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Strategic Management and Competitive AdvantageChapter 1 What is strategy and the strategic
management process?
Strategy and the strategic management process
A firm’s strategy is defined as its theory about how to gain competitive advantage. Each of these
theories is based on a set of assumptions and hypotheses about the way competition in this industry
is likely to evolve and how that evolution can be exploited to earn a profit.
The strategic management process is a sequential set of analyses and choices that can increase the
likelihood that a firm will choose a good strategy; a strategy that generates competitive advantage.
1. A firm’s mission
A firm’s mission is its long-term purpose. It defines what a firm aspires to be in the long run and what
it wants to avoid in the meantime. Often written down in form of mission statement.
- Some missions may not affect firm performance: example of a mission statement that
emphasized the importance of honesty and integrity, while the company was engaging in
fraud.
- Some missions can improve firm performance
- Some missions can hurt firm performance: something a firm’s mission will be very inwardly
focused and defined only with reference to the personal values and priorities of its founders
or top managers, independent of whether those values and priorities are consistent with the
economic realities facing a firm.
2. Objectives
Objectives are specific measurable targets a firm can use to evaluate the extent to which it is realizing
its mission. High-quality objectives are tightly connected to elements of a firm’s mission and low-
quality objectives either do not exist or are not connected to elements of a firm’s mission.
3. External and internal analysis
By conducting an external analysis, a firm identifies the critical threats and opportunities in its
competitive environment, how competition in this environment evolves and what implications that
evolution has for the threats and opportunities a firm is facing.
Internal analysis helps a firm identify its organizational strengths and weaknesses, understand which
of its resources and capabilities are likely to be sources of competitive advantage and it can be used
to identify those areas of its organization that require improvement and change.
4. Strategic choice
Strategic choice: a theory of how to gain competitive advantage. There are two categories:
- Business-level strategies are actions firms take to gain competitive advantage in a single
market or industry
- Corporate-level strategies are actions firms take to gain competitive advantage by operating
in multiple markets or industries.
The strategic choice should: supports the firm’s mission, is consistent with a firm’s objectives, exploits
opportunities in a firm’s environment with a firm’s strengths and neutralizes threats in a firm’s
environment while avoiding a firm’s weaknesses.
5. Strategic implementation
Strategy implementation occurs when a firm adopts organizational policies and practices that are
consistent with its strategy. Three important ones: a firm’s formal organizational structure, its formal
and informal management control systems and its employee compensation policies.
6. Competitive advantage
,What is competitive advantage?
A firm has competitive advantage when it is able to create more economic value than rival firms.
Economic value is simply the difference between the perceived benefits gained by a customer that
purchases a firm’s products or services and the full economic cost of these products and services.
Firms that create the same economic value as their rivals experience competitive parity.
- Temporary competitive advantage: that lasts for a very short period of time.
- Sustained competitive advantage: can last much longer.
The strategic management process, revisited
Figure 1.4
Measuring competitive advantage
It is hard to measure customers perception and the total costs associated with a particular product of
service. There are two approaches associated with measuring a firm’s competitive advantage:
1. Accounting measures of competitive advantage
Is calculated by using information from a firm’s published profit and loss balance sheet statements.
One way to use a firm’s accounting statements to measure its competitive advantage is through the
use of accounting ratios. Accounting ratios are simply numbers taken from a firm’s financial statement
that are manipulated in ways that describe various aspects of a firm’s performance.
- Profitability ratios
- Liquidity ratios
- Leverage ratios
- Activity ratios
The ratios need to be compared to the average of accounting ratios of other firms in the industry. A
firm earns above average accounting performance when its performance is greater than the industry
average. A firm earns average accounting performance when its performance is equal to the industry
average and when a firm earns below average accounting performance, than its performance is less
that the industry average.
2. Economic measures of competitive advantage
The cost of capital is the rate of return that a firm promises to pay its suppliers of capital to induce
them to invest in the firm. This is not included in most accounting measures. Economic measures of
competitive advantage compare a firm’s level of return to its cost of capital instead of to the average
level of return in the industry. To sources of capital:
- Cost of debt: equal to the interest that a firm must pay its debt holders in order to induce
those debt holders to lend money to a firm.
- Cost of equity: equal to the rate of return a firm must promise its equity holders in order to
induce these individuals and institutions to invest in a firm.
A firms weighted average cost of capital (WACC) is the percentage of a firm’s total capital. A firm that
earns above its costs is called above normal economic performance. A firm that earns its cost of
capital is called normal economic performance and a firm that earns less than its cost of capital is
called below normal economic performance.
Disadvantage of economic measures: it can be difficult to calculate a firm’s costs of capital. This is
true if a firm is privately held = if it has stock that is not traded on public stock markets or if it is a
division of a larger company.
The relationship between economic and accounting performance measures
Firms that perform well using one of these measures usually perform well using the other. However it
is possible for a firm to have above average accounting performance and simultaneously have below
normal economic performance.
, Emergent versus intended strategies
Emergent strategies are theories of how to gain competitive advantage in an industry that emerge
over time or that have been radically reshaped once they are initially implemented. This happens
because it will often be the case that at the time the firm chooses its strategy, some of the
information needed to complete the strategic management process may not be available.
Chapter 2 Evaluating a firm’s external environment
Understanding a firm’s general environment
The general environment consists of broad trends in the context within which a firm operates. It
consists of 6 interrelated elements:
1. Technological change: creates both opportunity, as firms begin to explore how to use
technology to create new products and services, and threats, as technological change forces
firms to rethink their technological strategies.
2. Demographic trends: demographics is the distribution of individuals in a society in term of
age, sex, marital status, income and other personal attributes that determine buying
patterns. It can help understand whether its products or services will appeal to customers
and how many potential customers it might have. Focussing too narrow on a demographic
segment can limit demand for a firm’s products.
3. Cultural trends: culture is values, beliefs, norms that guide behaviour in a society.
4. Economic climate: is the overall health of the economic systems within which a firm operates.
When activity in an economy is relatively low, the economy is said to be in recession. A severe
recession that lasts for several years is known as a depression. The alternating pattern of
prosperity followed by recession, followed by prosperity is called the business cycle.
5. Legal and political conditions: are the laws and the legal system’s impact on business,
together with the general nature of the relationship between government and business.
6. Specific international events: includes events such as civil wars, political groups, terrorism,
wars between countries etc.
The structure-conduct-performance (S-C-P model), model of firm
performance
The term structure in this model refers to industry structure, measured by such factors as the number
of competitors in an industry, the heterogeneity of products in an industry, the cost of entry and exit
in an industry etc. Conduct refers to the strategies that firms in an industry implement. Performance
has to meanings.
1. The performance of individual firms
2. The performance of the economy as a whole
Figure 2.2
Very useful in informing both research and government policy. However, sometimes it can be
awkward to use to identify threats in a firm’s local environment.
A model of environmental threats
The five most common threats faced by firms in their local competitive environments:
1. Threat from new competition
New competitors are firms that have either recently started operating in an industry or that threaten
to begin operation in an industry soon. The extent to which new competitors act as a threat to an
incumbent firm’s performance depends on the cost of entry. If the costs are greater than the
potential profits a new competitor could obtain by entering, then entry will not be forthcoming, and
new competitors are not a threat to incumbent firms. The threat of new competitors also depends on
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