes. Such amounts can
be used for dividend payments or funding capital
expenditures.

5. Free cash flow After-tax profits + Depreciation –
Capital expenditures – Dividends

A quick and rough estimate of the cash a company’s
business is generating after payment of operating
expenses, interest, taxes, dividends, and desirable
reinvestments in the business. The larger a company’s
free cash flow, the greater its ability to internally
fund new strategic initiatives, repay debt, make new
acquisitions, repurchase shares of stock, or increase
dividend payments.

Question 2: What Are the Company’s Important Resources and
Capabilities and Do They Have Enough Competitive Power to
Produce a Competitive Advantage Over Rivals?

An essential element of deciding whether a company’s internal situation is fundamentally healthy or unhealthy
entails examining the attractiveness of its resources and capabilities. A company’s resources and capabilities are
competitive assets and determine whether its competitive power in the marketplace will be impressively strong
or disappointingly weak. Companies with second-rate competitive assets are nearly always relegated to a trailing
position in the industry.

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Resource and capability analysis provides managers with a powerful tool for sizing up the company’s
competitive assets and determining whether they can provide the foundation necessary for competitive success
in the marketplace. This is a two-step process. The first step is to identify the company’s competitively important
resources and capabilities. The second step is to examine them more closely to ascertain which are the most
competitively important and whether they can support a sustainable competitive advantage over rival firms. This
second step involves applying four tests of the competitive power of a resource or capability.

Identifying a Company’s Competitively Important Resources and Capabilities
A company’s competitively important resources and capabilities are fundamental building blocks in crafting a
competitive strategy.1 Broadly speaking, any asset or productive input that a firm owns or controls qualifies as
a resource. Most firms have many kinds and types of resources, and these tend to vary widely in quality and
competitive value. For example, a company’s brand name is a resource, whose value varies widely. Some brands
like Coca-Cola, Nike, and Google are quite valuable because they are well-known globally while others are
virtually unknown and have little competitive value (Turtle Beach, Kumho, Asus). Our interest here is not in
cataloging every resource a company has but rather in identifying those resources that have competitive value
and can enhance its competitiveness.

Identifying Valuable Company Resources. Valuable or competitively relevant resources can relate to any
of the following:

l Physical resources: valuable land and real estate, state-of-the-art manufacturing plants, equipment,
distribution facilities, and/or well-equipped R&D facilities, the locations of retail stores, plants, and
distribution centers (including the overall pattern of their physical locations), and ownership of or access
rights to valuable natural-resource deposits.

l Human assets and intellectual capital: an educated, well-trained, talented and experienced workforce,
the cumulative learning and know-how of key personnel and work groups regarding important business
functions and/or technologies; proven managerial and leadership skills, proven skills in operating key
parts of the business efficiently and effectively.2

l Organizational and technological resources: proprietary technology and production capabilities,
patents, proven R&D capabilities, strong e-commerce capabilities, proven quality control systems,
state-of-the-art information and data management systems (systems for monitoring various operating
activities in real-time, just-in-time inventory management systems, and business analytics capabilities),
and proven software development capabilities.

l Financial resources: cash and marketable securities, a strong balance sheet and credit rating (thus giving
the company added borrowing capacity and access to additional financial capital).

l Intangible assets: brand names, trademarks, copyrights, company image, reputational assets (for
technological leadership or excellent product quality or customer service or honesty and fair dealing),
buyer loyalty and goodwill, a strong work ethic and motivational drive that is embedded in the company’s
workforce, a tradition of close teamwork and coordination across the company’s organizational units,
the creativity and innovativeness of certain personnel and work groups, the trust and effective working
relationships established with various external partners, and cultural norms and behaviors that promote
responding quickly to changing circumstances, fast organizational learning, and continuously striving
to achieve operating excellence in the performance of internal activities.

l Relationships: alliances, joint ventures or partnerships that provide access to valuable technologies,
specialized know-how, or attractive geographic markets; fruitful partnerships with suppliers that reduce
costs and/or enhance product quality and performance; a strong network of distributors and/or retail
dealers.

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Identifying Valuable Company Capabilities. A capability concerns the proficiency with which a company
can perform an activity. A company’s skill or proficiency in performing different facets of its operations can range
from one of minimal capability (perhaps having just struggled to perform an activity for the first time) to the
other extreme of being able to perform the activity with a level of competence that exceeds any other company in
the industry. In general, the competitive value of a capability depends on two factors: the competence a company
has achieved in performing the activity and the role of the activity in the company’s strategy, as explained below:

1. A company’s proficiency rises from that of mere ability to perform an activity to the level of a
competence when it learns to perform the activity consistently well and at acceptable cost. Usually,
competence in performing an activity originates
with deliberate efforts to simply develop the ability
to do it, however imperfectly or inefficiently.
Then, as experience builds and the company gains
proficiency to perform the activity consistently
well and at an acceptable cost, its ability evolves
into a true competence and capability. Whether
a competence has competitive value depends
on whether it relates directly to a company’s strategy or competitive success or whether it concerns
an activity that has minimal competitive bearing (like administering employee benefit programs or
accuracy in preparing financial statements).

Some competitively valuable competencies relate to fairly specific skills and expertise (like just-in-time
inventory control, low-cost manufacturing efficiency, picking locations for new stores, or designing
an unusually appealing and user-friendly website for online sales). They spring from proficiency in
a single discipline or function and may be performed in a single department or organizational unit.
Other competencies, however, are inherently multidisciplinary and cross-functional. They are the result
of effective collaboration among people with different expertise working in different organizational
units. A competence in continuous product innovation, for example, comes from teaming the efforts of
people and groups with expertise in market research, new product R&D, design and engineering, cost-
effective manufacturing, and market testing.3 Virtually all organizational competences are knowledge
based, residing in the intellectual capital of company employees and not in assets on its balance sheet.

2. A core competence is a proficiently performed internal activity that is central to a company’s strategy
and competitiveness.4 A core competence is a more competitively valuable capability than a competence
because of the well-performed activity’s key role in the company’s strategy and the contribution it
makes to the company’s market success, competitiveness, and profitability. A core competence can
relate to any of several aspects of a company’s
business: expertise in integrating multiple
technologies to create families of new products,
skills in manufacturing a high-quality product at a
low cost, or the capability to fill customer orders
accurately and swiftly. Most core competencies
are grounded in cross-department combinations
of knowledge and expertise rather than being the
product of a single department or work group.
Amazon.com has a core competence in online
retailing and website operations. Kellogg’s has
a core competence in developing, producing, and marketing breakfast cereals. Microsoft has a core
competence in developing operating systems for computers and user software like Microsoft Office®,
plus it has recently developed a core competence in creating new artificial intelligence software and
solutions. L’Oréal, the world’s largest beauty products company with 18 dermatologic and cosmetic
research centers, a large accumulation of scientific knowledge concerning skin and hair care, patents
and secret formulas for hair and skin care products, and robotic techniques for testing the safety of

CORE CONCEPT
A company has a competence in performing an
activity when, over time, it gains the experience
and know-how to perform the activity consistently
well and at acceptable cost.

CORE CONCEPT
A core competence is an activity that a company
performs quite well and that is also central to its
strategy and competitiveness. A core competence
is a more important capability than a competence
because it adds power to a company’s strategy
and has a bigger positive impact on its competitive
success.

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hair and skin care products, has developed a strong and competitively successful core competence in
developing hair care products, skin care products, cosmetics, and fragrances.

3. A distinctive competence is a competitively valuable activity that a company performs better than its
rivals.5 A distinctive competence thus signifies greater proficiency than a core competence. Because
a distinctive competence represents a level of
proficiency that rivals do not have, it qualifies as a
competitively superior capability with competitive
advantage potential. It is always easier for a
company to build competitive advantage when
it has a distinctive competence in performing an
activity important to market success, when rival
companies do not have offsetting competencies,
and when it is costly and time-consuming for rivals to imitate the competence. Companies that have a
distinctive competence include Google, which has a distinctive competence in search engine technology,
and Walt Disney Co., which has a distinctive competence in creating and operating theme parks.

In determining whether a company has a competitively attractive collection of resources and capabilities, it
is important to identify which of its skills and proficiencies qualify as a competence, which represent a core
competence, and whether it may enjoy a distinctive competence in one or more activities it performs.6 Both core
competencies and distinctive competencies are valuable because they enhance a company’s competitiveness.
But mere ability to perform an activity well does not necessarily give a company competitive clout. Some
competencies merely enable market survival because most rivals also have them—indeed, not having
a competence or competitive capability that rivals have can result in competitive disadvantage. An apparel
manufacturer cannot survive without the capability to produce its apparel items cost efficiently, given the intensely
price-competitive nature of the apparel industry. A cell-phone maker cannot survive without the capability to
introduce next-generation cell phones with appealing new features and functions that attract a profitable number
of buyers. A provider of subscription-based streamed entertainment cannot prosper without the capabilities to
create appealing original content.

Astute Bundling of a Company’s Resources and Capabilities Can Result in Added Competitive
Power. In identifying company resources and capabilities with competitive value, it is important to understand
that a particular resource or capability which may not seem to have much competitive value by itself can be
much more valuable when bundled with certain other company resources and/or capabilities (that also, taken
singly, appear to lack important competitive value). There are numerous instances when resource/capability
bundles have important competitive power even when
individual components of the bundle do not. For example,
Nike’s resource bundle of styling expertise, professional
endorsements, well-regarded brand name and image,
marketing and brand-building skills, network of distributors/
retailers, and managerial know-how has provided sufficient
competitive power for Nike to remain the dominant global
leader in athletic footwear and sports apparel for over 20
years.

It is equally important to understand that the value of a
company resource/capability is often also a function of
the company’s proficiency in using the resource/capability
to perform an activity.7 For instance, the degree to which
a company’s manufacturing plants are a competitively valuable resource hinges, in part, upon whether the
products being manufactured are of poor quality, lower-than-average quality, better-than-average quality, or
superior quality. A company’s manufacturing capabilities thus matter. Moreover, in most cases, a company’s
manufacturing capabilities are enhanced or weakened by its product R&D capabilities and its product design
capabilities.

CORE CONCEPT
A distinctive competence is a competitively
important activity that a company performs better
than its rivals—it thus represents a competitively
superior capability.

CORE CONCEPT
A resource/capability bundle is a group of
resources and/or capabilities that, when linked
and integrated into a functioning whole, has
greater competitive value than the summed value
of the individual components—in other words,
combining individual resources and capabilities
into an integrated bundle produces a 1 + 1 = 3 gain
in competitive power versus just a 1 + 1 = 2 gain
when the same resources and capabilities are
unbundled.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 79

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Four Ways to Test the Competitive Power of a Resource or Capability
What is most telling about the importance and value of a company’s resources and capabilities, individually and
collectively, is how powerful they are in the marketplace. The competitive power of a resource or capability is
measured by how many of the following four tests it can pass:8

1. Does the resource or capability have competitive value? The competitive value of a resource or capability
is determined by how much it helps a company improve its customer value proposition (and thereby
better attract and please customers), the degree to which it enables a company to compete effectively
against rivals, and its role in the company’s profit proposition. Unless a resource or capability contributes
to the power of a company’s strategy and helps maintain or enhance the company’s competitiveness
vis-à-vis rivals, it cannot pass the test of being competitively valuable. Companies must guard against
contending that most any kind of expertise or know-how or well-performed activity qualifies as a core or
a distinctive competence or gives them substantial competitive clout. Apple’s iOS operating system for
its PCs is by most accounts a world beater (compared to Windows 11), but Apple has failed to convert its
know-how and capability in operating system design into competitive success in the global PC market—
its global market share in PCs has lagged well behind HP, Dell, and Lenovo for over two decades.
Moreover, it is important to recognize that a resource or capability can quickly lose its competitive
value because of rapid changes in technology or customer preferences or the importance of certain
distribution channels or other market-related factors. For example, a company’s ability to benefit from
strong capabilities in product innovation is governed by how quickly rivals can introduce their own new
products with many of the same features. The branch offices of commercial banks are becoming a less
valuable competitive asset because of growing use of direct deposits, automated teller machines, debit
cards, and telephone and online banking options that reduce the need to “go to the bank.”

2. Do many or most rivals have much the same resource or capability? A resource or capability that most
of a company’s rivals also possess cannot be a basis for outcompeting rivals or achieving competitive
advantage. Indeed, when most companies in an industry can legitimately lay claim to having a particular
resource or capability, then that resource or capability is valuable only from the standpoint of helping
industry members maintain competitive parity in the marketplace and perhaps indicating the resource
or capability is an industry key success factor. A resource or capability achieves its greatest competitive
value only if (1) it is rare (in the sense of being possessed by one, or at most two, companies competing
in the same market arena) and (2) has sufficient competitive power (like a distinctive competence) to
enable a firm to outcompete rivals and gain a sustainable competitive advantage.

3. Is the resource or capability hard to copy? The more difficult and more expensive it is for rivals to
imitate a competitively valuable resource or capability, the greater its potential for enabling a company
to outcompete rivals and win a competitive advantage. Resources tend to be difficult to copy when
they are unique (a fantastic real estate location, patent-protected technology or product features, an
unusually talented and motivated labor force), when they must be built over time in ways that are
difficult to imitate (a well-known brand name, mastery of a complex production process, a global
network of dealers and distributors), and when they entail financial outlays or large-scale operations
that few industry members can undertake. Capabilities can be hard to copy and take considerable time
for rivals to develop when they have high skill or knowledge-based requirements, involve complicated
technology, and/or entail extensive cross-functional collaboration. Valuable resources and capabilities
that are also hard-to-copy can often significantly boost a company’s competitive strength and sustain
good-to-excellent profitability.

4. Can the value of a resource or capability be trumped by substitute resources and capabilities of rivals?
Resources that are valuable, not widely possessed by rivals, and hard to copy, lose much of their
competitive power if rivals have substitute resources or capabilities of equal or greater competitive
power.9 For instance, manufacturers relying on robotics and automated production processes to gain
a cost advantage in production activities may find their technology-based cost advantage completely
nullified by rivals who also can implement robot-assisted production techniques but who also move

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their production operations to countries having both low wages and an adequately skilled labor force,
and thereby can achieve even lower production costs.

The vast majority of companies are not well endowed with standout resources or capabilities capable of passing
all four tests with high marks. Most firms have a mixed bag of resources and capabilities—one or two quite
valuable, some good, many satisfactory (on a par with
rivals), and others mediocre. Resources and capabilities
that are competitively valuable pass the first of the four
tests, but not necessarily the other three. As contributors to
the competitiveness of a company’s strategy, competitively
valuable resources/capabilities are mainly important in
gaining parity with many (maybe most) rivals; but such
resources/capabilities may or may not have the competitive
power to produce significant competitive advantage without the presence of important bundling effects or other
qualities that greatly boost buyer appeal for a company’s product offering.

For a company to have resources/capabilities that can pass the first two tests entails a much higher hurdle—having
a resource or capability that is valuable, likely not possessed by rivals (rare), and potentially has significant
competitive power because it is competitively superior in some important respect. Companies in the top tier of
their industry may have as many as two or three core competencies but only a very few companies, usually the
strongest industry leaders or up-and-coming challengers, have a capability that truly qualifies as a distinctive
competence. A standout resource that delivers competitive superiority is as rare as having a resource/capability
that qualifies as a distinctive competence. This is why, absent important resource/capability bundling effects,
it is so hard for a company to achieve a sustainable competitive advantage over rivals. Achieving sustainable
competitive advantage usually requires a company to have at least one resource/capability that can pass the first
three tests (except in those instances where important resource/capability bundling effects are present).

However, as discussed earlier, a company that lacks a standout resource or distinctive competence and only has
resources/capabilities that can pass the first test can still integrate a group of good-to-adequate resources and
capabilities into a competitively effective bundle that yields adequate to good profitability. Fast-food chains
like Wendy’s, Shake Shack, and Burger King, despite having only satisfactory resources and capabilities, have
nonetheless achieved respectable market positions and profitability competing against McDonald’s. Discount
retailers Target and Kohl’s have bundled good enough resources and capabilities to profitably compete against
Walmart and its richer, deeper resources/capabilities. Lululemon, an up-and-coming performance sport apparel
retailer whose chief competitors include Nike, Adidas, and Under Armour—all with arguably broader and
deeper collections of competitively valuable resources and capabilities, has in the past six years put together an
increasingly potent collection of resources and capabilities that have enabled it to surpass Under Armour in sales
in North America, increase its global revenues by 147 percent and net profits by 77 percent during 2018–2023.

A Company’s Important Resources and Capabilities Must Be Dynamic and
Freshly-Honed to Sustain Its Competitiveness
For a company’s important resources and capabilities to remain competitively valuable over time, they must be
continually polished, updated, and sometimes augmented
with altogether new kinds of resources and expertise.10
It takes freshly honed and sometimes totally refurbished
or completely new resources/capabilities for a company
to effectively respond to ongoing changes in customer
needs and expectations. Diligent managerial attention to
sharpening and recalibrating company competencies and
capabilities protects a company’s long-term competitiveness
against the improving capabilities of rivals and their
strategic maneuvering to win bigger sales and market shares. Absent such attention, a company’s competencies
and capabilities risk becoming stale over time and eroding company performance.11

CORE CONCEPT
The degree of success a company enjoys in
the marketplace is governed by the combined
competitive power of its resources and
capabilities.

CORE CONCEPT
A company requires a dynamically evolving
portfolio of competitively valuable resources
and capabilities to sustain its competitiveness
and help drive improvements in its performance.
Otherwise, the power of its competitive assets
grows stale.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 81

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The Role of Dynamic Capabilities. Management’s challenge in creating and maintaining a dynamic
and competitively effective portfolio of resources and capabilities has two elements: (1) attending to ongoing
recalibration and refurbishment of the company’s competitive assets and (2) casting a watchful eye for
opportunities to develop totally new resources and capabilities for delivering better customer value and/or
outcompeting rivals. Companies that succeed in meeting both challenges are likely to be in the enviable position
of having an ever stronger and competitively potent arsenal
of resources and capabilities.

Company executives that grasp the strategic importance of
incrementally improving the company’s existing competitive
assets and from time-to-time adding new resources/
capabilities make a point of ensuring that these actions are
an ongoing, high-priority activity. By making proactive
oversight of these activities a routine managerial function, they gain the experience and know-how to do a
consistently good job of dynamically managing the company’s important competitive assets. At that point, their
ability to freshen and augment the company’s resource/capability portfolio becomes what is known as a dynamic
capability.12 This dynamic capability also includes an ongoing top management search for opportunities to
create new resources and capabilities to increase the company’s competitiveness. When a company’s executive
management team achieves proficient dynamic capability to modify, deepen, and augment the company’s
competitively important resources and capabilities, the company is better able to maintain, if not enhance, its
competitiveness in the marketplace and significantly improve its chances for long-term competitive success.

Question 3: What Are the Company’s Competitively Important
Strengths and Weaknesses and Are They Well-Suited
to Capturing Its Best Market Opportunities and
Defending Against External Threats?
One of the simplest and most powerful tools for assessing a company’s overall situation is widely known as SWOT
analysis, so named because it zeros in on a company’s competitively important Strengths and Weaknesses,
its market Opportunities, and those external Threats that
can adversely impact the company’s well-being. Doing a
first-rate SWOT analysis has considerable managerial value
because it helps company managers single out and focus
on all the factors needed to craft a winning strategy that
fits the company’s overall internal and external situation.
To achieve good fit with the company’s situation, managers
must devise a strategy that capitalizes on the company’s most potent competitive strengths, corrects important
competitive weaknesses, aims squarely at capturing the company’s best market opportunities, and helps defend
against the external threats to its future well-being and business prospects.

Identifying a Company’s Competitively Important Strengths
A strength can relate to something a company is good at doing (a competitively important capability or a
core competence), a competitively valuable resource
(like a well-known brand name or a reputation for award-
winning customer service or large numbers of high-traffic
store locations), and certain kinds of competitively relevant
achievements or attributes that contribute to a company’s
competitiveness in the marketplace (like having low overall
costs relative to competitors, being a market share leader,
having a wider product line than rivals, and having wider geographic market coverage than rivals).

Executive attention to making sure a company
always has competitively valuable resources
and capabilities that dynamically evolve and
help sustain the company’s competitiveness is a
strategically important top management task.

SWOT analysis is a simple but powerful
tool for sizing up a company’s competitively
relevant strengths and weaknesses, its market
opportunities, and the external threats to its future
well-being.

CORE CONCEPT
A company’s competitively important strengths
are competitive assets that positively impact its
competitiveness and ability to succeed in the
marketplace.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 82

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Most usually, a company’s strengths stem from the caliber and competitive power of its resources and capabilities;
managers can draw on resource and capability analysis to make objective assessments of the potency of the
company’s resources and capabilities. While individual resources and capabilities that can pass one or more of
the four tests of competitive power typically represent the company’s greatest strengths, managers should be
careful not to overlook the competitive strength that results from bundling less potent resources and capabilities.
Further, a resource or capability that lacks much competitive power may still be useful for successfully gaining
entry into a new market or market segment. A resource bundle that fails to match those of top-tier companies
may, nonetheless, allow a company to compete quite successfully against second-tier rivals.

Identifying a Company’s Competitively Important Weaknesses
A weakness, or competitive deficiency, is something a company lacks or does poorly (in comparison to others)
or a condition that puts it at a disadvantage in the marketplace. A company’s weaknesses can relate to (1) inferior
or unproven skills, expertise, capabilities, or intellectual
capital in competitively important areas of the business;
(2) deficiencies in competitively important physical,
organizational, or intangible resources; or (3) weak or
missing capabilities in key areas. Company weaknesses are
thus internal shortcomings or deficiencies that constitute
competitive liabilities. Nearly all companies have competitive liabilities of one kind or another. Whether a
company’s weaknesses make it competitively vulnerable depends on how much they matter in the marketplace
and whether they are mostly offset or minimized by the company’s strengths.

Table 4.2 contains a representative sample of things to consider in identifying a company’s competitively
relevant strengths and weaknesses. Sizing up a company’s complement of strengths and weaknesses is akin to
constructing a strategic balance sheet, where strengths represent competitive assets and weaknesses represent
competitive liabilities. Obviously, the ideal outcome is for a company’s competitive assets to outweigh its
competitive liabilities by a healthy margin—a 50-50 balance (or worse) is ominous.

CORE CONCEPT
A company’s weaknesses are internal
shortcomings that constitute competitive liabilities.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 83

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Table 4.2 What to Look for in Identifying a Company’s Strengths,
Weaknesses, Opportunities, and Threats

Potential Competitive Strengths
l Core competencies in _______
l A distinctive competence in _______
l A product strongly differentiated from those of rivals
l Resources and capabilities well matched to industry

key success factors
l A strong financial condition; ample financial resources

to grow the business
l Strong brand name/company reputation
l Strong customer loyalty
l Proven technological capabilities, proprietary

technology/important patents
l Strong bargaining power over suppliers or buyers
l Cost advantages over rivals
l Proven skills in advertising and promotion
l Proven product innovation capabilities
l Proven capabilities in improving production processes
l Good supply chain management capabilities
l Strong customer service capabilities
l Better product quality relative to rivals
l Wide geographic coverage and/or strong global

distribution capability
l Alliances/joint ventures with firms that provide access

to valuable technology, expertise and/or attractive
geographic markets

Potential Market Opportunities
l Openings to win market share from rivals
l Sharply rising buyer demand for the industry’s product
l Serving additional customer groups or market

segments
l Expanding into new geographic markets
l Expanding the company’s product line to meet a

broader range of customer needs
l Utilizing existing company skills or technological

know-how to enter new product lines or new
businesses

l Growing online sales (often because more buyers
have shifted to making purchases online)

l Integrating forward or backward
l Falling trade barriers in attractive foreign markets
l Acquiring rival firms or companies with attractive

capabilities
l Entering into alliances or joint ventures to expand the

firm’s market coverage or boost its competitiveness
l Openings to exploit emerging new technologies

Potential Competitive Weaknesses
l Core competencies that are weaker or less well-

developed than key rivals
l Resources and capabilities that are not well matched to

an industry’s key success factors
l Heavy debt burden; a weak credit rating
l Short on financial resources to grow the business and

pursue promising initiatives
l Higher overall unit costs relative to key rivals
l Weaker product innovation capabilities than key rivals
l A product/service with attributes or features inferior to

those of rivals
l Too narrow a product line relative to rivals
l Weaker brand name/reputation than rivals
l Weaker dealer network than key rivals
l Weak global distribution capability
l Weaker product quality, R&D, and/or technological

know-how than key rivals
l In an overcrowded strategic group
l Losing market share because _________
l Competitive disadvantages in ________
l Inferior intellectual capital relative to rivals
l Subpar profitability because _________
l Plagued with internal operating problems or obsolete

facilities
l Too much underutilized plant capacity

Potential External Threats to a Company’s
Well-Being and Future Profitability
l More intense competitive pressures from industry rivals

and/or sellers of substitute products—may squeeze
profit

margins

l The entry (or likely entry) of new competitors into the
company’s market stronghold (especially lower-cost
foreign competitors)

l Growing bargaining power of buyers and/or suppliers
l Slowing or declining market demand for the industry’s

product
l A shift in buyer needs and tastes away from the

industry’s product
l Adverse demographic changes that threaten to curtail

demand for the industry’s product
l Technological changes that weaken buyer demand or

weaken the company’s competitiveness
l Restrictive trade policies or tariffs; disruptive trade wars
l Costly new regulatory requirements
l Tighter credit conditions
l Rising prices for energy or other key inputs

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Identifying a Company’s Best Market Opportunities
Market opportunity is a big factor in shaping a company’s strategy. Indeed, managers can’t properly tailor strategy
to the company’s external situation without first identifying its market opportunities and appraising the growth
and profit potential each one holds. Depending on the prevailing circumstances, a company’s opportunities can
be plentiful or scarce, fleeting or lasting, and can range from wildly attractive (an absolute “must” to pursue)
to marginally interesting (because of the high risks, large capital requirements, or unappealing revenue growth
and profit potentials) to unsuitable (because the company’s resource strengths and capabilities are ill-suited to
successfully capitalize on some opportunities). Typical market opportunities are shown in Table 4.2.

Newly emerging and fast-changing markets sometimes present stunningly big or “golden” opportunities, but it
is typically hard for managers at one company to peer into “the fog of the future” and spot them much ahead of
managers at other companies.13 But as the fog begins to clear, golden opportunities are nearly always pursued
rapidly. And the companies that seize them are usually those that have been actively waiting, staying alert with
diligent market reconnaissance, and preparing themselves to capitalize on shifting market conditions by patiently
assembling an arsenal of competitively valuable resources and a war chest of cash to finance aggressive action
when the time comes.14 In mature markets, unusually attractive market opportunities emerge sporadically, often
after long periods of relative calm—but future market conditions may be less foggy, thus facilitating good
market reconnaissance and making emerging opportunities easier for industry members to detect.

In evaluating a company’s market opportunities and ranking their attractiveness, managers have to guard
against viewing every industry opportunity as a company opportunity. Rarely does a company have sufficient
resources and capabilities to pursue all available market opportunities simultaneously without spreading itself
too thin. More importantly, a company’s resource strengths
and competitively valuable capabilities are almost always
better-suited for pursuing and capturing some opportunities
than others; indeed, few companies have the resources
and capabilities needed to be competitively successful
in pursuing every one of an industry’s opportunities. A
company is always well advised to pass on a particular
market opportunity unless it has or can readily acquire potent
enough resources and capabilities to compete successfully
and profitably in pursuing the opportunity. Competitive
weak companies—because they lack the requisite resource
strengths and capabilities—can find themselves hopelessly
outclassed if they unwisely try to pursue an industry’s
biggest and best market opportunities in head-to-head competition with rivals having much stronger resources and
competitive capabilities. Consequently, in choosing which market opportunities to pursue, company strategists
should concentrate their attention on those opportunities where the requirements for competitive success match
up well with the company’s resource strengths and most potent capabilities—it is precisely these opportunities
where the company is most likely to enjoy competitive success, attractive profitability, and good potential for
achieving a sustainable competitive advantage over rivals.

Identifying the External Threats to a Company’s Future Profitability
Often, certain factors in a company’s external environment pose threats to its competitive well-being and future
profitability. External threats can stem from such factors as the growing intensity of one or more of the five
competitive forces, the emergence of cheaper or better technologies, the entry of lower-cost foreign competitors
into a company’s market stronghold, new regulations that are more burdensome to a company than to its
competitors, unfavorable demographic shifts, and political upheaval in a foreign country where the company has
facilities. Table 4.2 lists representative potential threats.

External threats may pose no more than a moderate degree of adversity (all companies confront some threatening
elements in the course of doing business), or they may be so ominous they put a company’s future survival at

CORE CONCEPT
The most appealing market opportunities for a
company to pursue are those where its resource
strengths and valuable capabilities will be
competitively powerful in the marketplace and
generate the greatest competitive success. The
pursuit of opportunities with good resource/
capability fit offer a company its best prospects for
both attractive profitability and the achievement of
a sustainable competitive advantage over rivals.

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risk. On rare occasions, market shocks can give birth to a sudden-death threat that throws a company into an
immediate crisis and battle to survive. In 2017–2019, many companies engaged in international trade faced
threats stemming from trade disputes between the United States and numerous other countries and the imposition
of higher tariffs on the goods the companies were exporting or importing. In 2020, the sudden emergence of
the Covid-19 pandemic posed a significant threat to the worldwide airline industry, cruise lines, the tourist
industry, restaurants (due to restrictions on indoor dining), many retailers (due to stay-at-home orders and the
reluctance of people to go shopping), and the owners of metropolitan downtown commercial office buildings
(due to tenants either allowing or mandating that their employees work from home.) The pandemic-related
threat to many of these businesses extended into 2021. When the COVID-19 threat ended in 2021–2022, a
number of employers unexpectedly decided that many of their workers could continue to work from home and
cancelled their leases of office space; the resulting explosion in vacant office spaces in downtown buildings in
many metropolitan cities posed a long-term threat to the owners of these buildings who were dependent on rental
income to pay the mortgages they took out to purchase the buildings. The expected increases in the demand for
electric vehicles over the long-term threatens the businesses of oil producers across the world due to the resulting
weaker demand for gasoline. Concerns about climate change were prompting governments in many countries to
impose new rules and regulations restricting oil and natural gas drilling and production and to offer subsidies for
the installation of solar roofs and the construction of solar farms and wind turbines. Plainly, it is management’s
job to identify the threats to the company’s future prospects and to evaluate what strategic actions can be taken
to neutralize or lessen their impact.

What Do the SWOT Listings Reveal?
SWOT analysis involves more than making four lists. The two most important parts of SWOT analysis are drawing
conclusions from the SWOT listings about the company’s overall situation, and translating these conclusions
into strategic actions to create an overall strategy well-
matched to the company’s overall situation—as indicated
by its strengths and weaknesses, its market opportunities,
and its external threats. Figure 4.2 shows the steps involved
in gleaning insights from SWOT analysis.

The answers to the following questions often reveal just
what story the SWOT listings tell about the company’s
overall situation:

l What are the attractive aspects of the company’s situation?

l What aspects are of the most concern?

l Do the company’s strengths give it sufficient competitive power to compete successfully?

l Are the company’s weaknesses/deficiencies of major or minor consequence? Must remedial action be
taken immediately? Or, are the weaknesses/deficiencies sufficiently negated by the company’s strengths
that corrective action is probably not the best use of company resources?

l Does the company have resources and capabilities that are especially well-suited to successfully pursuing
and capturing its most attractive market opportunities? Is the company lacking certain resources or
capabilities that make it inadvisable to pursue any particular market opportunities?

l Are the external threats alarming, or are they something the company appears able to deal with and
defend against?

l All things considered, where on a scale of 1 to 10 (where 1 is alarmingly weak and 10 is exceptionally
strong), does the company’s overall situation and future prospects rank?

Simply making lists of a company’s strengths,
weaknesses, opportunities, and threats is not
enough. The payoff from SWOT analysis comes
from the conclusions that can be drawn about the
company’s overall situation and the implications
for strategy improvement that flow from the four
lists.

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Figure 4.2 The Three Steps of SWOT Analysis: Identify, Draw Conclusions,
Translate into Strategic Action

Identify the company’s
competitively important
strengths and competitive
assets

Identify the company’s
competitively important
weaknesses and
deficiencies

Identify the
company’s market
opportunities

Identify external threats
to the company’s
future well-being

Conclusions concerning the company’s overall business
situation:
l Where on the scale from “alarmingly weak” to

“exceptionally strong” does the attractiveness of the
company’s situation rank?

l What are the attractive and unattractive aspects of the
company’s situation?

Implications for improving company strategy:
l Use company strengths and capabilities as

corner stones for strategy.
l Pursue those market opportunities best suited to

company strengths and capabilities.
l Correct weaknesses and deficiencies that impair

pursuit of important market opportunities or heighten
vulnerability to external threats.

l Use company strengths to lessen the impact of
important external threats.

What Can Be Gleaned from the
SWOT Listings?

The final piece of SWOT analysis is to translate the diagnosis of the company’s internal and external circumstances
into actions for improving the company’s strategy and business prospects.

Translating the SWOT Analysis Results into Effective Strategic Action. The SWOT analysis results
provide excellent guidance to managers in crafting a strategy (or improving an existing strategy) in ways that
may enable the strategy to pass the three tests of a winning strategy. As you should recall, a winning strategy
must fit the company’s internal and external situation, help build competitive advantage, and boost company
performance. Four conditions are necessary for a company’s strategy to be a good to excellent fit with its overall
situation:

1. The foundation and centerpiece of a company’s strategy to profitably compete against rivals must be its
most competitively powerful resources and capabilities. Using a company’s most potent resources and
capabilities to power its strategy gives the company
its best chance for market success, competitive
advantage, and better performance.15 Should the
power of the company’s resources and capabilities
prove competitively stronger than those of some
or many rivals, its future business performance
should be good. And, in the best-case outcome, if
certain of the company’s most potent resources and
capabilities are hard for rivals to copy or trump,
then achieving a sustainable competitive advantage
can be within reach. Strategies that place heavy demands on areas and activities where the company is
comparatively weak or has unproven competitive capability should be avoided.

CORE CONCEPT
Relying on a company’s strongest resources and
capabilities to power its strategy produces the
best fit with the company’s internal and external
situation, thereby making such an approach
to crafting strategy the surest route to market
success and good business results.

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2. The strategy must include actions to correct those competitive weaknesses that make the company
vulnerable to attack from rivals, depress profitability, or disqualify it from pursuing a particularly
attractive opportunity. However, there is scant reason to devote much attention to correcting those
weaknesses or deficiencies that are well defended by other company resources and capabilities.

3. The company’s strategy must include strategic initiatives aimed squarely at capturing those market
opportunities best suited to the company’s strengths and competitive assets. Management should almost
always deploy some of the company’s most potent resources and capabilities to spearhead such initiatives.
Indeed, what makes a market opportunity attractive to pursue is that the company has competitively
powerful resources and capabilities that can be used to seize opportunities to grow the business, boost
performance, and potentially achieve competitive advantage. However, there are instances where some
market opportunities can be pursued with resource/capability bundles having sufficient competitive
power to get the job done.

4. The strategy should include efforts to defend against those external threats that can adversely impact
the company’s long-term business prospects or put its survival at risk. How much attention to devote
to defending against external threats hinges on how vulnerable the company is, whether attractive
defensive moves can be taken to lessen their impact, and whether the costs of undertaking such moves
represent the best use of company resources. Some external threats are often beyond a firm’s ability
to influence or defend against; in such cases, the best course of action can be to wait until the threat
materializes and try to offset its impact with actions in other parts of the business.

Question 4: Are the Company’s Prices and Costs Competitive
with Those of Key Rivals, and Does It Have an Appealing
Customer Value Proposition?

Company managers are often stunned when a competitor cuts its price to “unbelievably low” levels or when a
new market entrant comes on strong with a very low price. Such rivals may not, however, be “dumping” (an
economic term for selling at prices below cost) or buying market share with a super-low price or waging a
desperate move to gain sales—they may simply have substantially lower costs. Then there are occasions when
a competitor storms the market with a new product that ratchets the quality level up so high some customers
will call an immediate halt to their purchases and refuse to pay the substantially higher asking price for the new
product.

Regardless of where on the price-quality-performance spectrum a company competes, it must remain competitive
in terms of its customer value proposition to stay in the game. Two telling signs of whether a company’s business
position is strong or precarious are (1) whether its prices are justified by the value it delivers to customers and
(2) whether its costs are competitive with industry rivals delivering similar customer value at a similar price. The
greater the amount of customer value a company can offer profitably compared to its rivals, the less vulnerable it
is to competitive attack. And if it can deliver the same amount of value at lower costs (or more value at the same
cost), it will enjoy a competitive edge.

Two analytical tools are particularly useful in determining whether a company’s customer value proposition,
prices, and costs are competitive: value chain analysis and benchmarking.

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The Concept of a Company Value Chain
Every company’s business consists of a collection of activities undertaken in the course of designing, producing,
marketing, delivering, and supporting its product or service. All of the various activities a company performs
internally combine to form a value chain—so-called because creating value for customers is what chains a
company’s various activities into a purposeful group of functions and tasks. A company’s value chain consists
of two broad categories of activities: the primary activities
foremost in the company’s scheme for creating and
delivering value to customers and the requisite support
activities that facilitate and enhance the performance of the
primary activities.16 The kinds of primary and secondary
activities that comprise a company’s value chain vary
according to the specifics of its business—hence, the
primary and secondary activities shown in Figure 4.3 are
illustrative rather than definitive.

For example, the primary activities at hotel operators
like Marriott include site selection and construction,
reservations, the operation of hotel properties (check-in
and check-out, maintenance and housekeeping, dining and room service, and conventions and meetings), and
management of its portfolio of hotel property locations. Its principal support activities include accounting, hiring
and training, advertising, building a recognized and reputable brand name, and general administration. The
primary activities for retailers like Best Buy or Home Depot involve merchandise selection and buying, supply
chain management, store layout and product display, sales floor operations, website operations for online sales,
and customer service, whereas its support activities include site selection, hiring and training, store maintenance,
advertising, and general administration. Supply chain management is a crucial activity for Toyota, Costco, and
Apple but is not a value chain component at Facebook or PayPal or Visa. Sales and marketing are dominant
activities at Procter & Gamble and Nike but have far lesser roles at oil drilling companies and natural gas
pipeline companies. Order delivery is a crucial activity at Domino’s Pizza but is currently not an internal value
chain activity at McDonald’s, Walgreens, and TJMaxx.

With its focus on value-creating activities, the value chain is an ideal tool for examining tworkings of a company’s
business model—its customer value proposition and profit proposition. It permits a deep look at the company’s
cost structure and ability to charge low or at least competitive prices. It can reveal the costs a company is
spending on product differentiation efforts to deliver greater customer value and support higher prices, such as
product quality and customer service. Company value chains necessarily include a profit margin component,
since profits are necessary to compensate owners/shareholders who bear risks and provide capital. When the
revenues generated from a company’s value-creating activities are sufficient to cover operating costs and yield
an attractive profit, then the organization has an appealing
value chain—its customer value proposition and its profit
proposition are well aligned and signal a successful business
model. Absent the ability to create a value chain capable of
delivering sufficient customer value and producing adequate
profitability, a company is competitively vulnerable and its
survival open to question.

Comparing the Value Chains of Rival Companies
Value chain analysis facilitates a comparison of how rivals,
activity-by-activity, deliver value to customers. Typically,
there are important differences in the value chains of rival companies. A company that makes a no-frills product
and provides minimal customer services has a value chain with activities and costs that are different from a
competitor that produces a full-featured, high-performance product and has a full range of customer service
offerings. The “operations” component of the value chain for a manufacturer that makes all of its own parts and
components and assembles them into a finished product differs from the “operations” of a rival producer that

CORE CONCEPT
A company’s value chain identifies the primary
activities it performs that create customer value
and the related support activities. The “outputs”
of an organization’s value chain activities are the
value delivered to customers and the resulting
revenues it collects. The “inputs” are all of the
resources required to conduct the various value
chain activities; use of these resources create
costs.

CORE CONCEPT
The greater the value a company can profitably
deliver to its customers relative to the value close
rivals deliver, the less competitively vulnerable
it becomes. The higher a company’s costs
relative to those of rivals delivering comparable
customer value at a comparable price, the more
competitively vulnerable it becomes.

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buys the needed parts and components from outside suppliers and only performs assembly operations. Movie
theaters that show the new releases of movie studios and derive a big portion of their revenues from concession
sales employ different value-creating activities and have different costs from Netflix and other providers of
movies streamed over the Internet directly to viewers’ TVs and mobile devices.

Differences in the value chains of close competitors raise two very important questions. One, whose value chain
delivers the best customer value relative to the prices being charged? Two, which company has the lowest cost
value chain? When one competitor employs a value chain approach that delivers greater value to customers
relative to the price it charges, it gains competitive advantage even if its costs are equivalent to (or maybe slightly
higher than) those of its close rivals. When close competitors deliver much the same value to customers, charge
comparable prices, and employ similar value chains, then competitive advantage accrues to the company that
operates its value chain most cost efficiently. Consequently, it is incumbent on company managers to vigilantly
monitor how effectively and efficiently the company delivers value to customers relative to rival companies—
gaining a competitive edge over rivals hinges on being able to deliver equivalent customer value at lower cost
or greater customer value at the same cost.

Figure 4.3 A Representative Company Value Chain

PRIMARY ACTIVITIES
l Supply Chain Management—Activities, costs, and assets associated with purchasing fuel, energy, raw

materials, parts and components, merchandise, and consumable items from vendors; receiving, storing and
disseminating inputs from suppliers; inspection; and inventory management.

l Operations —Activities, costs, and assets associated with converting inputs into final product from (producing,
assembly, packaging, equipment maintenance, facilities, operations, quality assurance, environmental protection).

l Distribution—Activities, costs, and assets dealing with physically distributing the product to buyers (finished
goods warehousing, order processing, order picking and packing, shipping, delivery vehicle operations,
establishing and maintaining a network of dealers and distributors).

l Sales and Marketing—Activities, costs, and assets related to sales force efforts, advertising and promotion,
market research and planning, and dealer/distributor support.

l Service—Activities, costs, and assets associated with providing assistance to buyers, such as installations,
spare parts delivery, maintenance and repair, technical assistance, buyer inquiries, and complaints.

SUPPORT ACTIVITIES
l Product R&D, Technology, and Systems Development—Activities, costs, and assets relating to product R&D, process

R&D, process design improvement, equipment design, computer software development, telecommunications
systems, computer-assisted design and engineering, database capabilities, and
development of computerized support systems.

l Human Resource Management—Activities, costs, and assets associated with the recruitment, hiring, training,
development, and compensation of all types of personnel; labor relations activities; and development of
knowledge-based skills and core competencies.

l General Administration—Activities, costs, and assets relating to general management, accounting and finance, legal
regulatory affairs, safety and security, management information systems, forming strategic alliances and collaborating
with strategic partners, and other overhead functions.

Supply
Chain

Manage-
ment

Operations Distribution Sales and
Marketing

Service Profit
Margin

Product R&D, Technology, and Systems Development

Human Resources Management

General Administration

Primary
Activities

and
Costs

Support
Activities

and
Costs

Source: Based on the discussion in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), pp. 37–43.

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A Company’s Primary and Support Activities Identify the Major Components of Its Internal
Cost Structure The combined costs of all the various primary and support activities comprising a company’s
value chain define its internal cost structure. Further, the cost of each activity contributes to whether the
company’s overall cost position relative to rivals is
favorable or unfavorable. The roles of value chain analysis
and benchmarking are to develop the data for comparing
a company’s costs activity-by-activity against the costs of
key rivals and to learn which internal activities are a source of cost advantage or disadvantage.

Evaluating a company’s cost-competitiveness involves using what accountants call activity-based costing to
determine the costs of performing each value chain activity.17 The degree to which a company’s total costs should
be broken down into costs for specific activities depends on how valuable it is to know the costs of specific
activities versus broadly defined activities. At the very least, cost estimates are needed for each broad category
of primary and support activities, but cost estimates for more specific activities within each broad category may
be needed if a company discovers it has a cost disadvantage vis-à-vis rivals and wants to pin down the exact
source or activity causing the cost disadvantage. However, a company’s own internal costs are insufficient to
assess whether its product offering and customer value proposition are competitive with those of rivals. Cost and
price differences among competing companies can have their origins in activities performed by suppliers or by
distribution allies involved in getting the product to the final customers or end users of the product, in which case
the company’s entire value chain system becomes relevant.

The Value Chain System for an Entire Industry
A company’s value chain is embedded in a larger system of activities that includes the value chains of its suppliers
and the value chains of whatever wholesale distributors and retailers it utilizes in getting its product or service to
end users.18 Suppliers’ value chains are relevant because suppliers perform activities and incur costs in creating
and delivering the purchased inputs used in a company’s own value-creating activities. The costs, performance
features, and quality of these inputs influence a company’s own costs and product differentiation capabilities.
Anything a company can do to help its suppliers drive
down the costs of their value chain activities or improve
the quality and performance of the items being supplied
can enhance its own competitiveness—a powerful reason
for working collaboratively with suppliers in managing
supply chain activities.19 Automakers, for example, have
encouraged their automotive parts suppliers to build plants
near the auto assembly plants to facilitate just-in-time deliveries, reduce warehousing and shipping costs, and
better enable close collaboration on parts design and production scheduling.

Similarly, the value chains of a company’s distribution channel partners are relevant because (1) the costs and
margins of a company’s distributors and retail dealers are part of the price the ultimate consumer pays, and (2)
the activities that distribution allies perform affect sales volumes and customer satisfaction. For these reasons,
companies normally work closely with their distribution allies (who are their direct customers) to perform value
chain activities in mutually beneficial ways. For instance, motor vehicle manufacturers have a competitive
interest in working closely with their automobile dealers to (1) promote better customer satisfaction with dealers’
repair and maintenance services and (2) develop sales and marketing programs to achieve higher sales volumes.
Producers of bathroom and kitchen faucets are heavily dependent on whether the sales and promotional activities
of their distributors and building supply retailers are effective in attracting the interest of homebuilders and do-
it-yourselfers, and whether distributors/retailers operate their value chains cost effectively enough to be able to
sell at prices that lead to attractive sales volumes.

As a consequence, accurately assessing a company’s competitiveness entails scrutinizing the nature and costs of
value chain activities across an industry’s entire value chain system for delivering a product or service to end-
use customers. A typical industry value chain that incorporates the value chains of suppliers and forward channel
allies (if any) is shown in Figure 4.4. As was the case with company value chains, the specific activities comprising

Each activity in a company’s value chain gives rise
to costs and ties up assets.

A company’s cost-competitiveness depends not
only on the costs of internally performed activities
(its own value chain) but also on costs in the value
chains of its suppliers and distribution channel
allies.

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industry value chains vary significantly from industry to industry. The primary value chain activities in the pulp
and paper industry (timber farming, logging, pulp mills, paper making, and distribution) differ from the primary
value chain activities in the home appliance industry (product design, parts and components manufacture,
assembly, wholesale distribution, retail sales) and differ yet again for the soft drink industry (processing of
basic ingredients and syrup manufacture, bottling and can filling, wholesale distribution, advertising, and retail
merchandising).

Figure 4.4 A Representative Value Chain System for an Entire Industry

Supplier-Related
Value Chains

A Company’s
Own Value Chain

Forward Channel
Value Chains

Activities,
costs, and
margins of
suppliers

Internally
performed
activities,

costs,
and

margins

Activities,
costs, and
margins

of forward
channel

allies and
strategic
partners

Buyer or
end-user

value
chains

Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive Advantage (New York: Free Press,
1985), p. 35.

Once a company has developed good cost estimates for each major activity in its own value chain, has a good
grasp of the value chains its close rivals employ, and has sufficient cost data relating to the value chain activities
of suppliers and distribution allies, it is ready to explore whether its costs compare favorably or unfavorably with
those of key rivals. This is where benchmarking comes in.

Benchmarking: A Tool for Assessing Whether the Costs and Effectiveness
of a Company’s Value Chain Activities Are in Line
Benchmarking entails comparing how different companies (both inside and outside the industry) perform
various value chain activities—how inventories are managed, how products are assembled, how fast the
company can get new products to market, how customer orders are filled and shipped—and then making cross-
company comparisons of the costs of these activities.20 The
objectives of benchmarking are to identify the best means of
performing an activity, to learn how other companies have
actually achieved lower costs or better results in performing
benchmarked activities, and to take action to emulate those
best practices whenever benchmarking reveals that its costs
and results of performing an activity are not on a par with
what other companies have achieved. A best practice is a
method or technique of performing an activity or business
process that produces results superior to those achieved with other methods/techniques. To qualify as a legitimate
best practice, the method must have been employed by at least one enterprise and shown to be consistently
effective in lowering costs, improving quality or performance, shortening time requirements, enhancing safety,
or achieving some other highly positive operating outcome(s).

Xerox pioneered the use of benchmarking to become more cost competitive, quickly deciding not to restrict
its benchmarking efforts to its office equipment rivals but to extend them to any company regarded as “world
class” in performing any activity relevant to Xerox’s business.21 Other companies quickly picked up on Xerox’s

CORE CONCEPT
Benchmarking is a potent tool for learning which
companies are best at performing particular
activities and emulating their techniques (or “best
practices”) to improve the cost and effectiveness
of a company’s own internal activities.

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approach. Toyota managers got their idea for just-in-time inventory deliveries by studying how U.S. supermarkets
replenished their shelves. Southwest Airlines reduced the turnaround time of its aircraft at each scheduled stop
by studying pit crews on the auto racing circuit. More than 80 percent of Fortune 500 companies reportedly use
benchmarking for comparing themselves against rivals in performing activities in ways that produce superior
outcomes.

The tough part of benchmarking is not whether to do it but rather how to gain access to information about other
companies’ practices and costs. Sometimes benchmarking can be accomplished by collecting information from
published reports, trade groups, and industry research firms and by talking to knowledgeable industry analysts,
customers, and suppliers. Sometimes field trips to the facilities of competing or noncompeting companies
can be arranged to observe how things are done, ask questions, compare practices and processes, and perhaps
exchange data on various cost components—but the problem here is that most companies, even if they agree
to host facilities tours and answer questions, are unlikely to share competitively sensitive cost information.
Furthermore, comparing one company’s costs to another’s costs may not involve comparing apples to apples
if the two companies employ different cost accounting principles to calculate the costs of particular activities.

