BUSINESS: The Ultimate Resource

November 2003 Upgrade 14

BEST PRACTICE
Strategy
by Hermann Simon
Introduction
Strategy is an art and a science. There is no one best way in strategy. Even so, one must strive in each case to integrate external opportunities and internal resources and avoid any one-sided internal or external orientation. Above strategy stands vision, that is, a clear, if necessarily rough idea of how the business enterprise is to look in future and where it is to stand. Strategy implies the controlled evolution of the enterprise, with organization and culture as central elements in the process. As far as organization is concerned, the rule that structure follows strategy applies: organization is a means to the end of strategy. Culture, on the other hand, is part of the restrictive framework within which strategy operates: it tends to be superordinate to it, since it is highly resistant to change. The environment too is of great significance in the formulation and implementation of strategy. Strategy must strive to achieve and secure legitimacy and trust vis--vis business partners. All these demands flow together in one overall strategy model. In this sense strategy is all-encompassing.

What Is Strategy?
Strategy is the art and science of developing and deploying all the forces within an enterprise in such a way as to ensure its survival for the longest possible time on the most profitable possible terms. The maximization of shareholder value over the long term, and thus the guaranteeing of the enterprises capacity for survival, is also covered by this definition. Strategy for the enterprise as a whole, usually referred to as corporate strategy, and strategies for the so-called strategic business units, usually referred to collectively as business strategy, are both to be formulated in accordance with it. How an enterprise can and should formulate and implement its strategy is a question on which there are two opposing points of view. According to the first of these, the aim of strategy is to position the enterprise in such a way within the competitive environment that it can satisfy precisely-identified customer needs better than its competitors. Here external forces are the drivers of strategy.

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The second view sees the basis of strategy formulation and competitiveness as lying in factors intrinsic to the enterprise, so-called internal resources. The concept of core competence (being able to do something better), popularized by Prahalad and Hamel, is representative of this school of thought, as is the idea of time-based competition (being quicker). The point is to acquire and develop those resources or capabilities that your competitors do not possess, since they are only available in limited quantities in markets. Which of the two views is correct? In my opinion, neitherbecause they are one-sided. My conception of strategy is that external opportunities and internal resources need to be integrated. External opportunities alone are no guarantee of success, if you do not possess the necessary resources. Thus Volkswagen failed in the computer market, even though this market was growing strongly and presented a very attractive proposition. Conversely, internal resources have no value if there is no market demand. Defense technology firms with outstanding technological competences often have difficulty finding a market for them. The change in perspective is reflected in the development of the instruments of strategy that strategic managers have at their disposal today.1 The SWOT model (Strengths, Weaknesses, Opportunities, Threats) developed in the 1950s is still widely used even today. It combines an external with an internal perspective. During the 1970s and 1980s instruments for the externally oriented positioning of companies predominated. Portfolio matrices designed to ensure competitive appeal and competitive position typify this approach, as do concepts of competitive advantage as expounded by Porter. During the 1990s the analysis of internal resources began to gain ground. Its instruments, viewed in isolation, are able to solve particular kinds of problem. Thus a restructuring of internal processes (business process reengineering) can bring about enormous savings in costs and time. Bigger profits, similarly, can be achieved through improving pricing processes, for example, by orienting price structuring not on costs but on customer benefit. Since the potential for reducing costs is largely exhausted, pricing processes have gained in importance.2 But the essential challenge for strategy lies in formulating the options for structuring both external opportunities and internal resources efficiently. The question Where do we want to compete? cannot be answered in isolation from the question How do we want to compete? Statistical investigations show that, in fact, average returns vary widely between different industries.3 The same investigations show, conversely, that the differences in profitability between companies within an industry can be massive. These observations point on the one hand to barriers to entryotherwise
1 2

For a comprehensive review of instruments of strategy, see Simon and von der Gathen (2002) See Simon and Fassnacht (2002) 3 Fortune, July 22, 2002, p. 23f