However, a third and fairly reliable source of benchmarking information has emerged. The explosive interest
of companies in benchmarking costs and identifying best practices has prompted consulting organizations
(Accenture, A.T. Kearney, Benchnet—The Benchmarking Exchange, and Best Practices, LLC) and several
trade associations (the Qualserve Benchmarking Clearinghouse and the Strategic Planning Institute’s Council
on Benchmarking) to gather benchmarking data, distribute information about best practices, and provide
comparative cost data without identifying the names of particular companies. Having an independent group
gather the information and report it in a manner that disguises the names of individual companies protects
competitively sensitive data and lessens the potential for unethical behavior by company personnel in gathering
their own data about competitors.

Strategic Options for Creating an Advantage or Remedying a Disadvantage
as Concerns Cost or the Value Delivered to Customers
Examining the costs of a company’s own value chain activities and comparing them to rivals indicates who
has how much of a cost advantage or disadvantage and which cost components are responsible. Value chain
analysis and benchmarking can also disclose whether a company has an advantage or disadvantage vis-à-vis
rivals in delivering value to customers. Such information is vital in strategic actions to create a cost or value
advantage or eliminate a cost/value disadvantage. The three main areas in a company’s total value chain system
where company managers can try to create a cost/value advantage or remedy a cost/value disadvantage are (1) a
company’s own activity segments, (2) suppliers’ part of the overall value chain, and (3) the distribution channel
portion of the chain.

Improving the Performance of Internally Performed Activities Managers can pursue any of several
strategic approaches to reduce the costs of internally performed value chain activities and improve a company’s
cost competitiveness:22

l Implement best practices throughout the company, particularly for high-cost activities.

l Redesign the product and/or some of its components to eliminate high-cost components or facilitate
speedier and more economical manufacture or assembly.

l Relocate high-cost activities to geographic areas where they can be performed more cheaply.

l Outsource certain internally performed activities to vendors or contractors that can perform them more
cheaply than they can be performed in-house.

l Shift to lower-cost production technologies and/or invest in productivity-enhancing equipment (robotics,
flexible manufacturing techniques, real-time process monitoring).

l Stop performing activities of minimal value to customers (like seldom-used customer services).

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A second approach to eliminating a competitive disadvantage or creating a competitive advantage in how internal
activities are performed is by improving the performance of those activities capable of delivering added value to
customers. Efforts to deliver higher customer value at the same or lower cost can include:

l Adopting best practice approaches for activities affecting quality and customer service and activities
known to affect buyer brand preferences.

l Implementing new design innovations and/or investing in production methods that improve quality,
curtail maintenance requirements, extend product life, or reduce after-the-sale repair costs incurred by
customers.

l Emphasizing better performance of activities most responsible for creating those product/service
attributes known to impact buyer preferences for one brand versus another brand. The goal here should
be to revamp those activities that result in attributes that cause buyers to dislike the company’s brand
and to do an even better job of performing activities that can further enhance the attributes that buyers
like about the company’s brand.

l Outsourcing activities to vendors/contractors with the resources/capabilities to help deliver higher
customer value at the same or lower cost.

In searching for cost-reducing opportunities or value-enhancing opportunities, it is important to recognize that the
manner in which one activity is done spills over to impact the costs/value of how other activities are performed.
For instance, how a television or washing machine is designed impacts the number of parts and components,
their respective manufacturing costs, the time and expense of assembling the various parts and components into
a finished product, and, from a customer value perspective, how well the product performs, repair frequencies,
maintenance costs, and product life.

Improving the Performance of Supplier-Related Value Chain Activities A company can gain cost
savings in supplier-related value chain activities by pressuring suppliers for lower prices, switching to lower-
priced substitute inputs, and collaborating closely with suppliers to identify mutual cost-saving opportunities.23
For example, collaborating with suppliers to achieve just-in-time deliveries from suppliers can lower a company’s
inventory and internal logistics costs and may also allow suppliers to economize on their warehousing, shipping,
and production scheduling costs—a win–win outcome for both. In a few instances, companies may find it is
cheaper to integrate backward into the business of high-cost suppliers and make the item in-house instead of
buying it from outsiders.

A company can enhance the value it delivers to customers through its supplier relationships by selecting/retaining
only those suppliers that meet higher-quality standards, bringing in suppliers to partner in the design process, and
providing quality-based incentives to suppliers, particularly as concerns reducing parts defects. Fewer defects
not only improve quality throughout the value chain system but also can curtail the annoyance customers have
when a recently purchased product fails shortly after purchase (due to parts failures) and has to be repaired or
replaced under warranty. In addition, fewer defects lower warranty costs and lower the costs of product testing
and replacement of defective parts/components prior to shipment.

Improving the Performance of Distribution-Related Value Chain Activities Any of three means can
be used to achieve better cost-competitiveness in the distribution portion of an industry value chain:24

1. Pressure distributors, dealers, and other forward channel allies to reduce their costs and markups to
make the final price to buyers more competitive with the prices of rival brands.

2. Collaborate with forward channel allies to identify win–win opportunities to reduce costs. For example,
a chocolate manufacturer learned that by shipping its bulk chocolate in liquid form in tank cars instead
of in 10-pound molded bars, it could save its candy bar manufacturing customers the costs associated
with unpacking and melting and also eliminate its own costs of molding and packing bars.

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3. Change to a more economical distribution strategy, including switching to cheaper distribution channels
(selling direct to consumers via the online sales at the company’s website) or possibly integrating
forward into company-owned retail outlets.

The means of enhancing differentiation through the activities of distribution-related allies include (1) engaging
in cooperative advertising and promotion campaigns, (2) creating exclusive distribution arrangements or using
other incentives to boost the efforts of distribution allies to deliver enhanced value to end-use customers, (3)
creating and enforcing higher standards for distribution allies to observe in performing their activities, and (4)
providing training to forward channel partners in using best practices to perform their activities.

Translating Proficient Performance of Value Chain Activities into Competitive
Advantage
A company that does a first-rate job of managing its value chain activities relative to competitors stands a good
chance of achieving sustainable competitive advantage.
As shown in Figure 4.5, competitive advantage can be
achieved by out-managing rivals in either of two ways: (1)
by performing value chain activities more efficiently and
cost effectively, thereby gaining a low-cost advantage over
rivals or (2) by performing certain value chain activities in
ways that drive value-creating improvements in quality,
features, performance, and other attributes, thereby gaining a differentiation-based competitive advantage keyed
to what customers perceive as a superior product offering.

Achieving Proficient Performance of Value Chain Activities Depends on Having the Right
Resources and Capabilities As laid out in Figure 4.5, either approach requires focused management attention
on building and nurturing resources and capabilities that enable the value chain activities to be performed
proficiently enough to produce the desired outcome—lower costs or greater value-creating differentiation. A
company’s value chain is all about performing activities, and proficient performance of key activities requires
having not just the right resources and capabilities but developing and constantly improving them so they become
ever more competitively valuable.

Achieving a cost-based competitive advantage requires determined efforts to be cost-efficient in performing
value chain activities. Such efforts must be ongoing and persistent, and they have to involve each and every
value chain activity. The goal must be continuous cost reduction, not on-again/off-again efforts. This requires
a frugal culture where all company personnel not only exhibit cost-conscious behavior but also where they
are diligent in discovering and implementing operating practices that lower costs. Cost-benchmarking and
aggressive implementation of cost-lowering best practices must be the norm. Companies whose managers are
truly committed to low-cost performance of value chain activities and succeed in engaging company personnel
to discover innovative ways to drive costs out of the business have a real chance of gaining a durable low-cost
edge over rivals. It is not as easy as it seems to imitate a company’s low-cost practices. Walmart, Nucor Steel,
Dollar General, Irish airline Ryanair, Toyota, and French discount retailer Carrefour have been highly successful
in preserving a low-cost advantage by out-managing their rivals in how cost efficiently company value chain
activities are performed.

On the other hand, companies that succeed in achieving a differentiation-based competitive advantage do
so because of a strong commitment to proficiently performing those value chain activities that add value for
customers and more strongly differentiate their product offering from rivals. For example, uniquely good customer
service capabilities are crucial at such high-end hotel properties as Ritz-Carlton, Four Seasons, and St. Regis.
First-rate product innovation capabilities are paramount at Google, Microsoft, the makers of high performance
fabrics, and the developers of cybersecurity software. Product design capabilities underlie a company’s success
in the furniture business, high-fashion apparel, smartphones, exercise equipment, and the household appliance
buisness. Standout engineering design and manufacturing/assembly capabilities are essential at Mercedes,
BMW, Toyota, and Tesla. To the extent that a company continues to invest resources in building greater and

Performing value chain activities in ways that
give a company either a lower-cost advantage or
a value-creating differentiation advantage over
rivals are two surefire ways to secure competitive
advantage.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 95

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greater proficiency in performing the targeted value chain activities, and top management makes the associated
resources and capabilities cornerstones of the company’s
strategy to attract and please customers, then, over time,
its proficiencies rise to the level of a core competence.
Later, with further organizational learning and gains in
proficiency, a core competence may evolve into a distinctive
competence. Such superiority over rivals in performing one
(or possibly several) differentiation-enhancing value chain
activities can prove unusually difficult for rivals to match
or offset. As a general rule, it is substantially harder for
rivals to achieve “best in industry” proficiency in performing a key value chain activity than it is for them to
clone the features and attributes of a hot-selling product or service.25 This is especially true when a company
with a distinctive competence avoids becoming complacent and works diligently to maintain its industry-leading
expertise and capability.

Figure 4.5 Translating Company Performance of Value Chain Activities
into Competitive Advantage

Company
managers decide
to perform value
chain activities in
ways that drive

improvements in
quality, features,

performance,
and other

differentiation-
enhancing

aspects

Competencies
and

capabilities
gradually
emerge in
performing

certain
differentiation-

enhancing
value chain

activities

Company
proficiency in

performing
some of these
differentiation-

enhancing
value chain

activities
rises to the

level of a core

competence

Company
proficiency in

performing
one or more

differentiation-
enhancing
value chain

activities
continues to

build and
evolves into
a distinctive
competence

Company
gains a

competitive
advantage
based on
superior

differentiation-
enhancing
capabilities
that deliver

added value to
customers

Option 2: Beat rivals by performing certain differentiation-enhancing value chain activities more
proficiently, thus creating a differentiation-based competitive advantage keyed to delivering what
customers perceive as a superior product offering.

Option 1: Beat rivals by performing value chain activities more cheaply, thus achieving a cost-based
competitive advantage

Company
managers decide
to perform value
chain activities

in the most
cost-efficient

manner—every
value chain
activity is

examined for
possible cost

savings

Competencies
and

capabilities
gradually
emerge in
performing

many
value chain

activities
very cost
efficiently

Company
proficiency in
cost-efficient
performance

of value chain
activities

rises to the
level of
a core

competence

Company
proficiency in
cost-efficient
performance

of value chain
activities

continues to
build and

evolves into
a distinctive
competence

Company
gains a

competitive
advantage
based on
superior

cost-lowering
capabilities

Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive Advantage (New York: Free
Press, 1985), p. 35.

Becoming more cost efficient than rivals in
performing value chain activities entails building
and nurturing resources and capabilities that
differ substantially from those needed to
achieve a value-enhancing, differentiation-based
competitive advantage.

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Question 5: Is the Company Competitively Stronger
Or Weaker Than Key Rivals?

Using value chain analysis and benchmarking to determine a company’s competitiveness on price, cost, and
delivering value to customers is necessary but not sufficient. A more comprehensive assessment of the company’s
overall competitive strength is needed. The answers to two questions are of particular interest: First, how does
the company rank relative to competitors on each important factor that determines market success? Second, all
things considered, does the company have a net competitive advantage or disadvantage versus its closest rivals?

An easy-to-use method for answering these two questions involves developing quantitative strength ratings for
the company and its key competitors on each industry key success factor and each competitive trait or capability
that impacts a company’s competitiveness and determines whether it is competitively strong or weak. Much of
the information needed for doing a competitive strength assessment comes from previous analyses. Industry and
competitive analysis reveal the key success factors and competitive capabilities that separate industry winners
from losers. Benchmarking data and scouting key competitors provide a basis for judging the competitive strength
of rivals on such factors as cost, key product attributes (quality, styling, performance features), customer service,
image and reputation, financial strength, technological capability, distribution capability, and other competitively
important traits. SWOT analysis reveals how the company in question stacks up on these same strength measures.

Step 1 in doing a competitive strength assessment is to make a list of the industry’s key success factors and the
most telling measures of competitive strength or weakness (six to ten measures usually suffice). Step 2 is to
assign weights to each of the measures of competitive strength based on their perceived importance—it is highly
unlikely that all the different measures are equally important. For instance, in an industry where the products/
services of rivals are virtually identical, having low unit costs relative to rivals is nearly always the most important
determinant of competitive strength. Importance weights can be as high as 0.50 in situations where one particular
competitive strength measure is overwhelmingly decisive, or the high weights might be only 0.20 or 0.25 when
two or three strength measures are more important than the rest. Lesser competitive strength indicators can carry
weights of 0.05 or 0.10. The sum of the weights for each measure must add up to 1.0.

Step 3 is to rate the firm and its rivals on each competitive strength measure, using a rating scale of 1 to 10 (where
1 is competitively very weak and 10 is competitively very strong). Step 4 is to multiply each strength rating by its
importance weight to obtain weighted strength scores (a strength rating of 4 multiplied by an importance weight
of 0.20 gives a weighted strength score of 0.80). Step 5 is to sum each company’s weighted strength ratings
to obtain an overall weighted competitive strength rating. Step 6 is to use the overall weighted competitive
strength ratings to draw conclusions about the size and extent of the company’s net competitive advantage or
disadvantage vis-à-vis its rivals and to take specific note of areas of strength and weakness.

Table 4.3 provides an example of competitive strength assessment in which a hypothetical company (ABC
Company) competes against two rivals. In the example,
relative cost is the most telling measure of competitive
strength and the other strength measures are of lesser
importance. The company with the highest rating on a given
measure has an implied competitive edge on that measure,
with the size of its edge reflected in the difference between
its weighted rating and rivals’ weighted ratings. For
instance, Rival 1’s 3.00 weighted strength rating on relative
cost signals a considerable cost advantage versus ABC
Company (with a 1.50 weighted score on relative cost) and
an even bigger cost advantage against Rival 2 (with a weighted score of 0.30). The measure-by-measure ratings
reveal the competitive areas where a company is strongest and weakest, and against whom.

The weighted overall competitive strength scores indicate how all the different strength measures add up—
whether the company has a net overall competitive advantage or disadvantage versus each rival. The more a

The sizes of the differences between a company’s
weighted overall competitive strength score
and that of a lower-rated rival signals both their
differing degrees of competitive strength and the
size of the higher-rated company’s net competitive
advantage and the lower-rated company’s net
disadvantage.

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company’s weighted overall competitive strength rating exceeds the scores of lower-rated rivals, the stronger
is its overall competitiveness versus those rivals; the further a company’s score is below those of higher-rated
rivals, the weaker is its ability to compete successfully. The bigger the difference between a company’s overall
weighted rating and the scores of lower-rated rivals, the bigger is its implied net competitive advantage over
these rivals. Thus, Rival 1’s overall weighted score of 7.70 indicates a greater net competitive advantage over
Rival 2 (with a score of 2.10) than over ABC Company (with a score of 5.95). Conversely, the bigger the
difference between a company’s overall rating and the scores of higher-rated rivals, the greater its implied net
competitive disadvantage. Rival 2’s score of 2.10 gives it a smaller net competitive disadvantage against ABC
Company (with an overall score of 5.95) than against Rival 1 (with an overall score of 7.70).

Table 4.3 A Representative Weighted Competitive Strength Assessment

Competitive Strength Assessments
[Rating scale: 1 = Very weak; 10 = Very strong]

ABC Co. Rival 1 Rival 2
Key Success Factors and Strength
Measures

Importance
Weight

Strength
Rating

Weighted
Score

Strength
Rating

Weighted
Score

Strength
Rating

Weighted
Score

Quality/product performance 0.10 8 0.80 5 0.50 1 0.10
Reputation/image 0.10 8 0.80 7 0.70 1 0.10
Manufacturing capabilities 0.10 2 0.20 10 1.00 5 0.50
Technological skills 0.05 10 0.50 1 0.05 3 0.15
Ability to access buyers via
distributors/retailers 0.05 9 0.45 4 0.20 5 0.25

New product innovation
capability 0.05 9 0.45 4 0.20 5 0.25

Financial resources 0.10 5 0.50 10 1.00 3 0.30
Relative cost position 0.30 5 1.50 10 3.00 1 0.30
Customer service capabilities 0.15 5 0.75 7 1.05 1 0.15
Sum of importance weights 1.00
Weighted overall competitive
strength rating 5.95 7.70 2.10

Strategic Implications of the Competitive Strength Assessments
In addition to showing how competitively strong or weak a company is relative to its rivals, the strength ratings
provide guidelines for designing wise offensive and defensive strategies. For example, if ABC Co. wants to
go on the offensive to win additional sales and market share, such an offensive probably needs to be aimed
directly at winning customers away from Rival 2 (which has a lower overall strength score) rather than Rival
1 (which has a higher overall strength score). Moreover, while ABC has high ratings for technological skills (a
10 rating), dealer network/distribution capability (a 9 rating), new product innovation capability (a 9 rating),
quality/product performance (an 8 rating), and reputation/image (an 8 rating), these strength measures have low
importance weights—meaning that ABC has strengths in areas that don’t translate into much competitive clout in
the marketplace. Even so, it outclasses Rival 2 in all five areas, plus it enjoys substantially lower costs than Rival
2 (ABC has a 5 rating on relative cost position versus a 1 rating for Rival 2)—and relative cost position carries
the highest importance weight of all the strength measures. ABC also has greater competitive strength than Rival
2 regarding customer service capabilities (which carries the second-highest importance weight). Hence, because
ABC’s strengths are in the very areas where Rival 2 is weak, ABC is in good position to attack Rival 2. Indeed,
ABC may well be able to persuade a number of Rival 2’s customers to switch their purchases over to its product.

But ABC should be cautious about cutting prices aggressively to win customers away from Rival 2, because
Rival 1 could interpret that as an attack by ABC to win away Rival 1’s customers as well. And Rival 1 is in

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far and away the best position to compete on the basis of low price, given its high rating on relative cost in an
industry where low costs are competitively important (relative cost carries an importance weight of 0.30). Rival
1’s very strong relative cost position vis-à-vis both ABC and Rival 2 arms it with the ability to use its lower-cost
advantage to thwart any price-cutting on ABC’s part. Clearly ABC is vulnerable to any retaliatory price cuts by
Rival 1—Rival 1 can easily defeat both ABC and Rival 2
in a price-based battle for sales and market share. If ABC
wants to defend against its vulnerability to potential price-
cutting by Rival 1, it needs to aim a portion of its strategy at
lowering its costs.

The point here is that a competitively astute company
should take both the individual and overall strength scores
into account in deciding what strategic moves to make.
When a company has important competitive strengths in areas where one or more rivals are weak, it makes sense
to consider offensive moves based on these strengths to exploit rivals’ competitive weaknesses. When a company
has important competitive weaknesses in areas where one or more rivals are strong, it makes sense to consider
defensive moves to curtail its vulnerability.

Question 6: What Strategic Issues and Problems Does
Top Management Need to Address in Crafting a Strategy
to Fit the Situation?
The final and most important analytical step is to zero in on exactly which strategic issues company managers
need to worry about and consider in crafting a strategy well-suited to the company’s specific circumstances.
Compiling a “worry list” involves drawing heavily on the results of the analysis of both the company’s external
and internal environments. The task here is to get a clear fix on exactly what competitive challenges the company
confronts on the road ahead, which of the company’s competitive shortcomings need to be remedied, what
obstacles stand in the way of improving the company’s competitive position in the marketplace and boosting
its financial performance, what combination of strategic actions offers the best path to competitive advantage,
and what specific problems/issues merit front-burner attention by company managers in crafting future strategic
actions.

The “worry list” of significant strategic issues and problems that need to be dealt with in forthcoming strategic
initiatives can include things such as how to stave off market challenges from new foreign competitors, how to
combat the price discounting of rivals, how to reduce the
company’s high costs and pave the way for price reductions,
how to sustain the company’s present rate of growth in light
of slowing buyer demand, whether to expand the company’s
product line, whether to correct the company’s competitive
deficiencies by acquiring a rival company with the missing
strengths, whether to expand into foreign markets rapidly or
cautiously, whether to reposition the company and move to
a different strategic group, what to do about growing buyer
interest in substitute products, and what to do to combat the
aging demographics of the company’s customer base. The
worry list thus relies on such language as “how to…,” “what to do about…,” and “whether to…” to precisely
identify the specific issues/problems that management needs to address and try to resolve in deciding what
upcoming strategic actions to take. The worry list thus serves as an agenda of strategically relevant issues/
problems that managers need to focus on in crafting a refurbished strategy that fits the particulars of the company’s
external and internal situation.

A company’s competitive strength scores
pinpoint its strengths and weaknesses against
rivals and point directly to the kinds of offensive/
defensive actions it can use to exploit its
competitive strengths and reduce its competitive
vulnerabilities.

Compiling a “worry list” that sets forth the
strategic issues and problems a company faces
should embrace such language as “how to…,”
“whether to …” and “what to do about….” The
purpose of compiling a worry list is to create
an agenda of items that need to be addressed
in crafting a set of strategic actions that fit the
company’s overall situation.

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Only after managers have first done serious strategic thinking about how to deal with the items on the worry list
are they truly prepared to pick and choose among the alternative strategic actions and initiatives in fashioning
an overall strategy that suits the company’s situation—the
items on the worry list are most definitely a relevant and
important part of the company’s situation.26 If the items
on the worry list are relatively minor—which suggests the
company’s present strategy is mostly on track and reasonably
well matched to the company’s overall situation—company
managers seldom need to go much beyond fine-tuning the
present strategy to arrive at a strategy suitable for the road
ahead. If, however, the issues and problems confronting the company signal that the present strategy requires
significant overhaul, the task of crafting a revamped strategy better suited to the company’s internal and external
situation needs to be right at the top of management’s action agenda.

Key Points
There are six key questions to consider in evaluating a company’s resources and ability to compete successfully:

1. How well is the company’s present strategy working? This involves evaluating the strategy from a
qualitative standpoint (completeness, internal consistency, rationale, and suitability to the situation) and
also from a quantitative standpoint (the strategic and financial results the strategy is producing). The
stronger a company’s current overall performance, the less likely the need for radical strategy changes.
The weaker a company’s performance and/or the faster the changes in its external situation, the more its
current strategy must be questioned.

2. What are the company’s important resources and capabilities, and do they have the competitive power
to enable the company to produce a competitive advantage over rival companies? The task here is
to identify the company’s most valuable resources and capabilities and to assess their competitive
power using four tests. The degree of success a company enjoys in the marketplace is governed by the
combined competitive power of its resources and capabilities. Executive attention to making sure a
company always has competitively valuable resources and capabilities that dynamically evolve and help
sustain the company’s competitiveness is a strategically important top management task.

3. What are the company’s competitively important strengths and weaknesses and how well-suited are
they to capturing its best market opportunities and defending against the external threats to its future
well-being? A SWOT analysis provides an overview of a firm’s situation and is an essential component
of crafting a strategy that is well-suited to the company’s internal and external circumstances. The two
most important parts of a SWOT analysis are (1) drawing conclusions about what story the compilation
of strengths, weaknesses, opportunities, and threats tell about the company’s overall situation, and (2)
acting on those conclusions to better develop a strategy that satisfies the three requirements of a winning
strategy: (1) fit the company’s internal and external situation, (2) help build competitive advantage, and
(3) improve performance. A company’s most competitively potent resources and capabilities should
be the foundation of its strategy. Using a company’s most potent resources and capabilities to power
its strategy gives the company its best chance for market success, competitive advantage, and better
performance. A well-conceived strategy must include actions to correct those competitive weaknesses
that make the company vulnerable to attack from rivals, depress profitability, or disqualify it from
pursuing a particularly attractive opportunity. Market opportunities and external threats come into play
because fitting a company’s strategy to a company’s situation requires aiming an important portion of
the company’s strategy at pursuing attractive market opportunities and defending against threats to its
future profitability and well-being.

4. Are the company’s prices and costs competitive with those of key rivals, and does it have an appealing
customer value proposition? The greater the value a company can profitably deliver to its customers

CORE CONCEPT
A strategy is neither complete nor well matched to
the company’s situation unless it contains actions
and initiatives to address each issue or problem
on the “worry list.”

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relative to the value delivered by close rivals, the less competitively vulnerable it becomes. The higher a
company’s costs relative to those of rivals delivering comparable customer value at a comparable price,
the more competitively vulnerable it becomes. Value chain analysis and benchmarking are essential tools
in determining how well a company is performing particular functions and activities, learning whether
its costs are in line with competitors, and deciding which internal activities and business processes need
to be scrutinized for improvement. Performing value chain activities in ways that give a company either
a lower-cost advantage or a value-creating differentiation advantage over rivals are two surefire ways
to create competitive advantage.

5. Is the company competitively stronger or weaker than key rivals? The key appraisals here involve how
the company matches up against key rivals on industry key success factors and other chief determinants
of competitive success and whether and why the company has a competitive advantage or disadvantage.
Quantitative competitive strength assessments, using the method presented in Table 4.3, indicate where
a company is competitively strong and weak, and provide insight into the company’s ability to defend
or enhance its market position. As a rule, a company’s competitive strategy should be built around its
competitive strengths and should aim at shoring up areas where it is competitively vulnerable. When
a company has important competitive strengths in areas where one or more rivals are weak, it makes
sense to consider offensive moves to exploit rivals’ competitive weaknesses. When a company has
important competitive weaknesses in areas where one or more rivals are strong, it makes sense to
consider defensive moves to curtail its vulnerability.

6. What strategic issues and problems does top management need to address in crafting a strategy to fit
the situation? This analytical step zeros in on the strategic issues and problems that stand in the way of
the company’s success. It involves drawing on the results of both the analysis of the company’s external
environment and the evaluations of the company’s overall internal situation to compile a “worry list”
of issues and problems that managers need to address and try to resolve in refurbishing the company’s
strategy to better fit its overall situation. The worry list uses such language as “how to…,” “whether
to…” and ‘what to do about…” to single out the specific strategy-related concerns that merit front-burner
management attention. A company’s strategy is neither complete nor well matched to the particulars of
its situation unless it contains actions and initiatives to address every issue or problem on the worry list.

Accurate appraisal of a company’s internal situation, like penetrating analysis of its external environment, is a
valuable precondition for good strategy making. Absent such analysis, company managers are unlikely to craft
a strategy that is well suited to the company’s resources, competitive capabilities, and best market opportunities.

What Is Strategy
and Why Is It Important?

What Do We Mean by “Strategy”?

Strategy and the Quest for Competitive Advantage

A Company’s Strategy is Partly Proactive and Partly Reactive

Strategy and Ethics: Passing the Test
of Moral Scrutiny

The Relationship Between a Company’s Strategy and Its Business Model

What Makes a Strategy a Winner?

Why Crafting and Executing Strategy Are Important Tasks

The Road Ahead

Key Points

Charting a Company’s Long-Term Direction: Vision, Mission,
Objectives, and Strategy

What Does the Strategy-Making,
Strategy-Executing Process Entail?

Task 1: Developing a Strategic Vision, Mission Statement, and Set of Core Values

Task 2: Setting Objectives

Task 3: Crafting A Strategy

Task 4: Implementing and Executing the Strategy

Task 5: Evaluating Performance and Initiating Corrective Adjustments

Corporate Governance: The Role of the Board of Directors in the Strategy-Making, Strategy-Executing Process

Key Points

Evaluating a Company’s
External Environment

THE STRATEGICALLY RELEVANT FACTORS
INFLUENCING A COMPANY’S EXTERNAL ENVIRONMENT

Assessing a Company’s Industry and Competitive Environment

Question 1: What Competitive Forces Do Industry
Members Face and How Strong Are They?

Question 2: What Factors Are Driving Industry Change and What Impact Will They Have?

Question 3: What Market Positions Do Rivals Occupy—Who Is Strongly Positioned and Who Is Not?

Question 4: What Strategic Moves Are Rivals Likely to Make Next?

Question 5: What Are the Key Factors for Future Competitive Success?

Question 6: Is the Industry Outlook Conducive to Good Profitability?

Key Points

Evaluating a Company’s Resources and Ability to Compete Successfully

QUESTION 1: HOW WELL IS THE COMPANY’S PRESENT STRATEGY WORKING?

QUESTION 2: WHAT ARE THE COMPANY’S IMPORTANT RESOURCES AND CAPABILITIES AND DO THEY HAVE ENOUGH COMPETITIVE POWER TO PRODUCE A COMPETITIVE ADVANTAGE OVER RIVALS?

QUESTION 3: WHAT ARE THE COMPANY’S COMPETITIVELY IMPORTANT STRENGTHS AND WEAKNESSES AND ARE THEY WELL-SUITED TO CAPTURING ITS BEST MARKET OPPORTUNITIES AND DEFENDING AGAINST EXTERNAL THREATS?

QUESTION 4: ARE THE COMPANY’S PRICES AND COSTS COMPETITIVE WITH THOSE OF KEY RIVALS, AND DOES IT HAVE AN APPEALING CUSTOMER VALUE PROPOSITION?

QUESTION 5: IS THE COMPANY COMPETITIVELY STRONGER OR WEAKER THAN KEY RIVALS?

QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS DOES TOP MANAGEMENT NEED TO ADDRESS IN CRAFTING A STRATEGY TO FIT THE SITUATION?

KEY POINTS

The Five Generic Competitive Strategy Options: Which One to Employ?

THE FIVE GENERIC COMPETITIVE STRATEGIES

BROAD LOW-COST PROVIDER STRATEGIES

BROAD DIFFERENTIATION STRATEGIES

FOCUSED (OR MARKET NICHE) STRATEGIES

BEST-COST PROVIDER STRATEGIES

SUCCESSFUL COMPETITIVE STRATEGIES ARE ALWAYS UNDERPINNED BY RESOURCES AND CAPABILITIES THAT ALLOW THE STRATEGY TO BE WELL-EXECUTED

KEY POINTS

Supplementing the Chosen Competitive Strategy—
Other Important Strategy Choices

GOING ON THE OFFENSIVE—STRATEGIC OPTIONS TO IMPROVE A COMPANY’S MARKET POSITION

DEFENSIVE STRATEGIES—PROTECTING MARKET POSITION AND COMPETITIVE ADVANTAGE

WEBSITE STRATEGIES

OUTSOURCING STRATEGIES

VERTICAL INTEGRATION STRATEGIES:
OPERATING ACROSS MORE STAGES
OF THE INDUSTRY VALUE CHAIN

STRATEGIC ALLIANCES AND PARTNERSHIPS

MERGER AND ACQUISITION STRATEGIES

CHOOSING APPROPRIATE FUNCTIONAL-AREA STRATEGIES

TIMING A COMPANY’S STRATEGIC MOVES

KEY POINTS

Strategies for Competing
Internationally or Globally

WHY COMPANIES DECIDE TO ENTER FOREIGN MARKETS

WHY COMPETING ACROSS NATIONAL BORDERS CAUSES STRATEGY MAKING TO BE MORE COMPLEX

THE CONCEPTS OF MULTICOUNTRY COMPETITION AND GLOBAL COMPETITION

STRATEGY OPTIONS FOR ESTABLISHING A COMPETITIVE PRESENCE IN FOREIGN MARKETS

COMPETING IN FOREIGN MARKETS: THE THREE COMPETITIVE STRATEGY APPROACHES

BUILDING CROSS-BORDER COMPETITIVE ADVANTAGE

PROFIT SANCTUARIES AND GLOBAL STRATEGIC OFFENSIVES

Key Points

Diversification Strategies

What Does Crafting a Diversification Strategy Entail?

CHOOSING THE DIVERSIFICATION PATH:
RELATED VS. UNRELATED BUSINESSES

EVALUATING THE STRATEGY OF A DIVERSIFIED COMPANY

KEY POINTS

Strategy, Ethics, and Social Responsibility

What Do We Mean by Business Ethics?

where do Ethical standards come from?

THE THREE CATEGORIES OF MANAGEMENT MORALITY

WHAT ARE THE DRIVERS OF UNETHICAL STRATEGIES AND BUSINESS BEHAVIOR?

WHY SHOULD COMPANY STRATEGIES BE ETHICAL?

Strategy, Social Responsibility, and Corporate Citizenship

KEY POINTS

Building an Organization
Capable of Good Strategy Execution

A FRAMEWORK FOR EXECUTING STRATEGY

BUILDING AN ORGANIZATION CAPABLE OF GOOD STRATEGY EXECUTION: THREE KEY ACTIONS

STAFFING THE ORGANIZATION

DEVELOPING AND STRENGTHENING EXECUTION-CRITICAL RESOURCES AND CAPABILITIES

STRUCTURING THE ORGANIZATION AND WORK EFFORT

KEY POINTS

Managing Internal Operations:
Actions That Promote
Good Strategy Execution

Allocating Needed Resources to Execution-Critical Activities

ENSURING THAT POLICIES AND PROCEDURES FACILITATE STRATEGY EXECUTION

ADOPTING BEST PRACTICES AND EMPLOYING PROCESS MANAGEMENT TOOLS TO IMPROVE EXECUTION

INSTALLING INFORMATION AND OPERATING SYSTEMS

TYING REWARDS AND INCENTIVES DIRECTLY TO ACHIEVING GOOD PERFORMANCE OUTCOMES

KEY POINTS

Corporate Culture and Leadership—Keys to Good Strategy Execution

INSTILLING A CORPORATE CULTURE THAT PROMOTES GOOD STRATEGY EXECUTION

LEADING THE STRATEGY EXECUTION PROCESS

KEY POINTS

122Chapter 6 Supplementing the Chosen Competitive Strategy—Other Important Strategy Choices

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Strategy: Core Concepts and Analytical Approaches

An e-book marketed by McGraw Hill LLC

Arthur A. Thompson, The University of Alabama 8th Edition, 2025–2026

122

Chapter 6
Supplementing the Chosen Competitive
Strategy—Other Important Strategy
Choices

Winners in business play rough and don’t apologize for it. The nicest part of playing hardball is watching your
competitors squirm.
—George Stalk, Jr. and Rob Lachenauer

Acquisitions, as opposed to internal development, can increase the speed of achieving scale economies, and
product or geographic market entry.
—Asli M. Arikan, Professor and Consultant

Don’t form an alliance to correct a weakness and don’t ally with a partner that is trying to correct a weakness
of its own. The only result from a marriage of weaknesses is the creation of even more weaknesses.
—Michel Robert

Think of your priorities not in terms of what activities you do, but when you do them. Timing is everything.
—Dan Millman

Once a company has settled on which of the five basic competitive strategies to employ, attention turns to
what other strategic actions it can take to complement its competitive approach, strengthen its market
position, and maximize the power of its overall strategy. Several decisions must be made:

l Whether to go on the offensive and initiate aggressive strategic moves to improve the company’s market
position.

l Whether to employ defensive strategies to protect the company’s market position.

l What role the company’s website should play in its overall strategy to be a successful performer.

l Whether to outsource certain value chain activities or perform them in-house.

l Whether to integrate backward or forward into more stages of the industry value chain.

l Whether to enter into strategic alliances or partnership arrangements with other enterprises.

l Whether to bolster the company’s market position via mergers or acquisitions.

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l When to undertake strategic moves—whether advantage or disadvantage lies in being a first mover, a
fast follower, or a late mover.

This chapter presents the pros and cons of each of these strategy-enhancing measures.

Figure 6.1 shows the menu of strategic options a company has in crafting a comprehensive set of strategic actions
and the order in which the choices should generally be made. The portion of Figure 6.1 below the five generic
competitive strategy options illustrates the structure of this chapter and the topics that will be covered.

Figure 6.1 A Company’s Menu of Strategy Options

First Mover? Fast-Follower? Late-Mover?

Generic Competitive Strategy Options

What type of website
strategy to employ?

Whether to outsource selected
value chain activities?

Initiate offensive
strategic moves?

Employ defensive
strategic moves?

Employ backward or forward
vertical integration strategies?

Enter into strategic alliances
and partnerships?

Use merger and acquisition strategies
to strengthen competitiveness?

Low-Cost
Provider?

Broad
Differentiation?

Focused
Low Cost?

Focused
Differentiation?

Best-Cost
Provider?

(A company’s first strategic choice)

Complementary Strategy Options
(A company’s second set of strategic choices)

R&D
Engineering Production Marketing

& Sales
Human

Resources Finance

Functional Area Strategies to Support the Above Strategic Choices

Timing a Company’s Strategic Moves in the Marketplace

(When to initiate actions to pursue or make adjustments
in any of the above strategic choices—timing matters!)

(A company’s third set of strategic choices)

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Going on the Offensive—Strategic Options to Improve
a Company’s Market Position

No matter which of the five generic competitive strategies a company employs, there are times when it makes
sense for a company to go on the offensive to improve its market position and business performance. Strategic
offensives are called for when a company sees opportunities to gain profitable market share at rivals’ expense,
when a company should strive to whittle away at a strong rival’s competitive advantage, and when a company opts
to pursue newly emerging market opportunities. Companies
like Google, Amazon, Apple, Microsoft, Nvidia, and Meta/
Facebook play hardball, aggressively pursuing competitive
advantage and trying to reap the benefits a competitive edge
offers—a leading market share, excellent profit margins,
rapid growth (as compared to rivals), and the reputational
rewards of being known as a company on the move.1 The
best offensives tend to incorporate several behaviors and
principles: (1) focusing relentlessly on building competitive
advantage and then striving to convert competitive
advantage into decisive advantage, (2) employing the
element of surprise as opposed to doing what rivals expect and are prepared for, (3) applying resources where
rivals are least able to defend themselves, and (4) being impatient with the status quo and displaying a strong bias
for swift and decisive actions to overwhelm rivals.2

Choosing the Basis for Competitive Attack
As a rule, challenging rivals on competitive grounds where they are strong is an uphill struggle.3 Offensive
initiatives that exploit competitor weaknesses stand a better chance of succeeding than do those that challenge
competitor strengths, especially if the weaknesses represent important vulnerabilities and weak rivals can be
caught by surprise with no ready defense.4

A company’s strategic offensives should be powered by competitively powerful resources and capabilities—such
as a better-known brand name, lower production and/or distribution costs, better technological capability, or a
core or distinctive competence in designing and producing
superior performing products. Designing a strategic
offensive spearheaded by relatively weak company
resources and capabilities is like marching into battle with a
popgun—the prospects for success are dim. For instance, it
is foolish for a company with relatively high costs to employ
a price-cutting offensive. Price-cutting offensives are best
left to financially strong companies whose costs are relatively low in comparison to those of the companies being
attacked. Likewise, it is ill-advised to pursue a product innovation offensive without proven expertise in R&D,
new product development, and speeding new or improved products to market.

The principal offensive strategy options include the following:

l Offering an equally good or better product at a lower price. Lower prices can produce market share
gains if competitors don’t respond with price cuts of their own and if the challenger convinces buyers
that its product is just as good or better. However, such a strategy increases total profits only if the
gains in additional unit sales are enough to offset the impact of thinner margins per unit sold. Price-
cutting offensives generally work best when a company first achieves a cost advantage and then hits
competitors with a lower price.5

l Leapfrogging competitors by being the first adopter of next-generation technologies or being first to
market with next-generation products. In technology-based industries, the opportune time to launch an
offensive against rivals is by leading the way in introducing a next-generation technology or product.

CORE CONCEPT
Sometimes a company’s best strategic option
is to seize the initiative, go on the attack, and
launch a strategic offensive to improve its market
position. It takes successful offensive strategies
to build competitive advantage, widen an existing
advantage, or narrow the advantage held by a
strong competitor.

CORE CONCEPT
The best offensives use a company’s most potent
resources and capabilities to attack rivals where
they are competitively weakest.

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Amazon got its Alexa-enabled Amazon Echo into the smart-home controls market about two years
ahead of Google’s Google Home device. In late 2023, Nvidia launched a major offensive by introducing
a series of new semiconductor chips with dramatic artificial intelligence capabilities; buyer demand
exploded overnight, driving Nvidia’s revenues up from $27.0 billion in fiscal 2023 (ending January
28, 2023) to $60.9 billion by the end of fiscal 2024 (January 29, 2024) and a projected $110 billion for
fiscal 2025. Nvidia’s prices for some of these chips exceeded $100.000 apiece. Nvidia quickly followed
up with more new chip introductions with more cutting-edge capabilities, giving it a dominant position
in processing data and performing complex calculations at high speeds (called accelerated computing),
an unmatched generative artificial intelligence platform, and a growing array of capabilities to provide
customers with value-creating AI software and solutions. Some analysts projected that Nvidia’s
revenues could reach $300 billion by 2029.

l Pursuing continuous product innovation to draw sales and market share away from rivals with
comparatively weak product innovation capabilities. Ongoing introductions of new/improved products
can put rivals with deficient product innovation capabilities under tremendous competitive pressure. But
such offensives can be sustained only if a company can keep its product development pipeline full of
new and improved products that spark buyer enthusiasm.6

l Pursuing disruptive product innovation to create new markets. While this strategy can be riskier and
more costly than continuous product innovation, “big bang” disruptive product innovation can be a
game changer if successful.7 Disruptive innovation involves perfecting a new product with a few trial
users, then quickly rolling it out to the whole market in an attempt to get many buyers to embrace an
altogether new and better value proposition quickly. Examples include online degree programs, self-
driving capabilities for motor vehicles, Apple Music, and Amazon’s Kindle (which undercuts the sales
of hardcopy fiction and non-fiction books).

l Adopting and improving on the good ideas of other companies (rivals or otherwise).8 The idea of
warehouse home improvement centers did not originate with The Home Depot cofounders Arthur Blank
and Bernie Marcus. They got the “big box” concept from their former employer Handy Dan Home
Improvement. But they were quick to improve on Handy Dan’s business model and strategy and take
The Home Depot to the next plateau in terms of product line breadth and customer service. Offense-
minded companies are often quick to adopt any good idea (not nailed down by a patent or other legal
protection) in an effort to create competitive advantage for themselves.9

l Deliberately attacking those market segments where a key rival makes big profits.10 Long a dominant
force in small automobiles, Toyota launched a hardball attack on General Motors, Ford, and Chrysler in
the U.S. market for light trucks and SUVs, the very market segments where the Detroit automakers have
historically earned big profits (roughly $10,000 to $15,000 per vehicle). Toyota now offers equivalent
vehicles, earns handsome profits of its own in these two market segments, and has stolen sales and
market share from its U.S.-based rivals. Dell opted to introduce its own brand of printers and printing
supplies in the 1990s because its principal rival in desktop and laptop computers was Hewlett-Packard,
which made its biggest profits in printing and printing supplies; by attacking H-P in the market for
printers, Dell sought to force H-P to devote management attention and resources to defending its printing
business and distract its attention away from trying to wrest market leadership away from Dell in the PC
market.

l Attacking the competitive weaknesses of rivals. Such offensives present many options. One is to go
after the customers of those rivals whose products lag on quality, features, or product performance. If
a company has especially good customer service capabilities, it can make special sales pitches to the
customers of those rivals who provide subpar customer service. Aggressors with a recognized brand
name and strong marketing skills can launch efforts to win customers away from rivals with weak brand
recognition. There is considerable appeal in emphasizing sales to buyers in geographic regions where
several rivals have low market shares or are less well-equipped to serve. If the attacker’s most potent

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resources and capabilities should prove powerful enough to outcompete the targeted rivals and result in
competitive advantage, so much the better.

l Maneuvering around competitors and concentrating on capturing unoccupied or less contested market
territory. Examples include launching initiatives to build strong positions in geographic areas or market
segments where close rivals have little or no market presence. Southwest Airlines became a major carrier
not by invading the turf where big airlines had their “hubs”—like Chicago O’Hare, Dallas-Fort Worth,
and New York LaGuardia, but by scheduling point-to-point flights to lesser-sized airports (Las Vegas,
Baltimore-Washington, Chicago Midway, Houston Hobby, Oakland, Burbank, San Diego, St. Louis,
Tampa, and Fort Lauderdale) where relatively weak competition enabled it to gain the leading market
share in a fairly short time. Going into 2024, Southwest commanded the biggest share of passenger
traffic in over half of the 107 airports it served in the United States.

l Using hit-and-run or guerrilla warfare tactics to grab sales and market share from complacent or
distracted rivals. Options for “guerrilla offensives” include occasional low-balling on price (to win
a big order or steal a key account from a rival); surprising key rivals with sporadic but intense bursts
of promotional activity (offering a 20 percent discount for one week to draw customers away from
rival brands); or undertaking special campaigns to attract buyers away from rivals plagued with a
strike or problems in meeting buyer demand.11 Guerrilla offensives are particularly well suited to small
challengers who have neither the resources nor the market visibility to mount a full-fledged attack on
industry leaders.

l Launching a preemptive strike to secure an advantageous position that rivals are prevented or
discouraged from duplicating.12 What makes a move preemptive is its one-of-a-kind nature—whoever
strikes first stands to acquire competitive assets that rivals can’t readily match. Examples of preemptive
moves include (1) securing the best distributors in a particular geographic region or country; (2) obtaining
the most favorable site along a heavily traveled thoroughfare, at a new interchange or intersection, in
a new shopping development, in a natural beauty spot, close to cheap transportation or raw material
supplies or market outlets, and so on; (3) tying up the most reliable, high-quality suppliers via exclusive
partnerships, long-term contracts, or even acquisition; and (4) moving swiftly to acquire the assets of
distressed rivals at bargain prices. To be successful, a preemptive move doesn’t have to totally block
rivals from following or copying; it merely needs to give a firm a prime position that is not easily
circumvented.

How long it takes for an offensive to yield good results varies with the competitive circumstances.13 It can be
short if buyers respond immediately (as can occur with a dramatic price cut, an imaginative ad campaign, or
an especially appealing new product). Securing a competitive edge can take much longer if winning consumer
acceptance of the company’s product will take some time or if the firm may need several years to debug a new
technology or put new production capacity in place. But how long it takes for an offensive move to improve a
company’s market standing—and whether the move will prove successful—depends in part on whether and how
quickly rivals recognize the threat and begin a counter-response. And any responses on the part of rivals hinge
on whether (1) they have effective countermoves in their arsenal of strategic options and (2) they believe that a
counterattack is worth the expense and the distraction.14

Blue Ocean Strategy—A Special Kind of Offensive
A blue ocean strategy seeks to gain a dramatic and durable competitive advantage by abandoning efforts to
beat out competitors in existing markets and, instead, inventing a new industry or distinctive market segment
that renders existing competitors largely irrelevant and allows a company to create and capture altogether new
demand.14 This strategy views the business universe as consisting of two distinct types of market space. One is
where industry boundaries are defined and accepted, the competitive rules of the game are well understood and
accepted by all industry members, and companies use their resources and capabilities to compete against rivals
and achieve satisfactory or better performance. In such markets, lively competition constrains a company’s
prospects for rapid growth and superior profitability since rivals move quickly to either imitate or counter the

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successes of competitors. The second type of market space is a “blue ocean” where the industry does not really
exist yet, is untainted by competition, and offers wide open opportunity for profitable and rapid growth if a
company can come up with an innovative new product offering and strategy that allows it to create new demand
rather than fight over existing demand. Companies that create blue ocean market spaces can often sustain their
initially won competitive advantage without encountering a major competitive challenge for 10 to 15 years
provided their blue ocean strategy translates into strong brand name awareness and there are other high barriers
to imitating its product offering.

A terrific example of blue ocean market creation is the online auction market that eBay created and now
dominates. Other examples of companies that have created blue ocean market spaces include Etsy in online
retailing of handmade crafts, Palentir in complex data analysis software, Beyond Meat and Impossible Foods in
plant-based meat substitutes, Uber and Lyft in ride-hailing services, and Cirque du Soleil in live entertainment.
Cirque du Soleil “reinvented the circus” by creating a distinctly different market space for its performances (Las
Vegas night clubs and theater settings) and pulling in a whole new group of customers—adults and corporate
clients—who not only were noncustomers of traditional circuses (like Ringling Brothers, the long-time and
legendary industry leader), but were also willing to pay several times more than the price of a conventional circus
ticket to have an “entertainment experience” featuring sophisticated clowns and star-quality acrobatic acts in a
comfortable atmosphere.

Choosing Which Rivals to Attack
Offensive-minded firms need to analyze which of their rivals to challenge as well as how to mount that challenge.
The following are the best targets for offensive attacks:15

l Market leaders that are vulnerable. Offensive attacks make good sense when a market-leading company
has some glaring weaknesses that are preventing it from delivering good value to its customers. Signs
that one of an industry’s leading companies is competitively vulnerable include unhappy buyers, a loss
of several major customers, inferior product quality or performance, a limited product line, declining
success in introducing innovative new products, narrowing profit margins because of a failure to
overcome rising cost pressures, strong emotional commitment to an aging technology the leader has
pioneered, failure to modernize plants and equipment, and a preoccupation with diversification into
other industries. Offensives to attack important competitive weaknesses of market leaders have real
promise when the challenger is able to revamp its value chain or innovate to gain a fresh cost-based or
differentiation-based competitive advantage.16 To be judged successful, attacks on leaders don’t have to
result in making the aggressor the new leader; a challenger may “win” by simply becoming a stronger
runner-up. Caution is well advised in challenging strong market leaders—there is a significant risk of
squandering valuable resources in a futile effort or precipitating a fierce and profitless industrywide
battle for market share.

l Runner-up firms with weaknesses in areas where the challenger is strong. Runner-up firms are an
especially attractive target when a challenger’s resource strengths and competitive capabilities are well
suited to exploiting their weaknesses.

l Struggling enterprises on the verge of going under. Challenging a hard-pressed rival in ways that further
deplete its financial strength and competitive position can weaken its resolve and hasten its exit from
the market. It often makes sense to attack a struggling enterprise in its most profitable market segments,
since this will threaten its survival the most.

l Small local and regional firms with limited resources and/or capabilities. Because small firms typically
have limited expertise and resources, a challenger with broader and/or deeper resources and valuable
capabilities often has the competitive firepower to successfully win the business of some of their biggest
customers—particularly those customers that are growing rapidly, have increasingly sophisticated
requirements, and may already be thinking about switching to a supplier with more full-service
capability.

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Defensive Strategies—Protecting Market Position and
Competitive Advantage

In a competitive market, all firms are subject to offensive challenges from rivals. The purposes of defensive
strategies are to lower the risk of being attacked, weaken the
impact of any attack that occurs, and induce challengers to
aim their offensive initiatives at other rivals. While defensive
strategies usually don’t enhance a firm’s competitive
advantage, they can definitely help fortify its competitive
position, protect its most valuable resources and capabilities
from imitation, and defend whatever competitive advantage
it might have. Defensive strategies can take either of two forms: actions to block challengers and actions to signal
the likelihood of strong retaliation.

Blocking the Avenues Open to Challengers The most frequently employed approach to defending a
company’s present position involves actions that restrict a challenger’s options for initiating competitive
attack. There are any number of obstacles that can be put in the path of would-be challengers.17 A defender
can participate in alternative technologies as a hedge against rivals attacking with a new or better technology.
A defender can introduce new features, add new models, or broaden its product line to close off gaps and
vacant niches to opportunity-seeking challengers. It can thwart rivals’ efforts to attack with a lower price by
maintaining a lineup of product selections that includes economy-priced options for price-sensitive buyers. It can
try to discourage buyers from trying competitors’ brands by
lengthening warranties, offering free training and support
services, developing the capability to deliver spare parts
to users faster than rivals can, providing coupons and
sample giveaways to buyers most prone to experiment, and
making early announcements about impending new products or probable price cuts to induce potential buyers
to postpone switching. It can challenge the quality or safety of rivals’ products. Finally, a defender can grant
volume discounts or better financing terms to dealers and distributors to discourage them from experimenting
with other suppliers, or it can convince them to handle its product line exclusively and force competitors to use
other distribution outlets.

Signaling Challengers that Retaliation Is Likely The goal of signaling challengers that strong retaliation
is likely in the event of an attack is either to dissuade challengers from attacking at all or to divert them to less-
threatening options. Either goal can be achieved by letting challengers know the battle will cost more than it is
worth. Would-be challengers can be signaled by:18

l Publicly announcing management’s commitment to maintain the firm’s present market share.

l Publicly committing the company to a policy of matching competitors’ prices and terms of sale.

l Maintaining a war chest of cash and marketable securities to fund retaliatory countermeasures if
challengers try to steal away some of its customers.

l Making an occasional strong counter-response to the moves of weak competitors to enhance the firm’s
image as a tough defender.

For signaling to be effective, however, challengers must believe that the signaler has every intention of pursuing
retaliatory actions if attacked.

CORE CONCEPT
Good defensive strategies can help protect
competitive advantage but rarely are the basis for
creating it.

There are many ways to throw obstacles in the
path of would-be challengers.

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Website Strategies
Every company with a website has to address what role the site should play in the company’s competitive strategy.
In particular, to what degree should a company use online sales as a means for selling its products or services
direct to users? Should a company use its website only as
a means of disseminating information about the company
and its products (relying exclusively on its wholesale and
retail partners to make all sales to end users)? Or should
online sales at the company’s website be (1) a secondary or
minor channel for accessing customers, (2) one of several
important distribution channels for accessing customers, (3)
the primary distribution channel for accessing customers,
or (4) the exclusive channel for transacting sales with customers?19 Let’s look at each of these strategic options
in turn.

Product Information–Only Strategies—Avoiding Channel Conflict
Operating a website that contains extensive product information but relies on click-throughs to the websites of
distribution channel partners for sales transactions (or that informs site visitors where nearby retail stores are
located) is an attractive option for manufacturers and/or wholesalers that have invested heavily in building and
cultivating retail dealer networks to access end users. A company vigorously pursuing online sales to consumers
at the same time it is also heavily promoting sales to consumers through its network of wholesalers and retailers
is competing directly against its distribution allies. Such actions constitute channel conflict and are a tricky
road to negotiate. A company actively trying to grow online sales is signaling a weak strategic commitment
to its dealers and a willingness to cannibalize dealers’ sales and growth potential. The likely result is angry
dealers and loss of dealer goodwill. Some or many of the company’s dealers may opt to put more effort into
marketing the brands of rival manufacturers who don’t sell online or whose online sales effort is passive and
nonthreatening. Quite possibly, a company may lose more sales by offending its dealers than it gains from its
own online sales effort. Consequently, in industries where the strong support and goodwill of dealer networks is
essential, companies may conclude it is important to avoid channel conflict and, consequently, that their website
should be designed to partner with dealers rather than compete with them.

Website Sales as a Minor Distribution Channel
A second strategic option is to use online sales as a relatively minor distribution channel for achieving incremental
sales, gaining online sales experience, and doing marketing research. If channel conflict poses a big obstacle to
online sales, or if only a small fraction of buyers can be attracted to make online purchases, then companies are
well advised to pursue online sales with the strategic intent of gaining experience, learning more about buyer
tastes and preferences, testing reaction to new products, creating added market buzz about their products, and
boosting overall sales volume a few percentage points. Sony and Nike, for example, sell most all of their products
at their websites without provoking much resistance from their retail dealers—their website prices are the same
(sometimes higher) than the prices of their dealers, which gives buyers little incentive to buy online as compared
to shopping at the stores of local dealers. However, Nike does allow shoppers at its website to order custom-
designed shoes, which gives Nike valuable insight into buyer fashion preferences and aids the company’s new
product development personnel in deciding what new shoe designs, colors, and accents to introduce.

Sometimes, manufacturers are willing to accept the channel conflict problems that arise from selling online in
head-to-head competition with distribution channel allies because they expect that over the long term online
sales at their websites will become progressively larger and more profitable. A strategy to gradually grow online
sales into an important distribution channel can make sense in three instances:

Companies today must wrestle with whether
to use their websites just as a means of
disseminating information about the company
and its product offerings or whether to operate an
e-store that sells direct to online shoppers.

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l When profit margins from online sales are bigger than those earned from selling to wholesale/retail
customers.

l When encouraging buyers to visit the company’s website helps educate them about the ease and
convenience of purchasing online and, over time, prompts more and more buyers to purchase online
(where company profit margins are typically greater)—which can make incurring channel conflict in the
short term and competing against traditional distribution allies worthwhile.

l When selling directly to end users allows a manufacturer to make greater use of build-to-order
manufacturing and assembly, which if met with growing buyer approval would increase the rate at
which sales migrate from distribution allies to the company’s website; such migration could lead to
streamlining the company’s value chain and boosting its profit margins.

Brick-and-Click Strategies
Some companies employ brick-and-click strategies, whereby they sell to consumers both at their own websites
and at their own company-owned retail stores (or the stores of independent retailers). Brick-and-click strategies
have two big appeals: They are an economic means of expanding a company’s geographic reach, and they give
both existing and potential customers another choice of how to communicate with the company, shop for product
information, make purchases, or resolve customer service problems. Software developers, for example, have
come to rely on the Internet as a highly effective distribution channel to complement sales at brick-and-mortar
retailers. Allowing end users to make an online purchase and download it immediately has the big advantage
of eliminating the costs of producing and packaging CDs and cutting out the costs and margins of software
wholesalers and retailers (often 35 to 50 percent of the retail price). Chain retailers like Walmart, Costco, Kohl’s,
Wayfair, and Best Buy operate online stores for their products primarily as a convenience to customers who
prefer to buy online and have the items shipped or available for pickup at nearby stores.

Many brick-and-mortar retailers can enter online retailing at relatively low cost—all they need is a web store for
displaying products, accepting customer orders, and systems for filling and delivering orders. Brick-and-mortar
retailers (as well as manufacturers with company-owned retail stores) can use personnel at their distribution
centers and/or retail stores to fill and ship the orders of online buyers, and they can allow online buyers to pick
up their orders at the nearest local retail store. Walgreens, a leading drugstore chain, lets customers order a
prescription online and then pick it up at the drive-through window or inside counter of a local store. Allowing
customers to order online and then pick up their orders at local stores has become a popular strategy for many
retailers because it enables them to better compete with Amazon. In banking, a brick-and-click strategy allows
customers to use local branches and ATMs for depositing checks and getting cash while using online systems to
pay bills, monitor account balances, and transfer funds. Costco and Walmart both use their websites to not only
display and sell the items stocked in its stores but also to display and sell a wider number of brands and selections
that are not stocked in their stores for reasons of limited floor space—like sofas, mattresses, swing sets, outdoor
furniture, and large appliances, all of which which are shipped direct to buyers. Using online sales to expand
product offerings and give customers wider selection boosts company sales and shipping buyer orders directly
to their homes boosts profit margins.

Strategies for Online Enterprises
A company that elects to use its website as the exclusive channel for accessing buyers is essentially an online
business—all customer-related transactions occur at the company’s website. Thousands of enterprises have
chosen this strategic approach, including Netflix, Etsy, Rocket Mortgage, Wayfair, eBay, Booking.com, and
Chewy, an online pet products retailer. In 2020, Pier One Imports closed all its brick-and-mortar stores and
relaunched as an online-only retailer under the name Pier 1. Women’s apparel retailers bebe and Dressbarn also
closed their retail stores and relaunched as online-only retailers. For a company to succeed in using online sales
as its exclusive distribution channel, its product or service must be one for which buying online holds strong
appeal. The strategies adopted by online enterprises must address several issues:

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l How it will deliver unique value to buyers. Online businesses must usually attract buyers on the basis of
low price, convenience, superior product information, build-to-order options, or attentive online service.

l Whether it will pursue competitive advantage based on lower costs, differentiation, or better value for
the money. For an online-only sales strategy to succeed in head-to-head competition with brick-and-
mortar and brick-and-click rivals, an online seller’s value chain approach must hold potential for a low-
cost advantage, competitively valuable differentiating attributes, or a best-cost provider advantage.

l Whether it will have a broad or a narrow product offering. A one-stop shopping strategy like that
employed by Amazon.com (which offers “Earth’s Biggest Selection” of items for sale at 13 international
websites) has the appealing economics of helping spread fixed operating costs over a wide number of
items and a large customer base. Online enterprises like Lending Club (an online-only bank), Airbnb,
Hilton.com, and Rocket Mortgage (a large online provider of home mortgages) have adopted classic
focus strategies and cater to a sharply defined target audience shopping for a particular product or
product category.

l Whether to outsource order fulfillment activities or perform them internally. Most online sellers find it
more economical to outsource order fulfillment activities to specialists who make a business of providing
warehouse space, stocking inventories, and installing the capabilities to pick, pack, and ship orders
cost-efficiently for a number of different online retailers. Only very high-volume online retailers, like
Wayfair, Chewy, and Overstock.com can develop and install the capabilities to perform order fulfillment
activities internally at costs below those of outside specialists. Amazon has over 3 million small- and
medium-sized selling partners that use its online store to market and sell their products; a big percentage
of these selling partners pay an order fulfillment fee to Amazon to stock their products and ship them
to buyers, allowing them to focus exclusively on online sales. However, in China, the vast majority
of small businesses that use Alibaba’s online platforms to display and sell their products online are
responsible for handling their own order fulfillment activities.

l How it will draw traffic to its website and then convert page views into revenues. Websites must be
cleverly marketed. Unless web surfers hear about the site, like what they see on their first visit (and
perhaps make a purchase), and are intrigued enough to return again and again to both view information
and make purchases, the site is unlikely to generate adequate revenues. The best test of effective marketing
and the appeal of an online company’s product offering is the ratio at which page views are converted
into revenues (the “look-to-buy” ratio). The difficulty small online enterprises have in drawing traffic
to their own websites is why so many have opted to utilize the high-traffic online platforms of Amazon,
Shopify, Mercado Libre (South America), and Alibaba (China) to conduct their sales activities.

Outsourcing Strategies
Outsourcing strategies involve a conscious decision to abandon or forgo attempts to perform certain value
chain activities internally and to instead farm them out to outside specialists and strategic allies.20 Many PC
makers, for example, have shifted from assembling units in-house to outsourcing the entire assembly process to
manufacturing specialists that assemble many brands of PCs
(and thus can capture all the available economies of scale),
are better able to bargain down the prices of PC components
(by buying in large volumes), and have developed best
practice capabilities in performing specific assembly tasks
accurately and cheaply. Most all name brand apparel firms
have in-house capability to design, market, and distribute
their products but they outsource all fabric manufacture and garment-making activities to contract manufacturers
in low-wage countries. Starbucks finds purchasing coffee beans from independent growers in most of the world’s
coffee-growing regions far more advantageous than having its own coffee-growing operation.

CORE CONCEPT
Outsourcing involves farming out certain value
chain activities to outside vendors and narrowing
the scope of its internal operations.

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Outsourcing certain value chain activities can be strategically advantageous whenever:

l An activity can be performed better or more cheaply by outside specialists. A company should generally
not perform any value chain activity internally that outsiders can perform more efficiently or effectively.
The chief exception is when a particular activity is strategically crucial and internal control over that
activity is deemed essential. Fashion retailer Dolce and Gabbana outsources manufacture of its brand of
sunglasses to Luxottica—a company considered to be the world’s best producer of top-quality fashion
sunglasses and high-tech prescription eyewear; Luxottica is known for its Ray-Ban, Oakley, and Oliver
Peoples brands.

l The activity is not crucial to the firm’s ability to achieve sustainable competitive advantage. Outsourcing
of maintenance services, data processing and data storage, fringe benefit management, website operations,
call center operations, and similar administrative support activities to specialists is commonplace.
Colgate reduced its information systems costs by more than 10 percent annually through an outsourcing
agreement with IBM. Many small companies outsource such HR activities as benefit administration,
payroll activities, and training.

l It streamlines company operations in ways that improve organizational flexibility or speeds the time
to get new products to market. Outsourcing of parts and components gives a company the flexibility
to switch suppliers in the event one or more of its present suppliers fall behind competing suppliers.
To the extent that its suppliers can speedily get next-generation parts and components into production,
a company can get its own next-generation product offerings into the marketplace quicker. Moreover,
seeking new suppliers with the needed capabilities already in place is frequently quicker, easier, less
risky, and cheaper. Firms that internally produce the parts and components they need are periodically
confronted with sometimes formidable costs to update obsolete parts-making capabilities or to install
and master new parts-making technologies.

l It reduces the company’s risk exposure to changing technology or shifting buyer preferences. When
a company outsources certain parts, components, and services, its suppliers must bear the burden of
incorporating state-of-the-art technologies and/or undertaking redesigns and upgrades to accommodate
a company’s plans to introduce next-generation products. If what a supplier provides is designed out of
next-generation products or rendered unnecessary by technological change, it is the supplier’s business
that suffers rather than the company’s business.

l It improves a company’s ability to innovate. Collaborative partnerships with world-class suppliers who
have cutting-edge intellectual capital and are early adopters of the latest technology give a company
access to ever better parts and components—such supplier-driven innovations, when incorporated into
a company’s own product offering, fuel a company’s ability to introduce its own new and improved
products.

l It allows a company to assemble diverse kinds of expertise speedily and efficiently. A company can
nearly always gain quicker access to first-rate capabilities and expertise by partnering with suppliers
who already have them in place rather than trying to build them from scratch with its own company
personnel.

l It allows a company to concentrate on its core business, leverage its key resources, and do even better
what it already does best. A company is better able to build and develop its own competitively valuable
competences and capabilities when it concentrates its full resources and energies on performing those
value chain activities that it can perform better than outsiders and/or that it needs to have under its
direct control. Nike, for example, devotes its energy to designing, marketing, and distributing athletic
footwear, sports apparel, and sports equipment, while outsourcing the manufacture of all its products to
contract factories. Apple outsources production of its iPod, iPhone, and iPad models to Chinese contract
manufacturer Foxconn. Hewlett-Packard and IBM have sold some of their manufacturing plants to
outsiders and contracted to repurchase the output from the new owners.

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The Big Risk of Outsourcing Value Chain Activities
The biggest danger of outsourcing is that a company will farm out too many or the wrong types of activities, thereby
unduly narrowing the scope of its capabilities in ways that unwittingly reduce its long-term competitiveness.21
For example, in recent years, companies anxious to reduce
operating costs have opted to outsource such strategically
important activities as product development, engineering
design, and sophisticated manufacturing tasks—the very
capabilities that underpin a company’s ability to lead
sustained product innovation. While these companies have
apparently been able to lower their operating costs by outsourcing these functions to outsiders, their ability to
lead the development of innovative new products is weakened because so many of the cutting-edge ideas and
technologies for next-generation products come from outsiders. For example, most U.S. brands of laptops and cell
phones are now not only manufactured but also designed in Asia.22 It is strategically dangerous for a company to
be dependent on outsiders to provide it with the skills, knowledge, and capabilities that over the long run heavily
influence its competitiveness and market success. Companies like Cisco are alert to the danger of farming out the
performance of strategy-critical value chain activities and take actions to protect against being held hostage by
outside suppliers. Cisco guards against loss of control and protects its manufacturing expertise by designing the
production methods its contract manufacturers must use. Cisco keeps the source code for its designs proprietary,
thereby controlling the initiation of all improvements and safeguarding its innovations from imitation. Further,
Cisco has developed online systems to monitor the factory operations of contract manufacturers around the
clock, so that it knows immediately when problems arise and can decide whether to get involved.

Vertical Integration Strategies: Operating Across More Stages
of the Industry Value Chain

Vertical integration extends a firm’s competitive and operating scope within the same industry. It involves
expanding the firm’s range of activities backward into sources of supply and/or forward toward end users. Thus,
if a manufacturer invests in facilities to produce certain
component parts that it formerly purchased from outside
suppliers, it has engaged in backward vertical integration
and extended its competitive scope backward into the
production of component parts, but its business remains
in the same industry as before. The only change is that it
has operations in two stages of the industry value chain.
Similarly, if a paint manufacturer—Sherwin-Williams, for example—elects to integrate forward by opening 500
retail stores to market its paint products directly to consumers, its entire business is still in the paint industry even
though its competitive scope extends from manufacturing to retailing.

A firm can pursue vertical integration by starting its own operations in other stages in the industry’s activity
chain or by acquiring a company already performing the activities it wants to bring in-house. Vertical integration
strategies can aim at full integration (participating in all stages of the industry value chain) or partial integration
(building positions in selected stages of the industry’s total value chain).

The Advantages of a Vertical Integration Strategy
The two best reasons for investing company resources in vertical integration are to strengthen the firm’s
competitive position and/or boost its profitability.23 Vertical integration has no real payoff with respect to profits or
strategy unless it produces sufficient cost savings/profit increases to justify the extra investment, adds materially
to a company’s competitive strengths, and/or helps differentiate the company’s product offering in ways buyers
deem valuable.

CORE CONCEPT
A vertically integrated firm is one whose business
activities extend across several portions or stages
of an industry’s overall value chain.

A company must guard against outsourcing
activities that can unwittingly degrade its
capabilities to be a master of its own destiny.

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Integrating Backward to Achieve Greater Competitiveness It is harder than one might think to
generate cost savings or boost profitability by integrating backward into activities such as parts and components
manufacture (which could otherwise be purchased from suppliers with specialized expertise in making these
parts and components). For backward integration to be a viable and profitable strategy, a company must be able
to (1) achieve the same scale economies as outside suppliers
and (2) match or beat suppliers’ production efficiency with
no drop-off in quality. Neither outcome is a slam dunk. To
begin with, a company’s in-house requirements are often too
small to reach the optimum size for low-cost operation—for
instance, if it takes a minimum production volume of one
million units to achieve mass production economies and a
company’s in-house requirements are just 250,000 units,
then it falls way short of being able to capture the scale economies of outside suppliers (who may readily find
buyers for one million or more units). Furthermore, matching the production efficiency of suppliers is fraught
with problems when suppliers have high-caliber production capabilities of their own, when the technology they
employ has elements that are hard to master, and/or when substantial R&D expertise is required to develop next-
version parts and components, or keep pace with advances in parts/components manufacturing processes.

That said, occasions still arise when a company can improve its cost position and competitiveness by performing
a broader range of value chain activities internally rather than having some of these activities performed by
outside suppliers. The best potential for being able to reduce costs via a backward integration strategy exists in
situations where a company must deal with a few suppliers with substantial bargaining power, where suppliers
have outsized profit margins, where the item being supplied is a major cost component, and where the requisite
technological/production capabilities are easily mastered or can be gained by acquiring a supplier with most or
all of the needed capabilities. Situations also arise when integrating backward can enable a company to reduce
costs by facilitating the coordination of production flows from one stage to the next and avoiding bottlenecks
and delays that disrupt production schedules. Furthermore, if a company has proprietary know-how that it wants
to keep from rivals, then in-house performance of value chain activities related to this know-how is beneficial
even if outsiders can perform such activities. Backward integration also spares a company the risk of being
heavily dependent on suppliers for crucial components or support services and reduces exposure to supplier
price increases.

Apple decided to backward integrate into the production of chips, other electronic components, and hardware
used in its iPhone and computers because they were major cost components, suppliers had bargaining power, and
in-house production would help coordinate design tasks and protect Apple’s proprietary technology. International
Paper Company backward integrated into pulp mills and located them adjacent to its paper plants to reap the
benefits of coordinated production flows, reduced energy usage, and negligible costs of transporting freshly
produced paper pulp directly to the production line in its paper plants.

Backward vertical integration can produce a differentiation-based competitive advantage when a company, by
performing activities internally, ends up with a better-quality or better-performing product, improved customer
service capabilities, or is able to deliver added value to customers in other ways. On occasion, integrating into
more stages along the industry value chain can add to a company’s differentiation capabilities by allowing it to
build or strengthen its core competences, better master strategy-critical capabilities, or add features that deliver
greater customer value. Panera Bread has been quite successful with a backward vertical integration strategy
to produce fresh dough that company-owned and franchised bakery-cafés use in making baguettes, pastries,
bagels, and other types of bread—not only does internally producing fresh dough promote consistent-quality
bakery products at Panera’s 2,150 locations and lower store costs for baking, but it has also enhanced Panera’s
profitability.

CORE CONCEPT
Backward vertical integration involves entry
into activities performed by suppliers or other
enterprises positioned in earlier stages of an
industry’s overall value chain.

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Integrating Forward to Enhance Competitiveness The strategic impetus for forward integration is
to gain better access to end users, improve market visibility, and enhance brand name awareness. In many
industries, independent sales agents, wholesalers, and retailers handle competing brands of the same product.
Because they have no allegiance to any one company’s brand, they concentrate their energies on pushing whatever
brand sells and earns them the biggest profits. Independent
insurance agencies, for example, represent a number of
different insurance companies; in trying to find the best
match between a customer’s insurance requirements and
the policies of alternative insurance companies, they have
the opportunity to promote the policies of certain insurers
and downplay the policies of other insurers. Consequently,
insurers like State Farm and Allstate have integrated forward and set up local sales offices with local agents to
exclusively market and service their insurance policies. Likewise, it can be advantageous for a manufacturer to
integrate forward into wholesaling or retailing via company-owned distributorships or a chain of retail stores
rather than depend on the marketing and sales efforts of independent distributors/retailers that stock multiple
brands and steer customers to those brands earning them the highest profits. To avoid dependence on distributors/
dealers with divided loyalties, Goodyear has integrated forward into company-owned and franchised retail tire
stores. Consumer-goods companies like Restoration Hardware, Coach, Under Armour, Nike, Tommy Hilfiger,
Pepperidge Farm, Calvin Klein, Gap, Ann Taylor, and Polo Ralph Lauren have integrated forward and operate
company-operated retail stores as well as their own branded stores in factory outlet malls that enable them
to move overstocked items, slow-selling items, and items with minor production flaws. Growing numbers
of manufacturers have integrated forward and begun selling directly to end-users at company websites, thus
reducing dependence on traditional wholesale and retail channels and taking advantage of the massive shift of
consumers to shopping online.

The Disadvantages of a Vertical Integration Strategy
Vertical integration has some important drawbacks, however. The biggest of these include the following:24

l Vertical integration boosts a firm’s capital investment in the industry, thereby increasing business risk
(what if industry growth and profitability unexpectedly go sour?).

l Integrating backward or forward creates a vested interest for a firm to continue performing the integrated
system of value chain activities it has invested money and effort into establishing (even if internal
performance of certain of these value chain activities later becomes suboptimal). Why? Because there
are barriers to quickly or easily exiting the performance of value chain activities spanning two or more
stages on the industry’s value chain, including facilities shutdowns, costly write-offs of undepreciated
assets, employee layoffs, and disrupted performance of related value chain activities. However, a
company that obtains parts and components from outside suppliers can always shop the market for
the newest, best, or cheapest parts and components. A company that does not have its own network of
company-owned distributorships and retail stores can switch distributors and/or distribution channel
emphasis whenever it is advantageous to do so.

l Some vertically integrated companies are slow to adopt new technologies or production methods because
of reluctance to write off undepreciated assets or because they assign higher priority to spending capital
for other company projects or because they see benefits in sticking with the present technology or
production methods a while longer. It is a constant struggle for manufacturers that have integrated
backward to keep up with all the ongoing advances in technology and best practice production techniques
for each of the many parts and components they make in-house. The faster the pace of change in an
industry’s value chain, the bigger the risk of a vertical integration strategy.

CORE CONCEPT
Forward vertical integration involves entering into
the performance of industry value chain activities
located closer to end users.

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l Integrating backward into parts and components manufacture reduces a company’s flexibility to
implement a cheaper/better product design or adjust its lineup of product offering in response to shifting
buyer preferences. It is one thing to eliminate use of a component made by a supplier and another to
stop using a component being made in-house (which can mean laying off employees and writing off the
associated investment in equipment and facilities or else making new investments needed to produce the
new or cheaper or better part/component). It is more disruptive and costly to delete or add new products
when a company not only assembles its own products but also operates facilities to produce many of the
associated parts/components. Most of the world’s automakers, despite their manufacturing expertise,
have concluded that purchasing a majority of their parts and components from best-in-class suppliers
results in greater design flexibility, higher quality, and lower costs than producing most of the needed
parts/components in-house.

l Vertical integration poses all kinds of capacity-matching problems. In motor vehicle manufacturing,
for example, the most efficient scale of operation for making axles is different from the most economic
volume for radiators, and different yet again for both engines and transmissions. Building the capacity
to produce just the right number of axles, radiators, engines, and transmissions in-house—and doing so
at the lowest unit cost for each—poses significant challenges in cost-effectively producing each different
part/component.

l Integrating forward or backward typically requires new or different skills and business capabilities.
Parts and components manufacturing, assembly operations, wholesale distribution, retailing, and
direct sales via the Internet involve using different know-how, resources, and capabilities to master the
performance of different value chain activities. A manufacturer that integrates backward into parts and
components production has to become proficient in different technologies and production methods and
very likely source needed materials from different suppliers. A manufacturing company contemplating
forward integration needs to consider carefully whether it makes good business sense to invest time
and money in developing the expertise and merchandising skills to be successful in wholesaling and/
or retailing. Many manufacturers learn the hard way that company-owned wholesale/retail networks
present many headaches, fit poorly with what they do best, and don’t always add the kind of value to
their core business as originally planned. Selling to customers online poses still another set of problems
when aiming to achieve proficient performance of strikingly different value chain activities.

In today’s world of close working relationships with suppliers and efficient supply chain management systems,
relatively few companies can make a strong economic case for integrating backward into the business of suppliers.
The best materials and components suppliers stay abreast of advancing technology and best practices and are
adept in making good quality items, delivering them on time, and keeping their costs and prices competitive.

Weighing the Pros and Cons of Vertical Integration All in all, therefore, a strategy of vertical integration
can have both important strengths and weaknesses. The tip of the scales depends on (1) the difficulties and costs
of acquiring or developing the resources and capabilities needed to operate in another stage of the industry value
chain, (2) the size of the benefits vertical integration offers in terms of lowering costs or enhancing differentiation
and the value delivered to customers; (3) the impact of vertical integration on investment costs, flexibility,
and response times, (4) the administrative costs of coordinating operations across more value chain activities;
and (5) whether the integration substantially enhances a company’s competitiveness and profitability. Vertical
integration strategies have merit according to which capabilities and value chain activities truly need to be
performed in-house and which can be performed better or cheaper by outsiders. Absent solid benefits in relation
to the associated costs and risks, integrating forward or backward is not likely to be an attractive strategy option.

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Strategic Alliances and Partnerships
Companies in all types of industries and in all parts of the world have elected to form strategic alliances and
partnerships to complement their own strategic initiatives and strengthen their competitiveness in domestic
and international markets. A strategic alliance is a formal
agreement between two or more separate companies in
which there is strategically relevant collaboration of some
sort, joint contribution of resources, shared risk, shared
control, and mutual dependence. Collaborative relationships
between partners may entail a contractual agreement
but they commonly stop short of formal ownership ties
(although sometimes an alliance member may have minority ownership of another member).

When an alliance involves formal ownership ties, it is called a joint venture. A joint venture entails forming
a new corporate entity that is jointly owned by two or more companies that agree to share in the revenues,
expenses, and profits (losses) of the venture according to their ownership percentages. In many joint ventures,
it is formally agreed that one of the owners (typically a majority owner) will exercise operating control over the
venture. Because a joint venture involves mutual ownership, it tends to be more durable than an alliance where a
partner can just abruptly decide to abandon the alliance. A joint venture owner who wants out of the venture must
negotiate arrangements to be bought out or else get the other owners to agree to dissolve the venture.

An alliance or joint venture becomes “strategic”—as opposed to just a useful collaborative arrangement—when
it serves any of the following purposes or intended outcomes:25

l It facilitates achievement of an important business objective (like reducing risk to a company’s business,
lowering costs, or delivering more value to customers in the form of better quality, extra features, and
greater durability).

l It helps build or strengthen a company’s competitively valuable resources and capabilities.

l It helps remedy an important resource deficiency or competitive weakness.

l It speeds the development of competitively important new technologies and/or product innovations.

l It facilitates entry into new geographic markets or pursuit of important market opportunities.

l It helps block or defend against a competitive threat or mitigate a significant risk to a company’s
business.

l It enhances a company’s bargaining power versus suppliers or buyers.

Recent high interest in making strategic alliances a key component of a company’s overall strategy is an about-
face from times past, when the vast majority of companies confidently believed they already had or could
independently develop whatever resources and capabilities were needed to be successful in their markets. But
in today’s world, large corporations—even those that are successful and financially strong—have concluded it
doesn’t always make good strategic and economic sense to be totally independent and self-sufficient with regard
to every resource and capability it may need or every market opportunity it wants to pursue. Joint ventures
are a favored partnership arrangement where two or more companies conclude they each want to pursue an
attractive business opportunity but lack the resources and capabilities to do so independently. By joining forces
and pooling their resources and capabilities in a joint venture, the resource/capability deficiencies can be readily
corrected and overcome; joint pursuit of a mutually attractive business opportunity therefore becomes less risky
and more likely to succeed.

CORE CONCEPT
Strategic alliances are collaborative arrangement
where two or more companies join forces to
achieve mutually beneficial outcomes.

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Why and How Strategic Alliances Are Advantageous
The most common reasons why companies enter into strategic alliances are to expedite the development of
promising new technologies or products, to overcome deficits in their own expertise and capabilities, to bring
together the personnel and expertise needed to create
desirable new skill sets and capabilities, to improve supply
chain efficiency, to gain economies of scale in production
and/or marketing, and to acquire or improve market access
through joint marketing agreements.26 When a company
needs to correct particular resource/capability gaps or
deficiencies, it may be faster and cheaper to partner with
other enterprises that have the missing resources and capabilities. Moreover, partnering offers greater flexibility
should a company’s competitive requirements later change. Manufacturers frequently pursue alliances with parts
and components suppliers to wring cost savings out of supply chain activities, to improve the quality of parts and
components, to better assure reliable supplies and on-time deliveries, and to speed new products to market. In
industries where technology is advancing rapidly, alliances are all about fast cycles of learning, staying abreast of
the latest developments, and gaining quick access to the latest round of technological know-how and capability.
In bringing together firms with different skills and intellectual capital, alliances open up learning opportunities
that help partner firms strengthen their own portfolios of resources, core competences, and capabilities and
thereby become more competitive.27

Companies find strategic alliances particularly valuable in several other instances. A company racing for global
market leadership needs alliances to:28

l Get into critical country markets quickly and accelerate the process of building a competitively potent
global market presence.

l Gain inside knowledge about unfamiliar markets and cultures through alliances with local partners. For
example, U.S., European, and Japanese companies wanting to build market footholds in China and other
fast-growing Asian markets have pursued local partnership arrangements to help guide them through the
maze of government regulations, to supply knowledge of local markets, to provide guidance on adapting
their products to better match local buying preferences, to set up local manufacturing capabilities, and/
or to assist in distribution, marketing, and promotional activities.

l Access valuable skills and competences that are concentrated in particular geographic locations
(such as software design competences in the United States, fashion design skills in Italy, and efficient
manufacturing skills in Japan, Taiwan, China, and other Southeast Asian countries).

A company that is racing to stake out a strong position in an industry of the future needs alliances to:29

l Establish a stronger beachhead for participating in the target industry.

l Master new technologies and build valuable expertise and capabilities faster than would be possible
through internal efforts alone.

l Open up broader opportunities in the target industry by melding the firm’s own resources and capabilities
with the resources and capabilities of partners to create competitively effective resource/capability
bundles.

Because of the varied benefits of strategic alliances, many large corporations have become involved in 30 to 50
alliances, and a number have formed hundreds of alliances. Genentech, a leader in biotechnology and human
genetics, has formed R&D alliances with more than 30 companies to boost its prospects for developing new
cures for various diseases and ailments. Samsung Group, which includes Samsung Electronics, has an ecosystem
of over 1,000 alliance partners involving activities pertaining to R&D, global procurement, and local marketing.

The best strategic alliances are highly selective,
focusing on particular value chain activities and on
obtaining a specific competitive benefit. They tend
to enable a firm to build on its strengths and learn.

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Hoffman-La Roche, a multinational healthcare company, set up Roche Partnering to manage its more than
190 alliances. During the COVID-19 pandemic, dozens of pharmaceutical companies entered into strategic
alliances or partnerships to speed the development of COVID-19 treatments and vaccines. Increasing numbers of
companies with a host of alliances now manage their alliances like a portfolio—terminating those that no longer
serve a useful purpose or that have produced meager results, forming promising new alliances, and restructuring
certain existing alliances to correct performance problems and/or redirect the collaborative effort.30

Many Alliances Are Short-Lived or Break Apart Most alliances that aim at technology-sharing or
providing market access turn out to be temporary, fulfilling their purpose after a few years because the benefits
of mutual learning have occurred and because both partners’ businesses have developed to the point where
they are ready to go their own ways. The likelihood that such alliances will be temporary makes it important
for each partner to learn thoroughly and rapidly about the other partner’s technology, business practices, and
organizational capabilities and then promptly transfer valuable ideas and practices into its own value chain
activities. Alliances tend to be longer lasting when (1) they involve collaboration with suppliers or distribution
allies, (2) each party’s contribution involves activities in different portions of the industry value chain, or (3) both
parties conclude that continued collaboration is in their mutual interest.

Most alliance partners don’t hesitate to terminate their collaboration when the payoffs run out or when alliance
members conclude the expected benefits are unlikely to materialize. A 1999 study by Accenture, a global business
consulting organization, revealed that 61 percent of alliances
were either outright failures or “limping along.” In 2004,
McKinsey & Company estimated that the overall success
rate of alliances was around 50 percent, based on whether
the alliance achieved the stated objectives.31 A 2007 study
found that, even though the number of strategic alliances
was increasing about 25 percent annually, the failure rate of alliances hovered between 60 to 70 percent.32 The
high “divorce rate” among strategic allies has several causes—an inability to work well together, tendencies
among alliance members to share only limited information about their valuable skills and expertise (which
prevented other members from learning much of value), changing conditions that render the purpose of the
alliance obsolete, growing disagreement among alliance members about the purpose, priorities, and/or targeted
benefits of the alliance, the emergence of more attractive paths to capture the intended benefits, and emerging
marketplace rivalry between certain alliance members.33 Experience indicates that alliances stand a reasonable
chance of helping a company reduce competitive disadvantage but rarely can entering into an alliance enable a
company to boost the competitive power of its resources and capabilities by enough to outcompete rivals or gain
a competitive advantage.

The Strategic Dangers of Relying Heavily on Alliances and Cooperative Partnerships The
Achilles heel of alliances and strategic cooperation is becoming dependent on other companies for essential
expertise and capabilities. To be a market leader (and perhaps even a serious market contender), a company
must ultimately develop its own capabilities in areas where internal strategic control is pivotal to protecting its
competitiveness and building competitive advantage. Moreover, some alliances and cooperative arrangements
hold only limited potential when a partner maintains full control over its most valuable skills and expertise and
is unwilling to give other alliance members much access to these capabilities. As a consequence, acquiring or
merging with a company possessing the needed resources and capabilities is often a better solution.

Merger and Acquistion Strategies
Mergers and acquisitions are especially suited for situations in which strategic alliances or partnerships do
not go far enough in providing a company with access to needed resources and capabilities.34 Ownership ties
are more permanent than partnership ties, allowing the operations of the merger/acquisition participants to be
tightly integrated and creating more in-house control and autonomy. A merger is the combining of two or more
companies into a newly created company that usually takes on a new name. An acquisition is a combination in
which one company, the acquirer, purchases and absorbs the operations of another, the acquired. The difference

Large numbers of strategic alliances fail to live
up to expectations and are dissolved after a few
years.

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between a merger and an acquisition relates more to the details of ownership, management control, and financial
arrangements than to strategy and competitive advantage.
The resources and capabilities of the newly created
enterprise end up much the same whether the combination
is the result of acquisition or merger.

The main impetus for merger and acquisition strategies is to
fundamentally alter a company’s trajectory and improve its
business outlook. Such strategies typically aim at achieving
any of four objectives:35

1. Creating a more cost-efficient operation out of the combined companies. Many mergers and acquisitions
are undertaken with the objective of transforming two or more otherwise high-cost companies into one
lean competitor with average or below-average costs. When a company acquires another company in the
same industry, there’s usually enough overlap in operations that certain inefficient plants can be closed
or distribution activities partly combined and downsized (when nearby centers serve some of the same
geographic areas) or sales force and marketing activities can be combined and downsized (when each
company has salespeople calling on the same customer). The combined companies may also be able to
reduce supply chain costs because of buying in greater volume from common suppliers and from closer
collaboration with supply chain partners. Likewise, it is usually feasible to squeeze out cost savings
in administrative activities, again by combining
and downsizing such administrative activities as
finance and accounting, information technology,
human resources, and so on.

2. Strengthening the resulting company’s resources,
capabilities, and competitiveness in important
ways. Combining the operations of two or more
companies, via merger and/or acquisition, is often
aimed at significantly bolstering the competitive
power of the resulting company’s resources, know-
how, skills and expertise—and doing so quickly (as compared to undertaking a time-consuming and
perhaps expensive internal effort to accomplish the same result). From 2000 through February 2024,
Cisco Systems purchased 139 companies to give it more technological reach and product breadth,
thereby enhancing its standing as the world’s biggest provider of hardware, software, and services for
building and operating Internet networks.

3. Expanding a company’s geographic coverage. One of the best and quickest ways to expand a company’s
geographic coverage is to acquire rivals with operations in the desired locations. And if there is some
geographic overlap, then a side benefit is being able to reduce costs by eliminating duplicate facilities in
those geographic areas where undesirable overlap exists. Banks like Wells Fargo and Bank of America
have pursued geographic expansion by making a series of acquisitions over the years, enabling them
to establish a market presence in an ever-growing number of states and localities. Food products
companies like Nestlé, Kraft, Unilever, and Procter & Gamble have made acquisitions an integral part
of their strategies to expand internationally. Travel company Expedia acquired HomeAway, an online
vacation rental enterprise, to extend its coverage in the vacation rental marketplace both internationally
and across the United States.

4. Extending the company’s business into new product categories. Many times, a company has gaps in
its product line that need to be filled. Acquisition can be a quicker and more potent way to broaden
a company’s product line than going through the lengthy exercise of doing the R&D, design and
engineering, and testing to put the company in position to prepare to manufacture and then introduce
an assortment of new products to grow its lineup of product offerings. PepsiCo acquired Quaker
Oats chiefly to bring Gatorade into the Pepsi family of beverages. While Coca-Cola has expanded its

CORE CONCEPT
A merger is the combining of two or more
companies into a newly created company that
usually has a different name. An acquisition is a
combination in which one company, the acquirer,
purchases and absorbs the operations of another,
the acquired.

Combining the operations of two companies, via
merger or acquisition, is an attractive strategic
option for fundamentally altering a company’s
trajectory—achieving operating economies,
strengthening the resulting company’s resources,
capabilities, and competitiveness in important
ways, and opening up avenues of new market
opportunity.

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beverage lineup by introducing its own new products (like Powerade and Dasani), it has also expanded
its lineup by acquiring Minute Maid (juices and juice drinks), Odwalla (juices), Hi-C (ready-to-drink
fruit beverages), and dozens of other brands of beverages. Going into 2024, Coca-Cola had a portfolio
of over 200 brands and thousands of beverage choices, some internally developed and most the result
of an active and longstanding acquisition program. In 2020, financial services and wealth management
firm Morgan Stanley acquired online stockbroker E*TRADE Financial Corp. as a means of extending
its financial services offerings to include online stock trading, a service already offered by rivals Merrill
Lynch and Charles Schwab. Also in 2020, Uber Technologies acquired privately held Postmates to
expand its footprint and capabilities in the home delivery business to include some 3,000+ localities in
the United States.

Many Mergers and Acquisitions Are Not Successful Mergers and acquisitions often do not result in the
hoped-for outcomes. The failure rate of mergers and acquisitions is between 70 and 90 percent.36 The reasons are
numerous.37 The anticipated revenue growth may not occur. Cost savings may prove smaller than expected. Gains
in competitive capabilities may take substantially longer to realize, or worse, never materialize at all. Efforts
to mesh the cultures can be defeated by formidable resistance from organizational members. Key employees
at the acquired company can become disenchanted with newly instituted changes and leave. Differences in
management styles and operating procedures can prove hard to resolve. Personnel at the acquired company may
stonewall changes, arguing forcefully for doing certain things the way they were done prior to the acquisition.

Unsuccessful mergers and acquisitions can be costly. Ford reportedly lost over $10 billion trying to make
successes of its $2.5 billion acquisition of Jaguar (1989) and $2.7 billion acquisition of Land Rover (2000);
frustrated by poor results, Ford sold the operations of both brands to India’s Tata Motors in 2008 for $2.3
billion.38 Bank of America’s supposedly bargain-priced $2.5 billion acquisition of ethically challenged and
financially troubled Countrywide Financial in January 2008 was, according to a prominent banking and finance
professor, “the worst deal in the history of American finance. Hands down.”39 Countrywide, a big originator of
questionable subprime and adjustable-rate mortgages that helped trigger the Fall 2008 collapse of the housing
market, cost Bank of America almost $57 billion in real estate losses, settlements with federal and state agencies
for selling toxic mortgage loans that were falsely represented as quality investments, and payments for legal
fees.40 Google’s $12.5 billion acquisition of struggling smartphone manufacturer Motorola Mobility in 2012
turned out to be minimally beneficial in helping to “supercharge Google’s Android ecosystem” (Google’s stated
reason for making the acquisition). When Google’s efforts to rejuvenate Motorola’s smartphone business by
spending over $1.3 billion on new product R&D and revamping Motorola’s product line resulted in disappointing
sales and huge operating losses, Google sold Motorola Mobility to China-based PC maker, Lenovo, for $2.9
billion in 2014 (however, Google retained ownership of Motorola’s extensive patent portfolio). While Lenovo
had great ambitions for utilizing Motorola Mobility as a vehicle for transforming both the Lenovo and Motorola
brands of smartphones into major contenders in the global smartphone market, six years later the results were
disappointing. During the first three quarters of 2020 the combined global market shares of the two brands was
in the low single digits, far behind the four best-selling brands—Samsung (~18.8%), Apple (~14.8%), Huawei
(~13.5%), and Xiaomi (~10.8%)—and also trailing three other brands.41 German chemical manufacturer Bayer’s
$63 billion acquisition of Monsanto in June 2018 proved problematic because a subsequent public uproar over
the safety of food products produced with Monsanto’s genetically modified seeds caused many farmers to refuse
to use such seeds and, further, because of the subsequent filing of an estimated 125,000 lawsuits alleging that
Monsanto’s popular best-selling Roundup weedkiller caused cancer—damages resulting from the settlement
of about 100,000 lawsuits amounted to about $11 billion as of January 2024; approximately 40,000 to 50,000
lawsuits remained unsettled. These two developments triggered a 38 percent drop in Bayer’s stock price in the
14 months following the closing of the acquisition, prompted Bayer to drop the use of the Monsanto name, and
forced a major restructuring of Bayer’s business makeup and internal operations to cope with the financial fallout
and the debt Bayer incurred in acquiring Monsanto.42

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Choosing Appropriate Functional-Area Strategies
A company’s strategy is not complete until company managers have made strategic choices about how the
various functional parts of the business—R&D, production, human resources, sales and marketing, finance,
and so on—will be managed in support of its basic competitive strategy approach and the other important
competitive moves being taken. Normally, functional-area strategy choices rank third on the menu of choosing
among the various strategy options, as shown in Figure 6.1. But whether commitments to particular functional
strategies are made before or after the choices of complementary strategic options (shown in Figure 6.1) is
beside the point—what’s really important is what the functional strategies are and how they mesh to enhance the
success of the company’s higher-level strategic actions.

In many respects, the nature of functional strategies is dictated by the choice of competitive strategy. For example,
a manufacturer employing a low-cost provider strategy needs (1) an R&D and product design strategy that
emphasizes efficient assembly and cheap-to-incorporate features, (2) a production strategy that stresses capture
of scale economies and actions to achieve low-cost manufacture (such as high labor productivity, efficient supply
chain management, and automated production processes), and (3) a low-budget marketing strategy. A business
pursuing a high-end differentiation strategy needs a production strategy geared to top-notch quality and product
performance, and a marketing strategy aimed at touting differentiating features and using advertising and a
trusted brand name to “pull” sales through the chosen distribution channels.

Beyond general prescriptions, it is difficult to say just what the content of the different functional-area strategies
should be without first knowing what higher-level strategic choices a company has made, the industry environment
in which it operates, the valuable resources and capabilities that can be leveraged, and so on. Suffice it to say here
that lower-ranking company personnel who have strategy-making responsibilities must be clear about which
higher-level strategies top executives have chosen and then must tailor the company’s functional-area strategies
accordingly.

Timing a Company’s Strategic Moves
When to make a strategic move is often as crucial as what move to make. Timing is especially important when
first-mover advantages or disadvantages exist.43 Being
first to initiate a strategic move can have a high payoff when:

l Pioneering helps build a firm’s image and
reputation with buyers and creates strong brand
loyalty. For example, Open Table’s early moves to
establish its online restaurant reservation service
built a strong brand and loyal user following that
fueled its expansion worldwide.

l An early lead enables a first mover to gain an absolute cost advantage over rivals because it captures
economies of scale sooner and enjoys volume-based cost advantages or because it is able to move down
a steep learning curve ahead of rivals and lower its unit costs as its experience accumulates in working
with the associated technology or production methods.

l A first-mover’s customers will thereafter face significant costs in switching to the product offerings of
later entrants. High switching costs can emerge when customers make large investments of time and
money in learning how to use a specific company’s new product or when they purchase complementary
products that can only be used with the first-mover’s product.

l Moving first constitutes a preemptive strike (like securing an especially favorable location or acquiring
an appealing company with uniquely valuable resources or capabilities).

CORE CONCEPT
Because of first-mover advantages and
disadvantages, competitive advantage can spring
from when a move is made as well as from what
move is made.

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l A first-mover’s actions are protected by patents, copyrights, or other forms of property rights, thus
thwarting the efforts of would-be followers to copy what the first mover did.

l A first-mover’s actions prove so overwhelmingly popular that its product sets the technical standard for
the industry.

Whenever buyers respond well to a pioneer’s initial move, the pioneer may be able to reap temporary monopoly
benefits—such as faster recovery of its initial investment, a cost advantage, and good profits—until rivals are
able to enter the same market space. The bigger the first-mover advantages, the more attractive making the first
move becomes and the more difficult it becomes for later movers to dislodge the advantages.44

To sustain any advantage that initially accrues to a pioneer, a first mover must be a fast learner and continue to
move aggressively to capitalize on any initial pioneering advantage. It helps immensely if the first mover has
deep financial pockets, important competences and competitive capabilities, and astute managers. If a first-
mover’s skills, know-how, and actions are easily copied or even surpassed, then followers and even late movers
can catch or overtake the first mover in a relatively short period. What makes being a first mover strategically
important is not being the first company to do something but rather being the first competitor to put together
the precise combination of features, customer value, and sound revenue/cost/profit economics that gives it an
edge over rivals in battling for market leadership.45 If the marketplace quickly takes to a first mover’s innovative
product offering, a first mover must have large-scale production, marketing, and distribution capabilities if it is
to remain ahead of fast followers who possess competitively valuable resources and capabilities. In cases where
the industry’s technology is advancing at a pace that enables rapid introduction of next-generation products, a
first mover cannot hope to sustain an early lead without having strong capabilities in R&D and fast-cycle product
development, along with the financial strength to fund these activities.

Sometimes, though, markets are slow to accept the innovative product offering of a first mover, in which case
a strategically astute fast follower with substantial resources and marketing muscle can overtake a first mover
(as Fox News did in surpassing first-mover CNN to become the most-watched cable news network). Sometimes
furious technological change or product innovation makes a first mover vulnerable to quickly appearing next-
generation technology or products. For instance, former market leaders in cell phones Nokia and BlackBerry
were quickly victimized by Apple’s far more innovative iPhone models and new Samsung smart phones based
on Google’s Android operating system. Hence, there are no guarantees that a first mover can sustain an early
competitive advantage.46

The Potential for Late-Mover Advantages or First-Mover Disadvantages
There are times, however, when being an adept follower rather than a first mover actually has its advantages.
Such late-mover advantages (or first-mover disadvantages) arise in five instances:

l When pioneering leadership is more costly than imitating followership, and only negligible experience
or learning-curve benefits accrue to the leader—a condition that allows imitative followers to (1) quickly
catch up to a first mover by learning from its experience and avoiding its mistakes and (2) achieve lower
costs than the first mover.

l When an innovator’s products are somewhat primitive and do not live up to buyer expectations, thus
allowing a clever follower with better-performing “next-generation” products to win disenchanted
buyers away from the leader.

l When buyers are skeptical about the benefits of a new technology or product being pioneered by a first
mover, thus allowing late movers to wait until the needs of buyers and the attributes they prefer are
clarified.

l When rapid market evolution (due to fast-paced changes in either technology or buyer needs) gives fast
followers and maybe even cautious late movers the opening to leapfrog a first-mover’s products with
more attractive next-version products.

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l When customer loyalty to the pioneer is low and a first-mover’s skills, know-how, and actions are easily
copied or even surpassed.

l When a first mover must make costly investments in R&D or in pioneering and perfecting its new
technology (that may or may not pay off) and followers can copy its product innovation or technological
advances without spending nearly so much time and money—in other words it turns out to be cheaper
and less risky to be a fast follower or even a late mover than a pioneer.