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companies would answer the question as to where? simply by selecting the most attractive industries. On the other hand, it is clear that the competences of successful companies are not so easily imitated by competitors, otherwise there would not be such great discrepancies between the profits of companies within the same industry. The question as to how? can only be decided on the basis of the resources and competences specific to the enterprise. A successful strategy combines internal and external perspectives. Organization and environment thus become indispensable elements of strategy. Strategy accepts the constant changes in the environment and in organization and steers the enterprise proactively by planning learning processes. It follows from this that strategy is a dynamic concept. It follows a vision, but only a plan can make possible the conversion of aims into programmable activities. This means too that strategy cannot restrict itself to defining a corporate strategy. It must make company aims concrete in the form of business strategies and implement these. The route from vision to plan is not deterministic and linear: it follows a learning process and adapts itself interactively to the development of external success potential and internal resources. Strategy, therefore, becomes the controlled evolution of the enterprise within its environment. There is no one best way of shaping this evolution. In the choice and implementation of their strategy, enterprises possess varying degrees of freedom, which they do well to exploit. As emphasized in the initial definition, strategy is not just a science, it is also an art. To bring about a long-term realization of its aims, the organization must possess a culture that internalizes the overall objectives of the enterprise. To achieve its objectives, every enterprise needs specific resources. In this context, competence takes on especial significance as a resource, since it is the basis of value creation. A basic prerequisite for the success of an enterprise is a type of behavior within its environment that is directed towards sustainability. In the long term, only enterprises that possess legitimacy in the eyes of their contemporaries will succeed. Legitimacy means acceptance of the enterprise and its aims. It rests primarily on the trust that customers, suppliers, and partners have in the enterprise. It is also part and parcel of a successful strategy that an enterprise should know its customers needs. The mission can be taken as a generalization of the customer needs that the enterprise can satisfy.

From Vision to Plan

Generally speaking, enterprise strategy has two levels: corporate and business strategy. The boundary between these two levels is fluid; in large enterprises, the separation is more clear-cut than it is in smaller ones. Corporate strategy establishes the general long-term aims of the enterprise. These include such things as stockholder orientation, achieving market leadership, or the

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acceptance of social responsibility toward staff. Goals such as these determine the course that the enterprise takes. In accordance with these aims, corporate strategy influences the portfolio that comprises all the areas of business in which the enterprise is active. The cornerstone of corporate strategy is clear vision. There is nothing either illusionary or mystical about vision. It is quite simply a conception of how the enterprise should look in the future and which path it should take. The vision should be clearly formulated and thus be able to be communicated effectively. It can encompass many different things (for example, technology, market leadership, region, dominance, conquest). Time-wise and qualitatively it transcends everyday business operations. Besides giving direction, it also has a motivational purpose. A good vision mobilizes the energies of the workforce and leads them along a particular path. At the level of business strategy, decisions are made that affect the individual strategic business units. These decisions relate in a narrower sense to the various product categories that an enterprise manufactures or markets, to its customers, partners, and markets. Typically, business strategy also has things to say about technologies, brand strategies, or behavior toward competitors within the specific strategic business units. Business strategy has a limited time horizon. Its implementation requires a plan, and that incorporates directives for strategic business units that are temporally and quantitatively specific. For any given business unit, the plan, for example, will lay down how a particular competitive strategy (cost leadership, specialization, or focus) is to be followed, what position in the market (premium, standard, or economy) should be chosen, or what sort of diversification should be undertaken. Strategy should not allow itself to be reduced to long-term planning. There ought to be interaction between vision and plan. As von Clausewitz says: Strategy must take to the field of battle as well, in order to arrange things in detail on the spot and to make such modifications to the whole as constantly become necessary. It cannot, even for a moment, stand back and let things go their own way. There is no clear-cut division between strategy and tactics.

Organization and Culture

Organization follows strategy, or as Alfred Chandler put it, structure follows strategy. The enterprise must configure itself, as a whole and in its individual units, in such a way that its strategic goals are reached. So there is no organization in a vacuum, no one general optimal form of organization, rather organization is always a means to an end. Organization also meshes corporate and business strategy, for only when the enterprise leaders and the business units know precisely what they have to do in terms of task assignment and the division of responsibility, can the whole complex entity that is the enterprise operate effectively and efficiently. Alongside its formal organization, the culture of an enterprise is of prime importance for strategy, culture being the values and norms taken for granted by its employees. But it is

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not the case that culture follows strategy, rather the reverse. Strategy must adapt to culture, and the latter must be reflected in organization. A retail business with an upmarket or premium culture cannot successfully take on a firm like Aldi, whose whole culture is oriented on costs and efficiency. Neither can a decentralized organization function properly, if its capacities for entrepreneurial and autonomous action are underdeveloped. The way in which an enterprise is organized determines what resources can be deployed at the level of business strategy. Of primary importance, however, are those resources that combine all of the four following qualities: value creation, scarcity, uniqueness, and being replaceable only with difficulty. The use of these resources is made possible by competences at organizational level, these being greater than the sum of individual competences.