To Be a First Mover or Not
In weighing the pros and cons of being a first mover versus a fast follower versus a slow mover, it matters
whether the race to market leadership in a particular industry is likely to be closer to a 2-year sprint or a 10-year
marathon. Being first out of the starting block turns out to be competitively important only when pioneering early
introduction of a technology or product delivers clear and substantial benefits to early adopters and buyers, thus
winning their immediate support, perhaps giving the pioneer a reputational head-start advantage, and forcing
would-be competitors to quickly follow the pioneer’s lead. In the remaining instances where the race is more
of a marathon, the companies that end up dominating new-to-the-world markets are almost never the pioneers
that gave birth to brand-new markets—first-mover advantages are fleeting and there is time for resourceful fast
followers and sometimes even late movers to overtake the early leaders.47

The first lesson here is that there is a market-penetration curve for every emerging opportunity; typically, the
curve has an inflection point at which all pieces of the business model fall into place, buyer demand explodes,
and the market takes off. The inflection point can come early on a fast-rising curve (like use of e-mail and sales
of smartphones) or further on up a slow-rising curve (as with battery-powered motor vehicles, solar and wind
power, and digital textbooks for college students—which have taken about 10 years to take off). The second
lesson is that the timing of strategic moves matters, which makes it important for a company’s strategists to
assess the particular first-mover advantages and disadvantages that may flow when either the company (or an
important rival) is first to initiate a specific strategic move. There are several other hard questions that need to
be asked:

l How fast will buyer demand for a first mover’s newly introduced product take off–will the market
penetration curve be fast-rising or slow-rising?

l Does market takeoff depend on the development of complementary products or services that currently
are not available?

l Will buyers need to learn new skills or adopt new behaviors?

l Will buyers encounter high switching costs in moving to a first-mover’s new product or service?

l Are there influential competitors in a position to delay or derail a first mover’s strategic actions?

Key Points
Once a company has selected which of the five generic competitive strategies to employ in its quest for
competitive advantage, it must decide whether and how to supplement its choice of a competitive strategy
approach, as shown in Figure 6.1.

Companies have a number of offensive strategy options for improving their market positions and trying to
secure a competitive advantage: offering an equal or better product at a lower price, leapfrogging competitors by
being the first to adopt next-generation technologies or the first to introduce next-generation products, pursuing
sustained product innovation, attacking competitors’ weaknesses, going after less contested or unoccupied
market territory, using hit-and-run tactics to steal sales away from unsuspecting rivals, and launching preemptive
strikes. A blue ocean type of offensive strategy seeks to gain a dramatic and durable competitive advantage

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by abandoning efforts to beat out competitors in existing markets and, instead, inventing a new industry or
distinctive market segment that renders existing competitors largely irrelevant and allows a company to create
and capture altogether new demand.

Defensive strategies to protect a company’s position usually take the form of making moves that put obstacles
in the path of would-be challengers and fortify the company’s present position while undertaking actions to
dissuade rivals from even trying to attack (by signaling that the resulting battle will be more costly to the
challenger than it is worth).

One of the most pertinent strategic issues that companies face is how to utilize its website—whether to use its
website as only a means of disseminating product information (with traditional distribution channel partners
making all sales to end users), as a secondary or minor channel, as one of several important distribution channels,
as the company’s primary distribution channel, or as the company’s exclusive channel for accessing customers.

Outsourcing pieces of the value chain formerly performed in-house can enhance a company’s competitiveness
whenever (1) an activity can be performed better or more cheaply by outside specialists; (2) the activity is not
crucial to the firm’s ability to achieve sustainable competitive advantage and won’t weaken its ability to be a
master of its own destiny by hollowing out the competitive power of its internal resources and capabilities;
(3) it reduces the company’s risk exposure to changing technology and/or changing buyer preferences; (4) it
streamlines company operations in ways that improve organizational flexibility, cuts cycle time, speeds decision
making, and reduces coordination costs; and/or (5) it allows a company to concentrate on its core business and
do what it does best.

Vertically integrating forward or backward makes strategic sense only if it strengthens a company’s position via
either cost reduction or creation of a value-enhancing, differentiation-based advantage. Otherwise, the drawbacks
of vertical integration (increased investment, greater business risk, increased vulnerability to technological
changes, and less flexibility in making product changes in response to shifting buyer preferences) are likely to
outweigh any advantages.

Many companies are using strategic alliances, collaborative partnerships, and joint ventures to help them in
the race to build a global market presence or be a leader in the industries of the future. These forms of strategic
cooperation with other companies can be an attractive, flexible, and often cost-effective means by which
companies can gain access to missing technology, expertise, and business capabilities.

Mergers and acquisitions are another attractive strategic option for strengthening a firm’s competitiveness. When
the operations of two companies are combined via merger or acquisition, the new company’s competitiveness
can be enhanced in any of several ways: lower costs; stronger technological skills; more or better competitive
capabilities; a more attractive lineup of products and services; wider geographic coverage; and/or greater
financial resources with which to invest in R&D, add capacity, or expand into new areas.

Once all the higher-level strategic choices have been made, company managers can turn to the task of crafting
functional and operating-level strategies to flesh out the details of the company’s overall business and competitive
strategy.

The timing of strategic moves also has relevance in the quest for competitive advantage. Company managers are
obligated to carefully consider the advantages or disadvantages that attach to being a first mover versus a fast
follower versus a wait-and-see late mover.

What Is Strategy
and Why Is It Important?

What Do We Mean by “Strategy”?

Strategy and the Quest for Competitive Advantage

A Company’s Strategy is Partly Proactive and Partly Reactive

Strategy and Ethics: Passing the Test
of Moral Scrutiny

The Relationship Between a Company’s Strategy and Its Business Model

What Makes a Strategy a Winner?

Why Crafting and Executing Strategy Are Important Tasks

The Road Ahead

Key Points

Charting a Company’s Long-Term Direction: Vision, Mission,
Objectives, and Strategy

What Does the Strategy-Making,
Strategy-Executing Process Entail?

Task 1: Developing a Strategic Vision, Mission Statement, and Set of Core Values

Task 2: Setting Objectives

Task 3: Crafting A Strategy

Task 4: Implementing and Executing the Strategy

Task 5: Evaluating Performance and Initiating Corrective Adjustments

Corporate Governance: The Role of the Board of Directors in the Strategy-Making, Strategy-Executing Process

Key Points

Evaluating a Company’s
External Environment

THE STRATEGICALLY RELEVANT FACTORS
INFLUENCING A COMPANY’S EXTERNAL ENVIRONMENT

Assessing a Company’s Industry and Competitive Environment

Question 1: What Competitive Forces Do Industry
Members Face and How Strong Are They?

Question 2: What Factors Are Driving Industry Change and What Impact Will They Have?

Question 3: What Market Positions Do Rivals Occupy—Who Is Strongly Positioned and Who Is Not?

Question 4: What Strategic Moves Are Rivals Likely to Make Next?

Question 5: What Are the Key Factors for Future Competitive Success?

Question 6: Is the Industry Outlook Conducive to Good Profitability?

Key Points

Evaluating a Company’s Resources and Ability to Compete Successfully

QUESTION 1: HOW WELL IS THE COMPANY’S PRESENT STRATEGY WORKING?

QUESTION 2: WHAT ARE THE COMPANY’S IMPORTANT RESOURCES AND CAPABILITIES AND DO THEY HAVE ENOUGH COMPETITIVE POWER TO PRODUCE A COMPETITIVE ADVANTAGE OVER RIVALS?

QUESTION 3: WHAT ARE THE COMPANY’S COMPETITIVELY IMPORTANT STRENGTHS AND WEAKNESSES AND ARE THEY WELL-SUITED TO CAPTURING ITS BEST MARKET OPPORTUNITIES AND DEFENDING AGAINST EXTERNAL THREATS?

QUESTION 4: ARE THE COMPANY’S PRICES AND COSTS COMPETITIVE WITH THOSE OF KEY RIVALS, AND DOES IT HAVE AN APPEALING CUSTOMER VALUE PROPOSITION?

QUESTION 5: IS THE COMPANY COMPETITIVELY STRONGER OR WEAKER THAN KEY RIVALS?

QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS DOES TOP MANAGEMENT NEED TO ADDRESS IN CRAFTING A STRATEGY TO FIT THE SITUATION?

KEY POINTS

The Five Generic Competitive Strategy Options: Which One to Employ?

THE FIVE GENERIC COMPETITIVE STRATEGIES

BROAD LOW-COST PROVIDER STRATEGIES

BROAD DIFFERENTIATION STRATEGIES

FOCUSED (OR MARKET NICHE) STRATEGIES

BEST-COST PROVIDER STRATEGIES

SUCCESSFUL COMPETITIVE STRATEGIES ARE ALWAYS UNDERPINNED BY RESOURCES AND CAPABILITIES THAT ALLOW THE STRATEGY TO BE WELL-EXECUTED

KEY POINTS

Supplementing the Chosen Competitive Strategy—
Other Important Strategy Choices

GOING ON THE OFFENSIVE—STRATEGIC OPTIONS TO IMPROVE A COMPANY’S MARKET POSITION

DEFENSIVE STRATEGIES—PROTECTING MARKET POSITION AND COMPETITIVE ADVANTAGE

WEBSITE STRATEGIES

OUTSOURCING STRATEGIES

VERTICAL INTEGRATION STRATEGIES:
OPERATING ACROSS MORE STAGES
OF THE INDUSTRY VALUE CHAIN

STRATEGIC ALLIANCES AND PARTNERSHIPS

MERGER AND ACQUISITION STRATEGIES

CHOOSING APPROPRIATE FUNCTIONAL-AREA STRATEGIES

TIMING A COMPANY’S STRATEGIC MOVES

KEY POINTS

Strategies for Competing
Internationally or Globally

WHY COMPANIES DECIDE TO ENTER FOREIGN MARKETS

WHY COMPETING ACROSS NATIONAL BORDERS CAUSES STRATEGY MAKING TO BE MORE COMPLEX

THE CONCEPTS OF MULTICOUNTRY COMPETITION AND GLOBAL COMPETITION

STRATEGY OPTIONS FOR ESTABLISHING A COMPETITIVE PRESENCE IN FOREIGN MARKETS

COMPETING IN FOREIGN MARKETS: THE THREE COMPETITIVE STRATEGY APPROACHES

BUILDING CROSS-BORDER COMPETITIVE ADVANTAGE

PROFIT SANCTUARIES AND GLOBAL STRATEGIC OFFENSIVES

Key Points

Diversification Strategies

What Does Crafting a Diversification Strategy Entail?

CHOOSING THE DIVERSIFICATION PATH:
RELATED VS. UNRELATED BUSINESSES

EVALUATING THE STRATEGY OF A DIVERSIFIED COMPANY

KEY POINTS

Strategy, Ethics, and Social Responsibility

What Do We Mean by Business Ethics?

where do Ethical standards come from?

THE THREE CATEGORIES OF MANAGEMENT MORALITY

WHAT ARE THE DRIVERS OF UNETHICAL STRATEGIES AND BUSINESS BEHAVIOR?

WHY SHOULD COMPANY STRATEGIES BE ETHICAL?

Strategy, Social Responsibility, and Corporate Citizenship

KEY POINTS

Building an Organization
Capable of Good Strategy Execution

A FRAMEWORK FOR EXECUTING STRATEGY

BUILDING AN ORGANIZATION CAPABLE OF GOOD STRATEGY EXECUTION: THREE KEY ACTIONS

STAFFING THE ORGANIZATION

DEVELOPING AND STRENGTHENING EXECUTION-CRITICAL RESOURCES AND CAPABILITIES

STRUCTURING THE ORGANIZATION AND WORK EFFORT

KEY POINTS

Managing Internal Operations:
Actions That Promote
Good Strategy Execution

Allocating Needed Resources to Execution-Critical Activities

ENSURING THAT POLICIES AND PROCEDURES FACILITATE STRATEGY EXECUTION

ADOPTING BEST PRACTICES AND EMPLOYING PROCESS MANAGEMENT TOOLS TO IMPROVE EXECUTION

INSTALLING INFORMATION AND OPERATING SYSTEMS

TYING REWARDS AND INCENTIVES DIRECTLY TO ACHIEVING GOOD PERFORMANCE OUTCOMES

KEY POINTS

Corporate Culture and Leadership—Keys to Good Strategy Execution

INSTILLING A CORPORATE CULTURE THAT PROMOTES GOOD STRATEGY EXECUTION

LEADING THE STRATEGY EXECUTION PROCESS

KEY POINTS

146Chapter 7 Strategies for Competing Internationally or Globally

146

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Strategy: Core Concepts and Analytical Approaches

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146

Chapter 7
Strategies for Competing
Internationally or Globally

You have no choice but to operate in a world shaped by globalization and the information revolution. There
are two options: Adapt or die.
—Andrew S. Grove, former Chairman and CEO, Intel Corporation

[I]ndustries actually vary a great deal in the pressures they put on a company to sell internationally.
—Niraj Dawar and Tony Frost, Professors, Richard Ivey School of Business

What counts in global competition is the right strategy.
—Heinrich von Pierer, former CEO of Siemens AG

Increasingly, multinational enterprises focus on building new core competencies through learning from their
foreign market operations.
—Asli M. Arikan, Professor and Consultant

Any company that aspires to industry leadership in the 21st century must think in terms of global, not
domestic, market leadership. The world economy is globalizing at an accelerating pace as ambitious,
growth-minded companies race to build stronger competitive positions in the markets of more and more

countries, as companies gain greater access to foreign markets, as country exports and imports increase, and as
wireless communications capabilities erode the relevance of geographic distance.

Typically, a company will start to compete internationally by entering just one or maybe a select few foreign
markets. Competing on a truly global scale comes later, after the company has established operations on several
continents and is marketing its products or services in many different geographic regions of the world. Thus,
there is a meaningful distinction between the competitive scope of a company that operates in a few foreign
countries (and whose strategy is to enter only a few more country markets) and a company with production
and/or sales operations in 50 to 100 countries (and whose strategy is to expand rapidly into additional country
markets). The former is most accurately termed an international competitor while the latter qualifies as a global
competitor.

This chapter focuses on strategy options for expanding beyond domestic boundaries and competing internationally
in a few countries or globally in a great many countries across the world. The spotlight is on four strategic issues
unique to competing across national borders:

Art Thompson
Highlight

Art Thompson
Sticky Note
Change {I}ndustries to Industries (in italics)

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1. Whether to customize the company’s offerings in each different country market to match local buyers’
tastes and preferences or to offer a mostly standardized product everywhere it operates.

2. Whether to employ essentially the same basic competitive strategy in all countries or modify the strategy
country by country to better match local buyer tastes and competitive conditions.

3. Where to locate the company’s production facilities, distribution centers, and customer service operations
to realize the greatest location-related advantages.

4. When and how to efficiently transfer some of the company’s competitively powerful resources and
capabilities from certain countries to other countries; such cross-border redeployment of competitively
potent resources/capabilities is useful for spearheading the company’s strategic offensives to enter new
country markets and more effectively battle local rivals for sales and market share.

In the process of exploring these issues, we introduce such core concepts as multicountry competition, global
competition, and profit sanctuaries. The chapter includes sections on why competing across national borders
makes strategy-making more complex; the principal strategy options for competing internationally or globally;
the importance of locating value chain activities in the most advantageous countries; the strategic value of profit
sanctuaries; and the initiation of global strategic offensives.

Why Companies Decide to Enter Foreign Markets
Companies opt to sell their products/services or to locate operations in some or many countries for any of four
major reasons:

1. To gain access to new customers. Expanding into the markets of countries around the world becomes
an imperative when a company encounters dwindling growth opportunities in its home market or if a
company aspires to be among the world leaders in its industry.

2. To achieve lower costs and thereby become more cost competitive. Many companies are driven to seek
out foreign buyers for their products and services because they cannot achieve a big enough sales
volume domestically to fully capture manufacturing economies of scale or learning-curve effects and
also increase a company’s bargaining power with suppliers because of its increased volume of purchases.
The relatively small size of country markets in Europe explains why companies like Michelin, BMW,
and Nestlé long ago began selling their products all across Europe and then moved into markets in North
America and Latin America. Many manufacturers have located production facilities in foreign countries
to take advantage of lower costs for labor and other production-related activities and/or to avoid the
payment of tariffs/duties on goods exported to countries with relatively high tariffs/duties on imported
goods and/or to mitigate the risks of adverse shifts in currency exchange rates. International expansion
can also increase a company’s bargaining power with suppliers because of its increased volume of
purchases. Companies in industries based on natural resources often find it necessary to have operations
in foreign countries since natural resource supplies (oil, natural gas, minerals, coffee beans, and rubber)
are located in many parts of the world and can be accessed most cost effectively at the source.

3. To further exploit competitively valuable resources and capabilities. A company with valuable
competitive assets can extend what may be a market-leading position in one or two countries into a
position of global market leadership. McDonald’s and Starbucks have leveraged their competitive assets
and operating expertise to enter geographic markets all across the world and have now established
themselves as strongly-positioned global leaders in their respective business segments.

4. To spread business risk across a wider market area. A company distributes its business risk by operating
in many countries rather than depending entirely on operations in a few countries. Thus, when a
company with operations across much of the world approaches market saturation in certain countries or

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encounters economic downturns or adverse competitive conditions in certain countries, its performance
may be bolstered by buoyant sales elsewhere. In general, a company’s business risk is lower when it
has a diverse collection of revenue streams coming from many countries rather than being dependent on
revenues generated in one or just a few countries.

In addition, the major suppliers of companies expanding internationally often do so in order to meet their
customers’ needs abroad and retain their position as a key supply chain partner. For example, when motor vehicle
companies have opened new plants in foreign locations, many of their big automotive parts suppliers quickly
opened new facilities nearby to permit timely delivery of their parts and components to the plant. Most all of the
major accounting firms in the United States have followed their clients into foreign markets.

Why Competing Across National Borders Causes Strategy
Making to Be More Complex

Crafting a strategy to compete in one or more countries or regions of the world is inherently more complex for
five reasons: (1) the presence of important cross-country differences in buyer tastes, which present a challenge
for companies in deciding whether to customize or standardize their products or services; (2) widely-differing
competitive conditions from country-to-country, as well as differences in market sizes and growth potential;
understanding these differences is important to competing effectively and deciding which countries offer the best
market potential; (3) sizable cross-country differences in wage rates, worker productivity, inflation rates, energy
supplies and costs, tax rates, and other factors that impact the pros and cons of locating company facilities in
one country versus another; (4) differing governmental policies and regulations that make the business climate
more favorable in some countries than in others; and (5) the risks of adverse shifts in currency exchange rates.

Cross-Country Differences in Buyer Tastes
Buyer tastes for a particular product or service sometimes differ substantially from country to country. In France,
consumers prefer top-loading washing machines, whereas in most other European countries consumers prefer
front-loading machines. Soups that appeal to Swedish
consumers are not popular in Malaysia. Italian coffee
drinkers prefer espressos, but in North America many coffee
drinkers prefer milder-roasted coffees. Northern Europeans
want large refrigerators because they tend to shop once a
week in supermarkets; southern Europeans are satisfied
with small refrigerators because they shop daily. In parts of
Asia, refrigerators are a status symbol and may be placed in
the living room, leading to preferences for stylish designs
and colors—in India, bright blue and red are popular colors.
In other Asian countries, household space is constrained
and many refrigerators are only four feet high so the top can be used for storage. In Hong Kong and Japan, the
preference is for compact appliances, but in Taiwan large appliances are more popular. Consequently, companies
operating in a global marketplace must wrestle with whether and how much to customize their offerings in
each different country market to match local buyers’ tastes and preferences or whether to pursue a strategy of
offering a mostly standardized product worldwide. While making products that are closely matched to local
tastes makes them more appealing to local buyers, customizing a company’s products country by country may
raise production and distribution costs due to the greater variety of designs and components, shorter production
runs, and the complications of added inventory handling and distribution logistics. Greater standardization of a
global company’s product offering, on the other hand, can lead to scale economies and learning-curve effects,
thus reducing production costs per unit and perhaps contributing to the achievement of a low-cost advantage.

CORE CONCEPT
The tension between the market pressures to
localize a company’s product offerings country by
country and the competitive pressures to lower
costs by offering mostly standardized products in
all countries where a company competes is one of
the big strategic issues that companies operating
in few or many country markets must address.

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Cross-Country Differences in Competitive Conditions, Population
Demographics, Market Sizes, and Growth Potential
Certain countries are known for having well-developed markets and competitively strong firms in particular
industries. For example, France is well-known for its competitive strength in fine wines, and Italy is known
for its strengths in high fashion apparel, wines, and olive oil. Chile has competitive strengths in industries such
as copper, fruit, fish products, paper and pulp, chemicals, and wine. Japan is known for having competitive
strength in consumer electronics, automobiles, semiconductors, steel products, and specialty steel. A country’s
competitively strong industries nearly always contain competitively successful companies with valuable
resources and capabilities, and are characterized by marketplaces:

l Where competitive conditions, as a rule, are materially stronger than in the country’s less well-known
industries.

l Where the local competitors are likely to have certain “home country advantages” not readily available
to a new foreign entrant—unless the foreign entrant has wisely entered into strategic alliances or
collaborative agreements with capable local enterprises to overcome or neutralize these advantages.

Understandably, differing population sizes, income levels, and other demographic factors give rise to considerable
differences in market size and growth rates from country to country. In emerging markets like India, China,
Brazil, and Malaysia, the potential for long-term growth in buyer demand for motor vehicles, PCs and tablets,
smartphones, steel, big-screen TVs, credit cards, and electric energy is higher than in the more mature economies
of Great Britain, Norway, Canada, and Japan. Owing to widely differing population demographics and income
levels, there is a far bigger market for luxury automobiles and high-fashion apparel in the United States and
Western Europe than in Argentina, India, Mexico, and Thailand. Cultural influences can also affect consumer
demand for a product. For instance, in China, many parents are reluctant to purchase PCs even when they can
afford them because of concerns that their children will be distracted from their schoolwork by surfing the
Internet, playing video games, and streaming music, movies, and TV shows.

Similarly, there are country-to-country differences in distribution channels, competitive conditions, and other
market-related factors that impact a company’s strategy choices. In India, there are efficient well-developed
national channels for distributing trucks, scooters, farm equipment, groceries, personal care items, and other
packaged products to the country’s three million retailers; however, in China, distribution is primarily local and
there is a limited national network for distributing most products. The marketplace for certain products/services
is intensely competitive in some countries and only moderately contested in others. Industry driving forces
may be one thing in Spain, quite another in Canada, and different yet again in Turkey, Argentina, and South
Korea. Sometimes, product designs suitable in one country are inappropriate in another because of differing local
customs and standards. For example, in the United States, electrical devices run on 110-volt electrical systems,
but in some European countries the standard is a 240-volt electric system, necessitating the use of different
electrical designs, components, and cord plugs.

The managerial challenge at companies with international or global operations is how best to tailor a company’s
strategy to take all these cross-country differences into account.

Cross-Country Differences in Operating Costs and Profitability
Differences in wage rates, worker productivity, energy costs, environmental regulations, tax rates, inflation rates,
tariffs/import duties, and the like from country to country are often so big that a company’s operating costs and
profitability are significantly impacted by where its production, distribution, and customer-service activities are
located. Wage rates, in particular, vary enormously from country to country. For example, 2021 data shows that
hourly compensation for manufacturing workers averaged $2.80 in Mexico, $2.82 in Ukraine (2018), $5.52 in
China, $5.87 in Turkey, $6.89 in Bulgaria, $7.98 in Brazil, $8.03 in Chile (2019), $12.91 in Hungary, $12.33 in
Poland, $15.14 in Portugal, $19.21 in Greece, $20.87 in New Zealand (2020), $28.39 in Spain, $29.52 in United
States, $29.61 in United Kingdom (2019), $33.32 in Canada (2020), $47.07 in France, $49.56 in Germany, and

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$57.30 in Norway.1 Not surprisingly, the big cross-country differences in wages rates have turned low-wage
countries like China, India, Pakistan, Cambodia, Vietnam, Mexico, Brazil, Guatemala, Honduras, the Philippines,
and several countries in Africa and Eastern Europe into production havens for goods that can be manufactured or
assembled by a relatively unskilled labor force. Indeed, China has emerged as the manufacturing capital of the
world—virtually all of the world’s major manufacturing companies now have facilities in China. A manufacturer
can also gain cost advantages by locating its manufacturing and assembly plants in countries with less costly
government regulations, low taxes, low energy costs, and cheaper access to essential natural resources.

Clearly, companies that locate production facilities in low-cost countries (or that source their products from
contract manufacturers in these countries) have a production-cost advantage over rivals with plants in countries
where costs are higher. In such cases, the low-cost countries become principal production sites, with most of the
output being exported to markets in other parts of the world. Likewise, concerns about short delivery times and
low shipping costs make some countries better locations than others for establishing distribution centers. Many
U.S. companies locate customer call centers in such lower wage countries as Ireland and India, where English is
spoken, and well-educated workers are readily available.

The Impact of Host Government Policies on the Local Business Climate
National governments enact all kinds of measures affecting business conditions and the operation of foreign
companies in their markets. It matters whether these measures create a favorable or unfavorable business climate.
Governments of countries anxious to spur economic growth, create more jobs, and raise living standards for their
citizens (Ireland is a good example) usually make a special effort to create a business climate that outsiders
will view favorably. They may provide such incentives as reduced taxes, low-cost loans, site location and site
development assistance, and government-sponsored training for workers to both foreign and domestic companies
to construct or expand production and distribution facilities. When new business issues or developments arise,
“pro-business” governments make a practice of seeking advice and counsel from business leaders. When tougher
business regulations are deemed appropriate, they endeavor to make the transition to more costly and stringent
regulations somewhat business friendly rather than adversarial.

On the other hand, governments sometimes enact policies that, from a business perspective, make locating
facilities within a country’s borders less attractive. For example, the nature of a company’s operations may make
it particularly costly to achieve compliance with a country’s environmental regulations. The governments of
emerging or developing countries often create uneven playing fields that give domestic companies an advantage—
they may enact policies to discourage foreign imports or provide subsidies and low-interest loans to domestic
companies to enable them to better compete against foreign companies or enact burdensome procedures and
requirements for imported goods to pass customs inspection (to make it harder for imported goods to compete
against the products of local businesses), and impose tariffs or quotas on the imports of certain goods (also to
help protect local businesses from foreign competition).2 Foreign governments sometimes also specify that a
certain percentage of the parts and components used in manufacturing a product in their country be obtained
from local suppliers, require prior approval of a foreign company’s capital spending projects, limit withdrawal
of funds from the country, and require minority (sometimes majority) ownership of foreign company operations
by local companies or investors. There are times when a government may place restrictions on exports to ensure
adequate local supplies and regulate the prices of imported and locally produced goods. Governments controlled
by newly elected left-leaning or socialist politicians often impose very high taxes on large corporations to fund
new government programs that benefit low-income families and the disadvantaged. Such governmental actions
make a country’s business climate unattractive, and in some cases, may be sufficiently onerous to discourage a
company from locating production or distribution facilities in that country or maybe even selling its products in
that country.

A country’s business climate is also a function of the political and economic risks associated with operating
within its borders. Political risks have to do with the instability of weak governments, growing possibilities
that a country’s citizenry will revolt against dictatorial government leaders, the likelihood that current or future
governmental leaders will pursue legislation or regulations that are onerous or burdensome to businesses, and the

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potential for future elections to produce government leaders who are corrupt or hostile to companies from certain
foreign countries operating within their borders. For example, if socialist politicians gain control of a country’s
government, there’s a political risk that a company’s assets will be nationalized and its operations taken over by
the government. Economic risks have to do with the stability of a country’s economy and monetary system—
whether inflation rates might skyrocket, whether risky bank lending practices could lead to large numbers of
bank failures and economic disruptions, or whether out-of-control government spending could spur a meltdown
of the country’s credit rating, cause interest rates on government debt to escalate, and cause prolonged economic
distress. In some countries, the threat of piracy and lack of protection for a company’s intellectual property pose
substantial economic risks.

The Risks of Adverse Exchange Rate Shifts
When companies produce and market their products and services in many different countries, they are subject to
the impacts of sometimes favorable and sometimes unfavorable changes in currency exchange rates. The rates
of exchange between different currencies can vary by as much as 20 to 40 percent annually, with the changes
occurring sometimes gradually and sometimes swiftly. Sizable shifts in exchange rates pose significant risks for
two reasons:

1. They are very hard to predict because of the variety of factors involved and the uncertainties surrounding
when and by how much the various factors affecting exchange rates will change.

2. They shuffle the cards of which countries—either temporarily or long term—represent the low-cost
manufacturing location and which rivals have a temporary or longer-term cost-based competitive
advantage because of the countries where their production operations are located.

To illustrate the economic and competitive risks associated with fluctuating exchange rates, consider the case of
a U.S. company that has located manufacturing facilities in Brazil (where the currency is reals—pronounced ray-
alls) and that exports most of its Brazilian-made goods to markets in the European Union (where the currency
is euros). To keep the numbers simple, assume that the exchange rate is 4 Brazilian reals for 1 euro and that
the product being made in Brazil has a manufacturing cost of 4 Brazilian reals (or 1 euro). Now suppose the
exchange rate shifts from 4 reals per euro to 5 reals per euro (meaning that the real has declined in value and the
euro is stronger). Making the product in Brazil is now more cost competitive because a Brazilian good costing
4 reals to produce has fallen to only 0.8 euros at the new exchange rate (4 reals divided by 5 reals per euro =
0.8 euros). This clearly puts a producer of the Brazilian-made good in a better position to compete against the
European makers of the same good. On the other hand, should the value of the Brazilian real grow stronger
in relation to the euro—resulting in an exchange rate of 3 reals to 1 euro—the same Brazilian-made good
formerly costing 4 reals (or 1 euro) to produce now has a
cost of 1.33 euros (4 reals divided by 3 reals per euro =
1.33), putting a producer of the Brazilian-made good in a
weaker competitive position vis-à-vis European producers.
Plainly, the attraction of manufacturing a good in Brazil and
selling it in Europe is far greater when the euro is strong (an
exchange rate of 1 euro for 5 Brazilian reals) than when the
euro is weak and exchanges for only 3 Brazilian reals.

But there is one more piece to the story. When the exchange
rate changes from 4 reals per euro to 5 reals per euro, not only
is the cost competitiveness of the Brazilian manufacturer
stronger relative to European manufacturers of the same
item, but the Brazilian-made good that formerly cost 1 euro
and now costs only 0.8 euros can also be sold to consumers
in the European Union for a lower euro price than before. In other words, the combination of a stronger euro
and a weaker real acts to lower the price of Brazilian-made goods in all the countries that are members of the

CORE CONCEPT
Companies that export goods to foreign
countries always gain in competitiveness when
the currency of the country in which the goods
are manufactured grows weaker relative to the
currencies of countries to which the goods are
being exported. A company is disadvantaged
when the currency of the country where its goods
are being manufactured grows stronger relative to
the currencies of countries to which it is exporting
its goods.

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European Union, which is likely to spur sales of the Brazilian-made good in Europe and boost Brazilian exports
to Europe. Conversely, should the exchange rate shift from 4 reals per euro to 3 reals per euro—which makes a
Brazilian manufacturer less cost competitive with rival European manufacturers—the Brazilian-made good that
formerly cost 1 euro and now costs 1.33 euros will sell for a higher price in euros than before, which will weaken
the demand of European consumers for Brazilian-made goods and reduce Brazilian exports to Europe. Thus, the
exporters of Brazilian-made goods are likely to experience (1) rising demand for their goods in Europe whenever
the Brazilian real grows weaker relative to the euro and (2) falling demand for their goods in Europe whenever
the real grows stronger relative to the euro. Consequently, from the standpoint of a company with Brazilian
manufacturing plants, a weaker Brazilian real is a favorable exchange rate shift and a stronger Brazilian real is
an unfavorable exchange rate shift.

It follows from the previous discussion that shifting exchange rates have a big impact on domestic manufacturers’
ability to compete with foreign rivals. For example, U.S.-based manufacturers locked in a fierce competitive
battle with low-cost foreign imports benefit from a weaker U.S. dollar for the following reasons:

l Declines in the value of the U.S. dollar against foreign currencies raise the U.S. dollar costs of goods
manufactured by foreign rivals at plants located in the countries whose currencies have grown stronger
relative to the U.S. dollar. A weaker dollar acts to reduce or eliminate whatever cost advantage foreign
manufacturers may have had over U.S. manufacturers (and helps protect the manufacturing jobs of U.S.
workers).

l A weaker dollar makes foreign-made goods more expensive in dollar terms to U.S. consumers—this
curtails U.S. buyer demand for foreign-made goods, stimulates greater demand on the part of U.S.
consumers for U.S.-made goods, and reduces U.S. imports of foreign-made goods.

l A weaker U.S. dollar enables the U.S.-made goods to be sold at lower prices to consumers in those
countries whose currencies have grown stronger relative to the U.S. dollar—such lower prices boost
foreign buyer demand for the now relatively cheaper U.S.-made goods, thereby stimulating exports
of U.S.-made goods to foreign countries and perhaps creating more jobs in U.S.-based manufacturing
plants.

l A weaker dollar increases the dollar value of profits a company earns in those foreign country markets
where the local currency is stronger relative to the dollar. For example, if a U.S.-based manufacturer
earns a profit of €10 million on its sales in Europe, those €10 million convert to a larger number of U.S.
dollars when the dollar grows weaker against the euro.

A weaker U.S. dollar is therefore an economically favorable exchange rate shift for manufacturing plants based
in the United States. A decline in the value of the U.S. dollar strengthens the cost competitiveness of U.S.-
based manufacturing plants and boosts foreign buyers’ demand for U.S.-made goods. When the value of the
U.S. dollar is expected to remain weak for some time to come, foreign companies have an incentive to build
manufacturing facilities in the United States to make goods
for U.S. consumers rather than export the same goods to the
United States from foreign plants where production costs in
dollar terms have been driven up by the decline in the value
of the dollar.

Conversely, a stronger U.S. dollar is an unfavorable
exchange rate shift for U.S.-based manufacturing plants
because it makes such plants less cost-competitive with
foreign plants and weakens foreign demand for U.S.-made goods. A strong dollar also weakens the incentive of
foreign companies to locate manufacturing facilities in the United States to make goods for U.S. consumers. The
same reasoning applies to companies with plants in countries in the European Union where the euro is the local
currency. A weak euro versus other currencies enhances the cost competitiveness of companies manufacturing

CORE CONCEPT
Domestic companies facing competitive pressure
from lower-cost foreign rivals benefit when their
government’s currency grows weaker in relation
to the currencies of the countries where the lower-
cost foreign rivals have their manufacturing plants.

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goods in Europe vis-à-vis foreign rivals with plants in countries whose currencies have grown stronger relative
to the euro; a strong euro versus other currencies weakens the cost-competitiveness of companies with plants in
the European Union.

The Concepts of Multicountry Competition and
Global Competition

Important differences exist in the patterns of international competition from industry to industry.3 At one
extreme is multicountry competition, in which there’s so much cross-country variation in market conditions
and in the companies contending for leadership that the market contest among rivals in one country is localized
to that country and not closely connected to the market contests in other countries. The standout features of
multicountry competition are that (1) buyers in different
countries are attracted to different product attributes, (2)
sellers vary from country to country, and (3) industry
conditions and competitive forces in each national market
differ in important respects. Take the banking industry
in Poland, Mexico, and Australia as an example—the
requirements and expectations of banking customers vary
among the three countries, the lead banking competitors in
Poland differ from those in Mexico or Australia, and the
competitive battle going on among the leading banks in Poland is unrelated to the rivalry taking place in Mexico
or Australia. Thus, with multicountry competition, rival firms compete for national championships and winning
in one country does not necessarily signal the ability to fare well in other countries. In multicountry competition,
the power of a company’s resources, capabilities, and strategy in one country may have limited impact on its
competitiveness in other countries where it operates. Moreover, any competitive advantage a company secures
in one country is largely confined to that country; the spillover effects to other countries are minimal. Industries
characterized by multicountry competition include radio and TV broadcasting, consumer banking, metals
fabrication, baking, and retailing.

At the other extreme is global competition, in which prices and competitive conditions across country markets
are strongly linked and the term global or world market has true meaning. In a globally competitive industry,
much the same group of rival companies competes in many different countries, but especially so in countries
where sales volumes are large and where having a competitive presence is strategically important to building
a strong global position in the industry. Thus, a company’s competitive position in one country both affects
and is affected by its position in other countries. In global
competition, a firm’s overall competitive advantage grows
out of its entire worldwide operations; the competitive
advantage it creates at its home base is supplemented
by advantages growing out of its operations in other
countries (having plants in low-wage countries, being able
to transfer competitively valuable expertise from country
to country, having the capability to serve customers who
also have multinational operations, and having brand
name recognition in many parts of the world). Rival firms in globally competitive industries vie for worldwide
leadership. Global competition exists in motor vehicles, television sets, tires, cell phones, personal computers,
copiers, watches, bicycles, and commercial aircraft.

It is also important to recognize that an industry can be in transition from multicountry competition to global
competition. In a number of today’s industries—beer and major home appliances are prime examples—leading
domestic competitors have begun expanding into more and more foreign markets, often acquiring local or
regional brands, integrating them into their operations, and expanding their distribution to more countries.
As some industry members start to build global brands and a global presence, other industry members find

CORE CONCEPT
Multicountry competition exists when competition
in one national market is not closely connected to
competition in another national market. There is
no global or world market, just a collection of self-
contained country markets.

CORE CONCEPT
Global competition exists when competitive
conditions across national markets are linked
strongly enough to form a true international
market and when leading competitors compete
head-to-head in many different countries.

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themselves pressured to follow the same strategic path. As the industry consolidates to fewer players, such
that many of the same companies find themselves in head-to-head competition in more and more country
markets, global competition begins to replace multicountry competition. Global competition can also replace
multicountry competition when consumer preferences and/or uses of a product converge across the world—as
has been occurring in the market for smart phones, streamed entertainment, and LED lighting. Less diversity
of tastes and preferences enables companies to create global brands and sell essentially the same products in
different countries. But even in industries where cross-country consumer tastes remain fairly diverse, global
competition can emerge if companies are able to use cost-effective “custom mass production” methods at one or
more large-scale plants to economically produce different product versions and thus accommodate the different
preferences of people in different countries.

In addition to taking the obvious cultural and political differences between countries into account, a company must
shape its strategic approach to competing in foreign markets according to whether its industry is characterized by
multicountry competition, global competition, or a transition from one to the other.

Strategy Options for Establishing a Competitive Presence
in Foreign Markets

There are five strategic ways a company can establish a competitive presence in foreign markets:

1. Maintain a national (one-country) production base and export goods to foreign markets.

2. License foreign firms to use the company’s technology or to produce and distribute the company’s
products.

3. Employ a franchising strategy in foreign markets.

4. Establish a subsidiary in a foreign market via acquisition or the creation of an entirely new organization
that performs many value chain activities internally.

5. Rely on strategic alliances or joint ventures with foreign companies as the primary vehicle for entering
foreign markets.

The following sections discuss these five strategy options in more detail.

Export Strategies
Using domestic plants as a production base for exporting goods to foreign markets is an excellent initial strategy
for pursuing international sales. It is a conservative way to explore competing in markets of foreign countries.
The amount of capital needed to begin exporting is often minimal; existing production capacity may well be
sufficient to make goods for export. With an export strategy, a manufacturer can limit its involvement in foreign
markets by contracting with foreign wholesalers experienced in importing to handle the entire distribution and
marketing function in their countries or regions of the world. Or, if it is more advantageous to maintain internal
control over these functions, a manufacturer can establish its own distribution and sales organizations in some
or all of the target foreign markets. Either way, a home-based production and export strategy helps the firm
minimize its direct investments in foreign countries. Such strategies are commonly favored by Chinese, Korean,
and Italian companies—products are designed and manufactured at home and then distributed through local
channels in the importing countries. The primary functions performed abroad relate chiefly to establishing a
network of distributors and perhaps conducting sales promotion and brand-awareness activities.

Whether an export strategy can be pursued successfully over the long run hinges on the relative cost competitiveness
of a company’s home-country production base. In some industries, firms gain additional scale economies and
learning-curve benefits from centralizing production in one or several giant plants whose output capability

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exceeds buyer demand in any one country market; obviously, a company must export to capture such economies.
However, an export strategy is vulnerable when (1) manufacturing costs in the home country are substantially
higher than in foreign countries where rivals have plants, (2) the costs of shipping the product to distant foreign
markets are relatively high, (3) adverse shifts occur in currency exchange rates, and (4) importing countries
impose tariffs or erect other trade barriers. Unless an exporter can both keep its production and shipping costs
competitive with rivals, secure adequate local distribution and marketing support of its products, and effectively
hedge against unfavorable changes in currency exchange rates, its success will be limited.

Licensing Strategies
Licensing as an entry strategy makes sense when a firm with valuable technical know-how, an appealing brand,
or a unique patented product has neither the internal organizational capability nor the resources to enter foreign
markets. Licensing also has the advantage of avoiding the risks of committing resources to country markets
that are unfamiliar, politically volatile, economically unstable, or otherwise risky. By licensing the technology,
trademark, or production rights to foreign-based firms, a company can generate income from royalties while
shifting the costs and risks of entering and competing successfully in foreign markets to the licensee. One
downside of licensing is that the licensee who bears the risk is also likely to be the biggest beneficiary from any
upside gain. Disney learned this lesson when it relied on licensing agreements to open its first foreign theme
park, Tokyo Disneyland. When the venture proved wildly successful, it was its licensing partner, the Oriental
Land Company, and not Disney who reaped the windfall. Another important disadvantage of licensing is the risk
of providing valuable technological know-how to foreign companies and thereby losing some degree of control
over its use; monitoring licensees and safeguarding the company’s proprietary know-how can prove difficult in
some circumstances. But if the royalty potential is considerable and the companies to whom licenses are granted
are trustworthy and reputable, then licensing can be an attractive option. Many software and pharmaceutical
companies use licensing strategies to participate in foreign markets.

Franchising Strategies
While licensing can work well for manufacturers and owners of proprietary technology, franchising is often
better suited to the international expansion efforts of service and retailing enterprises. McDonald’s, Yum! Brands
(the parent of Pizza Hut, KFC, and Taco Bell), Subway, Dunkin Donuts, Sport Clips, Minuteman Press, Jani-
King International (the world’s largest commercial cleaning franchisor), Roto-Rooter, 7-Eleven, Marriott, and
Hilton Hotels have all used franchising to build a presence in foreign markets. Franchising has much the same
advantages as licensing. The franchisee bears most of the costs and risks of establishing foreign locations; a
franchisor has to expend only the resources to recruit, train, support, and monitor franchisees. The big problem
a franchisor faces is maintaining quality control; foreign franchisees do not always exhibit strong commitment
to consistency and standardization, especially when the local culture does not stress the same kinds of quality
concerns. Another problem that can arise is whether to allow foreign franchisees to make modifications in the
franchisor’s product offering to better satisfy the preferences of consumers in the countries where they operate.
Should KFC allow its 23,000 international franchised locations to use substitute spices in the company’s chicken
recipes? Should McDonald’s give franchisees in each nation some leeway in what products they put on their
menus? Or should the same menu offerings be rigorously and unvaryingly required of all franchisees worldwide?

Forming Subsidiaries to Enter Foreign Markets Via Acquisition or Internal Startup
Very often companies electing to compete internationally or globally prefer to have direct control over all aspects
of operating in a foreign market. Companies that want to direct performance of core value chain activities
typically establish a wholly owned subsidiary, either by acquiring a local company or by establishing its own
new operating organization from the ground up. A subsidiary business that is established internally from scratch
is called an internal startup or a greenfield venture.

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Acquiring a local business is the quicker of the two options, and it may be the least risky and most cost-
efficient means of hurdling such entry barriers as gaining access to local distribution channels, building supplier
relationships, and establishing working relationships with key government officials and other constituencies.
Buying an ongoing operation allows the acquirer to move
directly to the task of transferring resources and personnel
to the newly acquired business, integrating and redirecting
the activities of the acquired business into its own operation,
putting its own strategy and valuable capabilities into place,
and initiating efforts to build a competitively strong market
position.4

The first issue an acquisition-minded firm must consider
is whether to pay a premium price for a successful local
company or to buy a struggling competitor at a bargain price and revamp its operations. If the buying firm
has little knowledge of the local market but ample capital, it is often better off purchasing a capable, strongly
positioned firm—unless the acquisition price is prohibitive. However, when the acquirer sees promising ways to
transform a weak firm into a strong one and has the resources and managerial know-how to do it, a struggling
company can be the more profitable approach.

Entering a new foreign country via internal startup makes sense when a company already operates in a number
of countries, has experience in getting new subsidiaries up and running and overseeing their operations, and
has a large pool of resources and capabilities to rapidly equip a new subsidiary with the personnel and what it
needs otherwise to compete successfully and profitably. Four other conditions make an internal startup strategy
appealing:

1. When creating an internal startup is cheaper than making an acquisition.

2. When adding new production capacity will not adversely impact the supply–demand balance in the
local market.

3. When a startup subsidiary has the resources and capability to gain good distribution access (perhaps
because of the company’s recognized brand name).

4. When a startup subsidiary can quickly be infused with the resources and capabilities needed to achieve
the cost structure and competitive strength to successfully battle local rivals.

Collaborative Strategies—Alliances and Joint Ventures with Foreign Partners
Entering into alliances, joint ventures, and other cooperative agreements with foreign companies are a favorite
and fruitful strategic means for entering a foreign market.5 A company can benefit immensely from a foreign
partner’s familiarity with local government regulations, its knowledge of local buying habits and product
preferences, its distribution channel capabilities, and so on.6
Both Japanese and American companies have been active
in forming alliances with European companies to better
compete in the 27-nation European Union and to capitalize
on emerging opportunities in the countries of Eastern
Europe. Many U.S. and European companies are allying
with Asian companies in their efforts to enter markets in
China, India, Thailand, Indonesia, and other Asian countries; alliances and joint ventures with Latin American
enterprises are common as well.

A second big appeal of cross-border alliances is to capture economies of scale in production and/or marketing—cost
reduction can be the difference-maker in enabling a company to be cost competitive in foreign markets. By joining
forces in producing components, assembling models, and marketing their products, collaborating companies can

Most companies elect to enter the market of
a foreign country by first establishing a wholly
owned subsidiary in the target country that
achieves entry either by acquiring a local
company and refurbishing its operations as
may be needed or by creating its own internal
organization from scratch.

Collaborative strategies involving alliances and/or
joint ventures with foreign partners are a popular
way for companies to edge their way into the
markets of foreign countries.

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realize cost savings not achievable with their own smaller volumes. A third reason to employ a collaborative
strategy is to share distribution facilities and dealer networks, thus mutually strengthening each partner’s access
to buyers. A fourth potential benefit of a collaborative strategy is the learning, expertise, and added capability that
comes from performing joint research, sharing technological know-how, studying one another’s manufacturing
methods, and understanding how to tailor sales and marketing approaches to fit local cultures and traditions.
Indeed, one of the win-win benefits of an alliance is to
learn from alliance partners and implant the knowledge and
know-how of these partners in a company’s own personnel.
A fifth benefit is that cross-border allies can direct their
competitive energies more toward mutual rivals and less
toward one another; working together collaboratively may
help them close the gap on leading companies. And, finally,
alliances can be a particularly useful way for companies
across the world to gain agreement on important technical
standards—cross-border alliances have been used to arrive
at standards for assorted computer devices, Internet-related technologies, ultra-high definition televisions, and
5G wireless communication systems.

Many companies believe that cross-border alliances and partnerships are a better strategic means of gaining the
preceding benefits (as compared to acquiring or merging with foreign-based companies to gain much the same
benefits) because they allow a company to preserve its independence (which is not the case with a merger),
retain veto power over how the alliance operates, and avoid using perhaps scarce financial resources to fund
acquisitions. Furthermore, an alliance offers the flexibility to readily disengage once its purpose has been served
or if the benefits prove elusive, whereas an acquisition is a more permanent sort of arrangement (although the
acquired company can, of course, be divested).7

The Risks of Strategic Collaborations Alliances and joint ventures with foreign partners have their pitfalls,
however. Sometimes local partners’ knowledge and expertise turns out to be less valuable than expected.8 Cross-
border allies typically must overcome language and cultural barriers and figure out how to deal with diverse or
incompatible operating practices. The communication, trust-building, and coordination costs are high in terms
of management time.9 It takes many meetings of many people working in good faith over a period of time to iron
out what is to be shared, what is to remain proprietary, and how the collaborative arrangements will work. Often,
partners soon discover they have different, sometimes conflicting, objectives for their collaborative efforts and/
or deep differences of opinion about how to proceed and/or important differences in corporate values and ethical
standards. Tensions can build up, working relationships cool, and the hoped-for benefits never materialize.10 It is
not unusual for there to be little rapport or personal chemistry among some of the key people on whom success
or failure of the collaborative efforts depends. And even if allies are able to develop good working relationships,
they can still have trouble reaching mutually agreeable ways to collaborate in competitively sensitive areas or to
launch new initiatives fast enough to stay abreast of changing technology or shifting market conditions.

Even if an alliance proves to be a win-win proposition for its members, a company must guard against becoming
overly dependent on foreign partners for essential expertise and competitive capabilities. Companies aiming
for global market leadership usually need to develop competitively valuable resources and capabilities that are
internally controlled to be masters of their destiny. Frequently, experienced multinational companies operating in
50 or more countries across the world find less need for entering into cross-border alliances than do companies
in the early stages of globalizing their operations.11 Companies with global operations make it a point to develop
senior managers who understand how “the system” works in different countries, plus they can avail themselves
of local managerial talent and know-how by simply hiring experienced local managers and thereby detouring
the hazards of collaborative alliances with local companies. One of the lessons about cross-border partnerships
is that they are more effective in helping a company establish a beachhead of new opportunity in world markets
than they are in enabling a company to achieve and sustain global market leadership.

Cross-border alliances enable a growth-minded
company to widen its geographic coverage
and strengthen its competitiveness in foreign
markets, while at the same time offering flexibility
and giving a company some leeway in pursuing
its own strategy and retaining some degree of
operating control.

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Competing in Foreign Markets: The Three Competitive
Strategy Approaches

The issue of whether and how to vary the company’s competitive approach to fit specific market conditions and
buyer preferences in each host country or whether to employ essentially the same competitive strategy approach
in all countries is perhaps the foremost strategic issue companies must address when they operate in the markets
of multiple countries.12 Figure 7.1 shows the three strategy approaches a company can take to resolve this issue.

Multicountry Strategies—A “Think Local, Act Local” Approach
The bigger the cross-country differences in buyer preferences and behaviors, cultural traditions, and market
conditions, the stronger the case for a “think local, act local” approach to strategy making that involves customizing
a company’s product offerings and perhaps its basic competitive strategy to fit the specific buyer preferences
and expectations and market conditions in each country
where it competes. In such instances, employing a set of
multicountry or localized strategies calls for deliberately
tailoring the company’s product offering in each country to
be relevant and appealing to local buyers and undertaking
whatever country-specific strategic initiatives and market
maneuvers are needed to compete effectively against local
rivals and produce good business results. In effect, localized
strategies aim at growing a company’s international sales
and market share by addressing country-specific buyer needs and expectations and by employing customized
strategic approaches and actions to combat local rivals and build local competitive advantage. A think local, act
local approach to crafting strategy also becomes a good, if not necessary, strategic option when host governments
enact regulations requiring that products sold locally meet strict manufacturing specifications or performance
standards and when the trade restrictions of host governments are so diverse and complicated that they preclude
a uniform, coordinated worldwide competitive approach.

A think local, act local approach typically requires delegating considerable strategy-making latitude to local
managers who have firsthand knowledge of local market and competitive conditions. Localized strategies often
entail having plants produce different product versions for different local markets and selling these different
versions under different brand names (to signal the presence
of different product attributes and avoid the potential for
buyer confusion associated with using the same brand
name for different product versions). Local managers have
responsibility for matching marketing, advertising, sales
promotion campaigns, and distribution channel emphasis to
fit local cultures and circumstances. They determine how
best to respond to the fresh strategic initiatives and market maneuvers of local rivals, and they decide which
newly emerging local market opportunities to pursue.

CORE CONCEPT
Multicountry or localized strategies involve
tailoring a company’s product offering and
competitive approach country by country to match
differing buyer preferences, market conditions,
and competitive circumstances.

The bigger the competitive strategy variations
from country to country, the more an international
competitor’s overall strategy becomes a collection
of localized country strategies.

Chapter 7 • Strategies for Competing Internationally or Globally 159

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Figure 7.1 The Three Strategic Options for Competing Internationally

Multicountry
Strategies—A “Think

Local, Act Local”
Approach

Employ localized strategies—one for each country market where the company
competes—and delegate lead responsibility for crafting strategy to local managers.
l Tailor the company’s product offering in each country to local buyers’ tastes and

expectations.
l Adopt country-specific strategic initiatives and market maneuvers to pursue emerging

local market opportunities, compete effectively against local rivals, and build a local
competitive advantage.

l Match marketing, advertising, sales promotion campaigns, and distribution channel
emphasis to fit local customs, cultures, and market circumstances.

Global Strategies—
A “Think Global,

Act Global”
Approach

Employ the same strategy worldwide and coordinate strategic actions from central
headquarters.
l Pursue the same basic competitive strategy theme (low-cost, differentiation, best-cost, or

focused) in all country markets—a global strategy.
l Offer the same products worldwide, with only minor deviations from one country to

another should local market conditions dictate.
l Build a global brand name.
l Emphasize the same distribution channels and marketing approaches worldwide.
l Stress cross-country sharing of competitively valuable resources and capabilities and be

quick to transfer them to newly entered countries.
l Strive to build a global competitive advantage over other rivals that compete globally.

Hybrid—”Think
Global, Act Local”

Strategy
Approaches

Employ a combination global-local strategy orchestrated partly by headquarters and
partly by local managers.
l Pursue essentially the same basic competitive strategy theme (low-cost, differentiation,

best-cost, or focused) in all country markets.
l Give local managers the latitude to adapt the global competitive strategy as may be

required to accommodate local buyer preferences, be responsive to local market
conditions, and compete effectively against local rivals.

l Allow local managers the latitude to incorporate minor country-specific variations in
product attributes to better satisfy local buyers but try to sell these slightly different
product versions under the same brand name unless the versions are too dissimilar.

l Strive to build a brand name that is well-recognized and competitively potent in most all
countries; use local brand names only when necessary.

l Counter the actions of global rivals with global responses and the actions of important
local rivals with localized responses.

A number of companies employ a think local, act local approach to strategy making. Castrol, a BP-owned
specialist in motor oils and other lubricants, produces roughly 3,000 formulas of lubricants to meet the
requirements of different climates, vehicle types and uses, and equipment applications on land, at sea, and in
the air. In the food products industry, it is common for companies to vary the ingredients in their products and
sell the localized versions under local brand names to cater to country-specific tastes and eating preferences.
Government requirements for gasoline additives that help reduce carbon monoxide, smog, and other emissions
are almost never the same from country to country, requiring oil refineries to use localized strategies in supplying
gasoline with the required additives to service stations in different countries. Motor vehicle manufacturers
routinely produce smaller, differently-styled, and more fuel-efficient gasoline-powered vehicles for European
markets where roads are narrower and gasoline prices are two to three times higher than in the North American
market (where many consumers prefer larger vehicles); the models they manufacture for the Asian market are
different yet again—and local managers tailor the sales and marketing of these vehicles to local cultures, buyer
tastes, and market conditions as well.

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However, think local, act local strategies have three important drawbacks:

l Customizing a company’s products country by country may raise production and distribution costs
due to the greater variety of designs and components, the added time and expense associated with
shifting production over to each product version, and the complications of added inventory handling and
distribution logistics.

l A collection of localized multicountry strategies is not conducive to building a single worldwide
competitive advantage. When a company’s competitive approach and product offering varies from
country to country, the nature and size of any resulting competitive edge also tends to vary (and in
some—maybe many—countries, a company will fail to achieve any meaningful competitive edge over
local rivals). At the most, localized multicountry strategies are capable of producing a group of local
competitive advantages of varying types and degrees of strength.

l Localized strategies handicap a company in using its existing complement of resources, capabilities,
and product offerings to speed entry and competitive success in additional country markets. Because a
multicountry competitor’s various localized strategies are each structured around resources, capabilities,
and product offerings that are specific to competing in a particular country, its overall resource/capability
pool tends to be diverse but shallow with regard to any one specific resource or capability. In entering
new country markets, a company often finds its current pool of fragmented resources, capabilities,
and variety of product offerings does not match up well—in quantity or quality—with those needed to
support execution of still different customized product offerings and strategies for the target countries it
wants to enter. In such cases, the company has to retool certain resources and capabilities, build others
from scratch, and design/produce new versions of its products.

Global Strategies—A “Think Global, Act Global” Approach
While multicountry or localized strategies are best suited for industries where multicountry competition dominates
and a fairly high degree of local responsiveness is competitively imperative, global strategies are best suited for
globally competitive industries. A global strategy is one in which the key strategy elements are fundamentally
the same in all countries—a company sells much the same products under the same brand names everywhere,
uses much the same distribution channels in all countries, and uses the same set of resources/capabilities to power
its strategy in all the countries where it competes. Although
the company’s strategy or product offering is sometimes
slightly adapted to fit circumstances in a few host countries,
the company’s fundamental competitive approach (low-
cost, differentiation, best-cost, or focused) remains intact
worldwide and local managers adhere closely to the global
strategy.

The use of highly similar, if not identical, cross-border
strategies in every country enables a company to (1) build
global brands, (2) refine and strengthen the competitively
valuable resources and capabilities that underpin its global strategy, (3) grow the numbers of company personnel
with experience and know-how in implementing the strategy and conducting operations in foreign markets,
and (4) tightly integrate and coordinate the company’s strategic moves worldwide. Strategic initiatives to enter
more countries nearly always entail transferring sufficient supplies of these resources and capabilities (including
experienced company personnel with competitively important know-how) to the targeted countries to help power
successful market entry. Typically, companies employing a global strategy expand into most if not all nations
where there is significant buyer demand.

Whenever country-to-country differences are small enough to be accommodated within the framework of a
global strategy, a global strategy is preferable to localized strategies for several important reasons. A globally
standardized product offering better enables a company to capture scale economies in manufacturing and focus

CORE CONCEPT
A global strategy is one where a company
employs the same basic competitive approach
in all countries where it operates, sells much the
same productseverywhere, strives to build global
brands, and coordinates its actions worldwide with
strong headquarters control. It represents a “think
global, act global” approach.

Chapter 7 • Strategies for Competing Internationally or Globally 161

on establishing a global brand image and reputation, one linked to the same product attributes in all countries.
A global strategy and product offering simplifies company efforts to build a deep pool of competitively potent
resources and capabilities suitable for entering and competing successfully in the markets of countries across
the world; as these resources are refined and strengthened, the potential emerges to secure a sustainable low-
cost or differentiation-based competitive advantage over other rivals racing for world market leadership. Well-
managed companies pursuing a global strategy are in a uniquely strong position to transfer newly developed
product enhancements, best practices in performing value chain activities, and new production technologies
from location to location and to make all of the company’s operating units worldwide aware of recent successes,
failures, and new ideas for strategic and operational improvements.13 Figure 7.2 highlights the basic differences
between a localized or multicountry strategy and a global strategy.

Hybrid Strategies—“Think Global, Act Local” Approaches
Often, a company can be more effective in accommodating cross-country variations in buyer tastes, local
customs, and market conditions with a hybrid or combination “think global, act local” competitive strategy
approach. This middle-ground strategy entails using the same basic competitive theme (low-cost, differentiation,
best-cost, or focused) in each country but allowing local managers ample latitude to (1) incorporate minor
country-specific variations in product attributes to address local buyers’ needs and expectations more precisely,
and (2) make whatever adjustments in production, distribution, and marketing strategies are needed to create a
good match with local market conditions and compete more successfully against local rivals. Slightly different
product versions sold under the same brand name may suffice to satisfy local tastes, and it may be feasible to
accommodate these versions rather economically in the course of designing and manufacturing the company’s
product offerings.14 Complete standardization of product offerings and other strategy elements is not necessary,
especially when some aspects of localization can be accommodated easily and when it is more competitively
effective to adapt an otherwise global approach to better fit local needs and conditions. Even if local product
versions in a few countries are different enough to merit use of local brands, the benefits of striving to build and
strengthen a mostly global brand name elsewhere are unlikely to be impaired by very much.

Many Multinational Companies Employ Strategies That Are as Close to Global as Circumstances
Permit Many, if not most, multinational companies lean toward strategies with as many global elements as buyer
needs/preferences and market circumstances permit. But some degree of localization is common. McDonald’s,
KFC, and Starbucks have discovered ways to customize their menu offerings in various countries without
compromising costs, product quality, and operating effectiveness. Whirlpool has been globalizing its low-cost
leadership strategy in home appliances for more than 20 years, striving to standardize parts and components and
move toward worldwide designs for as many of its appliance products as possible. But Whirlpool has found it
necessary to continue producing different versions of refrigerators, washing machines, and cooking appliances
for consumers in various countries because local buyers’ needs and preferences in these countries have not
converged sufficiently to permit complete global standardization. Microsoft adapts its software to accommodate
cross-country differences in languages, spelling, and punctuation, but otherwise its approach to competing is very
similar. Video game developers localize their product offerings by designing games for specific cultures (like
football for North America and soccer for Europe and South America) and also for different devices (computers,
game players, mobile phones, and assorted other handheld devices). Multinational producers of motor oils and
lubricants necessarily have hundreds or thousands of product versions to accommodate different motor vehicle
and machine requirements and widely varying climatic conditions across the world, but many of the remaining
strategy elements they employ are global in nature.

Chapter 7 • Strategies for Competing Internationally or Globally 162

Figure 7.2 How a Multicountry or Localized Strategy Differs from a Global

Strategy

Localized
Multicountry

Strategy

l Customize the company’s competitive approach as
needed to fit market and business circumstances in
each host country—strong responsiveness to local
conditions.

l Sell different product versions in different countries
under different brand names—adapt product attributes
to fit buyer tastes and preferences country by country.

l Either design manufacturing plants to cost effectively
produce many different product versions or else
scatter plants across many host countries, each making
product versions for local markets.

l Use local suppliers when local governments have local
content requirements.

l Adapt marketing and distribution to the prevailing local
customs, culture, and market circumstances.

l Develop resources and capabilities appropriate to
each country’s localized strategy. Cross-border transfer
of resources is limited because of strategy variability.

l Give country managers fairly wide strategy-making
latitude and autonomy over local operations.

l Strive to gain local competitive advantages (the nature
of any such competitive advantages that are achieved
will tend to vary from country to country).

Country A Country B Country C

Country D Country E

Strategies vary
according to local

conditions

Global
Strategy

Country A Country B Country C

Country D Country E

l Pursue the same basic competitive strategy worldwide
(low-cost, differentiation, best-cost, focused low-cost,
focused differentiation)—minimal responsiveness to
local conditions.

l Sell the same products under the same brand name
worldwide. Concentrate on building global brands as
opposed to strengthening local/regional brands sold in
local/regional markets.

l Locate plants on the basis of maximum locational
advantage, usually in countries where production
costs are lowest but plants may be scattered if
shipping costs are high or other locational advantages
dominate.

l Use the best suppliers from anywhere in the world.

l Coordinate marketing and distribution worldwide;
make minor adaptations to local countries where
needed.

l Compete on the basis of the same resources and
capabilities worldwide. Stress rapid cross-country
transfers of new capabilities, products, and best
practices.

l Coordinate major strategic decisions worldwide. Give
local managers leeway to make minor adjustments to
the global strategy.

l Strive to achieve the same type of competitive
advantage over rivals in every country where the
company competes.

Strategies are
nearly identical

everywhere

Building Cross-Border Competitive Advantage
An international or global competitor can strive to gain competitive advantage (or counteract disadvantages)
in two important ways.15 One, it can locate certain facilities and value chain activities in particular countries to
lower costs or achieve greater product differentiation. Two, it can build competitive advantage vis-à-vis rivals
by doing a better job than they do of sharing and transferring competitively valuable resources and capabilities
across the borders of the countries in which it competes.

Chapter 7 • Strategies for Competing Internationally or Globally 163

Using Location to Build Competitive Advantage
To use location to build cross-border competitive advantage, a company must consider two issues: (1) whether to
concentrate each activity it performs in a few select countries or to disperse performance of the activity to many
nations, and (2) in which countries to locate particular activities.16 The classic reason for locating an activity in
a particular country is low cost.17

When to Concentrate Activities in a Few Locations It is advantageous for a company to concentrate its
activities in a limited number of locations when:

l The costs of manufacturing or other activities are significantly lower in some geographic locations than
in others. For example, much of the world’s athletic footwear is manufactured in Asia because of low
labor costs; much of the production of PC circuit
boards is located in Taiwan because of low costs
and the high technical skills of the Taiwanese labor
force.

l Significant scale economies exist in production or
distribution. The presence of significant economies
of scale in components production or final assembly
means a company can gain major cost savings from operating a few large plants (with output volumes
big enough to fully capture scale economies) as opposed to a host of small plants scattered across the
world. Likewise, a company may be able to reduce its distribution costs by using large-scale regional
distribution centers serving multiple countries (or maybe customers within a “large” radius) as opposed
to having smaller distribution centers serving a single country (or customers within a “small” radius).

l Sizable learning and experience benefits are associated with performing certain value chain activities.
In some industries, a manufacturer can lower unit costs, boost quality, or master a new technology
more quickly by concentrating production in a few plants. The key to riding down the learning curve
faster is to concentrate production in a few locations to increase the cumulative production volume at
each plant (and thus the experience of each plant’s workforce), thereby enabling quicker capture of the
productivity gains associated with greater learning and experience.

l Certain locations have superior resources, allow better coordination of related activities, or offer other
valuable advantages. A research unit or a sophisticated production facility may be situated in a particular
nation because of its pool of technically-trained personnel. Samsung became a leader in memory chip
technology by establishing a major R&D facility in Silicon Valley and transferring the know-how it
gained back to its operations in South Korea. When just-in-time inventory practices yield big cost
savings and/or when an assembly firm has long-term partnering arrangements with its key suppliers,
parts manufacturing plants may be clustered around final assembly plants. A customer-service center or
sales office may be opened in a particular country to help cultivate strong relationships with important
customers located nearby. Airbus established an assembly plant for its commercial aircraft in Alabama
because it had several major customers located in the United States.

When to Disperse Activities Across Many Locations In some instances, dispersing activities is more
advantageous than concentrating them. Such buyer-related activities as distribution, face-to-face selling, certain
sales promotion and advertising activities, and after-sales service usually must take place close to buyers. This
means physically locating the capability to perform such activities in every country or region where a firm
has many buyers or important large-volume customers. For example, firms that make mining and oil-drilling
equipment typically have service operations in many international locations to enable quick spare parts delivery,
speedy equipment repair, and hands-on technical assistance wherever their major customers have operations.
Most multinational companies distribute their products from multiple geographic locations, both to shorten
delivery times to customers and economize on shipping costs. Large public accounting firms have numerous
international offices to service the foreign operations of their multinational corporate clients.

Companies that compete internationally or
globally can pursue competitive advantages
in world markets by locating their value chain
activities in whatever nations prove most
advantageous.

Chapter 7 • Strategies for Competing Internationally or Globally 164

Dispersing performance of an activity to many locations is also competitively advantageous when small-
scale performance of an activity is cheaper than performing the activity at a central location. All major motor
vehicle companies operate multiple assembly plants rather than a single giant assembly plant; very few global
companies would accept the penalty of long delivery times and high shipping costs associated with using a
single giant distribution center for shipping orders to customers worldwide. The presence of high import tariffs in
many countries can make it expensive to perform production and distribution activities outside these countries;
rather, it may prove cheaper to disperse performance of all activities from production forward to end users to
each of the high-tariff countries rather than incur the costs of their respective high import tariffs. In addition,
dispersing activities to multiple foreign locations helps hedge against the risks of fluctuating exchange rates,
supply interruptions (due to strikes or transportation delays), and adverse political developments. Such risks are
usually greater when activities are concentrated in one or just a few locations.

Even though multinational and global firms have strong reasons to disperse buyer-related activities to many
international locations, such activities as materials procurement, parts manufacture, finished goods assembly,
technology research, and new product development can frequently be decoupled from buyer locations and
performed wherever advantage lies. Components can be made in Mexico; technology research done in Frankfurt;
new products developed and tested in Phoenix; and assembly plants located in Spain, Brazil, Malaysia, or South
Carolina. Capital can be raised in whatever country it is available on the best terms.

Cross-Border Sharing and Transfer of Resources and Capabilities
to Build Competitive Advantage
When a company has competitively valuable resources and capabilities, it often makes sense to leverage them
further by expanding internationally and initiating a long-term strategic offensive to enter a number of country
markets. If its resources and capabilities prove potent in competing in newly entered country markets, then not
only does the company grow sales and profits but it extends its competitiveness and potential for competitive
advantage over a broader geographic domain, perhaps in time enabling the company to contend for global
market leadership. As an international or global company develops a market presence in many countries, it
should stay alert for opportunities to transfer some of its competitively powerful resources and capabilities from
countries where it has established competitively strong market positions to countries where it is competitively
weaker. Such infusions can be the extra boost subsidiaries with comparatively weaker competitive strength need
to battle local rivals on even terms, or better still, to begin to outcompete them.

Another way to enhance a company’s competitiveness internationally is to quickly transfer important new
technological know-how, recently developed core competencies, newly-implemented best practices, and ways to
improve/strengthen certain capabilities from its operations in one country to its operations in other countries. For
instance, if a company discovers ways to assemble a product faster and more cost effectively at one plant, then that
know-how can be transferred to its assembly plants in other countries. If a company’s North American operations
develop a core competence in speeding next-generation products to market more quickly, it can communicate
these methods to company operations elsewhere via Internet conferencing or by transferring some of its North
American personnel with the requisite expertise to its operations in other parts of the world. Whirlpool, the
leading global manufacturer of home appliances with 70 manufacturing and technology research centers around
the world and sales in nearly every country, uses an online global information technology platform to quickly and
effectively transfer key product innovations and improved production techniques both across national borders
and across its various appliance brands. Disney has been enormously adept at transferring its considerable
expertise in all aspects of its theme park operations in the United States to recently established Disney parks in
Tokyo, Hong Kong, Shanghai, and Paris. Disney’s cross-border transfers of its competitively potent resources
and capabilities in theme park design and operation, together with the universal appeal of the Disney name in
family entertainment products, have enabled it to achieve a global differentiation-based competitive advantage
in theme parks and family entertainment. Walmart’s international operations strategy involves transferring its
considerable resource capabilities in distribution and discount retailing to its retail units in 19 foreign countries.
Televisa, Mexico’s largest media company, used its expertise in Spanish culture and linguistics to become the
world’s most prolific producer of Spanish-language soap operas.

Chapter 7 • Strategies for Competing Internationally or Globally 165

Companies like Rolex, Tiffany, Chanel, Burberry, and Gucci have used their powerful brand names to successfully
enter country markets far beyond their home-country origins.18 The luxury brand name of each of these companies
represents a valuable competitive asset that can readily be shared by all of the brand’s international stores,
enabling them to attract buyers and sell their products over a wider geographic area than would otherwise occur.

Cross-border sharing of powerful brand names or important technological know-how and/or the transfer of
personnel with competitively valuable expertise from operations in one country to another country is a cost-
efficient and competitively effective way of leveraging existing resources and capabilities into competitive
success in a growing number of geographic markets. The cost of sharing or transferring already developed
resources and capabilities across country borders is low in comparison to the time and considerable expense it
takes for a country subsidiary to build matching resources and capabilities solely on its own initiative. Moreover,
deployment of the company’s valuable resources and capabilities across many countries spreads the fixed
development costs over a greater volume of unit sales, thus contributing to low unit costs and a potential cost-
based competitive advantage in recently entered geographic markets. Even if the shared/transferred resources or
capabilities have to be adapted to local market conditions, this can usually be done at low additional cost.

Furthermore, deploying a competitively valuable resource or capability to a growing number of geographic
markets contributes to the development of even greater resource depth and expert capability, especially if company
managers attend to the task of finetuning, updating, and enhancing its valuable resources and capabilities.
Resource/capability transfers, coupled with diligent internal efforts to refine and enhance competitively powerful
resources and capabilities, are a company’s two best approaches to achieving dominating depth in one or more
competitively valuable areas.19 Dominating depth in a competitively valuable resource, capability, or value chain
activity is a strong basis for sustainable competitive advantage over not just domestic rivals but over international
and global rivals as well.

However, cross-border resource-sharing and transfers of capabilities are not a guaranteed recipe for competitive
success in every market entered. Whether a strong resource or competitive capability can confer competitive
advantage in a different country depends on the conditions of rivalry in each particular country market and on
the extent to which lifestyles and buying habits vary internationally. While an entering firm may well possess
valuable resources and/or capabilities that yield a competitive advantage elsewhere, an entering firm may find
itself at a competitive disadvantage because local rivals have substitute resources and/or capabilities that are even
more competitively potent. Differing lifestyles and buying habits or preferences can result in particular resources
and capabilities being valuable in some countries and not so valuable in others. Sometimes a popular or well-
regarded brand in one country turns out to have little competitive clout against local brands in another country
because local buyers view the products offerings of local firms as more appealing or because the national pride
of local buyers causes them to support local firms over a particular foreign entrant or because many local buyers
are somehow “put off” by the ambience of a foreign entrant’s local stores or its advertising or its merchandising
techniques or some other factor.

Profit Sanctuaries and Global Strategic Offensives
Profit sanctuaries are country markets (or geographic regions) in which a company derives substantial profits
because of its strong or protected market position. In most
cases, a company’s biggest and most strategically crucial
profit sanctuary is its home market, but international and
global companies may also enjoy profit sanctuary status
in other nations where they have a strong competitive
position, big sales volume, and attractive profit margins.
Companies that compete globally are likely to have more
profit sanctuaries than companies that compete in just a few
country markets; a domestic-only competitor, of course,
can have only one profit sanctuary.

CORE CONCEPT
Companies with large, protected profit
sanctuaries have an advantage in competing
against companies that don’t have a protected
sanctuary. Companies with multiple profit
sanctuaries have an edge in competing against
rivals with only a single sanctuary.

Chapter 7 • Strategies for Competing Internationally or Globally 166

Nike, which markets its products in about 200 countries and had fiscal 2023 revenues of $51.2 billion, has two
major geographic profit sanctuaries: North America (where it reported 2023 operating profits of $5.5 billion)
and Greater China (where it reported 2023 operating earnings of $2.3 billion). McDonald’s, with over 40,000
locations (95 percent of which are franchised) in 111 countries, has its biggest profit sanctuary in the United
States, which accounted for between 45 percent and 54 percent of the company’s operating profits in 2020–2023.
Starbucks’ two biggest geographic profit sanctuaries during 2018-2023 were in the United States and China.

Offensive Attacks on Global Rivals
While international or global competitors can fashion a strategic offensive based on any of the nine offensive
strategy options discussed in Chapter 6, there are two additional offensive strategies particularly suited for
companies competing internationally or globally:20

1. Attack a rival’s profit sanctuaries. Launching an offensive in a country market where a key rival earns
a big percentage of its profits can put the rival on the defensive, forcing it to spend more on marketing/
advertising, trim its prices, boost product innovation
efforts, or otherwise undertake actions that raise its
costs and reduce its profit margins. Such offensives
are particularly attractive when the attacker (1) has
competitively valuable resources and capabilities
that it can divert from other countries to help
power its offensive attack and (2) can draw upon
the financial strength of profit sanctuaries in other
locations to help subsidize its razor-thin margins
or even losses in the country market where the
rival is being attacked. Supporting an offensive
with resources, capabilities, and profits in other market locations is called cross-market subsidization.
While attacking a rival’s profit sanctuary violates the principle of attacking competitor weaknesses
instead of competitor strengths, such an attack can nonetheless prove useful when it poses a serious
threat to a rival’s business and forces it to devote added time and attention to defending a market that
is important to its competitive well-being and overall profitability. To the extent that a major rival’s
profits can be significantly eroded in an important profit sanctuary, its financial resources may be
sufficiently weakened to enable the attacker to gain the upper hand and build market momentum in
several geographic markets, not just in the market where the offensive is being waged. The bigger the
potential for such outcomes, the greater the appeal of attacking a rival’s profit sanctuary.

2. Dump goods at cut-rate prices in the markets of rivals. A company is said to be dumping when it
sells its goods in certain countries at prices that are (1) well below the prices at which it normally sells
elsewhere or (2) well below its full costs per unit. Generally, dumping occurs because a company has
excess production capacity and is anxious to keep
this capacity running rather than suffer the cost
penalty associated with idle capacity. Companies
that decide to dump goods at deep discounts
usually keep their selling prices high enough to
cover variable costs per unit, thereby limiting
their losses on each unit to some percentage of
fixed costs per unit. Dumping can be an appealing
offensive strategy in either of two instances. One is
when dumping drives down the going price so far in the targeted country that local rivals are quickly put
in dire financial straits (perhaps even forced into bankruptcy or driven out of business). For dumping to
pay off in this instance, however, the dumping company needs to have deep enough financial pockets to
cover any losses from its own sales at below-market prices, and the targeted rivals need to be financially

CORE CONCEPT
Cross market subsidization entails supporting
competitive offensives in one market with
resources, capabilities, and profits diverted from
operations in another market. Such competitive
tactics can be a powerful weapon against a rival
with only one profit sanctuary or limited resources
and capabilities.

CORE CONCEPT
A company is said to be engaging in dumping
when it sells its goods in certain countries at
prices that are either well below the prices at
which it normally sells elsewhere or else well
below its full costs per unit.

Art Thompson
Sticky Note
change “nine” to ” ten”

Art Thompson
Highlight

Chapter 7 • Strategies for Competing Internationally or Globally 167

weak to begin with so the onset of dumping at below-market prices quickly punishes their financial
performance by a significant amount.

The second instance in which dumping becomes an attractive strategy is when a company with unused
production capacity discovers it is cheaper to keep producing (as long as the selling prices cover average
variable costs per unit) than to incur the cost burdens associated with idle plant capacity. By keeping its
plants operating at or near capacity, not only may a dumping company be able to cover variable costs
and earn a contribution to fixed costs, but it may also be able to use its below-market prices to draw
price-sensitive customers away from rivals, then attentively court these new customers and retain their
business when prices later begin a gradual rise back to normal market levels. Thus, dumping may prove
useful as a way of entering the market of a particular country and establishing a customer base.

However, dumping strategies run a high risk of host government retaliation on behalf of the adversely
affected domestic companies. Most all governments can be expected to retaliate against dumping by
imposing special tariffs or duties on goods being imported from the countries of the guilty companies.
Indeed, as the trade among nations has mushroomed over the past ten years, most governments have
joined the World Trade Organization (WTO), which promotes fair trade practices among nations and
has authority to police dumping. The WTO allows member governments to impose tariffs or duties on
the imports of companies that have engaged in dumping wherever there is material injury to domestic
competitors. Companies found guilty of dumping frequently come under pressure from their own
government to cease dumping, especially if the imposition of higher tariffs or duties adversely affect
innocent companies based in the same country or if widening imposition of special tariffs threatens to
deteriorate into a trade war.

Key Points
Companies opt to compete in the world marketplace to gain access to new customers, achieve lower costs, and
thereby become more cost competitive, to better leverage their competitively valuable resources and capabilities,
and to spread their business risk across a wider market area. Four strategic issues are unique to competing across
national boundaries:

1. Whether to customize the company’s offerings in each different country market to match local buyers’
tastes and preferences or to offer a mostly standardized product worldwide.

2. Whether to employ essentially the same basic competitive strategy in all countries or modify the strategy
country by country to create a better fit with local market and competitive conditions.

3. Where to locate the company’s production facilities, distribution centers, and customer service operations
to realize the greatest location-related advantages.

4. When and how to efficiently transfer some of the company’s competitively powerful resources and
capabilities from countries where it has a strong market position (1) to countries where it is competitively
weak and (2) to countries it is preparing to enter—such transfers help company subsidiaries in these
countries more effectively battle local rivals for sales and market share.

Multicountry competition refers to situations where competition in one national market is largely independent
of competition in another national market—there is no “international market,” just a collection of self-contained
country (or maybe regional) markets. Global competition exists when competitive conditions across national
markets are linked strongly enough to form a true world market and when leading competitors compete head-
to-head in many different countries.

There are five strategic ways for a company to establish a competitive presence in the markets of other countries:
(1) maintaining a national (one-country) production base and exporting goods to foreign markets, (2) licensing

Chapter 7 • Strategies for Competing Internationally or Globally 168

foreign firms to use the company’s technology or produce and distribute the company’s products, (3) employing a
franchising strategy, (4) using acquisitions or internal startup to enter new foreign markets, and (5) using strategic
alliances or other collaborative partnerships to enter a foreign market or strengthen a firm’s competitiveness.

A company has three strategic options for tailoring its international competitive approach and product offering:
(1) localized multicountry strategies based on a “think local, act local” approach, (2) global strategies based on a
“think global, act global” approach, and (3) hybrid or combination “think global, act local” strategy approaches.
A “think local, act local” approach is appropriate for industries where multicountry competition dominates. A
localized multicountry approach calls for a company to vary its product offering and competitive approach from
country to country to accommodate differing buyer preferences and market conditions. A “think global, act
global” approach works best in markets that are globally competitive or beginning to globalize, whereas a global
strategy-making approach involves employing the same basic competitive strategy (low-cost, differentiation,
best-cost, focused) in all country markets and marketing essentially the same products under the same brand
names in all countries where the company operates. A “think global, act local” approach can be used when
it is feasible for a company to employ essentially the same basic competitive strategy in all markets, but still
customize its product offering and some aspects of its operations to fit local market circumstances.

There are two important ways for a firm competing internationally or globally to pursue competitive advantage
or enhance an already existing competitive advantage: (1) it can locate certain facilities and value chain activities
in countries that enable it to lower costs or achieve greater product differentiation and (2) it can strengthen its
competitiveness vis-à-vis rivals by being more nimble in efficiently and effectively transferring competitively
valuable competencies and capabilities from one country to another.

Two types of offensive strategies are particularly suitable for companies operating internationally or globally:
(1) attack a rival’s profit sanctuaries and (2) dump goods at cut-rate prices in the markets of important rivals.
Dumping strategies, however, run the risk that government officials in the countries where dumping occurs will
respond by imposing high import tariffs, quotas, or other punitive measures on the offending foreign companies
in order to protect its local companies from “unfair competition.”

What Is Strategy
and Why Is It Important?

What Do We Mean by “Strategy”?

Strategy and the Quest for Competitive Advantage

A Company’s Strategy is Partly Proactive and Partly Reactive

Strategy and Ethics: Passing the Test
of Moral Scrutiny

The Relationship Between a Company’s Strategy and Its Business Model

What Makes a Strategy a Winner?

Why Crafting and Executing Strategy Are Important Tasks

The Road Ahead

Key Points

Charting a Company’s Long-Term Direction: Vision, Mission,
Objectives, and Strategy

What Does the Strategy-Making,
Strategy-Executing Process Entail?

Task 1: Developing a Strategic Vision, Mission Statement, and Set of Core Values

Task 2: Setting Objectives

Task 3: Crafting A Strategy

Task 4: Implementing and Executing the Strategy

Task 5: Evaluating Performance and Initiating Corrective Adjustments

Corporate Governance: The Role of the Board of Directors in the Strategy-Making, Strategy-Executing Process

Key Points

Evaluating a Company’s
External Environment

THE STRATEGICALLY RELEVANT FACTORS
INFLUENCING A COMPANY’S EXTERNAL ENVIRONMENT

Assessing a Company’s Industry and Competitive Environment

Question 1: What Competitive Forces Do Industry
Members Face and How Strong Are They?

Question 2: What Factors Are Driving Industry Change and What Impact Will They Have?

Question 3: What Market Positions Do Rivals Occupy—Who Is Strongly Positioned and Who Is Not?

Question 4: What Strategic Moves Are Rivals Likely to Make Next?

Question 5: What Are the Key Factors for Future Competitive Success?

Question 6: Is the Industry Outlook Conducive to Good Profitability?

Key Points

Evaluating a Company’s Resources and Ability to Compete Successfully

QUESTION 1: HOW WELL IS THE COMPANY’S PRESENT STRATEGY WORKING?

QUESTION 2: WHAT ARE THE COMPANY’S IMPORTANT RESOURCES AND CAPABILITIES AND DO THEY HAVE ENOUGH COMPETITIVE POWER TO PRODUCE A COMPETITIVE ADVANTAGE OVER RIVALS?

QUESTION 3: WHAT ARE THE COMPANY’S COMPETITIVELY IMPORTANT STRENGTHS AND WEAKNESSES AND ARE THEY WELL-SUITED TO CAPTURING ITS BEST MARKET OPPORTUNITIES AND DEFENDING AGAINST EXTERNAL THREATS?

QUESTION 4: ARE THE COMPANY’S PRICES AND COSTS COMPETITIVE WITH THOSE OF KEY RIVALS, AND DOES IT HAVE AN APPEALING CUSTOMER VALUE PROPOSITION?

QUESTION 5: IS THE COMPANY COMPETITIVELY STRONGER OR WEAKER THAN KEY RIVALS?

QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS DOES TOP MANAGEMENT NEED TO ADDRESS IN CRAFTING A STRATEGY TO FIT THE SITUATION?

KEY POINTS

The Five Generic Competitive Strategy Options: Which One to Employ?

THE FIVE GENERIC COMPETITIVE STRATEGIES

BROAD LOW-COST PROVIDER STRATEGIES

BROAD DIFFERENTIATION STRATEGIES

FOCUSED (OR MARKET NICHE) STRATEGIES

BEST-COST PROVIDER STRATEGIES

SUCCESSFUL COMPETITIVE STRATEGIES ARE ALWAYS UNDERPINNED BY RESOURCES AND CAPABILITIES THAT ALLOW THE STRATEGY TO BE WELL-EXECUTED

KEY POINTS

Supplementing the Chosen Competitive Strategy—
Other Important Strategy Choices

GOING ON THE OFFENSIVE—STRATEGIC OPTIONS TO IMPROVE A COMPANY’S MARKET POSITION

DEFENSIVE STRATEGIES—PROTECTING MARKET POSITION AND COMPETITIVE ADVANTAGE

WEBSITE STRATEGIES

OUTSOURCING STRATEGIES

VERTICAL INTEGRATION STRATEGIES:
OPERATING ACROSS MORE STAGES
OF THE INDUSTRY VALUE CHAIN

STRATEGIC ALLIANCES AND PARTNERSHIPS

MERGER AND ACQUISITION STRATEGIES

CHOOSING APPROPRIATE FUNCTIONAL-AREA STRATEGIES

TIMING A COMPANY’S STRATEGIC MOVES

KEY POINTS

Strategies for Competing
Internationally or Globally

WHY COMPANIES DECIDE TO ENTER FOREIGN MARKETS

WHY COMPETING ACROSS NATIONAL BORDERS CAUSES STRATEGY MAKING TO BE MORE COMPLEX

THE CONCEPTS OF MULTICOUNTRY COMPETITION AND GLOBAL COMPETITION

STRATEGY OPTIONS FOR ESTABLISHING A COMPETITIVE PRESENCE IN FOREIGN MARKETS

COMPETING IN FOREIGN MARKETS: THE THREE COMPETITIVE STRATEGY APPROACHES

BUILDING CROSS-BORDER COMPETITIVE ADVANTAGE

PROFIT SANCTUARIES AND GLOBAL STRATEGIC OFFENSIVES

Key Points

Diversification Strategies

What Does Crafting a Diversification Strategy Entail?

CHOOSING THE DIVERSIFICATION PATH:
RELATED VS. UNRELATED BUSINESSES

EVALUATING THE STRATEGY OF A DIVERSIFIED COMPANY

KEY POINTS

Strategy, Ethics, and Social Responsibility

What Do We Mean by Business Ethics?

where do Ethical standards come from?

THE THREE CATEGORIES OF MANAGEMENT MORALITY

WHAT ARE THE DRIVERS OF UNETHICAL STRATEGIES AND BUSINESS BEHAVIOR?

WHY SHOULD COMPANY STRATEGIES BE ETHICAL?

Strategy, Social Responsibility, and Corporate Citizenship

KEY POINTS

Building an Organization
Capable of Good Strategy Execution

A FRAMEWORK FOR EXECUTING STRATEGY

BUILDING AN ORGANIZATION CAPABLE OF GOOD STRATEGY EXECUTION: THREE KEY ACTIONS

STAFFING THE ORGANIZATION

DEVELOPING AND STRENGTHENING EXECUTION-CRITICAL RESOURCES AND CAPABILITIES

STRUCTURING THE ORGANIZATION AND WORK EFFORT

KEY POINTS

Managing Internal Operations:
Actions That Promote
Good Strategy Execution

Allocating Needed Resources to Execution-Critical Activities

ENSURING THAT POLICIES AND PROCEDURES FACILITATE STRATEGY EXECUTION

ADOPTING BEST PRACTICES AND EMPLOYING PROCESS MANAGEMENT TOOLS TO IMPROVE EXECUTION

INSTALLING INFORMATION AND OPERATING SYSTEMS

TYING REWARDS AND INCENTIVES DIRECTLY TO ACHIEVING GOOD PERFORMANCE OUTCOMES

KEY POINTS

Corporate Culture and Leadership—Keys to Good Strategy Execution

INSTILLING A CORPORATE CULTURE THAT PROMOTES GOOD STRATEGY EXECUTION

LEADING THE STRATEGY EXECUTION PROCESS

KEY POINTS

169Chapter 8

Diversification Strategies

169

Strategy: Core Concepts and Analytical Approaches

An e-book marketed by McGraw Hill LLC

Arthur A. Thompson, The University of Alabama 8th Edition, 2025–2026

169

Chapter 8
Diversification Strategies

The question of diversification—where and how to expand into new businesses—is the heart of corporate
strategy.
—Ron Adner, Professor, Author, and Consultant

Fit between a parent and its businesses is a two-edged sword: A good fit can create value; a bad one can
destroy it.
—Andrew Campbell, Michael Gould, and Marcus Alexander

Corporate diversification that exploits existing resources and capabilities in new markets or builds new core
competencies is likely be a source of competitive advantage.
—Asli M. Arikan, Professor and Consultant

In this chapter, we move up one level in the strategy-making hierarchy, from strategy making in a single-
business enterprise to strategy making in a diversified enterprise. Because a diversified company is a
collection of individual businesses, the strategy-making task is more complicated. In a one-business

company, managers have to come up with a game plan for competing successfully in a single industry arena or
a single line of business—the result is what was labeled as business strategy in Chapter 2. But in a diversified
company, the strategy-making challenge involves assessing multiple industry environments and developing a
set of business strategies, one for each industry arena (or line of business) in which the diversified company
operates. And top executives at a diversified company must still go one step further and devise a companywide
(or corporate) strategy for improving the attractiveness and performance of the company’s overall business
lineup and for making a rational whole out of its diversified collection of individual businesses and individual
business strategies.

In the first portion of this chapter, we describe what crafting a diversification strategy entails, when and why
diversification makes good strategic sense, and the pros and cons of related versus unrelated diversification
strategies. The second part of the chapter looks at how to evaluate the attractiveness of a diversified company’s
business lineup, how to decide whether it has a good diversification strategy, and the strategic options for
improving a diversified company’s future performance.

Chapter 8 • Diversification Strategies 170

What Does Crafting a Diversification Strategy Entail?
The task of crafting a diversified company’s overall or corporate strategy falls squarely in the lap of top-level
executives and involves four distinct facets:

1. Picking new industries to enter and deciding on the means of entry. Pursuing diversification requires
top-level decisions about which industries to enter (and why these make good business sense) and then,
for each industry, whether to enter by acquiring a company already in the target industry, internally
developing its own new business in the target industry, or forming a joint venture or strategic alliance
with another company.

2. Pursuing opportunities to leverage cross-business value chain relationships and strategic fits into
competitive advantage. The task here is to determine whether there are opportunities to strengthen a
diversified company’s businesses by transferring competitively valuable resources and capabilities from
one business to another, combining the related value chain activities of different businesses to achieve
lower costs, sharing the use of a powerful and well-respected brand name across multiple businesses,
and encouraging cross-business knowledge sharing and collaboration to create competitively valuable
new resources and capabilities.

3. Evaluating the growth and profitability prospects of each of the company’s businesses, establishing
investment priorities for each business, and then using these priorities to steer corporate resources to
individual businesses. Typically, this translates into investing aggressively and pursuing rapid-growth
strategies in attractive businesses with the best profit prospects, investing cautiously in businesses with just
average prospects, initiating profit improvement or turnaround strategies in under-performing businesses
that have potential, and divesting businesses with unacceptable prospects. A corporate parent’s actions
to help strengthen the long-term competitive positions and profitability of its individual businesses can
include providing managerial expertise, funding for desirable new operating improvements and capital
investments, assorted kinds of administrative support from central headquarters, and other resources
that may be useful (which may include acquiring similar businesses and merging their operations into
an existing business).

4. Initiating actions to boost the combined performance of the corporation’s collection of businesses.
Strategic options for improving the corporation’s overall performance include (1) sticking closely with
the existing business lineup and pursuing opportunities presented by these businesses, (2) broadening
the scope of diversification by entering additional industries, (3) retrenching to a narrower scope of
diversification by divesting poorly performing businesses that are no longer attractive or that don’t fit
into management’s long-range plans, and (4) broadly restructuring the entire company by divesting
some businesses and acquiring others so as to put a whole new face on the company’s business lineup.

The demanding and time-consuming nature of these four tasks explains why top executives in diversified
companies generally refrain from becoming immersed in the details of crafting and executing business-level
strategies. Rather, the normal procedure is to delegate lead responsibility for business strategy to the heads of
each business, giving them the latitude to develop strategies suited to the particular industry and competitive
circumstances in which their business operates, and holding them accountable for producing good financial and
strategic results.

Figure 8.1 shows the things to look for in identifying a company’s diversification strategy. Having a clear fix on
the main elements of a company’s diversification strategy sets the stage for evaluating how good the strategy is
and proposing strategic moves to boost the company’s performance.

Chapter 8 • Diversification Strategies 171

Figure 8.1 Identifying a Diversified Company’s Strategy

Is the
company’s

diversification based
narrowly in a few

industries or broadly
in many

industries?

A
Diversified
Company’s

Strategy

Are the
businesses the

company has diversified
into related, unrelated

or a mixture
of both?

Is the
scope of company
operations mostly

domestic, increasingly
multinational, or

global?

Any recent
moves to strengthen

the company’s
positions in existing

businessses?
Any recent
moves to

build positions
in new

industries?

Any recent
moves to divest
weak business

units?

Any effort
to capture

cross-business
strategic fits?

What is the
company’s approach to
allocating investment
capital and resources

across its present
businesses?

When to Consider Diversifying
So long as a company has its hands full trying to capitalize on profitable growth opportunities in its present
industry, there is no urgency to diversify into other businesses. But it is risky for a single-business company
to continue to keep all of its eggs in one industry basket when, for whatever reasons, its long-term prospects
for continued good performance start to dim. Changing industry conditions—new technologies, product
innovation that stimulates the introduction of substitute products, fast-shifting buyer preferences, or intensifying
competition—can undermine a company’s ability to deliver ongoing gains in revenues and profits. Profitable
growth opportunities are typically limited in mature industries and markets where buyer demand is flat or
declining. Thus, diversification always merits strong consideration at single-business companies when industry
conditions take a turn for the worse and are expected to be long-lasting.

However, there are four other instances in which a company becomes a prime candidate for diversifying:1

l When it spots opportunities for expanding into industries whose technologies and/or products
complement its present business.

l When it can leverage existing resources and capabilities by expanding into businesses where these same
resources and capabilities are key success factors and valuable competitive assets.

Chapter 8 • Diversification Strategies 172

l When diversifying into closely related businesses opens new avenues for reducing costs.

l When it has a powerful and well-known brand name that can be transferred to the products of other
businesses and help drive the sales and profits of such businesses to higher levels.

The decision to diversify presents wide-open possibilities. A company can diversify into closely related businesses
or into totally unrelated businesses. It can diversify its present revenue and earning base to a small extent (so that
new businesses account for less than 15 percent of companywide revenues and profits) or to a major extent (so
that new businesses produce 30 percent or more of revenues and profits). It can move into one or two large new
businesses or a greater number of small ones. It can achieve multibusiness/multi-industry status by acquiring an
existing company already in a business/industry it wants to enter, forming its own new business subsidiary to
enter a promising industry, and/or forming a joint venture with one or more companies to enter new businesses.
But in every case, a decision to diversify must start with good economic and business justification for doing so.

Moves to Diversify into a New Business Should Pass Three Tests
Diversification must do more for a company than just spread its business risk across more industries. In principle,
diversification into a new business cannot be considered wise or justifiable unless it offers good prospects of
added long-term economic value for shareholders—value that shareholders cannot capture on their own by
purchasing stock in companies in different industries or investing in mutual funds or exchange-traded funds
(ETFs) to spread their investments across several industries. A move to diversify into a new business stands little
chance of producing added long-term shareholder value unless it can pass three tests:2

1. The industry attractiveness test. Whether an industry is attractive depends chiefly on the presence
of industry and competitive conditions conducive to earning as good or better profits and return on
investment than the company is earning in its present business(es). It is hard to justify diversifying
into an industry where profit expectations are lower than in the company’s present businesses. For an
industry to be attractive it should also have resource/capability requirements that are well-matched to
the resources and capabilities of the company considering entry and offer good opportunities for long-
term growth.

2. The cost-of-entry test. The cost to enter the target industry must not be so high it erodes the potential for
good profitability. A Catch-22 can prevail here, however. The more attractive an industry’s prospects
are for growth and good long-term profitability, the more expensive it can be to get into. Entry barriers
for startup companies are likely to be high in attractive industries—if barriers were low, a rush of new
entrants would soon erode the potential for high profitability. And buying a well-positioned company
in an appealing industry often entails a high acquisition cost that makes passing the cost-of-entry test
less likely. For instance, suppose the price to purchase a company is $3 million and the company to be
acquired is earning after-tax profits of $200,000 on an equity investment of $1 million (a 20 percent
annual return). Simple arithmetic requires that the profits be tripled if the purchaser (paying $3 million)
is to earn the same 20 percent return. Building the acquired firm’s earnings from $200,000 to $600,000
annually could take several years—and require additional investment on which the purchaser would also
have to earn a 20 percent return. Since the owners of a successful and growing company usually demand
a price that reflects their business’s profit prospects, it’s easy for the acquisitions of well positioned and/
or attractively profitable companies to fail the cost-of-entry test. One must further recognize that the
true costs of entry entail transaction costs in completing an acquisition deal. These include the costs of
searching for an attractive acquisition target; the costs of evaluating its worth and negotiating a deal; the
fees that often are paid to investment banking firms, lawyers, and others to advise them and assist with
the deal-making process; the legal and accounting costs of conducting due diligence; and the costs of
integrating the acquired company into the parent company’s operations.

Chapter 8 • Diversification Strategies 173

3. The better-off test. Diversifying into a new business must offer potential for the company’s existing
businesses and the new business to perform better together under a single corporate umbrella than they
would perform operating as independent stand-
alone businesses—an outcome known as synergy.
For example, let’s say Company A diversifies by
purchasing Company B in another industry. If A
and B’s consolidated profits in the years to come
prove no greater than what each could have earned
on its own, then A’s diversification won’t provide
its shareholders with added value. Company A’s
shareholders could have achieved the same 1 + 1
= 2 result by merely purchasing stock in Company B. Diversification does not result in added long-
term value for shareholders unless it produces a 1 + 1 = 3 effect where sister businesses perform better
together as part of the same firm than they could have performed as independent companies.

Diversification moves that satisfy all three tests have the greatest potential to grow shareholder value over the
long term. Diversification moves that can pass only one or two tests are suspect.

Choosing the Diversification Path: Related vs.
Unrelated Businesses

Once a company decides to diversify, its first big strategy decision is whether to diversify into related businesses,
unrelated businesses, or some mix of both (see Figure 8.2). Businesses are said to be related when their value
chains possess competitively valuable cross-business relationships that present opportunities for the businesses
to perform better under the same corporate umbrella than
they could by operating as stand-alone entities. The big
appeal of related diversification is to build shareholder
value by leveraging these cross-business relationships into
competitive advantage, thus allowing the company as a
whole to perform better than just the sum of its individual
businesses. Businesses are said to be unrelated when the
activities that compose their respective value chains are
so dissimilar that no competitively valuable cross-business
relationships are present. One must be careful about assuming different businesses are unrelated just because
their products are quite different. For example, Citizen Watch Company is engaged in three businesses—
watches, machine tools, and flat panel displays—that seem on the surface to be unrelated, but hidden from
view one discovers that these businesses are indeed related because the value chains of all three products
involve production activities that rely heavily on common miniaturization know-how and advanced precision
technologies. The lesson here is that it is not product relatedness that defines a related diversification strategy.
Rather, what makes businesses related is the relatedness of their key value chain activities and the specialized
resources and capabilities that enable these activities.