Environment
The second strategic determinant, which also links corporate with business strategy, is the environment. Every enterprise is bound in by a complex web of relations with its environment, and its exchanges with its partners via these links are multifarious and have both material and immaterial components. Links to partners can only be successfully created and sustained over the long term, if the enterprise has legitimacy at the corporate level, that is, if it has credibility in the eyes of its partners and enjoys their trust. Legitimacy means more than conformity with laws and regulations: it means acceptance of the enterprises aims and activities by its partners, who include investors, banks, suppliers, customers, and state organizations. It is important to note in this context that legitimacy has no objective existence; it depends entirely on the perceptions of others. There is no quick way of achieving legitimacy. It can only be built up over the long term. By contrast, however, it only takes a short-term or one-off crisis to do as much damage to legitimacy, trust, and reputation as to any other aspect of an enterprise. Examples such as the sinking of the Brent Spar drilling platform or the Enron scandal, which dragged the accounting firm of Arthur Andersen down into the abyss as well as Enron itself, illustrate this well enough. Even incidents that affect only a particular product or region (say, contamination of food products in a single country) can have instant worldwide repercussions on the enterprise as a whole (for example, child labor in the companies that supplied the sports shoe giant Nike). Corporate strategy must aim to prevent such risks by building up and securing legitimacy over the long term. These frame conditions have very concrete consequences for activities in some areas of business: quality control, the selection of suppliers and partners, etc. The environment is also important as a determinant of strategy because an enterprise must decide what customer needs it intends to satisfy in its strategic business areas, that is to say that it must define its mission vis--vis its customers. The mission, as a concept, is arrived at by abstracting from the customer needs that the enterprise satisfies. Reflections

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on the mission that an enterprise fulfills are most pressing when it diversifies its activities. Does an activity fall within the framework of the mission, should the vision be extended to include it, or ought the activity to be ruled out? The more precisely the mission is formulated, the more precise the answers that can be given to questions of this kind. Too narrowly conceived a mission can restrict the scope of strategy overmuch, so that opportunities are excluded and survival may even be threatened, because one is too bound to old markets.

Checklist
Is your strategy comprehensive? The following checklist, based on the strategy model, will help you to analyze your companys strategy. Corporate Strategy Vision: content, communicability, staff knowledge thereof Long-term aims: quantitative and qualitative Shareholder value Growth Business area portfolio: makeup, synergy effects Social responsibility toward employees Company competences

Business Strategy Positioning, diversification, competitive strategies Technologies: manufacturing, R & D, outsourcing Products: categories, brands, pricing Markets: customers, suppliers, competitors, alliances

Organization Structure Culture: values, norms Resources: uniqueness, replaceability, availability, value-creating potential Competences: individual level, organizational level

Environment Customers: sectors, needs Competitors: direct and potential competitors, substitute products Legitimacy: investors, banks, suppliers, customers, public institutions Mission: compatibility with resources and competences

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Conclusion
There is no one best way in strategy that leads automatically from target-setting to implementation. Strategy is an integrative concept. It includes both setting targets and implementation. It can be understood as the controlled evolution of an enterprise within four parameters. These are the two levelscorporate and business strategyand the two determinantsorganization and environment. Only an integrative strategy, that coordinates these four elements and their interrelations can ensure the long-term survival of an enterprise.

About the Author

Hermann Simon is founder and chairman of the strategy and marketing consultants Simon, Kucher & Partners. He is the co-author of Power Pricing (Simon & Schuster, 1997) and author of Hidden Champions (Harvard Business School Press, 1996).

Bloomsbury Publishing Plc 2003