The next two sections explore the ins and outs of related and unrelated diversification.

CORE CONCEPT
Creating added long-term value for shareholders
via diversification requires building a multibusiness
company where the whole is greater than the
sum of its parts—such 1 + 1 = 3 effects are called
synergy.

CORE CONCEPT
Related businesses possess competitively
valuable cross-business value chain matchups.
Unrelated businesses have dissimilar value chains
containing no competitively useful cross-business
relationships.

Chapter 8 • Diversification Strategies 174

Figure 8.2 The Three Fundamental Strategy Alternatives for Pursuing Diversification

Diversify into
Related Businesses

Diversify into
Unrelated Businesses

Diversify into Both Related
and Unrelated Businesses

Diversification
Strategy
Options

The Case for Diversifying into Related Businesses
A related diversification strategy involves building the company around businesses whose value chains possess
competitively valuable strategic fits, as shown in Figure 8.3. Strategic fit exists whenever one or more activities
in the value chains of different businesses are sufficiently similar to present opportunities for one or more of the
following:3

l Transferring competitively valuable resources and capabilities from one business to enhance the
competitiveness and performance of a sister business. Frequently, a company pursuing related
diversification has one or more businesses with competitively valuable resources, expertise, and know-
how in performing certain value chain activities that
are well-suited to performing closely related value
chain activities in a sister business. General Mills,
for example, over several decades has diversified
into a closely related set of food businesses on
the basis of a growing collection of resources and
capabilities in the realm of “kitchen chemistry” and
food production technologies; it has drawn upon
these resources/capabilities to build a business
portfolio via both internal startup and acquisition
that includes such brands as Gold Medal, Pillsbury,
Betty Crocker baking products, General Mills
cereals (Cheerios, Wheaties, and Chex), Nature
Valley nutrition bars, Cascadian Farms cereals and
vegetables, Annie’s and Progresso soups, Fiber
One, Old El Paso, Green Giant, Häagen-Dazs, and Yoplait. In such instances, prompt and aggressive
actions to transfer a portion of these competitively potent resources and capabilities from one or more of
a diversified company’s businesses and redeploy them to resource and/or capability-deficient businesses
can significantly enhance the latter’s performance of key value chain activities, boost the value it delivers
to customers, and significantly improve its competitiveness and profitability.

Sometimes, however, the transfer of competitively valuable resources and capabilities is reversed,
proceeding from a newly acquired business to existing businesses. For example, when Disney acquired
Marvel Comics, Disney executives immediately made Marvel’s iconic Spiderman, Iron Man, and
Black Widow characters available for use at Disney theme parks, in Disney retail stores, and in Disney
video games. Cross-business resource transfers can be accomplished by shifting personnel with the
requisite expertise and technological know-how from one business to another, instituting in-depth

CORE CONCEPT
Strategic fit exists when the value chains of
different businesses present opportunities
for cross-business resource transfer, lower
costs through combining the performance of
related value chain activities, cross-business
use of a potent brand name, and/or cross-
business collaboration to build new or stronger
resources and capabilities that can enhance the
competitiveness of one or more of the company’s
businesses.

Chapter 8 • Diversification Strategies 175

training to boost the capabilities of personnel at resource-deficient businesses, increasing cross-business
knowledge sharing via online systems, enforcing cross-business adoption of best practices and other
desirable operating procedures, and making competitive assets controlled by one business available to
other businesses when appropriate.

l Combining the related value chain activities of separate businesses into a single operation to
achieve lower costs. In companies pursuing
related diversification, it is sometimes feasible to
manufacture the products of different businesses
in a single plant or use the same warehouses for
shipping and distribution, or have a single sales
force (or network of dealers/retailers) for the
products of different businesses when they are
marketed to the same types of customers, or have
different businesses use the same administrative
infrastructure (for finance and accounting, human
resources, information technology, and so on).
Such cost-saving benefits along the value chains
of related businesses are called economies of
scope—a concept distinct from economies of scale. Economies of scale are cost savings that accrue
directly from a larger operation—for example, unit costs may be lower in a large plant than in a small
plant, lower in a large distribution center than in a small one, and lower for large-volume purchases of
components than for small-volume purchases. Economies of scope, however, stem directly from cost-
saving strategic fits along the value chains of related businesses that allow sister businesses to operate
more cost efficiently as part of the same company than they can operate as stand-alone businesses. The
greater the cross-business economies associated with cost-saving strategic fits, the greater the potential
for a related diversification strategy to yield a competitive advantage based on lower costs than rivals.

l Exploiting use of a well-known and potent brand name. For example, Honda’s name in motorcycles and
automobiles gave it instant credibility and recognition in entering the lawn mower business, allowing
it to achieve a significant market share without spending large sums on advertising to establish a brand
identity. Likewise, Apple’s reputation in PCs made it easier and cheaper to enter the market for digital
music players, smart phones, and connected watches.

l Cross-business collaboration to create competitively valuable resources and capabilities. Sister
businesses performing closely related value chain activities may seize opportunities to join forces, share
knowledge and talents, and collaborate to create altogether new capabilities (such as virtually defect-
free assembly methods or increased ability to speed new and improved products to market) that will be
mutually beneficial in improving their competitiveness and business performance.

All four types of actions to capture strategic fit opportunities along the value chains of related businesses tend
to produce synergistic outcomes: improved competitiveness of one or more businesses and greater ability to
perform better as sister businesses than as stand-alone businesses.

CORE CONCEPT
Economies of scope are cost reductions that
flow from operating in multiple businesses.
Such economies stem directly from strategic fit
efficiencies along the value chains of related
businesses. However, the cost reductions
materialize only after management has
successfully pursued internal actions to capture
them.

Chapter 8 • Diversification Strategies 176

Figure 8.3 Related Businesses Possess Related Value Chain Activities and
Competitively Valuable Cross-Business Strategic Fits

Competitively valuable opportunities for technology or skills transfer, cost reduction, common
brand-name usage, and cross-business collaboration exist at one or more points along the
value chains of business A and business B.

Supply
Chain

Activities
Technology

Sales
and

Marketing
Distribution Customer

Service

Operations

Supply
Chain

Activities
Technology

Sales
and

Marketing
Distribution Customer

Service
Operations

Strategic Fit and Competitive Advantage: The Keys to Added Profitability and Gains in
Shareholder Value What makes related diversification an attractive strategy is the opportunity to convert
cross-business strategic fits into a competitive advantage over business rivals whose operations do not offer
comparable strategic fit benefits.4 The greater the relatedness among a diversified company’s sister businesses,
the bigger a company’s window for converting strategic fits into competitive advantage via (1) cross-business
transfer of valuable skills, technology, competencies, capabilities, and other competitive assets, (2) the capture
of cost-saving efficiencies along the value chains of related businesses via sharing use of the same resources
(joint performance of new product or technology R&D, common use of plants and distribution centers, shared
use of the same sales force or dealer network or customer service infrastructure, and the like), (3) cross-business
use of a well-respected brand name, and/or (4) cross-
business collaboration to create new resource strengths and
capabilities.5

The competitive advantage potential that flows from the
capture of strategic-fit benefits is what enables a company
pursuing related diversification to achieve 1 + 1 = 3 financial
performance and the hoped-for gains in shareholder value.
The strategic and business logic is compelling: capturing
strategic fits along the value chains of its related businesses
gives a diversified company a clear path to achieving
competitive advantage over undiversified competitors and competitors whose own diversification efforts do
not offer equivalent strategic-fit benefits.6 Such competitive advantage potential provides a company with a
dependable basis for earning profits and a return on investment that exceeds what the company’s businesses
could earn as stand-alone enterprises. Converting the competitive advantage potential into greater profitability
fuels 1 + 1 = 3 gains in shareholder value—the necessary outcome for satisfying the better-off test and proving
the business merit of a company’s diversification effort.

CORE CONCEPT
Diversifying into related businesses and then
capturing the existing competitively valuable
strategic fit benefits puts sister businesses in
position to perform better financially as part of the
same company than they could have performed
as independent enterprises, thus providing a clear
avenue for boosting shareholder value.

Chapter 8 • Diversification Strategies 177

Bear in mind three things here. One, capturing cross-business strategic fits via a strategy of related diversification
builds long-term economic value for shareholders in ways they cannot undertake by simply owning a portfolio of
stocks of companies in different industries. Two, the capture of cross-business strategic-fit benefits is possible only
via a strategy of related diversification. Three, the benefits of cross-business strategic fits are not automatically
realized when a company diversifies into related businesses—the benefits materialize only after management has
successfully pursued internal actions to capture them.

The Case for Diversifying into Unrelated Businesses
Whereas related diversification strategies seek to build shareholder value by diversifying only into businesses
with important cross-business strategic fits, the hallmark of unrelated diversification strategies is managerial
willingness to enter any industry and operate any business where company executives see opportunity to realize
consistently good financial results. Companies pursuing
unrelated diversification are often labeled conglomerates
because the businesses they have diversified into range
broadly across diverse industries with little or no discernible
strategic fits in their value chains (as shown in Figure 8.4).
Companies that pursue unrelated diversification nearly
always enter new businesses by acquiring an established
company rather than by forming a startup subsidiary within
their own corporate structures or participating in joint
ventures. With a strategy of unrelated diversification, an
acquisition is deemed attractive if it passes the industry attractiveness and cost-of-entry tests and if it has good
prospects for attractive financial performance—little, if any, consideration is given to whether the value chains
of a conglomerate’s businesses have any strategic fits.

In companies pursuing unrelated diversification, top executives spend much time and effort screening acquisition
candidates and evaluating the pros and cons of keeping or divesting existing businesses, using such criteria as:

l Whether the business can meet corporate targets for profitability and return on investment.

l Whether the business is in an industry with attractive growth potential.

l Whether a distressed business can be acquired at a bargain price, turned around quickly (with astute
managerial actions and initiatives on the part of the company) into a profitable enterprise with potential
to realize a high return on investment.

l Whether the business is big enough to contribute significantly to the parent firm’s bottom line.

Unrelated diversification certainly merits consideration when a single-business firm is trapped in or overly
dependent on an endangered or unattractive industry, especially if it has no competitively valuable resources
or capabilities it can transfer to a closely related industry. Unrelated diversification may also be justified when
a company strongly prefers to spread business risks widely, have the flexibility to deploy its capital resources
to maximum advantage by (1) investing in whatever industries offer the best profit prospects (as opposed to
considering only opportunities in industries with related value chain activities) and (2) diverting cash flows from
company businesses with lower growth and profit prospects to acquiring and expanding businesses with higher
growth and profit potentials, without regard to whether these businesses have value chain activities related to the
value chains of any of its present businesses.

However, for an unrelated diversification strategy to be successful in building value for shareholders, it must
grow the company’s profits above and beyond what could be achieved by the businesses operating independently
as standalone enterprises. Unless a diversified company’s collection of unrelated businesses is more profitable
operating under the company’s corporate umbrella than they would be operating as independent businesses, an

CORE CONCEPT
The basic premise of unrelated diversification
is that any company or business that can be
acquired on good financial terms and has
satisfactory growth and earnings potential
represents a good acquisition and a good
business opportunity.

Chapter 8 • Diversification Strategies 178

unrelated diversification strategy can not create economic value for shareholders. And unless it does so, there
is no real justifica tion for pursuing an unrelated diversification strategy, since top executives have a fiduciary
responsibility to maximize long-term shareholder value for the company’s shareholders.

What Is Appealing about Unrelated Diversification? A strategy of unrelated diversification has appeal
from several angles:

l Business risk is scattered over a set of truly diverse industries. In comparison to related diversification,
unrelated diversification more closely approximates pure diversification of financial and business risk
because the company’s investments are spread over businesses whose technologies and value chain
activities bear no close relationship and whose markets are largely disconnected.7

l The company’s financial resources can be employed to maximum advantage by (1) investing in whatever
industries offer the best profit prospects (as opposed to considering only opportunities in industries with
related value chain activities) and (2) diverting cash flows from company businesses with lower growth
and profit prospects to acquiring and expanding businesses with higher growth and profit potentials.

l To the extent that corporate managers are exceptionally astute at spotting bargain-priced companies
with big upside profit potential, shareholder wealth can be enhanced by buying distressed businesses at
a low price, turning their operations around fairly quickly with infusions of cash and managerial know-
how supplied by the parent company, and then riding the crest of the profit increases generated by these
businesses, or else enjoying the capital gains of selling rejuvenated businesses for amounts above the
purchase price.

l Company profitability may prove somewhat more stable over the course of economic upswings and
downswings because market conditions in all industries don’t move upward or downward simultaneously.
In a broadly diversified company, there’s a chance that market downtrends in some of the company’s
businesses will be partially offset by cyclical upswings in its other businesses, thus producing somewhat
less earnings volatility. (In actual practice, however, there’s no convincing evidence that the consolidated
profits of firms with unrelated diversification strategies are more stable or less subject to reversal in
periods of recession and economic stress than the profits of firms with related diversification strategies.)

Unrelated diversification certainly merits consideration when a firm is trapped in or overly dependent on an
endangered or unattractive industry, especially when it has no competitively valuable resources or capabilities
it can transfer to a closely related industry. Unrelated diversification may also be justified when a company
strongly prefers to spread business risks widely and not restrict itself to only owning businesses with related
value chain activities.

Chapter 8 • Diversification Strategies 179

Figure 8.4 Unrelated Businesses Have Unrelated Value Chains and No Cross-
Business Strategic Fits

Representative Value Chain Activities

Business
A

Value
Chain

Business
B

Value
Chain

Supply
Chain

Activities
Assembly Distribution Customer

Service

Product
R&D,

Engineering
and Design

Production
Advertising

and
Promotion

Sales to
Dealer

Network

An absence of competitively valuable strategic fits between the value
chains of business A and business B

Building Shareholder Value via Unrelated Diversification—The Essential Role of Astute
Corporate Parenting Given the absence of cross-business strategic fits with which to capture added competitive
advantage, the task of building long-term economic value for shareholders via unrelated diversification hinges
on (1) the business acumen of corporate executives and (2) the parent company having valuable resources and
high-caliber administrative expertise that can enhance the performance of the company’s individual businesses.

In companies committed to a strategy of unrelated diversification, astute corporate parenting plays an essential
role in achieving companywide financial results above and beyond what the individual businesses could achieve
as stand-alone entities. Strong parenting capabilities can help build shareholder value in four important ways:

l Utilize the business acumen of certain corporate executives in identifying undervalued or underperforming
companies and then further rely on the skills and expertise of these or other corporate executives in
pinpointing achievable ways that the operations of such companies can be overhauled and streamlined
to produce dramatic increases in profitability. Such restructuring can include pruning money-losing
products, closing down or selling portions of the business that are losing money, selling underutilized
assets, reducing unnecessary expenses, improving the appeal of product offerings, reducing administrative
overhead, and the like. Usually, a number of the top executives of a newly-acquired underperforming
business are quickly replaced with seasoned executives brought in specifically to lead the turnaround
efforts, return the business to good profitability, and put it well on its way to becoming a strong market
contender. Diversified companies with one or more corporate executives who have proven turnaround
capabilities in rejuvenating weakly performing companies can often apply these capabilities in a
relatively wide range of unrelated industries. Newell Rubbermaid (whose diverse product line includes

Chapter 8 • Diversification Strategies 180

Sharpie pens, Levolor window treatments, Goody hair accessories, Calphalon cookware, and Lenox
power and hand tools—all businesses with different value chain activities) developed such a strong set
of turnaround capabilities that the company was said to “Newellize” the businesses it acquired.

l Corporate managers advance the cause of adding shareholder value when they have the bargaining
skills to successfully negotiate a low price and other favorable terms in acquiring any new business the
corporate parent decides to enter (thereby helping satisfy the cost-of-entry test). Corporate managers
have further value-adding potential if they are astute in discerning when a particular company business
needs to be sold (because it is on the verge of confronting adverse industry and competitive conditions
and probable declines in long-term profitability) and also in finding buyers who will pay a price higher
than the company’s net investment in the business (so the sale of divested businesses will result in
capital gains for shareholders rather than capital losses).

l Corporate managers definitely add shareholder value when they possess the skills and business acumen
to do a superior job of overseeing, guiding, and otherwise parenting the firm’s business subsidiaries
that the subsidiaries perform at a higher level than they would otherwise be able to do as a stand-
alone enterprise (thus satisfying the better-off test). Because the senior executives of a large diversified
corporation have among them many years of experience in a variety of business settings, they are often
able to provide first-rate advice and guidance to the heads of the various business subsidiaries on how
to improve competitiveness and financial performance.8 The parenting activities of corporate executives
often includes identifying, recruiting, and hiring talented managers to run individual businesses and
thereby squeeze out better business performance than otherwise might have occurred.

l Corporate executives of financially strong diversified companies can add shareholder value by astutely
allocating financial resources across the company’s businesses. This can involve shifting funds from
businesses with excess cash (more than needed to fund their operating requirements) to cash-short
businesses with appealing growth opportunities. And there are occasions when corporate executives can
add value by using the corporation’s strong credit rating to raise capital at acceptable interest rates from
external sources and thus provide funds to individual business at lower interest rates than the businesses
would otherwise have to pay as standalone enterprises. A parent company’s ability to function as its
own internal capital market enhances overall corporate performance and increases shareholder value to
the extent that its top executives (1) have access to better information about investment opportunities
internal to the firm than do external financiers, (2) wisely engage in allocating internal cash flows and
borrowed funds to either existing businesses or making new acquisitions, and (3) are able to use the
corporation’s financial strength and credit rating to borrow monies to fund the capital requirements of
individual businesses and do so at lower interest costs than the individual businesses would have had to
pay as independent enterprises (assuming they could have obtained a loan on the strength of their own
balance sheets).

Other Benefits a Corporate Parent Can Provide to Boost the Performance of Its Business
Subsidiaries There are two other commonly employed ways that corporate parents can enhance the financial
performance of their unrelated businesses. One way is by providing them with administrative resources and
expertise that lower the administrative costs of the individual businesses and/or that enhance their operating
effectiveness and/or that lower administrative and overhead costs companywide. The administrative resources
and depth of expertise located at a company’s corporate headquarters are often considerable, enabling it to
effectively and cost-efficiently handle such administrative functions for its subsidiaries as accounting and tax
reporting, financial and risk management, human resource support and services, information systems and data
processing, legal services, and so on. Providing individual businesses with administrative support services creates
value by lowering companywide overhead costs and avoiding the inefficiencies of having each business handle
its own administrative functions. (Of course, this benefit of utilizing a diversified company’s administrative
resources and expertise to support the needs of its individual business is just as much available to corporations
pursuing related diversification as to those pursuing unrelated diversification.)

Chapter 8 • Diversification Strategies 181

A second way that a parent company can provide value to its unrelated business occurs when a corporate
parent has a well-recognized or highly reputable name or brand that is not strongly attached to a certain product
and thus can readily be shared by many or all of its individual businesses. General Electric, for example, has
successfully applied its GE brand to such unrelated products and businesses as metal additive manufacturing
(GE Additive), aircraft engines, aircraft parts, and avionics (GE Aerospace), wind turbines and hydro power (GE
Renewable Energy), electric power generation and high voltage distribution equipment (GE Power), software
that accelerates the electrification and decarbonization across the energy ecosystem (GE Digital), and multiple
types of financial solutions (GE Capital). Corporate brands that can be applied and shared in this fashion are
sometimes called umbrella brands. Utilizing a well-known corporate name in a company’s individual businesses
has the value-adding potential both to lower brand-building and reputational costs (by spreading them over many
businesses) and to enhance each business’s customer value proposition by linking its products to a name that
consumers trust.

To the extent that corporate parenting skills and other complementary parenting resources can actually deliver
enough added value to individual businesses to yield a stream of dividends and capital gains for stockholders
greater than a 1 + 1 = 2 outcome, a case can be made that unrelated diversification has truly enhanced shareholder
value.

The Path to Enhancing Shareholder Value via Unrelated Diversification For a strategy of unrelated
diversification to produce companywide financial results above and beyond what the businesses could generate
operating as stand-alone entities, corporate executives should pursue five outcomes:

1. Build a portfolio of businesses in unrelated industries by acquiring companies in any industry with growth
and earnings prospects that can satisfy the industry attractiveness test and by acquiring undervalued or
underperforming businesses that present appealing opportunities for being overhauled in ways that will
result in big gains in profitability. Both types of acquisitions raise the chances that a corporation’s entry
into new unrelated businesses can pass the better-off test.

2. Acquire companies at prices sufficiently low to pass the cost of entry test.

3. Develop and nurture outstanding corporate parenting capabilities. Successful deployment of such
capabilities raises the chance that building a
portfolio of unrelated businesses will yield 1 + 1 =
3 results and thus pass the better-off test.

4. Provide individual businesses with administrative
expertise and other corporate resources that
lower companywide administrative and overhead
costs and enhance the operating effectiveness of
individual businesses.

5. Become skilled in discerning when a particular
company business should be sold (because of
deteriorating industry and competitive conditions
or other factors that make its long-term profit outlook unattractive) and also in finding buyers who will
pay a price higher than the company’s net investment in the business (so the sale of divested businesses
will result in capital gains for shareholders rather than capital losses).

Astutely managed diversified companies understand the nature and value of corporate parenting resources and
develop the skills to leverage them effectively across their businesses. The more adept corporate-level executives
are at effectively building, nurturing, and deploying a rich collection of corporate parenting capabilities, the
more able they are to create added value for shareholders in comparison to other enterprises pursuing unrelated
diversification—diversified corporations with top-flight parenting capabilities have what is called a parenting
advantage. When a corporation has a parenting advantage and when its executives are also uniquely skilled in

CORE CONCEPT
A diversified company has a parenting advantage
when it has superior corporate parenting
capabilities relative to other diversified companies
and thus is more able to boost the combined
performance of its individual businesses through
high-level guidance, astute allocation of financial
resources, and various other types of corporate-
level resource support.

Chapter 8 • Diversification Strategies 182

identifying weak-performing companies where there are achievable opportunities to boost profits to appealingly
high levels, then the corporation has credible prospects of pursuing an unrelated diversification strategy that can
deliver 1 + 1 = 3 gains in long-term shareholder value.

The Two Big Drawbacks of Unrelated Diversification Unrelated diversification strategies have two
important negatives:

1. Demanding managerial requirements. Successfully managing a set of fundamentally different
businesses operating in fundamentally different industry and competitive environments is a challenging
and exceptionally difficult proposition.9 The more unrelated businesses that a company has diversified
into, the harder it is for corporate executives to have in-depth knowledge about each business (consider,
for example, that corporations like General Electric, Samsung, 3M, Honeywell, Johnson & Johnson,
and Mitsubishi have dozens of business subsidiaries making hundreds and sometimes thousands of
products). While headquarters executives can glean information about the industry from third-party
sources, ask lots of questions when visiting different business operations, and do their best to learn about
the company’s different businesses, they still remain heavily dependent on briefings from business unit
managers for many of the details and on “managing by the numbers”—that is, keeping close track of the
financial and operating results of each subsidiary and assuming that the heads of the various subsidiaries
have most everything under control so long as the latest financial and operating measures look good.
This can work provided the heads of the various business units are capable and favorable conditions
allow a business to consistently meet its numbers. But the problem comes when things start to go awry
in a business despite the best effort of business unit managers, and top-level corporate executives have to
get deeply involved in helping turn around a business they do not know that much about. Because every
business tends to encounter rough sledding at some juncture, unrelated diversification is a somewhat
risky strategy from a managerial perspective.10 Hard-to-resolve problems in one or more businesses or
big strategic mistakes (sloppy analysis of the industries a company is getting into, discovering that the
problems of a newly acquired business will require considerably more time and money to correct than
was expected, or being overly optimistic about a newly-acquired company’s future prospects) can cause
a precipitous drop in corporate earnings and crash the parent company’s stock price.11 Thus, companies
electing to pursue unrelated diversification strategies are usually well advised to avoid casting a wide
net to build their business portfolios—a few unrelated businesses is often better than many unrelated
businesses.

2. No potential for competitive advantage beyond any benefits of corporate parenting and what each
individual business can generate on its own. Unlike a related diversification strategy, there are no
cross-business strategic fits to draw on for reducing costs, transferring beneficial skills and technology,
leveraging use of a powerful brand name,
or collaborating to build mutually beneficial
competitive capabilities and thereby adding to any
competitive advantage the individual businesses
possess. Yes, a cash-rich and/or managerially adept
corporate parent pursuing unrelated diversification
can provide its subsidiaries with much-needed
capital, valuable top-management guidance and
advice, and capable administrative know-how, but
otherwise it has little to offer in enhancing the competitive strength of its individual business units.
Moreover, it must be noted that all the benefits accruing from first-rate corporate parenting capabilities
are not exclusively attached to a strategy of unrelated diversification—these same benefits are equally
available to companies pursuing a strategy of related diversification.

The drawbacks of demanding managerial requirements and limited competitive advantage potential greatly
weaken the appeal of an unrelated diversification strategy. Relying on the shrewd acquisition skills of corporate-
level executives and good-to-excellent corporate parenting capabilities to get 1 + 1 = 3 performance from a group

Without the added competitive advantage
potential that cross-business strategic fit provides,
it is hard for the consolidated performance of an
unrelated group of businesses to be any better
than the sum of what the individual business units
could achieve if they were independent.

Chapter 8 • Diversification Strategies 183

of unrelated businesses is a weaker and less reliable basis for creating shareholder value than is a strategy of
related diversification where competitively valuable cross-business strategic fits, astute acquisitions on the part
of corporate-level executives, and valuable corporate parenting resources and expertise can all combine to drive
1 + 1 = 3 outcomes. Hence the likelihood that a strategy of related diversification can add more shareholder value
than a strategy of unrelated diversification is indeed high. Real-world evidence supports this conclusion: There
are far more companies pursuing unrelated diversification strategies whose financial results have been mediocre
to poor than those whose financial performance over time has been good to excellent.12 Without exceptional
corporate parenting skills and resources, the odds are that unrelated diversification will produce 1 + 1 = 2 or
smaller gains for shareholders.

Combination Related–Unrelated Diversification Strategies
There’s nothing to preclude a company from diversifying into both related and unrelated businesses. Indeed, in
actual practice, the business make-up of diversified companies varies considerably. Some diversified companies
are really dominant-business enterprises—one major “core” business accounts for 50 to 80 percent of total
revenues and a collection of small related or unrelated businesses accounts for the remainder. Some diversified
companies are narrowly diversified around a few (two to five) related or unrelated businesses. Others are broadly
diversified around a wide-ranging collection of related businesses, unrelated businesses, or a mixture of both.
Also, a number of multibusiness enterprises have diversified into unrelated areas but have a collection of related
businesses within each area—thus giving them a business portfolio consisting of several unrelated groups of
related businesses. There’s ample room for companies to customize their diversification strategies to incorporate
elements of both related and unrelated diversification, as may suit their own collection of valuable competitive
assets, corporate resources, and strategic vision.

Evaluating the Strategy of a Diversified Company
Assessing the strategies of diversified companies builds on the concepts and methods used for single-business
companies. But there are some additional aspects to consider and a couple of new analytic tools to master. The
procedure for evaluating the pluses and minuses of a diversified company’s strategy and deciding what actions
to take to improve the company’s performance involves six steps:

1. Assessing the attractiveness of the industries the company has diversified into, both individually and as
a group.

2. Assessing the competitive strength of the company’s business units and drawing a nine-cell matrix to
simultaneously portray industry attractiveness and business unit competitive strength.

3. Evaluating the competitive value of cross-business strategic fits along the value chains of the company’s
various business units.

4. Checking whether the firm’s resources fit the requirements of its present business lineup.

5. Ranking the performance prospects of the businesses from best to worst and determining what the
corporate parent’s priorities should be in allocating resources to its various businesses.

6. Crafting new strategic moves to improve overall corporate performance.

The core concepts and analytical techniques underlying each of these steps merit further discussion.

Step 1: Assessing Industry Attractiveness
A principal consideration in evaluating a diversified company’s business make-up and the caliber of its strategy is
the attractiveness of the industries in which it has business operations. Answers to several questions are required:

Chapter 8 • Diversification Strategies 184

l Does each industry the company has diversified into represent a good business for the company to be
in—does it pass the industry attractiveness test?

l Which of the company’s industries are most attractive, and which are least attractive?

l How appealing is the whole group of industries in which the company has invested?

The more attractive the industries (both individually and as a group) a diversified company is in, the better its
prospects for good long-term performance.

Calculating Industry Attractiveness Scores A simple and reliable analytical tool for gauging industry
attractiveness involves calculating quantitative industry attractiveness scores based on the following measures:

l Market size and projected growth rate. Big industries are more attractive than small industries, and fast-
growing industries tend to be more attractive than slow-growing industries, other things being equal.

l The intensity of competition. Industries where competitive pressures are relatively weak are more
attractive than industries where competitive pressures are strong.

l Emerging opportunities and threats. Industries with promising opportunities and minimal threats on the
near horizon are more attractive than industries with modest opportunities and imposing threats.

l The presence of cross-industry strategic fits. The more one industry’s value chain and resource
requirements match up well with the value chain activities of other industries in which the company
has operations, the more attractive the industry is to a firm pursuing related diversification. However,
cross-industry strategic fits are not something that a company committed to a strategy of unrelated
diversification considers when it is evaluating industry attractiveness.

l Resource and capability requirements. Industries having resource/capability requirements within the
company’s reach are more attractive than industries where the requirements could strain corporate
financial resources and/or capabilities.

l Seasonal and cyclical factors. Industries where buyer demand is relatively steady year-round and not
unduly vulnerable to economic ups and downs tend to be more attractive than industries where there are
wide swings in buyer demand within or across years. However, seasonality may be a plus for a company
that is in several seasonal industries if the seasonal highs in one industry correspond to the lows in
another industry, thus helping even out monthly sales levels. Likewise, cyclical market demand in one
industry can be attractive if its up-cycle runs counter to the market down-cycles in another industry
where the company operates, thus helping reduce revenue and earnings volatility.

l Social, political, regulatory, and environmental factors. Industries with significant problems in such
areas as consumer health, safety, or environmental pollution or those subject to intense regulation are
less attractive than industries where such problems are not burning issues.

l Industry profitability. Industries with healthy profit margins and high rates of return on investment are
generally more attractive than industries with historically low or unstable profitability.

l Industry uncertainty and business risk. Industries with less uncertainty on the horizon and lower overall
business risk are more attractive than industries whose prospects for one reason or another are uncertain,
especially when the industry has formidable resource requirements.

Each attractiveness measure is then assigned a weight reflecting its relative importance in determining an
industry’s attractiveness—not all attractiveness measures are equally important. The intensity of competition
in an industry should nearly always carry a high weight (say, 0.20 to 0.30). Strategic-fit considerations should
be assigned a high weight for companies with related diversification strategies and dropped from the list of

Chapter 8 • Diversification Strategies 185

attractiveness measures altogether for companies pursuing unrelated diversification. Seasonal and cyclical
factors should generally be eliminated (or perhaps assigned a low weight) except in situations where they are
obviously relevant. The importance weights must add up to 1.0.

Next, every industry is rated on each of the chosen industry attractiveness measures, using a rating scale of 1
to 10 (where a high rating signifies high attractiveness and a low rating signifies low attractiveness). Keep in
mind here that the more intensely competitive an industry is, the lower the attractiveness rating for that industry.
Likewise, the higher the capital and resource requirements associated with being in a particular industry, the
lower the attractiveness rating. Weighted attractiveness scores are then calculated by multiplying the industry’s
rating on each measure by the corresponding weight. For example, a rating of 8 times a weight of 0.25 gives
a weighted attractiveness score of 2.00. The sum of the weighted scores for all the attractiveness measures
provides an overall industry attractiveness score. This procedure is illustrated in Table 8.1.

Table 8.1 Calculating Weighted Industry Attractiveness Scores

[Rating scale: 1 = Very unattractive to company; 10 = Very attractive to company]

Industry Attractiveness Assessments

Industry A Industry B Industry C

Industry Attractiveness
Measures

Importance
Weight

Attractiveness
Rating

Weighted
Score

Attractiveness
Rating

Weighted
Score

Attractiveness
Rating

Weighted
Score

Market size and projected
growth rate 0.10 8 0.80 3 0.30 5 0.50

Intensity of competition 0.25 8 2.00 2 0.50 5 1.25

Emerging opportunities
and threats 0.10 6 0.60 5 0.50 4 0.40

Cross-industry strategic
fits 0.20 8 1.60 2 0.40 3 0.60

Resource requirements 0.10 6 0.60 5 0.50 4 0.40

Seasonal and cyclical
influences 0.05 9 0.45 5 0.25 10 0.50

Social, political,
regulatory, and
environmental factors

0.05 8 0.40 3 0.15 7 0.35

Industry profitability 0.10 5 0.50 3 0.30 6 0.60

Industry uncertainty and
business risk 0.05 5 0.25 1 0.05 10 0.50

Sum of importance
weights 1.00

Weighted overall industry
attractiveness scores 7.20 2.95 5.10

Interpreting the Industry Attractiveness Scores Industries with a score much below 5.0 probably do not
pass the attractiveness test. If a company’s industry attractiveness scores are all above 5.0, it is probably fair to
conclude that the group of industries the company operates in is attractive as a whole. But the group of industries
takes on a decidedly lower degree of attractiveness as the number of industries with scores below 5.0 increases,
especially when industries with low scores account for a sizable fraction of the company’s revenues.

Chapter 8 • Diversification Strategies 186

For a diversified company to be a strong performer, a substantial portion of its revenues and profits must come
from business units in industries with relatively high industry attractiveness scores. It is particularly important
that a diversified company’s principal businesses be in industries with a good outlook for growth and above-
average profitability. Having a big fraction of the company’s revenues and profits come from industries with
slow growth, low profitability, intense competition, or other troubling conditions or characteristics tends to drag
overall company performance down. Business units in the least attractive industries are potential candidates for
divestiture, unless they are positioned strongly enough to overcome the unattractive aspects of their industry
environments or they are a strategically important component of the company’s business make-up.

Step 2: Assessing Business Unit Competitive Strength
The second step in evaluating a diversified company is to appraise the competitive strength of each business unit
in its respective industry. Doing an appraisal of each business unit’s strength and competitive position not only
reveals its chances for success in its industry but also provides a basis for ranking the units from competitively
strongest to competitively weakest and sizing up the competitive strength of all the business units as a group.

Calculating Competitive Strength Scores for Each Business Unit Quantitative measures of each
business unit’s competitive strength can be calculated using a procedure similar to that for measuring industry
attractiveness. The following factors are used in quantifying the competitive strengths of a diversified company’s
business subsidiaries:

l Relative market share. A business unit’s relative market share is defined as the ratio of its market
share to the market share held by the largest rival firm in the industry, with market share measured in
unit volume, not dollars. For instance, if Business A has a market-leading share of 40 percent and its
largest rival has 30 percent, A’s relative market share is 1.33. (Note that only business units that are
market share leaders in their respective industries can have relative market shares greater than 1.0.) If
Business B has a 15 percent market share and its largest rival has 30 percent, B’s relative market share is
0.5. The further below 1.0 a business unit’s relative market share is, the weaker its competitive strength
and market position vis-à-vis rivals. A 10 percent market share, for example, does not signal much
competitive strength if the leader’s share is 50 percent (a 0.20 relative market share), but a 10 percent
share is actually strong if the leader’s share is only 12 percent (a 0.83 relative market share). This is why
a company’s relative market share is a better measure of competitive strength than a company’s market
share based on either dollars or unit volume.

l Costs relative to competitors’ costs. Business
units that have low costs relative to those of key
competitors tend to be in a stronger position in
their industries than business units struggling to
maintain cost parity with major rivals. The only time a business unit’s competitive strength may not
be undermined by having higher costs than rivals is when it has incurred the higher costs to strongly
differentiate its product offering and its customers are willing to pay premium prices for the differentiating
features.

l Ability to match or beat rivals on key product attributes. A company’s competitiveness depends in part
on being able to satisfy buyer expectations with regard to features, product performance, reliability,
service, and other important attributes.

l Ability to benefit from strategic fits with sister businesses. Strategic fits with other businesses within the
company enhance a business unit’s competitive strength and may provide a competitive edge.

l Ability to exercise bargaining leverage with key suppliers or customers. Having bargaining leverage
signals competitive strength and can be a source of competitive advantage.

l Brand image and reputation. A widely known and respected brand name is a valuable competitive asset
in most industries.

Using relative market share to measure
competitive strength is analytically superior to
using straight-percentage market share.

Chapter 8 • Diversification Strategies 187

l Other competitively valuable resources and capabilities. Valuable resources and capabilities, including
important alliances and collaborative partnerships, enhance a company’s ability to compete successfully
and perhaps contend for industry leadership.

l Profitability relative to competitors. Business units that consistently earn above-average returns on
investment and have bigger profit margins than their rivals usually have stronger competitive positions.
Moreover, above-average profitability signals competitive advantage, whereas below-average
profitability usually denotes competitive disadvantage.

After settling on a set of competitive strength measures that are well matched to the circumstances of the various
business units, weights indicating each measure’s importance need to be assigned. A case can be made for
using different weights for different business units whenever the importance of the strength measures differs
significantly from business to business, but otherwise it is simpler just to go with a single set of weights and
avoid the added complication of multiple weights. As before, the importance weights must add up to 1.0. Each
business unit is then rated on each of the chosen strength measures, using a rating scale of 1 to 10 (where a high
rating signifies competitive strength and a low rating signifies competitive weakness). In the event the available
information is too skimpy to confidently assign a rating value to a business unit on a particular strength measure,
it is usually best to use a score of 5—this avoids biasing the overall score either up or down. Weighted strength
ratings are calculated by multiplying the business unit’s rating on each strength measure by the assigned weight.
For example, a strength score of 6 times a weight of 0.15 gives a weighted strength rating of 0.90. The sum of
weighted ratings across all the strength measures provides a quantitative measure of a business unit’s overall
competitive strength. Table 8.2 provides sample calculations of competitive strength ratings for three businesses.

Table 8.2 Calculating Weighted Competitive Strength Scores for a Diversified
Company’s Business Units

[Rating scale: 1 = Very weak; 10 = Very strong]

Competitive Strength Assessments

Business A in
Industry A

Business B in
Industry B

Business C in
Industry C

Competitive Strength
Measures

Importance
Weight

Strength
Rating

Weighted
Score

Strength
Rating

Weighted
Score

Strength
Rating

Weighted
Score

Market size and projected
growth rate 0.15 10 1.50 2 0.30 6 0.90

Intensity of competition 0.20 7 1.40 4 0.80 5 1.00
Emerging opportunities and
threats 0.05 9 0.45 5 0.25 8 0.40

Cross-industry strategic fits 0.20 8 1.60 4 0.80 8 0.80
Resource requirements 0.05 9 0.45 2 0.10 6 0.30
Seasonal and cyclical
influences 0.10 9 0.90 4 0.40 7 0.70

Social, political, regulatory,
and environmental factors 0.15 7 1.05 2 0.30 5 0.75

Industry profitability 0.10 5 0.50 2 0.20 4 0.40
Sum of importance weights 1.00

Weighted overall competetive
strengths scores 7.85 3.15 5.25

Chapter 8 • Diversification Strategies 188

Interpreting the Competitive Strength Scores Business units with competitive strength ratings above
6.7 (on a scale of 1 to 10) are strong market contenders in their industries. Businesses with ratings in the 3.3
to 6.7 range have moderate competitive strength vis-à-vis rivals. Businesses with ratings below 3.3 have a
competitively weak standing in the marketplace. If a diversified company’s business units all have competitive
strength scores above 5.0, it is fair to conclude that its business units are all fairly strong market contenders in
their respective industries. But as the number of business units with scores below 5.0 increases, there’s reason
to question whether the company can perform well with so many businesses in relatively weak competitive
positions. This concern takes on even more importance when business units with low scores account for a sizable
fraction of the company’s revenues.

Using a Nine-Cell Matrix to Simultaneously Portray Industry Attractiveness and Competitive
Strength The industry attractiveness and competitive strength scores can be used to portray the strategic
positions of each business in a diversified company. Industry attractiveness is plotted on the vertical axis, and
competitive strength on the horizontal axis. A nine-cell grid emerges from dividing the vertical axis into three
regions (high, medium, and low attractiveness) and the horizontal axis into three regions (strong, average, and

Figure 8.5 A Nine-Cell Industry Attractiveness–Competitive Strength Matrix

Chapter 8 • Diversification Strategies 189

weak competitive strength). As shown in Figure 8.5, scores of 6.7 or greater on a rating scale of 1 to 10 denote
high industry attractiveness, scores of 3.3 to 6.7 denote medium attractiveness, and scores below 3.3 signal low
attractiveness. Likewise, high competitive strength is defined as a score greater than 6.7, average strength as
scores of 3.3 to 6.7, and low strength as scores below 3.3. Each business unit is plotted on the nine-cell matrix
according to its overall attractiveness score and strength score, and then shown as a “bubble.” The size of each
bubble is scaled to what percentage of revenues the business generates relative to total corporate revenues. The
bubbles in Figure 8.5 were located on the grid using the four industry attractiveness scores from Table 8.1 and
the strength scores for the four business units in Table 8.2.

The locations of the business units on the attractiveness–
strength matrix provide valuable guidance in deploying
corporate resources to the various business units. Businesses
positioned in the three cells in the upper left portion of the
attractiveness–strength matrix (like Business A) have both
favorable industry attractiveness and competitive strength.

Businesses positioned in the three diagonal cells stretching
from the lower left to the upper right (like Business C in
Figure 8.5) usually merit medium or intermediate priority
in the parent’s resource allocation ranking. However, some
businesses in the medium-priority diagonal cells may have
brighter or dimmer prospects than others. For example, a
small business located in the upper right cell of the matrix, despite being in a highly attractive industry, may
occupy too weak of a competitive position in its industry to justify the investment and resources needed to turn
it into a strong market contender and shift its position left in the matrix over time.

Businesses in the three cells in the lower right corner of the matrix (like Business B in Figure 8.5) have
comparatively low industry attractiveness and minimal competitive strength, typically making them weak
performers with little potential for improvement. At best, they have the lowest claim on corporate resources and
often are good candidates for being divested (sold to other companies). However, there are occasions when a
business located in the three lower right cells generates sizable positive cash flows or has other traits that justify
its retention. It makes sense to retain such businesses and manage them in a manner calculated to maximize their
value. For example, it makes sense to maximize the operating cash flows from low-performing/low-potential
businesses and divert them to financing expansion of business units with greater potential for revenue and profit
growth or to making new acquisitions.

Step 3: Evaluating the Competitive Value of Cross-Business Strategic Fits
While this step can be bypassed for diversified companies whose businesses are all unrelated (since, by design,
no strategic fits are present), the presence of important strategic fits across the value chains of a company’s
related businesses is central to concluding just how good a company’s related diversification strategy is. But
more than just checking for the presence of good strategic
fits is required here. The real question is how much
competitive value can be generated from whatever strategic
fits exist? Are there value chain matchups that present
sizable opportunities to reduce costs by combining the
performance of certain value chain activities and thereby
capture economies of scope? Could cost savings associated
with economies of scope give one or more individual
businesses a cost-based advantage over rivals? Can much
competitive value be gained from cross-business transfer of technology, skills, or know-how to correct the
resource deficiencies of certain businesses and boost their bottom lines? Are there potential competitive benefits

The nine-cell attractiveness–strength matrix
provides strong logic for fully funding the resource
needs of competitively strong businesses in
attractive industries, investing selectively in
businesses with intermediate positions on the
grid, and getting rid of competitively weak
businesses in unattractive industries unless
they generate sizable cash flows that can
be redeployed elsewhere or have traits that
contribute to the performance of one or more
sister businesses.

CORE CONCEPT
A company’s related diversification strategy
derives its power in large part from the presence
of competitively valuable strategic fits among
its businesses and forceful company efforts to
capture the benefits of these fits.

Chapter 8 • Diversification Strategies 190

from cross-business sharing of a corporate parent’s umbrella brand name or corporate reputation? Could cross-
business collaboration to create new competitive capabilities lead to significant gains in performance? Without
significant cross-business strategic fits and strong company efforts to capture them, one has to be skeptical about
the potential for a diversified company’s related businesses to perform better together than apart.

Step 4: Checking for Good Resource Fit
The businesses in a diversified company’s lineup need to exhibit good resource fit. Resource fit exists when
(1) each company business has adequate access to the resources and capabilities it needs to be competitively
successful (these resources can either be internal to its own operations or supplied by its corporate parent) and
(2) the parent company has sufficient financial resources and parenting capabilities to support its entire group of
businesses without spreading itself too thin.

Financial Resource Fit The most important dimension of financial resource fit concerns whether a diversified
company can generate the internal cash flows sufficient to fund the capital requirements of its businesses, pay
dividends, meet its debt obligations, and otherwise remain
financially healthy. Different businesses have different cash
flow and investment characteristics. For example, business
units in rapidly growing industries are often cash hogs—
so labeled because the cash flows they are able to generate
from internal operations aren’t big enough to fund their
operations and capital requirements for growth. To keep
pace with rising buyer demand, rapid-growth businesses
frequently need sizable annual capital investments—for
new facilities and equipment, for new product development
or technology improvements, and for additional working capital to support inventory expansion and a larger base
of operations. A business in a fast-growing industry becomes an even bigger cash hog when it has a relatively low
market share and is pursuing a strategy to become an industry leader. Because a cash hog’s financial resources
must be provided by the corporate parent, corporate managers must decide whether it makes good financial and
strategic sense to keep pouring new money into a business that is likely to need cash infusions for some years to
come (until slowing growth causes its capital requirements to diminish and/or until increased profitability and
bigger cash flows from operations become large enough to fund its capital requirements).

In contrast, business units with leading market positions in mature industries may be cash cows in the sense that
they generate substantial cash surpluses over what is needed to adequately fund their operations. Market leaders
in slow-growth industries often generate sizable positive cash flows over and above what is needed for growth
and reinvestment because their industry-leading positions
tend to give them the sales volumes and reputation to
earn attractive profits and because the slow-growth nature
of their industry often entails relatively modest annual
investment requirements. Cash cows, though not always
attractive from a growth standpoint, are valuable businesses
from a financial resource perspective. The surplus cash
flows they generate can be used to pay corporate dividends,
finance acquisitions, and provide funds for investing in the
company’s promising cash hogs. It makes good financial and strategic sense for diversified companies to keep
cash cows in healthy condition, fortifying and defending their market position to preserve their cash-generating
capability over the long term and thereby have an ongoing source of financial resources to deploy elsewhere.
The cigarette business is one of the world’s biggest cash cow businesses. The businesses of both Microsoft and
Apple are huge cash cows; for example, in fiscal 2023, Microsoft had revenues of $211.9 billion and realized
a net cash flow from operations of $87.6 billion, of which $28.1 billion was used to fund additions to property
and equipment, and $19.8 billion was used to pay dividends, resulting in free cash flow of about $54.2 billion;

CORE CONCEPT
Resource fit concerns whether each company
business has adequate access to the resources
and capabilities needed to be competitively
successful and whether the corporate parent has
the financial means and parenting capabilities to
support its entire group of businesses.

CORE CONCEPT
A cash hog business generates cash flows that are
too small to fully fund its operations and growth;
a cash hog business requires cash infusions to
provide additional working capital and finance new
capital investment.

Chapter 8 • Diversification Strategies 191

as of June 30, 2023, Microsoft’s balance sheet showed the company had cash, cash equivalents, and short-term
investments totaling $111.3 billion. Wrigley’s, a producer of chewing gum and candies and now a subsidiary of
Mars, Inc., is said to be a consistent generator of surplus cash flows approaching 15 percent of revenues.13

Viewing a diversified group of businesses as a collection of cash flows and cash requirements (present and future)
is a major step forward in understanding the financial ramifications of diversification and why having businesses
with good financial fit is so important. The ideal condition
is that a diversified corporation’s cash cow businesses
generate sufficiently large free cash flows to fund the capital
needs of all its other businesses, pay dividends, cover its
debt repayments, and have funds left over for making new
acquisitions and/or repurchasing shares of stock. While
additional capital can usually be raised in financial markets
if internal cash flows are deficient, it is still important for
a diversified firm to have a healthy internal capital market
adequate to support the financial requirements of its business lineup. The greater the extent to which a diversified
company is able to fund the needed investment in its businesses through internally generated cash flows rather
than from borrowing or issuing additional shares of common stock, the more powerful its financial resource fit,
the less dependent the firm is on external sources of capital, and the stronger its credit rating. This can provide a
competitive advantage over single business rivals with small cash flows from operations, a weaker credit rating,
and limited ability to raise capital from external sources.

Aside from cash flow considerations, two other factors should be considered when assessing whether a diversified
company’s businesses exhibit good financial fit:

1. Do any of the company’s individual businesses present financial challenges in contributing adequately
to the company’s financial performance and overall well-being? A business exhibits a poor financial
fit if it soaks up a disproportionate share of a corporate parent’s financial resources, makes subpar
or inconsistent bottom-line contributions, is too small to make a material earnings contribution, or is
unduly risky (so that the financial well-being of the whole company could be jeopardized in the event it
falls upon hard times).

2. Does the company have adequate financial strength to fund its different businesses, pursue growth
via new acquisitions, and maintain a healthy credit rating? A diversified company’s strategy fails the
resource fit test when its financial resources are stretched across so many businesses that its credit rating
is impaired. Severe financial strain sometimes occurs when a company borrows so heavily to finance
new acquisitions that it has to trim way back on capital expenditures for existing businesses and use the
majority of its financial resources to meet interest obligations and to pay down debt.

Nonfinancial Resource Fits Just as a diversified company must have adequate financial resources to
support its various individual businesses, it must also have a big enough and deep enough pool of managerial,
administrative, and other parenting capabilities to ensure that each of its business units has the resources and
capabilities it requires for competitive success and good financial performance. The following three questions
help reveal whether a diversified company has adequate nonfinancial resources:

1. Is there any evidence indicating that any of the company’s business units are resource deficient?
Deficiencies can occur because certain needed resources and/or capabilities cannot be transferred in or
shared with sister businesses or because certain missing resources and/or capabilities cannot be supplied
by the corporate parent.

2. Are the corporate parent’s resources and parenting capabilities poorly matched to the resource
requirements of one or more businesses it has diversified into? For instance, BTR, a multibusiness
company in Great Britain, discovered that the company’s resources and managerial skills were well

CORE CONCEPT
A cash cow business generates cash flows over
and above its internal requirements, thus providing
a corporate parent with funds for investing in cash
hog businesses, financing new acquisitions, paying
dividends and/or repurchasing shares of stock.

Chapter 8 • Diversification Strategies 192

suited for parenting industrial manufacturing businesses but not for parenting its distribution businesses
(National Tyre Services and Texas-based Summers Group). As a result, BTR decided to divest its
distribution businesses and focus exclusively on diversifying around small industrial manufacturing.14

3. Are the parent company’s resources and capabilities being stretched too thinly by the resource/capability
requirements of one or more of its businesses? A diversified company must guard against overtaxing
its resources and capabilities, a condition that can arise when (1) it goes on an acquisition spree and
management is called upon to assimilate and oversee many new businesses quickly or (2) it lacks
sufficient supplies of competitively valuable resources and capabilities that it can transfer from one
or more existing business to bolster the competitiveness of resource-deficient businesses. The broader
the diversification, the greater the concern about whether corporate executives are overburdened or
overwhelmed by the demands of competently parenting so many different businesses. Plus, the more a
company’s related diversification strategy is tied to transferring know-how or technologies from existing
businesses to newly acquired or competitively weak businesses, the more time and money that has to be
put into developing a deep-enough pool of business-level and corporate-level resources and capabilities
to supply both new businesses and competitively weak businesses with the quantity and quality of the
resource infusions they need to be successful.15 Otherwise, its resource pool is spread too thinly across
many businesses, and the opportunity for achieving 1 + 1 = 3 outcomes slips through the cracks.

Step 5: Ranking the Performance Prospects of Business Units and
Assigning a Priority for Resource Allocation
Once a diversified company’s businesses are evaluated from the standpoints of industry attractiveness, competitive
strength, strategic fit, and resource fit, the next step is to use this information to rank the performance prospects
of the businesses from best to worst. Such rankings help top-level executives assign each business a priority for
corporate resource support and new capital investment.

The locations of the different businesses in the nine-cell industry attractiveness–competitive strength matrix
provide a solid basis for identifying high-opportunity businesses and low-opportunity businesses. Normally,
competitively strong businesses in attractive industries have significantly better performance prospects than
competitively weak businesses in unattractive industries. Also, normally, the revenue and earnings outlook
for businesses in fast-growing businesses is better than for businesses in slow-growing businesses. As a rule,
business subsidiaries with the brightest profit and growth prospects, attractive positions in the nine-cell matrix,
and solid strategic and/or resource fits should receive top priority in allocating corporate resources to individual
business units. However, in ranking the prospects of the different businesses from best to worst, it is usually wise
to also take into account each business’s past performance regarding sales growth, profit growth, contribution
to company earnings, return on capital invested in the business, and cash flow from operations. While past
performance is not always a reliable predictor of future performance, it does signal whether a business is a
consistent or inconsistent performer and how well it has coped with shifting market conditions in times past.

Allocating Financial Resources Figure 8.6 shows the chief strategic and financial options for allocating a
diversified company’s financial resources. Divesting businesses with the weakest future prospects and businesses
that lack adequate strategic fit and/or resource fit is one of the
best ways of generating additional funds for redeployment
to businesses with better opportunities and better strategic
and resource fits. Free cash flows from cash cow businesses
and the company’s profit sanctuaries also add to the pool of
funds that can be usefully redeployed. Ideally, a diversified
company will have sufficient resources to strengthen or
grow its existing businesses, make any new acquisitions that
are desirable, fund other promising business opportunities,
pay down existing debt, and periodically increase dividend
payments to shareholders and/or repurchase shares of stock. But, as a practical matter, a company’s resources
are limited. Thus, to make the best use of the available resources, top executives must steer resources to

For a company to make the best use of its limited
pool of resources, both financial and nonfinancial,
top executives must be diligent in steering
resources to those businesses with the best
opportunities and performance prospects, and
allocating only minimal resources to businesses
with weak prospects.

Chapter 8 • Diversification Strategies 193

businesses with the best opportunities and performance prospects and either divest or allocate minimal resources
to businesses with marginal or dim prospects—this is why ranking the performance prospects of the various
businesses from best to worst is so crucial. Strategic uses of corporate financial resources (see Figure 8.6) should
usually take precedence over financial uses unless there are strong reasons to strengthen the firm’s balance sheet
or better reward shareholders. And, as emphasized earlier, when a corporate parent has nonfinancial resources
that particular business units will find uniquely valuable in strengthening their performance and/or accelerating
their growth, allocating such resources to these business units should be automatic—they usually represent 1 +
1 = 3 opportunities that should not be missed.

Figure 8.6 The Chief Strategic and Financial Options for Allocating a Diversified
Company’s

Financial Resources

Strategic Options
for Allocating Company

Financial Resources

Financial Options
for Allocating Company

Financial Resources

Invest in ways to strengthen or grow

existing businesses

Make acquisitions to establish positions
in new industries or to complement

existing businesses

Fund long-range R&D ventures aimed
at opening market opportunities in new

or existing businesses

Pay off existing long-term
or short-term debt

Increase dividend payments
to shareholders

Repurchase shares of the company’s
common stock

Build cash reserves; invest in
short-term securities

Step 6: Crafting New Strategic Moves to Improve Overall Corporate Performance
The diagnosis and conclusions flowing from the five preceding analytical steps set the agenda for crafting
strategic moves to improve a diversified company’s overall performance. The strategic options boil down to five
broad categories of actions:

l Sticking closely with the existing business lineup and pursuing the profitable growth opportunities these
businesses present.

l Broadening the company’s business scope by making new acquisitions in new industries.

l Divesting certain businesses and retrenching to a narrower base of business operations.

l Restructuring the company’s business lineup and putting a whole new face on the company’s business
makeup.

l Pursuing multinational diversification and striving to globalize the operations of several of the company’s
business units.

Chapter 8 • Diversification Strategies 194

Sticking with the Present Business Lineup The option of sticking with the current business lineup makes
sense when the company’s present businesses offer attractive growth opportunities that should boost earnings and
contribute to greater shareholder value. As long as the company’s set of existing businesses have good prospects
for enhancing corporate performance and these businesses have good strategic and/or resource fits, then major
changes in the company’s business mix are usually unnecessary. Corporate executives can concentrate their
attention on getting the best performance from each of its businesses and steering corporate resources into those
areas of greatest potential and profitability. The specifics of “what to do” to wring better performance from the
present business lineup have to be dictated by each business’s circumstances and the preceding analysis of the
corporate parent’s diversification strategy.

Broadening the Company’s Business Scope Diversified companies sometimes find it desirable to
build positions in new industries, whether related or unrelated.16 Several motivating factors are in play. One
is sluggish growth and meager performance improvements that make the potential revenue and profit boost of
a newly acquired business look attractive. A second is the potential for transferring resources and capabilities
from existing businesses to newly-acquired related or complementary businesses. A third is rapidly changing
conditions in one or more of a company’s core businesses that make it desirable to expand into other industries.
A fourth, and often important, motivating factor for adding new businesses is to complement and strengthen
the market position and competitive capabilities of one or more of its present businesses. Procter & Gamble’s
acquisition of Gillette strengthened and extended P&G’s reach into personal care and household products—
Gillette’s businesses included Oral-B toothbrushes, Gillette razors and razor blades, Duracell batteries, Braun
shavers and small appliances (coffee makers, mixers, hair dryers, and electric toothbrushes), and toiletries (Right
Guard, Foamy, Soft & Dry, White Rain, and Dry Idea). Johnson & Johnson has used acquisitions to diversify
far beyond its well-known Band-Aid and baby care businesses to become a major player in pharmaceuticals,
medical devices, and medical diagnostics. Amazon has diversified beyond its online retail businesses and as
of early 2024 had over 100 subsidiaries and brands that included Amazon Web Services (a provider of cloud
computing services with 2023 revenues of $90.8 billion), Whole Foods Market, Zappos, Amazon Publishing,
Amazon Studios, Twitch, Ring (smart security systems), Prime Video (digital streaming), Amazon Music,
Audible (audio recordings of books sold on Amazon), Goodreads, Diaper.com, One Medical, Amazon Robotics,
Teachstreet, Amazon Zoox (self-driving robotaxis), and consumer electronics manufacturing (Kindle e-readers,
Fire tablets, Fire TV, Alexa, and Echo devices). Some companies depend on new acquisitions to drive a major
portion of their growth in revenues and earnings, and thus are always on the acquisition trail.

Retrenching to a Narrower Diversification Base A number of diversified firms have had difficulty
managing a diverse group of businesses and have elected to exit some of them. Retrenching to a narrower
diversification base is usually undertaken when top management concludes its diversification strategy has
ranged too far afield and the company can improve long-term performance by concentrating on building
stronger positions in a smaller number of core businesses
and industries. For instance, PepsiCo spun off its fast food
restaurant businesses (Kentucky Fried Chicken, Pizza
Hut, Taco Bell) as a publicly traded company to boost
internal cash flows available for strengthening its soft drink
business (which was losing market share to Coca-Cola) and
growing its more profitable Frito-Lay snack foods business;
PepsiCo’s CEO said divesting the three restaurant chains was needed in order to “bring all our human and
financial resources to bear on our soft drink and snack foods businesses and to dramatically sharpen PepsiCo’s
focus.”17 In 2015, Nike divested its Cole Haan and Umbro brands to focus on its Jordan and Converse footwear
brands that are more complementary to its Nike brand. eBay divested its PayPal business in 2015 by selling it to
the public via an initial public offering of common stock that generated proceeds to eBay of $45 billion, about 30
times what it paid to acquire PayPal in 2002. In 2017, Samsung Electronics sold its printing business to HP, Inc.
in order better focus on its core smartphone, television, appliance, and memory chip businesses.

Focusing corporate resources on a few core and
mostly related businesses avoids the mistake
of diversifying so broadly that resources and
management attention are stretched too thin.

Chapter 8 • Diversification Strategies 195

But there are other important reasons for divesting one or more of a company’s present businesses. Sometimes
divesting a business must be considered because market conditions in a once-attractive industry have badly
deteriorated. A business can become a prime candidate for divestiture because it lacks adequate strategic or
resource fit, because it is a cash hog with questionable long-term potential, or because remedying its competitive
weaknesses is too expensive relative to the likely gains in profitability. Sometimes a company acquires businesses
that, down the road, just do not work out as expected even though management has tried all it can think of to
make them profitable—mistakes cannot be completely avoided because it is hard to foresee how getting into
a new line of business will actually work out. Subpar performance by some business units is bound to occur,
thereby raising questions of whether to divest them or keep them and attempt a turnaround. Other business units,
despite adequate financial performance, may not mesh as well with the rest of the firm as was originally thought.

On occasion, a diversification move that seems sensible from a strategic-fit standpoint turns out to be a poor
cultural fit.18 When several pharmaceutical companies diversified into cosmetics and perfume, they discovered
their personnel had little respect for the “frivolous” nature of such products compared to the far nobler task
of developing miracle drugs to cure the ill. The absence of shared values and cultural compatibility between
the medical research and chemical-compounding expertise of the pharmaceutical companies and the fashion/
marketing orientation of the cosmetics business was the undoing of what otherwise was diversification into
businesses with technology-sharing potential, product development fit, and some overlap in distribution channels.

A useful guide to determine whether or when to divest a business subsidiary is to ask, “If we were not in this
business today, would we want to get into it now?”19 When the answer is no or probably not, divestiture should
be considered. In general, diversified companies need to divest low-performing businesses or businesses that
don’t fit in order to concentrate on expanding high-potential businesses and entering new ones with promising
opportunities.

Selling a business outright to another company is the most frequently used option for divesting a business.
But sometimes a business selected for divestiture has ample resource strengths to compete successfully on its
own. In such cases, a corporate parent may “spin off” the unwanted business as a financially and managerially
independent company, by selling shares to the investing public via an initial public offering or by distributing
shares in the new company to the corporate parent’s existing shareholders.

Restructuring a Company’s Business Lineup Restructuring involves divesting some businesses and
acquiring others to put a whole new face on the company’s business lineup.20 Performing radical surgery on a
company’s business lineup is appealing when its financial performance is being squeezed or eroded by:

l Mismatches between the businesses it has diversified into and the parent company’s resources and
parenting capabilities.

l Too many businesses in slow-growth, declining, low-margin, or otherwise unattractive industries.

l Too many competitively weak businesses.

l The emergence of new technologies that threaten the survival of one or more important businesses.

l Ongoing declines in the market shares of one or more major business units that are falling prey to more
market-savvy competitors.

l An excessive debt burden with interest costs that eat deeply into profitability.

l Ill-chosen acquisitions that haven’t lived up to expectations.

Restructuring is also undertaken when a newly appointed CEO decides to redirect the company. On occasion,
restructuring can be prompted by special circumstances—for example, when a firm has a unique opportunity
to make an acquisition so big and important it has to sell several existing business units to finance the new
acquisition, or when a company needs to sell off some businesses to raise the cash to enter a potentially big
industry with wave-of-the-future technologies or products.

Chapter 8 • Diversification Strategies 196

Candidates for divestiture in a corporate restructuring effort typically include not only weak or up-and-down
performers or those in unattractive industries, but also business units that lack strategic fit with the businesses
to be retained, businesses that are cash hogs or that lack other types of resource fit, and businesses that top
executives deem incompatible with the company’s revised diversification strategy (even though they may be
profitable or in an attractive industry). As businesses are divested, corporate restructuring generally involves
aligning the remaining business units into groups with the best strategic fits and then redeploying the cash
flows from the divested businesses to either pay down debt or make new acquisitions to strengthen the parent
company’s business position in the industries it has chosen to emphasize.21

In 2015, after two decades of acquiring 200 companies of varying types, Google initiated a multi-year
restructuring program which featured the creation of a new umbrella holding company called Alphabet, Inc. All
of Google’s core Internet products and service businesses were organized into Alphabet’s flagship subsidiary
officially named Google and put under the leadership of a single CEO. The Google subsidiary was subsequently
organized into two reporting segments: Google Services and Google Cloud. Google Services’ core products and
platforms consisted of Google Search, YouTube, the Android mobile operating system, the Chrome browser
and Chrome operating platform, Gmail, Google Nest devices, Pixel phones, Google Ads, Google Maps, Google
Drive, Google Meet, Google Assistant, Google Play, Google Docs, and Google Photos. Many of the earlier 200
acquisitions and 41 subsequent acquisitions were merged into one of Google Services units. The remaining
acquisitions either were divested or dissolved or else became a part of Alphabet’s “Other Bets” portfolio of
businesses, headed by a CEO. The Other Bets business collection changed frequently during 2016-2023, via
divestitures and new acquisitions coupled with multiple changes in direction and strategy as Google tried a
variety of initiatives with varying success to grow the “Other Bets” businesses and make the group profitable.
In 2023, Alphabet’s Other Bets group reported revenues of $1.5 billion and an operating loss of $4.1 billion.22

Pursuing Multinational Diversification This strategic approach to diversification offers two major avenues
for growing revenues and profits: One is to grow by entering additional businesses, and the other is to grow by
extending the operations of existing businesses into additional country markets. Pursuing both growth avenues
at the same time has exceptional competitive advantage potential:

l A multinational diversification strategy facilitates full capture of economies of scale and learning/
experience curve effects. In some businesses, the volume of sales needed to realize full economies of
scale and/or benefit fully from experience and learning-curve effects exceeds the volume that can be
achieved by operating within the boundaries of just one or several country markets, especially small
ones. The ability to drive down unit costs by expanding sales to additional country markets is one reason
why a diversified company may seek to acquire a business and then rapidly expand its operations into
more and more countries.

l A multinational diversification strategy provides opportunities to capture economies of scope arising
from cost-saving strategic fits among related businesses. Diversifying into related businesses offering
economies of scope paves the way for realizing a low-cost advantage over less diversified rivals.
Consider, for example, the competitive power that Sony derived from economies of scope when it entered
the video game business in 2000 with its PlayStation product line. Sony had an in-place distribution
capability to go after video game sales in all country markets where it presently did business in other
electronics product categories (TVs, computers, CD and DVD players, radios, and cameras). Plus, it had
the marketing clout and instant brand name credibility to persuade retailers to give Sony’s PlayStation
products prime shelf space and promotional support. These strategic-fit benefits helped Sony quickly
build a profitable presence in the global video game marketplace.

l A multinational diversification strategy provides opportunities to transfer competitively valuable
resources both from one business to another and from one country to another. A company pursuing
related diversification can gain a competitive edge over less diversified rivals by transferring
competitively valuable resources from one business to another; a multinational company can gain
competitive advantage over rivals with narrower geographic coverage by transferring competitively

Chapter 8 • Diversification Strategies 197

valuable resources from one country to another. However, a strategy of multinational diversification
enables simultaneous pursuit of both sources of competitive advantage.

l A multinational diversification strategy provides opportunities to leverage use of a well-known and
competitively powerful brand name. Diversified multinational companies that market the products of
different businesses under an umbrella brand name that is widely known and well-respected across the
world gain important marketing and advertising advantages over rivals with lesser-known brands. A
globally powerful brand name enables a company to (1) get prominent space on retailers’ shelves for
the products of its different businesses sold under that brand, (2) win sales and market share simply
on the confidence buyers place in products carrying the brand name, and (3) spend less money than
lesser-known rivals for advertising. For instance, while Sony may spend money to make consumers
aware of the availability of its newly introduced Sony products, it does not have to spend nearly as
much on achieving brand recognition and market acceptance as do competitors with lesser-known
brands. Further, if Sony moves into a new country market for the first time and does well selling Sony
PlayStations and video games, it is easier to sell consumers in that country Sony TVs, DVD players,
home theater products, headphones, cameras, and tablets. Additionally, the related advertising costs are
likely to be less because of having already established the Sony brand in buyers’ minds.

l A multinational diversification strategy provides opportunities for sister businesses to collaborate
in developing and leveraging competitively valuable resources and capabilities.23 For instance, by
channeling corporate resources into a combined R&D/technology effort for all related businesses, as
opposed to letting each business unit fund and direct its own R&D effort however it sees fit, a diversified
corporate parent can merge its expertise and efforts worldwide to advance core technologies, expedite
cross-business and cross-country product improvements, speed the development of new products that
complement existing products, and pursue promising technological avenues to create altogether new
businesses—all significant contributors to competitive advantage and better corporate performance.24
Honda has been very successful in building corporate-level R&D expertise in gasoline engines and
transferring the resulting technological advances to its businesses in automobiles, motorcycles, outboard
engines, snow blowers, lawn mowers, garden tillers, and portable power generators.

What makes a strategy of multinational diversification exceptionally appealing is that all five paths to competitive
advantage can be pursued simultaneously. A strategy of diversifying into related industries and then competing
globally in each of them thus has great potential for being a
winner in the marketplace because of the long-term growth
opportunities it offers and the multiple corporate-level
competitive advantage opportunities it contains. Indeed,
a strategy of multinational diversification contains more
competitive advantage potential (above and beyond what is
achievable through a particular business’s own competitive
strategy) than any other diversification strategy. The
strategic key to actually capturing maximum competitive advantage is for a diversified multinational company to
focus its diversification efforts in industries where there are resource-sharing and resource-transfer opportunities
and where there are important economies of scope and big benefits to cross-business use of a potent brand name.
The more a company’s diversification strategy yields these kinds of strategic-fit benefits, the more powerful a
competitor it becomes and the better its profit and growth performance is likely to be. Such advantages explain
why such consumer products companies as Procter & Gamble, Unilever, Nestlé, L’Oréal, Kimberly-Clark,
Colgate-Palmolive, General Mills, and Coca-Cola employ a strategy of multinational diversification.

CORE CONCEPT
A strategy of multinational diversification into
related businesses has more built-in potential
for competitive advantage than any other
diversification strategy.

Chapter 8 • Diversification Strategies 198

Key Points
A “good” diversification strategy must produce increases in long-term shareholder value—increases that
shareholders cannot otherwise obtain on their own. For a move to diversify into a new business to have a
reasonable prospect of adding shareholder value, it must be capable of passing the industry attractiveness test,
the cost-of-entry test, and the better-off test.

There are two fundamental approaches to diversifying—into related businesses and into unrelated businesses.
The rationale for related diversification is strategic: Diversify into businesses with strategic fits along their
respective value chains, capitalize on strategic-fit relationships to gain competitive advantage over rivals whose
operations do not offer comparable strategic fit benefits, and then use competitive advantage to boost profitability
and achieve the desired 1 + 1 = 3 impact on shareholder value. The greater the relatedness among the value
chains of a diversified company’s sister businesses, the bigger the window for converting strategic fits into
competitive advantage via (1) cross-business transfer of valuable competitive assets, (2) the capture of cost-
saving efficiencies via sharing use of the same resources, (3) cross-business use of a well-respected brand name,
and/or (4) cross-business collaboration to create new resource strengths and capabilities.

The basic premise of unrelated diversification is that any business that has good profit prospects and can be
acquired on good financial terms is a good business to diversify into. Unrelated diversification strategies
surrender the competitive advantage potential of strategic fit and seek to add long-term shareholder value in
five ways: (1) acquiring companies in any industry with growth and earnings prospects that can satisfy the
industry attractiveness test, (2) acquiring undervalued or underperforming businesses that present appealing
opportunities for being overhauled in ways that will result in big gains in profitability, (3) being disciplined
enough to acquire companies at prices sufficiently low to pass the cost of entry test, (4) developing and nurturing
outstanding corporate parenting resources and capabilities, and (5) discerning when it is time to exit a business
and find buyers who will pay the highest price. However, the greater the number of businesses a company has
diversified into and the more diverse these businesses are, the harder it is for corporate executives to select
capable managers to run each business, know when the major strategic proposals of business units are sound, or
help guide the creation of an effective action plan to restore profitability when a business unit encounters trouble.

Analyzing the attractiveness of a company’s diversification strategy is a six-step process:

Step 1: Evaluate the long-term attractiveness of the industries into which the firm has diversified. Industry
attractiveness needs to be evaluated from three angles: the attractiveness of each industry on its own, the
attractiveness of each industry relative to the others, and the attractiveness of all the industries as a group.

Step 2: Evaluate the relative competitive strength of each of the company’s business units. The purpose
of rating the competitive strength of each business is to gain a clear understanding of which businesses
are strong contenders in their industries, which are weak contenders, and the underlying reasons for their
strength or weakness. Drawing an industry attractiveness–competitive strength matrix helps identify the
prospects of each business and suggests the priorities for allocating corporate resources and investment
capital to each business.

Step 3: Evaluate the competitive value of cross-business strategic fits. A business is more attractive
strategically when it has value chain relationships with sister business units that offer potential to (1) realize
economies of scope or cost-saving efficiencies; (2) transfer technology, skills, know-how, or other resource
capabilities from one business to another; (3) leverage use of a well-known and trusted brand name; and/or
(4) collaborate with sister businesses to build new or stronger resource strengths and competitive capabilities.
Cross-business strategic fits represent a significant avenue for producing competitive advantage beyond
what any one business can achieve on its own.

Chapter 8 • Diversification Strategies 199

Step 4: Check whether the firm’s resources fit the requirements of its present business lineup. Resource fit
exists when (1) each company business has adequate access to the resources it needs to be competitively
successful (these resources can either be internal to its own operations or supplied by its corporate parent)
and (2) the parent company has sufficient financial resources and parenting capabilities to support its entire
group of businesses without spreading itself too thin.

Step 5: Rank the performance prospects of the businesses from best to worst and determine what the
corporate parent’s priority should be in allocating resources to its various businesses. The most important
considerations in judging business unit performance are sales growth, profit growth, contribution to
company earnings, and the return on capital invested in the business. Sometimes, cash flow generation
is a big consideration. Normally, strong business units in attractive industries have significantly better
performance prospects than weak businesses or businesses in unattractive industries. Business subsidiaries
with the brightest profit and growth prospects and solid strategic and resource fits generally should head the
list for corporate resource support.

Step 6: Craft new strategic moves to improve overall corporate performance. This step draws upon the
results of the preceding steps to devise actions for improving the collective performance of the company’s
different businesses. There are basically five strategic options: (1) sticking closely with the existing business
lineup and pursuing the opportunities these businesses present, (2) broadening the company’s business scope
by making new acquisitions in new industries, (3) divesting certain businesses and retrenching to a narrower
base of business operations, (4) restructuring the company’s business lineup and putting a whole new face
on the company’s business makeup, and (5) pursuing a strategy of multinational diversification.

What Is Strategy
and Why Is It Important?

What Do We Mean by “Strategy”?

Strategy and the Quest for Competitive Advantage

A Company’s Strategy is Partly Proactive and Partly Reactive

Strategy and Ethics: Passing the Test
of Moral Scrutiny

The Relationship Between a Company’s Strategy and Its Business Model

What Makes a Strategy a Winner?

Why Crafting and Executing Strategy Are Important Tasks

The Road Ahead

Key Points

Charting a Company’s Long-Term Direction: Vision, Mission,
Objectives, and Strategy

What Does the Strategy-Making,
Strategy-Executing Process Entail?

Task 1: Developing a Strategic Vision, Mission Statement, and Set of Core Values

Task 2: Setting Objectives

Task 3: Crafting A Strategy

Task 4: Implementing and Executing the Strategy

Task 5: Evaluating Performance and Initiating Corrective Adjustments

Corporate Governance: The Role of the Board of Directors in the Strategy-Making, Strategy-Executing Process

Key Points

Evaluating a Company’s
External Environment

THE STRATEGICALLY RELEVANT FACTORS
INFLUENCING A COMPANY’S EXTERNAL ENVIRONMENT

Assessing a Company’s Industry and Competitive Environment

Question 1: What Competitive Forces Do Industry
Members Face and How Strong Are They?

Question 2: What Factors Are Driving Industry Change and What Impact Will They Have?

Question 3: What Market Positions Do Rivals Occupy—Who Is Strongly Positioned and Who Is Not?

Question 4: What Strategic Moves Are Rivals Likely to Make Next?

Question 5: What Are the Key Factors for Future Competitive Success?

Question 6: Is the Industry Outlook Conducive to Good Profitability?

Key Points

Evaluating a Company’s Resources and Ability to Compete Successfully

QUESTION 1: HOW WELL IS THE COMPANY’S PRESENT STRATEGY WORKING?

QUESTION 2: WHAT ARE THE COMPANY’S IMPORTANT RESOURCES AND CAPABILITIES AND DO THEY HAVE ENOUGH COMPETITIVE POWER TO PRODUCE A COMPETITIVE ADVANTAGE OVER RIVALS?

QUESTION 3: WHAT ARE THE COMPANY’S COMPETITIVELY IMPORTANT STRENGTHS AND WEAKNESSES AND ARE THEY WELL-SUITED TO CAPTURING ITS BEST MARKET OPPORTUNITIES AND DEFENDING AGAINST EXTERNAL THREATS?

QUESTION 4: ARE THE COMPANY’S PRICES AND COSTS COMPETITIVE WITH THOSE OF KEY RIVALS, AND DOES IT HAVE AN APPEALING CUSTOMER VALUE PROPOSITION?

QUESTION 5: IS THE COMPANY COMPETITIVELY STRONGER OR WEAKER THAN KEY RIVALS?

QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS DOES TOP MANAGEMENT NEED TO ADDRESS IN CRAFTING A STRATEGY TO FIT THE SITUATION?

KEY POINTS

The Five Generic Competitive Strategy Options: Which One to Employ?

THE FIVE GENERIC COMPETITIVE STRATEGIES

BROAD LOW-COST PROVIDER STRATEGIES

BROAD DIFFERENTIATION STRATEGIES

FOCUSED (OR MARKET NICHE) STRATEGIES

BEST-COST PROVIDER STRATEGIES

SUCCESSFUL COMPETITIVE STRATEGIES ARE ALWAYS UNDERPINNED BY RESOURCES AND CAPABILITIES THAT ALLOW THE STRATEGY TO BE WELL-EXECUTED

KEY POINTS

Supplementing the Chosen Competitive Strategy—
Other Important Strategy Choices

GOING ON THE OFFENSIVE—STRATEGIC OPTIONS TO IMPROVE A COMPANY’S MARKET POSITION

DEFENSIVE STRATEGIES—PROTECTING MARKET POSITION AND COMPETITIVE ADVANTAGE

WEBSITE STRATEGIES

OUTSOURCING STRATEGIES

VERTICAL INTEGRATION STRATEGIES:
OPERATING ACROSS MORE STAGES
OF THE INDUSTRY VALUE CHAIN

STRATEGIC ALLIANCES AND PARTNERSHIPS

MERGER AND ACQUISITION STRATEGIES

CHOOSING APPROPRIATE FUNCTIONAL-AREA STRATEGIES

TIMING A COMPANY’S STRATEGIC MOVES

KEY POINTS

Strategies for Competing
Internationally or Globally

WHY COMPANIES DECIDE TO ENTER FOREIGN MARKETS

WHY COMPETING ACROSS NATIONAL BORDERS CAUSES STRATEGY MAKING TO BE MORE COMPLEX

THE CONCEPTS OF MULTICOUNTRY COMPETITION AND GLOBAL COMPETITION

STRATEGY OPTIONS FOR ESTABLISHING A COMPETITIVE PRESENCE IN FOREIGN MARKETS

COMPETING IN FOREIGN MARKETS: THE THREE COMPETITIVE STRATEGY APPROACHES

BUILDING CROSS-BORDER COMPETITIVE ADVANTAGE

PROFIT SANCTUARIES AND GLOBAL STRATEGIC OFFENSIVES

Key Points

Diversification Strategies

What Does Crafting a Diversification Strategy Entail?

CHOOSING THE DIVERSIFICATION PATH:
RELATED VS. UNRELATED BUSINESSES

EVALUATING THE STRATEGY OF A DIVERSIFIED COMPANY

KEY POINTS

Strategy, Ethics, and Social Responsibility

What Do We Mean by Business Ethics?

where do Ethical standards come from?

THE THREE CATEGORIES OF MANAGEMENT MORALITY

WHAT ARE THE DRIVERS OF UNETHICAL STRATEGIES AND BUSINESS BEHAVIOR?

WHY SHOULD COMPANY STRATEGIES BE ETHICAL?

Strategy, Social Responsibility, and Corporate Citizenship

KEY POINTS

Building an Organization
Capable of Good Strategy Execution

A FRAMEWORK FOR EXECUTING STRATEGY

BUILDING AN ORGANIZATION CAPABLE OF GOOD STRATEGY EXECUTION: THREE KEY ACTIONS

STAFFING THE ORGANIZATION

DEVELOPING AND STRENGTHENING EXECUTION-CRITICAL RESOURCES AND CAPABILITIES

STRUCTURING THE ORGANIZATION AND WORK EFFORT

KEY POINTS

Managing Internal Operations:
Actions That Promote
Good Strategy Execution

Allocating Needed Resources to Execution-Critical Activities

ENSURING THAT POLICIES AND PROCEDURES FACILITATE STRATEGY EXECUTION

ADOPTING BEST PRACTICES AND EMPLOYING PROCESS MANAGEMENT TOOLS TO IMPROVE EXECUTION

INSTALLING INFORMATION AND OPERATING SYSTEMS

TYING REWARDS AND INCENTIVES DIRECTLY TO ACHIEVING GOOD PERFORMANCE OUTCOMES

KEY POINTS

Corporate Culture and Leadership—Keys to Good Strategy Execution

INSTILLING A CORPORATE CULTURE THAT PROMOTES GOOD STRATEGY EXECUTION

LEADING THE STRATEGY EXECUTION PROCESS

KEY POINTS

200Chapter 9

Strategy, Ethics, and Social Responsibility

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Strategy: Core Concepts and Analytical Approaches

An e-book marketed by McGraw Hill LLC

Arthur A. Thompson, The University of Alabama 8th Edition, 2025–2026

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Chapter 9
Strategy, Ethics, and Social Responsibility

Corporations are economic entities, to be sure, but they are also social institutions that must justify their
existence by their overall contribution to society.
—Henry Mintzberg, Robert Simons, and Kunal Basu, professors

A well-run business must have high and consistent standards of ethics.
—Richard Branson—Founder of Virgin Atlantic Airlines and Virgin Group

The time is always right to do what is right.
—Martin Luther King, Jr., Civil rights activist and humanitarian

It takes many good deeds to build a good reputation and only one bad one to lose it.
—Benjamin Franklin

The choice between a healthy planet and good business strategy has always been a false one, and we’ve
proved that, with a company that runs on 100% clean energy and a supply chain transitioning to do the same.
—Lisa Jackson, Vice President of Environment, Policy, and Social Initiatives, Apple Inc.

Clearly, in capitalistic or market economies, top-level managers of privately-owned companies are
responsible and accountable for operating the enterprise profitably and acting in shareholders’ best
interests. Managers of public companies have a fiduciary duty to operate the enterprise in a manner that

creates value for shareholders—it’s a legal obligation. Just as clearly, a company and its personnel are duty-bound
to obey the law and comply with governmental regulations. But does a company also have a duty to go beyond
legal requirements and hold all company personnel responsible for conforming to high ethical standards? Does
a company have an obligation to be a good corporate citizen? Should a company display a social conscience by
devoting a portion of its resources to improving the quality of life in the communities where it operates and in
society at large? How far should a company go in protecting the environment, conserving natural resources for
use by future generations, and ensuring its operations do not ultimately endanger the planet?

This chapter focuses on whether a company, in the course of trying to craft and execute a strategy that delivers
value to both customers and shareholders, also has a duty to (1) act in an ethical manner, (2) be a committed
corporate citizen and allocate some of its financial and human resources to improving the well-being of employees,
the communities in which it operates, and society as a whole, and (3) screen its strategic initiatives and operating
practices for possible negative effects on the environment and future generations of the world’s population.

Chapter 9 • Strategy, Ethics, and Social Responsibility 201

What Do We Mean by Business Ethics?
Ethics concerns the principles and standards of right and wrong conduct. Business ethics concerns the application
of ethical principles and standards to the actions and decisions of business organizations and the conduct of their
personnel.1 Ethical principles in business are not materially
different from ethical principles in general. Why? Because
business actions must be judged in the context of society’s
standards of what is ethically right and wrong, not by
a special set of rules that apply just to business conduct.
If dishonesty is considered unethical and immoral, then
dishonest behavior in business—whether it relates to
customers, suppliers, employees, or shareholders—qualifies
as equally unethical and immoral. If being ethical entails not deliberately harming others, then businesses are
ethically obligated to recall a defective or unsafe product, regardless of the cost. If society deems bribery
unethical, then it is unethical for company personnel to make payoffs to government officials to win government
contracts or bestow gifts and other favors on prospective customers to win or retain their business. In short,
ethical behavior in business situations requires adhering to generally accepted norms about right and wrong. This
means that company managers should be expected to craft a strategy that complies with ethical standards and
strive to ensure that ethical norms are observed in executing the strategy. And it means all company personnel
have an obligation—indeed, a duty—to conduct their assigned piece of the company’s business in an ethical and
honorable manner.

Where Do Ethical Standards Come From?
Notions of right and wrong, fair and unfair, moral and immoral, ethical and unethical are present in all societies
and cultures. But there are three distinct schools of thought about the extent to which ethical standards travel
across cultures and whether multinational companies can apply the same set of ethical standards in any and all
locations where they operate.

The School of Ethical Universalism
According to the school of ethical universalism, the most fundamental concepts of what is right and what is
wrong are universal and transcend most all cultures, societies, and religions.2 For instance, being truthful (or not
lying or not being deliberately deceitful) strikes a chord of what is right in the people of all nations. Likewise,
demonstrating integrity of character, not cheating, and
treating people with courtesy and respect are concepts that
resonate across countries, cultures, and religions. In most
societies, people would concur it is unethical to knowingly
expose workers to toxic chemicals and hazardous materials
or to sell products known to be unsafe or harmful to the
users or to pillage or degrade the environment. These
universal ethical traits and behaviors are considered virtuous
and represent standards of conduct that a good person is
supposed to believe in and to observe. Thus, adherents of
the school of ethical universalism maintain it is entirely appropriate to expect all members of society (including
all personnel of all companies worldwide) to conform to universal ethical standards.3

The strength of ethical universalism is that it draws upon the collective views of multiple societies and cultures
to put some clear boundaries on what constitutes ethical and unethical business behavior no matter what
country or culture a company or its personnel are operating in. This means in those instances where basic
moral standards do not vary significantly according to local cultural beliefs, traditions, religious convictions, or

CORE CONCEPT
Business ethics deals with the application of
general ethical principles and standards to the
actions and decisions of businesses and the
conduct of their personnel.

CORE CONCEPT
The school of ethical universalism holds that
common moral agreement about right and wrong
actions and behaviors across multiple cultures
and countries form the basis for universal ethical
standards applicable to the members of all
societies, all companies, and all businesspeople.

Chapter 9 • Strategy, Ethics, and Social Responsibility 202

time and circumstance, a multinational company can develop a single code of ethics and apply it more or less
evenly across its worldwide operations.4 It can avoid the slippery slope that comes from having different ethical
standards for different company personnel depending on where in the world they are working.

The School of Ethical Relativism
According to the school of ethical relativism, while there are a few universal moral prescriptions—like being
truthful and trustworthy—that apply in most every society and business circumstance, there are also observable
variations in what societies generally agree to be ethically right and wrong. Indeed, differing religious beliefs,
historic traditions and customs, core values and beliefs, and behavioral norms across countries and cultures
frequently give rise to different standards about what is fair or unfair, moral or immoral, and ethically right or
wrong. These differing standards translate into differences
about what is considered ethical or unethical in the conduct
of business activities. For instance, European and American
managers often establish standards of business conduct
and ethical behavior that protect such core human rights
as freedom of movement and residence, freedom of speech
and political opinion, fairness of treatment, equal protection
under the law, and the right to privacy. In China, where
societal commitment to basic human rights is weak, human
rights considerations play a small role in determining what is
ethically right or wrong in conducting business activities. In
Japan, managers believe showing respect for the collective
good of society is an important ethical consideration. In
Muslim countries, managers typically apply ethical standards compatible with the teachings of Mohammed.
Consequently, the school of ethical relativism holds that a “one-size-fits-all” template for judging the ethical
appropriateness of business actions and the behaviors of company personnel is totally inappropriate. Rather, the
underlying thesis of ethical relativism is that whether certain actions or behaviors are ethically right or wrong
depends on what a local country or culture decides is ethically right or wrong—in other words, when there
are cross-country or cross-cultural differences in ethical standards, it is appropriate for local ethical standards
to take precedence over ethical standards elsewhere.5 This need to contour local ethical standards to fit local
customs, local notions of fair and proper individual treatment, and local business practices gives rise to multiple
sets of ethical standards. In a world of ethical relativism, there are few absolutes when it comes to business
ethics, and thus few ethical absolutes for consistently judging the ethical correctness of a company’s conduct in
various countries and markets.

While the ethical relativism rule of contouring ethical standards to fit local norms may seem reasonable on the
surface, it leads to the conclusion that what prevails as local morality is an adequate and definitive guide to
ethical behavior. But this poses some challenging ethical dilemmas. Consider the following two examples.

The Use of Underage Labor In industrialized nations, the use of “underage” workers is considered taboo.
Social activists are adamant that child labor is unethical, that legislation mandating compulsory education is
needed in all countries across the world, and that companies should neither employ children under the age
of 18 as full-time employees nor source any products from foreign suppliers that employ underage workers.
Many countries have passed legislation forbidding the use of underage labor or, at a minimum, regulating the
employment of workers under the age of 18. However, in Ethiopia, Zimbabwe, Pakistan, Afghanistan, Somalia,
Burma, North Korea, Yemen, Bangladesh, Botswana, Sri Lanka, Ghana, Nigeria, Sudan, and 45 other countries,
where poverty rates are very high, children are typically viewed as potential, even necessary, workers.6 In India,
China, Russia, and much of Africa, child labor laws are poorly enforced.7 As of 2022, the International Labor
Organization and United Nations Children’s Fund estimated there were 160 million child laborers aged 5 to 17
and some 79 million of them were engaged in hazardous work; in age groups 5-11, 12-14, and 15-17, child labor
was more prevalent among boys than girls.8

CORE CONCEPT
According to the school of ethical relativism,
differing religious beliefs, historic traditions and
customs, core values and beliefs, and behavioral
norms across countries and cultures give rise to
multiple sets of standards concerning what is
ethically right or wrong. These differing standards
mean that whether certain business-related
actions or behaviors are ethically right or wrong
depend on the prevailing local ethical standards.

Chapter 9 • Strategy, Ethics, and Social Responsibility 203

While exposing children to hazardous work, forced labor, and long work hours is unquestionably deplorable,
the fact remains that poverty-stricken families in many poor countries cannot subsist without the work efforts of
young family members; sending their children to school instead of having them participate in the workforce is not
a realistic option. Hence, greatly restricting the permissible kinds of employment of children in poor countries—
owing to strong pressures from well-meaning activist groups and government organizations whose systems
of values and beliefs prompt them to work toward banning many forms of child labor—risks the unintended
consequences of forcing children in impoverished families to seek work in “hidden” parts of the economy of
their countries, ber out on the street begging, or even reduced to trafficking in drugs or engaging in prostitution.9
To the extent that such unintended consequences occur,
have the best interests of underage workers, impoverished
families, and society in general been well served? On
the other hand, notwithstanding the principle of ethical
relativism, it is logical quicksand to contend that child labor
is unethical in industrialized countries (because it is contrary
to local custom) yet is ethically permissible in impoverished
countries where child labor is common practice. It would
seem ethically inconsistent to declare the employment of
underage labor to be an unethical business practice in one locality and an ethical business practice in another
location simply because of differing local customs.

The Payment of Bribes and Kickbacks A particularly thorny area facing multinational companies is
the degree of cross-country variability in paying bribes.10 In many countries, it is common for companies to
pay bribes to government officials to win a government contract, obtain a license or permit, or facilitate an
administrative ruling. In some developing nations, it is difficult for any foreign or domestic company to move
goods through customs without paying off low-level officials.11 Senior managers in China and Russia often use
their power to obtain kickbacks when they purchase materials or other products for their companies.12 Likewise,
in many countries it is normal to make payments to prospective customers to win or retain their business. Some
people stretch to justify the payment of bribes and kickbacks on grounds that bribing government officials to get
goods through customs or giving kickbacks to customers to retain their business or win new orders is simply a
payment for services rendered, in the same way that people tip for service at restaurants.13 Nevertheless, while
this argument is a clever and pragmatic way to rationalize viewing bribes as a normal and maybe unavoidable
cost of doing business, it rests on moral quicksand.

Companies that forbid the payment of bribes and kickbacks in their codes of ethical conduct and that are
serious about enforcing this prohibition face a particularly vexing problem in those countries where bribery and
kickback payments are an entrenched local custom and are not considered unethical.14 Refusing to pay bribes
or kickbacks in these countries (to comply with the company’s code of ethical conduct) is often tantamount to
losing business to competitors willing to make such payments—an outcome that penalizes ethical companies and
ethical company personnel (who may suffer lost sales commissions or bonuses). But, on the other hand, blinking
an eye at a company’s code of ethical conduct and going along with the payment of bribes or kickbacks not only
undercuts enforcement of and adherence to the company’s code of ethics but can also risk breaking the law. The
Foreign Corrupt Practices Act (FCPA) prohibits U.S. companies from paying bribes to government officials,
political parties, political candidates, or others in all countries where they do business. The Organization for
Economic Cooperation and Development (OECD) has anti-bribery standards that criminalize the bribery of
foreign public officials in international business transactions—all 37 OECD member countries and 7 nonmember
countries had adopted these standards by the end of 2018; the 2018 standards were further strengthened by five
additional recommendations adopted in 2021.15

Despite laws forbidding bribery to secure sales and contracts, the practice persists. Siemens, one of the world’s
largest corporations and headquartered in Munich, Germany, was fined $1.6 billion by the U.S. and German
governments for paying more than $800 million to more than 4,000 well-placed government officials in Asia,
Africa, Europe, the Middle East, and Latin America between 2001 and 2007 to help secure huge public works
contracts. Moreover, there was evidence that bribery of public officials was a core element of Siemens’ strategy.

Strict adherence to the principles of ethical
relativism leads to the untenable conclusion that
child labor is ethically impermissible in countries
where it is contrary to local custom, but it is
ethically permissible in countries where the use of
child labor is common practice.

Chapter 9 • Strategy, Ethics, and Social Responsibility 204

In 2017, the executive chairman of Insys Therapeutics was arrested for bribing doctors to overprescribe the
company’s opioid products. Also in 2017, oil services giant Halliburton agreed to pay $29.2 million to settle
charges related to payments made to a company in Angola to win oilfield services contracts; one of Halliburton’s
executive had to pay a $75,000 fine. In 2018, United Technologies agreed to pay nearly $14 million to settle
charges that it made illicit payments to facilitate sales of elevators and aircraft engines in the Middle East
and China. Legg Mason agreed to pay more than $34 million in 2018 to settle charges related to a scheme
to bribe Libyan government officials. Credit Suisse Group agreed to pay more than $30 million to the U.S.
Securities and Exchange Commission and a $47 million criminal penalty to resolve charges that the firm obtained
investment banking business in the Asia-Pacific region by corruptly influencing foreign officials in violation of
the FCPA. Brazil-based oil-and-gas company Petróleo Brasileiro S.A. (Petrobras) agreed to pay $1.78 billion
in a global resolution arising out of a massive bribery and bid-rigging scheme. Japan-based Panasonic paid
$143 million to the U.S. Securities and Exchange Commission to settle charges that it violated the FCPA by
paying an $875,000 bribe to a government official to help retain $700 million in contracts to supply in-flight
entertainment and communication systems to a Japanese government-owned airline. The global snack company
Mondelēz International had to pay a $13 million penalty for violations that its Cadbury candy subsidiary made
illicit payments to get approvals for a new chocolate factory in India. Other well-known companies caught up
in recent bribery cases include JPMorgan; pharmaceutical companies GlaxoSmithKline, Novartis, Sanofi, and
AstraZeneca; casino company Las Vegas Sands; aircraft manufacturer Embraer; and Dun & Bradstreet. An
OECD study of criminal proceedings for bribery in all the countries that had signed the OECD’s Anti-Bribery
Convention during the period February 1999–December 2021 revealed that 927 individuals and 676 companies
were convicted or sanctioned for foreign bribery or related offenses through criminal, administrative, or civil
proceedings; as of January 2022, some 677 investigations were ongoing.16

Using the Principle of Ethical Relativism to Create Ethical Standards Is Problematic for
Multinational Companies Relying upon the principle of ethical relativism to determine what is ethically
right or wrong poses major problems for multinational companies wanting to address the real issue of what
ethical standards to enforce companywide. It is a slippery slope indeed to resolve conflicting ethical standards
for operating in different countries. How can a multinational company, standing on the principle of ethical
relativism, declare it ethically permissible for company
personnel to pay bribes and kickbacks in countries where
such payments are customary but ethically impermissible
to make such payments in countries where bribes and
kickbacks are either not customary or illegal?

Business leaders who rely upon the principle of ethical
relativism to justify conflicting ethical standards for
operating in different countries have little moral basis for
establishing or enforcing ethical standards companywide.
Rather, when a company’s ethical standards vary from
country to country, the clear message sent to employees is that the company has no ethical standards or convictions
of its own and prefers to let its standards of ethically right and wrong be governed by the customs and practices
of the countries in which it operates. Applying multiple sets of ethical standards without a higher-order moral
compass is scarcely a basis for insisting that company personnel observe high standards of ethical behavior.

Ethics and Integrative Social Contracts Theory
Integrative social contracts theory provides yet a middle position between the opposing views of
universalism (that the same set of ethical standards should apply everywhere) and relativism (that ethical standards
should be governed by local custom and practice).17 According to this theory, the ethical standards a company
should try to uphold are governed by both (1) a limited number of universal ethical principles widely recognized
as putting legitimate ethical boundaries on actions and behavior in all situations and (2) the circumstances of
local cultures, traditions, and shared values that further prescribe what constitutes ethically permissible behavior
and what does not. However, universal ethical norms always take precedence over local ethical norms. In

Managers in multinational enterprises have to
figure out how to navigate the gray zone that
arises when their company operates in two or
more countries or cultures with differing customs
and ethical standards. Having multiple standards
that vary by locale is equivalent to having no
standard.

Chapter 9 • Strategy, Ethics, and Social Responsibility 205

other words, universal ethical principles apply in those situations where most all societies—endowed with
rationality and moral knowledge—have common moral agreement on what actions and behaviors fall inside
the boundaries of what is right and which ones fall outside. These mostly uniform and universal agreements
about what is morally right and wrong form a “social
contract” or contract with society that is binding on all
individuals, groups, organizations, and businesses in
terms of establishing right and wrong and drawing the line
between ethical and unethical behaviors.

But these universal ethical principles or norms nonetheless
still leave some “moral free space” for the people in a
particular country (or local culture or even a company) to
make specific interpretations of what other actions may
or may not be permissible within the bounds defined by
universal ethical principles. Hence, while firms, industries,
professional associations, and other business-relevant
groups are “contractually obligated” to society to observe
universal ethical norms, they have the discretion to go
beyond these universal norms and specify other behaviors
that are out of bounds and place further limitations on what
is considered ethical. Both the legal and medical professions
have standards regarding what kinds of advertising are
ethically permissible and what kinds are not. Food products companies are beginning to establish ethical
guidelines for judging what is and is not appropriate advertising for inherently unhealthy food products that may
cause dietary or obesity problems for people who eat them regularly or consume them in large quantities.

The strength of integrated social contracts theory is that it accommodates the best parts of ethical universalism
and ethical relativism. It is indisputable that cultural differences impact how business is conducted in various
parts of the world and that these cultural differences sometimes give rise to different ethical norms. But it is just
as indisputable that some ethical norms are more authentic or universally applicable than others, meaning that
in many instances of cross-country differences one side may be more “ethically correct” or “more right” than
another. In such instances, resolving cross-cultural differences in what is ethically permissible versus what is
not entails applying universal or “first-order” ethical norms and overriding the local or “second-order” ethical
norms. A good example of the application of integrated social contracts theory is the payment of bribes and
kickbacks. Yes, bribes and kickbacks are common in some countries, but does this justify paying them? Just
because bribery flourishes in a country does not mean it is an authentic or legitimate ethical norm. Virtually all
of the world’s major religions (Buddhism, Christianity, Confucianism, Hinduism, Islam, Judaism, Sikhism, and
Taoism) and all moral schools of thought condemn bribery and corruption.18 Therefore, a multinational company
might reasonably conclude that there is a universal ethical principle to be observed here—one of refusing to
condone bribery and kickbacks on the part of company personnel no matter what the local custom is and no
matter what the sales consequences are.

The Principles of Integrated Social Contracts Theory Work Well for Multinational Companies
Integrated social contracts theory offers clear guidance for the managers of multinational companies in resolving
cross-country ethical differences: Those parts of the company’s code of ethics that involve universal ethical
norms must be enforced worldwide, but within these boundaries there is room for company personnel to engage
in behaviors that conform to local ethical standards. Allowing room for the observance of local or second-order
ethical norms is a pragmatic and defensible middle-ground—it means a multinational enterprise does not have to
adopt the role of standard-bearer of moral truth and impose inflexible ethics standards worldwide no matter what.
And it avoids the fatal weakness of using the principle of ethical relativism to set ethical standards of right and
wrong that are totally governed by the customs and practices of the countries in which it operates and thus gives
company personnel a license to engage in behavior that clearly violates universal ethical norms.

CORE CONCEPT
According to integrated social contracts theory,
universal ethical principles or norms based on
the collective views of multiple cultures and
societies combine to form a “social contract”
that all individuals, groups, organizations, and
businesses in all situations have a duty to observe.
So long as the boundaries of this social contract
are observed, there is legitimate room for local
cultures or groups to prescribe what other actions
may or may not be ethically permissible. However,
according to integrated social contracts theory,
adherence to universal or “first-order” ethical
norms must always take precedence over local or
“second-order” norms.

Chapter 9 • Strategy, Ethics, and Social Responsibility 206

The Three Categories of Management Morality
Three categories of managers stand out with regard to ethical and moral principles in business affairs:19

l The moral manager. Moral managers are dedicated to high standards of ethical behavior, both in their
own actions and in their expectations of how the company’s business is to be conducted. They see
themselves as stewards of ethical behavior and believe it is important to pursue success in business
within the confines of both the letter and the spirit of what is ethical and legal. They typically regard
complying with the law as an ethical minimum, and they operate well above what the law requires.

l The immoral manager. Immoral managers have no regard for so-called ethical standards in business and
pay no attention to ethical principles in making decisions and conducting the company’s business. Their
philosophy is that good businesspeople cannot spend time watching out for the interests of others and
agonizing over “the right thing to do” from an ethical perspective. In the minds of immoral managers,
nice guys come in second and the competitive nature of business requires that you either trample on
others or get trampled yourself. They believe what really matters is the single-minded pursuit of their
own best interests. They are living examples of capitalistic greed, caring only about their own or their
organization’s gains and successes. Immoral managers may even be willing to short-circuit legal and
regulatory requirements if they think they can escape detection. And they are always on the lookout for
legal loopholes and creative ways to get around rules and regulations that block or constrain actions they
deem in their own or their company’s self-interest. Immoral managers are thus the bad guys. They have
few scruples, little or no integrity, and are willing to do most anything they believe they can get away
with. It doesn’t bother them much to be seen by others as wearing the black hats.

l The amoral manager. Amoral managers believe businesses ought to be able to do whatever the prevailing
laws and regulations allow them to do. If particular
business actions and behaviors are legal and do not
violate prevailing government regulations, they
should not be seen as unethical. Amoral managers
view the observance of high ethical standards
(doing more than what laws and regulations require)
as too Sunday-schoolish for the tough competitive
world of business, even though observing some
higher ethical considerations may be appropriate in
life outside of business. Their concept of right and
wrong tends to be lawyer-driven—“How much can
we get by with?” and “What are the risks of going
ahead even if a particular action is borderline?”

By some accounts, the population of managers is said to be distributed among all three types in a bell-shaped
curve, with immoral managers and moral managers occupying the two tails of the curve, and amoral managers
occupying the broad middle ground.20 Furthermore, within the population of managers, there is experiential
evidence to support that while the average manager is amoral most of the time, he or she may slip into a moral
or immoral mode on occasion, based on a variety of impinging factors and circumstances.

Evidence of Managerial Immorality in the Global Business Community
There is considerable evidence that a sizable majority of managers are either amoral or immoral. Ongoing
research by Berlin-based Transparency International shows corruption among public officials and in business
transactions is widespread across the world; the 2023 global average across 180 countries and territories was
43, below the midpoint of the scale of 0 (highly corrupt) to 100 (very clean); more than two-thirds of the
countries scored below 50 and 23 countries posted their lowest scores ever.21 Countries in Western Europe and
the European Union posted the highest regional score on the 2023 Corruption Perception Index (CPI), with

CORE CONCEPT
Amoral managers believe that businesses
ought to be able to do whatever current laws
and regulations allow them to do without being
shackled by any ethical considerations. They
think that what is permissible and what is not
are governed entirely by prevailing laws and
regulations, not by societal concepts of right and
wrong.

Chapter 9 • Strategy, Ethics, and Social Responsibility 207

an average of 65; the lowest performing geographic region on the 2023 CPI was the 49-country Sub-Saharan
region of Africa, where the average score was 33. Table 9.1 shows the CPI scores for 48 countries ranging from
the highest awarded score of 90 to the lowest score of 11. A global community where corruption is so prevalent
suggests that all too few companies ground their strategies on exemplary ethical principles or insist that company
personnel measure up to high ethical standards. And, as many business school professors have noted, there are
considerable numbers of amoral business students in our classrooms. So the task of rooting out shady and corrupt
business practices and creating an ethically strong global business climate is a daunting one.

Table 9.1 Corruption Perceptions Index, Selected Countries, 2023
(The CPI scores are based on a 100-point scale, where 100 = very clean and 0 = highly corrupt)

Country 2023 CPI
Score Country 2023 CPI

Score Country 2023 CPI
Score

Denmark 90 France 71 Jordan 46
Finland 87 United Kingdom 71 Kuwait 46
New Zealand 85 United States 69 China 42
Norway 84 Taiwan 67 Brazil 36
Singapore 83 South Korea 63 Thailand 35
Sweden 82 Israel 63 Turkey 34
Switzerland 82 Portugal 61 Mexico 31
Netherlands 79 Spain 60 Russia 26
Germany 78 Botswana 59 Iran 24
Ireland 77 Qatar 58 Iraq 23
Canada 76 Italy 56 Afghanistan 20
Australia 75 Poland 54 Libya 18
Hong Kong 75 Saudi Arabia 52 North Korea 17
Belgium 73 Malaysia 50 Syria 13
Japan 73 Crotia 50 Venezuela 13
Iceland 72 Greece 49 Somalia 11

Source: Transparency International, 2023 Corruption Perceptions Index, 3, (accessed February 17, 2024).

What Are the Drivers of Unethical Strategies and
Business Behavior?

The apparent pervasiveness of immoral and amoral businesspeople is one obvious reason why there is unethical
behavior in business dealings and why certain elements of a company’s strategy may be unethical. But apart
from “the business of business is business, not ethics” kind of thinking, there are three other main drivers of
unethical business behavior:22

l Lax oversight by company boards of directors that enables unscrupulous pursuit of personal gain,
wealth, and other selfish interests. People obsessed with wealth accumulation, greed, power, status,
and other selfish interests often push ethical principles aside in their quest for self-gain. Driven by
their ambitions, they exhibit few qualms in skirting the rules or doing whatever is necessary to achieve
their goals. The first and only priority of such corporate “bad apples” is to look out for their own best
interests, and if climbing the ladder of success means having few scruples and ignoring others’ welfare,
so be it. In theory, a company’s board of directors is duty bound to oversee the behavior of corporate
executives and call an immediate halt to any unethical strategies or conduct. Incidents have occurred at
such companies as Samsung, Equifax, Goldman Sachs, Nissan, Deutsche Bank, Weinstein Company,
CBS, Kobe Steel, and Uber where corporate leaders were fired, forced to resign, or charged with gross
ethical misconduct.

http://www.transparency.org/en/cpi/2020

Chapter 9 • Strategy, Ethics, and Social Responsibility 208

In practice, however, the oversight of corporate boards sometimes proves faulty, enabling the
unscrupulous pursuit of self-serving behavior and unethical conduct on the part of corporate executives
to go undetected or unchecked. A particularly egregious example of defective oversight was the failure
of corporate boards in 2007-2008 to shut down the consciously unethical strategies at many banks
and mortgage companies that were boosting the fees they earned on home mortgages by deliberately
lowering lending standards and approving so-called “subprime loans” for homebuyers whose incomes
were insufficient to make their monthly mortgage payments.

l Heavy pressures on company managers to meet or beat short-term performance targets. When key
personnel at companies are continuously scrambling to meet the quarterly and annual sales and profit
expectations of investors and financial analysts or to hit other ambitious performance targets, they often
feel enormous pressure to do whatever it takes to protect their reputation for delivering good results.
Executives know that investors will see quarterly misses in revenue and earnings expectations as a
red flag and drive down the company’s stock price. The pres sure to “never miss a quarter”—to not
upset the expectations of analysts, investors, and creditors—can push managers to engage in short-term
maneuvers to make the numbers, regardless of whether these moves are really in the best long-term
inter ests of the company. Sometimes the pressure induces company personnel to stretch the rules until
the limits of ethical conduct are overlooked.23 Once people cross ethical boundaries to “meet or beat
their numbers,” the threshold for making more extreme ethical compromises becomes lower.

Between 2002 and 2016, Wells Fargo put such pressure on its employees that opened customer accounts
to hit sales quotas and to help meet the bank’s profit targets that some 5,300 employees resorted to the
practice of creating millions of fake savings, checking, and credit card accounts on behalf of Wells
Fargo clients without their consent (some 3.5 million such fake accounts were discovered); over 500,000
Wells Fargo customers were also signed up for automatic bill payment without authorization. In 2017,
after the practices became known, Wells Fargo was forced to return $2.6 million to customers, pay
$186 million in fines to bank regulators, and settle a class action lawsuit for $142 million. Wells Fargo’s
reputation took a big hit, its stock price plummeted, and its CEO and other executives lost their jobs. As
part of its actions to make amends for these and other misdeeds that were also discovered, Wells Fargo
agreed to overhaul its board of directors. In February 2020, Wells Fargo agreed to pay $3 billion to settle
long-running civil and criminal charges by U.S. Justice Department prosecutors and the Securities and
Exchange Commission for its rampant fraudulent sales practices and unethical wrongdoings.

l A company culture that puts profitability and good business performance ahead of ethical behavior.
When a company’s culture spawns an ethically corrupt or amoral work climate, people have a company-
approved license to ignore “what’s right” and engage in almost any behavior or employ almost any
strategy they think they can get away with. Such cultural norms as “no one expects strict adherence
to ethical standards,” “everyone else does it,” and “it is okay to bend the rules to get the job done”
permeate the work environment.24 At such companies, ethically immoral or amoral people are certain
to play down observance of ethical strategic actions and business conduct. Moreover, cultural pressures
to use unethical means should circumstances dictate can prompt otherwise honorable people to behave
unethically. In contrast, however, when high ethical standards are deeply embedded in a company’s
culture, the culture typically functions as a powerful mechanism for promoting ethical conduct on the
part of all company personnel. The unethical culture that prevailed at Wells Fargo during 2002–2016
was said to be the root cause of its scandalous behavior.

Why Should Company Strategies Be Ethical?
There are two reasons why a company’s strategy should be ethical: (1) because a strategy that is unethical in
whole or in part is morally wrong and reflects badly on the character of the company personnel involved and (2)
because an ethical strategy can be good business and serve the self-interest of shareholders.

Chapter 9 • Strategy, Ethics, and Social Responsibility 209

The Moral Case for an Ethical Strategy
The bottom line here is that pursuing ethically principled strategic actions is morally correct and represents
“the right thing to do,” whereas undertaking unethical strategic actions is morally incorrect and “the wrong
thing to do.” Moreover, it reflects well on a manager’s character to insist that every strategic action be able to
pass moral scrutiny, and it reflects badly on a manager’s
character to initiate or condone strategic actions that are
shady and outside the boundaries of what qualifies as
ethical. Ultimately, whether a company ends up pursuing
an ethical or unethical strategy depends on the character of
the managers making the decisions of which alternatives to
pursue. Ethical strategy making is generally the product of
managers who are of strong moral character (that is, who are
trustworthy, have integrity, and truly care about conducting
the company’s business honorably). Managers with high
ethical principles and a strong sense of right and wrong are usually advocates of a corporate code of ethics and
strong ethics compliance, and they are genuinely committed to upholding corporate values and ethical business
practices. They walk the talk in displaying the company’s stated values and living up to its business principles
and ethical standards. They understand there is a big difference between adopting values statements and codes
of ethics that serve merely as window dressing and those that truly paint the white lines for a company’s actual
strategy and business conduct. As a consequence, ethically strong managers consciously opt for strategic actions
that are in accord with ethical principles and standards—they display no tolerance for strategies with ethically
controversial components.

Ethically ambivalent managers are the ones most likely to condone (or enable) strategies that do not meet ethical
standards—and they usually do so because of several reasons:

l They lack a strong personal commitment to high ethical standards and/or strict compliance with the
company’s code of ethics (if one exists).

l They willingly support or go along with actions and strategy elements that are ethically questionable,
especially if company lawyers advise that such actions/strategies are legal (or at least not overtly illegal).
Some managers will definitely risk crossing ethical lines when they believe they are unlikely to suffer
much punishment or severe reputational embarrassment.

l They choose not to put a halt to ethically questionable (and sometimes unethical) actions/strategy
elements that help achieve company performance targets and thereby allow them and others to earn
higher performance bonuses.

The Business Case for Ethical Strategies
While it is undoubtedly true that unethical business behavior may sometimes contribute to higher company
profits (so long as such behavior escapes public scrutiny), pursuing unethical strategies and tolerating unethical
conduct damages a company’s reputation and has costly consequences that injure shareholders. Figure 9.1 shows
the wide-ranging costs a company can incur when unethical behavior is discovered, the wrongdoings of company
personnel are headlined in the media, and it is forced to make amends for its behavior. The more egregious a
company’s ethical violations, the bigger the hit to its bottom line, and the greater the damage to its reputation
(and to the reputations and job security of the company personnel involved). In high-profile instances, the costs
of ethical misconduct can easily run into the hundreds of millions and even billions of dollars, especially if they
provoke widespread public outrage and many people were harmed.

CORE CONCEPT
The moral case for ethical strategy making is
predicated on the belief that crafting and pursuing
a wholly ethical strategy is the only “right” or
“morally correct” way to run a business; a strategy
with unethical elements cannot withstand moral
scrutiny and is therefore “wrong.”

Chapter 9 • Strategy, Ethics, and Social Responsibility 210

Figure 9.1 The Costs Companies Incur When Ethical Wrongdoing Is Discovered,
Publicly Exposed, and Subsequently Punished

l Government fines and
penalties

l Civil penalties arising from
class-action lawsuits and
other litigation aimed at
punishing the company for
its offense and the harm
done to others

l The costs to shareholders
in the form of a lower stock
price, lower earnings, and
possibly lower dividends

l Loss of customer trust
l Customer defections
l A tarnished or badly

damaged reputation
l Lower employee morale

and higher degrees of
employee cynicism

l Higher employee turnover
l Higher recruiting costs

and difficulty in attracting
talented employees

l Adverse effects on
employee productivity

l The costs of complying with
often harsher government
regulations

l Legal and investigative
costs incurred by the
company

l The costs of providing
remedial education and
ethics training to company
personnel

l Costs of taking corrective
actions

l Administrative costs
associated with ensuring
future compliance

Visible costs Internal
administrative costs

Intangible or
less visible costs

Source: Adapted from Terry Thomas, John R. Schermerhorn, and John W. Dienhart, “Strategic Leadership of
Ethical Behavior,” Academy of Management Executive 18, no. 2 (May 2004), p. 58.

The fallout of a company’s ethical misconduct goes well beyond just the costs of making amends for the
misdeeds, most particularly the adverse short-term and intermediate-term impact on a company’s reputation.
Buyers shun companies caught up in highly publicized ethical scandals. Companies with tarnished reputations
have difficulty in recruiting and retaining talented employees; indeed, many people consider a company’s ethical
reputation when deciding whether to accept a job offer.25 Most ethically upstanding people are repulsed by a
work environment where unethical behavior is condoned; they don’t want to get trapped in a compromising
situation, nor do they want their personal reputations damaged by an unsavory employer’s actions. Creditors are
usually unnerved by a borrower’s unethical actions because of the potential business and reputational fallout and
subsequent higher risk of default on repayment.

All told, a company’s unethical behavior can do considerable damage to shareholders in the form of lost revenues,
higher costs, lower profits, lower stock prices, and a diminished business reputation. To some significant degree,
therefore, ethical strategies and ethical conduct are good
business. Most companies understand the value of operating
in a manner that wins the approval of suppliers, employees,
investors, and society at large. Most businesspeople
recognize the risks and adverse fallout attached to the
discovery of unethical behavior. Hence, companies have
an incentive to employ strategies that can pass the test of
being ethical. And, even if a company’s managers are not
of strong moral character and personally committed to high ethical standards, they have good reason to operate
within ethical bounds, if only to (1) avoid the risk of embarrassment, scandal, disciplinary action, fines, and
possible jail time for unethical conduct on their part and (2) escape being held accountable for lax enforcement
of ethical standards and unethical behavior by personnel under their supervision.

Shareholders suffer when a company’s unethical
behavior is discovered and punished. Making
amends for unethical business conduct can be
costly, and it takes years to rehabilitate a badly
damaged company reputation.

Chapter 9 • Strategy, Ethics, and Social Responsibility 211

Connecting High Ethical Standards to the Task of Crafting and Executing

Strategy

Many companies have acknowledged their ethical obligations in official codes of ethical conduct. In the United
States, for example, the Sarbanes–Oxley Act, passed in 2002, requires that companies whose stock is publicly
traded have a code of ethics or else explain in writing to the Securities and Exchange Commission why they
do not. But the senior executives of ethically principled companies understand there’s a big difference between
adopting a code of ethics that is mandated window dressing (and also has the public relations benefit of making
the company look good to outsiders) and those that truly paint the white lines for a company’s actual strategy
and the conduct of all company personnel.26 They know that the litmus test of whether a company’s code of ethics
is cosmetic or real is the extent to which they are embraced in crafting strategy and in how the company’s daily
operations are conducted. Executives committed to high standards make a point of considering three sets of
questions whenever a new strategic initiative or policy or operating practice is under review:

l Is what we are proposing to do fully compliant with our code of ethics?

l Is there any aspect of the strategy (or policy or operating practice) that gives the appearance of being
ethically questionable?

l Is there anything in the proposed action that customers, employees, suppliers, stockholders, competitors,
community activists, regulators, or the media might consider as ethically objectionable?

Unless questions of this nature are posed—either in open discussion or by force of habit in the minds of company
managers—there is a risk that strategic initiatives and/or the way daily operations are conducted will become
disconnected from the company’s code of ethics. If company managers believe strongly in living up to the
company’s ethical standards, they will unhesitatingly reject strategic initiatives and operating approaches that
don’t measure up. However, in a company with cosmetic ethical standards, any linkage of the professed standards
to its strategy and operating practices stems mainly from a desire to avoid the risks of approving actions that are
later deemed unethical and perhaps illegal.

Strategy, Social Responsibility, and Corporate Citizenship
The idea that businesses have an obligation to foster social betterment, a much-debated topic during the past 50
years, took root in the 19th century when progressive companies in the aftermath of the industrial revolution
began to provide workers with housing and other amenities. The notion that corporate executives should balance
the interests of all stakeholders—shareholders, employees, customers, suppliers, the communities in which they
operated, and society at large—began to blossom in the 1960s. Some years later, a group of chief executives of
America’s 200 largest corporations, calling themselves the Business Roundtable, came out in strong support of
the concept of corporate social responsibility:27

Balancing the shareholder’s expectations of maximum return against other priorities is one of the fundamental
problems confronting corporate management. The shareholder must receive a good return but the legitimate
concerns of other constituencies (customers, employees, communities, suppliers and society at large) also
must have the appropriate attention . . . [Leading managers] believe that by giving enlightened consideration to
balancing the legitimate claims of all its constituents, a corporation will best serve the interest of its shareholders.

Today, corporate social responsibility is a concept that resonates in Western Europe, the United States, Canada,
and such developing nations as Brazil and India.

The Concepts of Social Responsibility and Good Corporate Citizenship
The essence of socially responsible business behavior is that a company should balance strategic actions to
benefit shareholders against the duty to be a good corporate citizen. The underlying thesis is that company
managers should display a social conscience in operating the business, and specifically take into account how

Chapter 9 • Strategy, Ethics, and Social Responsibility 212

management decisions and company actions affect the well-
being of employees, local communities, the environment,
and society at large.28 Acting in a socially responsible
manner thus has five components, as depicted in Figure 9.2:

l Striving to employ an ethical strategy and observe
ethical principles in operating the business. A
sincere commitment to observing ethical principles
is necessary simply because unethical strategies
and conduct are incompatible with the concept of
good corporate citizenship and socially responsible
business behavior.

l Making charitable contributions, supporting worthy organizational causes and philanthropic initiatives,
participating in community service activities, providing resources for projects aimed at making a difference
in the lives of the disadvantaged, and engaging in efforts to better the quality of life worldwide. Some
companies fulfill their philanthropic obligations by spreading their efforts over a multitude of charitable
and community activities—for instance, Microsoft, Johnson & Johnson, LinkedIn, IBM, and Google
support a broad variety of community art, social welfare, and environmental programs. Others prefer to
focus their energies more narrowly. McDonald’s, for example, concentrates on sponsoring the Ronald
McDonald House program (which provides a home away from home for the families of seriously ill
children receiving treatment at nearby hospitals), preventing child abuse and neglect, and participating
in local community service activities. Leading prescription drug maker GlaxoSmithKline, Genentech,
and other pharmaceutical companies either donate or heavily discount medicines for distribution in
the least-developed nations. Companies frequently reinforce their philanthropic efforts by encouraging
employees to support charitable causes and participate in community affairs and by matching employee
donations to charities and public service organizations.

l Taking actions to protect or enhance the environment and, in particular, to minimize or eliminate
any adverse impact on the environment stemming from the company’s own business activities. Social
responsibility as it applies to environmental protection entails actively striving to be good stewards of
the environment. This means using the best available science and technology to reduce environmentally
harmful aspects of its operations below the levels required by prevailing environmental regulations. It
also means putting time and money into improving the environment in ways that extend past a company’s
own industry boundaries—such as participating in recycling projects, adopting energy practices that
reduce the company’s carbon footprint and help mitigate climate change, and supporting efforts to
clean up local water supplies. Retailers like Walmart and The Home Depot in the United States and
B&Q in the United Kingdom have pressured their suppliers to adopt stronger environmental protection
practices.29 Ice cream maker Häagen-Daz started a social media campaign to raise awareness about
the dangers associated with the decreasing honeybee population and donates a portion of its profits to
research on this issue.

l Creating a work environment that enhances employees’ quality of life and makes the company a great
place to work. Numerous companies go beyond providing the ordinary kinds of compensation and
exert extra efforts to enhance their employees’ quality of life at work and at home. This can include
varied and engaging job assignments, career development programs, ongoing training to ensure future
employability (as will be needed with the advent of artificial intelligence and robotics technology), onsite
day care, flexible work schedules for single parents, workplace exercise facilities, special leaves to care
for sick family members, work-at-home opportunities, gender pay equity, special safety programs, and
showcase plants and offices.

l Building a workforce that is diverse with respect to gender, race, national origin, and perhaps other
aspects that different people bring to the workplace. Most large companies in the United States have
established workforce diversity programs, and some go the extra mile to ensure their workplaces are

CORE CONCEPT
The notion of social responsibility as it applies to
businesses concerns a company’s duty to operate
honorably, provide good working conditions for
employees, be a good steward of the environment,
and actively work to better the quality of life in the
local communities where it operates and in society
at large.

Chapter 9 • Strategy, Ethics, and Social Responsibility 213

attractive to ethnic minorities and inclusive of all groups and perspectives.30 The pursuit of workforce
diversity can be good business—Johnson & Johnson and Pfizer believe a reputation for workforce
diversity makes recruiting employees easier (talented employees from diverse backgrounds often seek
out such companies). Coca-Cola, which believes that strategic success depends on getting people all over
the world to become loyal consumers of the company’s beverages, exerts considerable effort to build
a public persona of inclusiveness for people of all races, gender, nationalities, abilities, interests, and
talents. Multinational companies are particularly inclined to make workforce diversity a visible strategic
component, since they recognize that respecting individual differences and promoting inclusiveness
resonate well with people all around the world. Ernst & Young, one of the largest global accounting firms,
stresses a workforce diversity strategy that emphasizes valuing and respecting differences, fostering
innovation through individual diversity, and promoting inclusiveness so that its 300,000 employees in
700+ offices in over 150 countries can feel valued, engaged, and empowered in developing creative
ways to serve the firm’s clients. Ernst & Young has been on Fortune’s list of the “100 Best Companies
to Work For” for over twenty years. At many companies, the diversity initiative extends to suppliers—
sourcing items from small businesses owned by women or ethnic minorities.

The particular combination of socially responsible endeavors a company elects to pursue defines its social
responsibility strategy. At General Mills, a global marketer of food products, its social responsibility strategy
centers on reducing greenhouse gas emissions across its value chain by 30 percent by 2030 and achieving net zero
emissions by 2050, advancing the use of regenerative agriculture techniques on thousands of acres of farmland,
transitioning to the use of 100 percent renewable electricity across its global owned operations, designing and
usin recyclable and reusable packaging for its products, and sending zero waste to landfills at its global production
facilities.31 New Belgium Brewing Company strives to be a sustainable business by using solar panels to power
its bottling plant as well as an anaerobic digester to convert wastewater into energy, and their employees use
bikes to get around the brewery. Chick-fil-A, an Atlanta-based fast-food chain with more than 3,000 outlets
in 48 states, Puerto Rico, and Canada sponsors a Leader Academy attended by thousands of young people
annually, has a scholarship program for employees that
since 1973 has awarded more than $162 million to 93,000
employees to attend colleges and universities (including
$1,000 and $2,500 Remarkable Futures scholarships and
$25,000 True Inspiration Scholarships), conducts marriage
enrichment retreats for couples, provides millions of dollars
in food donations to local shelters and soup kitchens, has a
$5-plus million dollar True Inspiration program that makes
$50,000 to $350,000 grants to local non-profit community
organizations, foster homes, and community “heroes,” undertakes a series of activities to protect and enhance the
environment, and has a closed-on-Sunday policy to ensure every Chick-fil-A employee and restaurant operator
has an opportunity to worship, spend time with family and friends, or rest and relax.32 At Unilever, a $66 billion
Anglo-Dutch manufacturer of over 400 brands of consumer products headquartered in London, is pursuing a
corporate social responsibility strategy aimed at being a global leader in sustainable business and helping achieve
four outcomes: (1) helping drive climate action to achieve a net zero carbon footprint, (2) reduce plastic usage
and move toward a waste-free world, (3) help regenerate nature and promote sustainable agricultural practices,
and (4) pursue initiatives aimed at workplace fairness and ensuring that everyone who directly provides goods
and services to Unilever will earn at least a living wage or income by 2030.33

Companies that exhibit a strong commitment to corporate social responsibility are often recognized by being
included on such lists as 3BL Media’s “100 Best Corporate Citizens.” There are 12 companies that have made the
list every year since 2009, including Abbott Laboratories, Accenture, Bristol-Myers Squibb, Cisco, Colgate-
Palmolive, Gap, General Mills, Intel, Microsoft, Nike, PepsiCo, and Weyerhaeuser. Other companies
ranking in the top 15 on the 2023 list include Hewlett Packard Enterprise Co., HP Inc., Hasbro, Inc., The
Estee Lauder Companies, Merck & Co., Johnson & Johnson, QUALCOMM, The Hershey Co., Owens Corning,
Trane Technologies, Ecolab, and Biogen.34

CORE CONCEPT
A company’s social responsibility strategy is
defined by the specific combination of socially
beneficial and community citizenship activities
it elects to support with its contributions of time,
money, and other resources.

Chapter 9 • Strategy, Ethics, and Social Responsibility 214

Figure 9.2 The Five Components of a Social Responsibility Strategy

Actions to ensure
the company has an
ethical strategy and
operates honorably

and ethically

A Company’s
Social

Responsibility
Strategy

Actions to support
charitable causes,

participate in community
service activities,

and better the
quality of life

Protect ing
and sustaining

the environment

Actions to
enhance employee

well-being and make
the company a great

place to work

Actions to
promote

workforce
diversity A Company’s

Social
Responsibility

Strategy

Source: Adapted from material in Ronald Paul Hill, Debra Stephens, and Iain Smith, “Corporate Social
Responsibility: An Examination of Individual Firm Behavior,” Business and Society Review 108, no. 3
(September 2003), p. 348.

Environmental Sustainability Strategies A rapidly growing number of companies are now expanding their
exercise of social responsibility and corporate citizenship to include efforts to operate in a more environmentally
sustainable fashion. Environmental sustainability strategies entail actions to operate businesses in a manner
that protects and maybe even enhances natural resources
and ecological support systems, guards against outcomes
that will ultimately endanger the planet, and is therefore
sustainable for centuries.35 One aspect of environmental
sustainability is keeping use of the Earth’s natural resources
within levels that can be replenished or else will not
compromise the ability of future generations to meet their
needs. Some scientists claim that levels of certain resources
(like fresh water and the harvesting of edible fish from the
oceans) either are already unsustainable or will be soon,
given that the world’s consumption rises as populations, incomes, and living standards rise. Other aspects of
sustainability include greater reliance on sustainable energy sources (like wind and solar power), greater use of
recyclable materials, efforts to reduce contributions to climate change caused by human activities, increased use
of sustainable methods of growing foods (to reduce topsoil depletion and avoid use of pesticides, herbicides,
fertilizers, and other chemicals that may be harmful to human health or ecological systems), doing more to protect

CORE CONCEPT
A company’s environmental sustainability
strategy consists of its deliberate actions to
protect the environment, provide for the longevity
of natural resources, maintain ecological support
systems for future generations, and guard against
ultimate endangerment of the planet.

Chapter 9 • Strategy, Ethics, and Social Responsibility 215

wildlife habitats, using environmentally sound waste management practices, and increased efforts to decouple
environmental degradation and economic growth (according to many scientists, economic growth has historically
been accompanied by declines in the well-being of the environment). Google has pursued sustainability in its
efforts to address adverse environmental impacts by implementing initiatives to reduce energy consumption at
its data centers and by donating $1 billion to renewable energy projects.36

Social Responsibility Strategies and the Triple Bottom Line Growing numbers of companies are
recognizing the merits of measuring their performance in the social responsibility arena and have set formal
performance targets in three areas: “profit, people, and planet”—often referred to as the company’s “triple
bottom line” or TBL.37 The profit component of TBL concerns the traditional measure of company performance
and refers broadly to a company’s overall financial and strategic performance, not simply the bottom line of the
income statement. The people component, or “social bottom line,” is intended as a composite measure of the
impact that the company’s various social initiatives have on people (employees, those living in communities
where the company operates, and the members of society at large). The planet component, or “environmental
bottom line,” refers to the firm’s ecological impact and its contributions to environmental sustainability. The
TBL concept is useful for highlighting a company’s efforts to be a better corporate citizen, to contribute to the
well-being of more than just its customers and shareholders, and to deliberately manage its activities in ways that
grow its social and environmental bottom lines.

Growing numbers of companies have started using TBL measures. Most of these companies (including Nike,
Southwest Airlines, Starbucks, and General Mills) have instituted internal means of measuring their performance
on the three Ps of profit, people, and planet, and cite the benefits and outcomes of their efforts in special reports
posted on their websites. TBL reporting is emerging as an increasingly important way for companies to make the
results of their corporate social responsibility (CSR) and TBL strategies apparent to stakeholders. Some activist
stakeholders are using these reports to hold companies accountable for their impact on society. In recent years,
thousands of mostly small companies with annual revenues under $50 million have opted to pursue independent
third-party certification of the beneficial impacts of their CSR and TBL strategies. Such certification entails
completing a lengthy impact assessment and submitting confidential documentation to the independent third
party to verify the claimed beneficial impacts and performance outcomes; companies receiving a score of 80
points or higher earn “B Corp Certification.”38 Companies that have qualified for B Corp Certification include
Athleta, Bombas, Ben & Jerry’s, King Arthur Flour, The Body Shop, Stonyfield Farm, Sir Kensington, Seventh
Generation, Cabot Creamery, Patagonia, Green Mountain Power, Kombacha, Allbirds, Warby Parker, and New
Belgium Brewing.

The Moral Case for Corporate Social Responsibility and Environmentally
Sustainable Business Practices
The moral case for why businesses should act in a manner that benefits all of the company’s stakeholders—not
just those of shareholders—boils down to “It’s the right thing to do.” Ordinary decency, civic-mindedness, and
contributing to society’s well-being should be expected of any business.39 In today’s social and political climate,
most business leaders can be expected to acknowledge
that socially responsible actions are important and that
businesses have a duty to be good corporate citizens. But
there is a complementary school of thought that every
business operates on the basis of an implied social contract
with the members of society. According to this contract, society grants a business the right to conduct its business
affairs and agrees not to unreasonably restrain its pursuit of a fair profit for the goods or services it sells. In return
for this “license to operate,” a business is obligated to act as a responsible citizen and do its fair share to promote
the general well-being of society and the environment. Such a view clearly puts a moral burden on a company
to operate honorably, provide good working conditions to employees, be a good environmental steward, and
display good corporate citizenship, thereby boosting its social and environmental bottom lines.

Every action a company takes can be interpreted
as a statement of what it stands for.

Chapter 9 • Strategy, Ethics, and Social Responsibility 216

The Business Case for Corporate Social Responsibility and Environmentally
Sustainable Business Practices
Whatever one thinks about the validity of the moral case for corporate social responsibility and environmentally
sustainable business practices, there are definitely good business reasons why companies should be public
spirited and devote time and resources to social responsibility initiatives, environmental sustainability, and good
corporate citizenship:

l Such actions can lead to increased buyer patronage. A strong visible social responsibility strategy gives
a company an edge in differentiating itself from rivals and in appealing to those consumers who prefer
to do business with companies that are good corporate citizens. Ben & Jerry’s, Whole Foods Market,
Stonyfield Farm, Patagonia, Keurig Green Mountain, Bombas, and The Body Shop have definitely
expanded their customer bases because of their visible and well-publicized activities as socially
conscious companies. More and more companies are also recognizing the cash register payoff of social
responsibility strategies that reach out to people of all cultures and demographics (including women,
retirees, and ethnic groups).

l A strong commitment to socially responsible behavior reduces the risk of reputation-damaging incidents.
Companies that place little importance on operating in a socially responsible manner are more prone
to scandal and embarassment. Consumer, environmental, and human rights activist groups are quick
to criticize businesses whose behavior they consider to be out of line, and they are adept at getting
their message into the media and onto the Internet. Pressure groups can generate widespread adverse
publicity, promote boycotts, and influence like-minded or sympathetic buyers to avoid an offender’s
products. Research has shown that product boycott
announcements are associated with a decline in a
company’s stock price.40 When a major oil company
suffered damage to its reputation on environmental
and social grounds, the CEO repeatedly said the
most negative impact the company suffered—and
the one that made him fear for the future of the
company—was that bright young graduates were
no longer attracted to work for the company.41 For many years, Nike received stinging criticism for
not policing sweatshop conditions in the Asian factories that produced Nike footwear, causing Nike
cofounder and former CEO Phil Knight to observe that “Nike has become synonymous with slave wages,
forced overtime, and arbitrary abuse.”42 In 1997, Nike began an extensive effort to monitor conditions
in the factories of the contract manufacturers that produced Nike shoes. As Knight said, “Good shoes
come from good factories and good factories have good labor relations.” Nonetheless, twenty-five years
later, Nike continues to be targeted by human rights activists that its monitoring procedures are flawed
and that more needs to be done to improve working conditions at the plants of contract manufacturers
making products for Nike.

l Socially responsible actions yield internal benefits (particularly concerning employee recruiting,
workforce retention, and training costs) and can improve operational efficiency. Companies with
deservedly good reputations for contributing time and money to the betterment of society are better able
to attract and retain employees, compared to companies with tarnished reputations. Some employees just
feel better about working for a company committed to improving society.43 This can contribute to lower
turnover and better worker productivity. Other direct and indirect economic benefits include lower costs
for staff recruitment and training. For example, Starbucks is said to enjoy much lower rates of employee
turnover because of its full benefits package for both full-time and part-time employees, management
efforts to make Starbucks a great place to work, and the company’s socially responsible practices. When
a U.S. manufacturer of recycled paper, taking eco-efficiency to heart, discovered how to increase its fiber
recovery rate, it saved the equivalent of 20,000 tons of waste paper—a factor that helped the company
become the industry’s lowest-cost producer.44 By helping two-thirds of its employees stop smoking and

CORE CONCEPT
The higher the public profile of a company or its
brand, the greater the scrutiny of its activities and
the higher the potential for it to become a target
for pressure group action.

Chapter 9 • Strategy, Ethics, and Social Responsibility 217

investing in a number of wellness programs for employees, Johnson & Johnson saved $250 million on
its health care costs over a 10-year period.45 Making a company a great place to work pays dividends
in recruiting talented workers, stimulating more creativity and energy on the part of workers, boosting
worker productivity, and building greater employee commitment to the company’s business mission/
vision and success in the marketplace.

l Corporate social responsibility and environmental sustainability strategies can create opportunities for
revenue enhancement. In many cases, the revenue opportunities are tied to a company’s core products.
Efforts to reduce greenhouse gas emissions have resulted in the creation and production of battery-
powered electric vehicles—a growing revenue source for motor vehicle manufacturers. General Electric,
one of the world’s largest producers of power generation equipment, has created a profitable new
business in wind turbines. PepsiCo and Coca-Cola have expanded into juices and other more nutritious
drinks to give consumers healthier alternatives to their carbonated beverages. Sometimes, revenue
enhancement opportunities come from innovative ways to reduce waste and use the by-products of a
company’s production activities. Tyson Foods, the world’s largest meat producer, entered into a joint
venture to produce jet fuel for both military and commercial aircraft and diesel fuel for automobile and
truck engines from the vast amount of beef and chicken fat resulting from its meat product businesses.

l Well-conceived social responsibility strategies work to the advantage of shareholders. A two-year study
of leading companies found that improving environmental compliance and developing environmentally
friendly products can enhance earnings per share, profitability, and the likelihood of winning contracts.46
The stock prices of companies that rate high on social and environmental performance criteria were
found to perform 35 to 45 percent better than the average of the 2,500 companies comprising the
Dow Jones Global Index.47 A review of some 135
studies indicated there is a positive, but small,
correlation between good corporate behavior and
good financial performance; only two percent
of the studies showed that dedicating corporate
resources to socially responsible activities harmed
shareholders’ interests.48 Furthermore, socially
responsible business behavior helps avoid or
preempt legal and regulatory actions that could
prove costly and otherwise burdensome. In some
cases, it is possible to craft corporate social responsibility strategies that contribute to competitive
advantage and, at the same time, deliver greater value to society.49 For instance, Walmart, by working
with its suppliers to reduce the use of packaging materials and revamping the routes of its delivery
trucks to cut out 100 million miles of travel, saved $200 million in costs annually (which enhanced its
cost competitiveness vis-à-vis rivals) and lowered carbon emissions.50 Walmart, Home Depot, PepsiCo,
Anheuser-Busch, and UPS are actively testing Tesla’s battery-operated semi-trucks as potential
substitutes for their fleets of diesel trucks. Amazon has ordered 100,000 battery-operated Rivian vans to
serve as the primary vehicle for the new nationwide delivery service it is establishing.

In sum, companies that take social responsibility seriously can improve their business reputations and operational
efficiency while also reducing their risk exposure and encouraging customer loyalty and employee-inspired
innovation. Overall, companies that take special pains to protect the environment (beyond what is required by
law), are active in community affairs, and are generous supporters of charitable causes and projects that benefit
society are more likely to be seen as good investments and as good companies to work for or do business with.
Shareholders are likely to view the business case for social responsibility as a strong one, even though they
certainly have a right to question whether the time and money spent on the company’s social responsibility
strategy is too much or too little.

There’s little hard evidence indicating
shareholders are disadvantaged in any meaningful
way by a company’s actions to be socially
responsible; on the contrary, a social responsibility
strategy that packs some punch and is more
than rhetorical flourish can produce outcomes
beneficial to shareholders.

Chapter 9 • Strategy, Ethics, and Social Responsibility 218

Companies are, of course, sometimes rewarded for bad behavior—a company able to shift environmental and
other social costs associated with its activities onto society as a whole can reap larger short-term profits. The
major cigarette producers for many years were able to earn greatly inflated profits by shifting the health-related
costs of smoking onto others and escaping any responsibility for the harm their products caused. Most companies
will, of course, try to evade paying for the social harms of their operations as long as they can. Calling a halt to
such actions usually hinges upon (1) the effectiveness of activist social groups in publicizing a company’s harmful
actions and marshaling public opinion for something to be done, (2) the enactment of corrective legislation or
regulations, and (3) decisions on the part of socially conscious buyers to take their business elsewhere.

Key Points
Business ethics concerns the application of ethical principles and standards to the actions and decisions of
business organizations and the conduct of their personnel. Ethical principles in business are not materially
different from ethical principles in general.

There are three schools of thought about ethical standards:

l According to the school of ethical universalism, common moral agreement about right and wrong
actions and behaviors across multiple cultures and countries gives rise to universal ethical standards
that apply to members of all societies, all companies, and all businesspeople.

l According to the school of ethical relativism, different societal cultures and customs have divergent
values and standards of right and wrong. Thus, what is ethical or unethical must be judged in the light
of local customs and social mores and can vary from one culture or nation to another.

l According to integrated social contracts theory, universal ethical principles or norms based on the
collective views of multiple cultures and societies combine to form a “social contract” that all individuals
in all situations have a duty to observe. Within the boundaries of this social contract, local cultures or
groups can specify what other actions may or may not be ethically permissible. However, universal
ethical norms always take precedence over local ethical norms.

Three categories of managers stand out regarding their prevailing beliefs in, and commitments to, ethical and
moral principles in business affairs: the moral manager; the immoral manager, and the amoral manager. By
some accounts, the population of managers is said to be distributed among all three types in a bell-shaped curve,
with immoral managers and moral managers occupying the two tails of the curve, and the amoral managers,
especially the intentionally amoral managers, occupying the broad middle ground.

The apparently large numbers of immoral and amoral businesspeople are one obvious reason why some
companies resort to unethical strategic behavior. But there are three other drivers of unethical business behavior:
(1) lax oversight by company boards of directors that enables unscrupulous pursuit of personal gain, wealth,
and other selfish interests, (2) heavy pressures on company managers to meet or beat earnings targets, and (3) a
company culture that puts the profitability and good business performance ahead of ethical behavior. However, a
company’s culture can function as a powerful means of promoting ethical conduct when high ethical principles
are deeply embedded in its culture.

A company’s strategy should be ethical because a strategy that is unethical in whole or in part is morally wrong
and reflects badly on the character of the company personnel involved and because an ethical strategy is good
business and in the self-interest of shareholders.

Corporate social responsibility concerns a company’s duty to operate honorably, provide good working
conditions for employees, be a good environmental steward, and actively work to better the quality of life in
the communities where it operates and in society at large. The particular combination of socially responsible
endeavors a company elects to pursue defines its social responsibility strategy.

Chapter 9 • Strategy, Ethics, and Social Responsibility 219

The moral case for corporate social responsibility and environmentally sustainable business practices boils down
to a simple concept: It is the right thing to do. A business is obligated to act as a responsible citizen and do its fair
share to promote the general well-being of society and the environment.

There are solid reasons why social responsibility and environmental sustainability strategies are good business—
it can be conducive to greater buyer patronage, reduce the risk of reputation-damaging incidents, and boost
operating efficiency—outcomes that definitely are in the long-term best interests of shareholders.

What Is Strategy
and Why Is It Important?

What Do We Mean by “Strategy”?

Strategy and the Quest for Competitive Advantage

A Company’s Strategy is Partly Proactive and Partly Reactive

Strategy and Ethics: Passing the Test
of Moral Scrutiny

The Relationship Between a Company’s Strategy and Its Business Model

What Makes a Strategy a Winner?

Why Crafting and Executing Strategy Are Important Tasks

The Road Ahead

Key Points

Charting a Company’s Long-Term Direction: Vision, Mission,
Objectives, and Strategy

What Does the Strategy-Making,
Strategy-Executing Process Entail?

Task 1: Developing a Strategic Vision, Mission Statement, and Set of Core Values

Task 2: Setting Objectives

Task 3: Crafting A Strategy

Task 4: Implementing and Executing the Strategy

Task 5: Evaluating Performance and Initiating Corrective Adjustments

Corporate Governance: The Role of the Board of Directors in the Strategy-Making, Strategy-Executing Process

Key Points

Evaluating a Company’s
External Environment

THE STRATEGICALLY RELEVANT FACTORS
INFLUENCING A COMPANY’S EXTERNAL ENVIRONMENT

Assessing a Company’s Industry and Competitive Environment

Question 1: What Competitive Forces Do Industry
Members Face and How Strong Are They?

Question 2: What Factors Are Driving Industry Change and What Impact Will They Have?

Question 3: What Market Positions Do Rivals Occupy—Who Is Strongly Positioned and Who Is Not?

Question 4: What Strategic Moves Are Rivals Likely to Make Next?

Question 5: What Are the Key Factors for Future Competitive Success?

Question 6: Is the Industry Outlook Conducive to Good Profitability?

Key Points

Evaluating a Company’s Resources and Ability to Compete Successfully

QUESTION 1: HOW WELL IS THE COMPANY’S PRESENT STRATEGY WORKING?

QUESTION 2: WHAT ARE THE COMPANY’S IMPORTANT RESOURCES AND CAPABILITIES AND DO THEY HAVE ENOUGH COMPETITIVE POWER TO PRODUCE A COMPETITIVE ADVANTAGE OVER RIVALS?

QUESTION 3: WHAT ARE THE COMPANY’S COMPETITIVELY IMPORTANT STRENGTHS AND WEAKNESSES AND ARE THEY WELL-SUITED TO CAPTURING ITS BEST MARKET OPPORTUNITIES AND DEFENDING AGAINST EXTERNAL THREATS?

QUESTION 4: ARE THE COMPANY’S PRICES AND COSTS COMPETITIVE WITH THOSE OF KEY RIVALS, AND DOES IT HAVE AN APPEALING CUSTOMER VALUE PROPOSITION?

QUESTION 5: IS THE COMPANY COMPETITIVELY STRONGER OR WEAKER THAN KEY RIVALS?

QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS DOES TOP MANAGEMENT NEED TO ADDRESS IN CRAFTING A STRATEGY TO FIT THE SITUATION?

KEY POINTS

The Five Generic Competitive Strategy Options: Which One to Employ?

THE FIVE GENERIC COMPETITIVE STRATEGIES

BROAD LOW-COST PROVIDER STRATEGIES

BROAD DIFFERENTIATION STRATEGIES

FOCUSED (OR MARKET NICHE) STRATEGIES

BEST-COST PROVIDER STRATEGIES

SUCCESSFUL COMPETITIVE STRATEGIES ARE ALWAYS UNDERPINNED BY RESOURCES AND CAPABILITIES THAT ALLOW THE STRATEGY TO BE WELL-EXECUTED

KEY POINTS

Supplementing the Chosen Competitive Strategy—
Other Important Strategy Choices

GOING ON THE OFFENSIVE—STRATEGIC OPTIONS TO IMPROVE A COMPANY’S MARKET POSITION

DEFENSIVE STRATEGIES—PROTECTING MARKET POSITION AND COMPETITIVE ADVANTAGE

WEBSITE STRATEGIES

OUTSOURCING STRATEGIES

VERTICAL INTEGRATION STRATEGIES:
OPERATING ACROSS MORE STAGES
OF THE INDUSTRY VALUE CHAIN

STRATEGIC ALLIANCES AND PARTNERSHIPS

MERGER AND ACQUISITION STRATEGIES

CHOOSING APPROPRIATE FUNCTIONAL-AREA STRATEGIES

TIMING A COMPANY’S STRATEGIC MOVES

KEY POINTS

Strategies for Competing
Internationally or Globally

WHY COMPANIES DECIDE TO ENTER FOREIGN MARKETS

WHY COMPETING ACROSS NATIONAL BORDERS CAUSES STRATEGY MAKING TO BE MORE COMPLEX

THE CONCEPTS OF MULTICOUNTRY COMPETITION AND GLOBAL COMPETITION

STRATEGY OPTIONS FOR ESTABLISHING A COMPETITIVE PRESENCE IN FOREIGN MARKETS

COMPETING IN FOREIGN MARKETS: THE THREE COMPETITIVE STRATEGY APPROACHES

BUILDING CROSS-BORDER COMPETITIVE ADVANTAGE

PROFIT SANCTUARIES AND GLOBAL STRATEGIC OFFENSIVES

Key Points

Diversification Strategies

What Does Crafting a Diversification Strategy Entail?

CHOOSING THE DIVERSIFICATION PATH:
RELATED VS. UNRELATED BUSINESSES

EVALUATING THE STRATEGY OF A DIVERSIFIED COMPANY

KEY POINTS

Strategy, Ethics, and Social Responsibility

What Do We Mean by Business Ethics?

where do Ethical standards come from?

THE THREE CATEGORIES OF MANAGEMENT MORALITY

WHAT ARE THE DRIVERS OF UNETHICAL STRATEGIES AND BUSINESS BEHAVIOR?

WHY SHOULD COMPANY STRATEGIES BE ETHICAL?

Strategy, Social Responsibility, and Corporate Citizenship

KEY POINTS

Building an Organization
Capable of Good Strategy Execution

A FRAMEWORK FOR EXECUTING STRATEGY

BUILDING AN ORGANIZATION CAPABLE OF GOOD STRATEGY EXECUTION: THREE KEY ACTIONS

STAFFING THE ORGANIZATION

DEVELOPING AND STRENGTHENING EXECUTION-CRITICAL RESOURCES AND CAPABILITIES

STRUCTURING THE ORGANIZATION AND WORK EFFORT

KEY POINTS

Managing Internal Operations:
Actions That Promote
Good Strategy Execution

Allocating Needed Resources to Execution-Critical Activities

ENSURING THAT POLICIES AND PROCEDURES FACILITATE STRATEGY EXECUTION

ADOPTING BEST PRACTICES AND EMPLOYING PROCESS MANAGEMENT TOOLS TO IMPROVE EXECUTION

INSTALLING INFORMATION AND OPERATING SYSTEMS

TYING REWARDS AND INCENTIVES DIRECTLY TO ACHIEVING GOOD PERFORMANCE OUTCOMES

KEY POINTS

Corporate Culture and Leadership—Keys to Good Strategy Execution

INSTILLING A CORPORATE CULTURE THAT PROMOTES GOOD STRATEGY EXECUTION

LEADING THE STRATEGY EXECUTION PROCESS

KEY POINTS

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