Strategic Management and Competitive Advantage – Jay B. Barney and William S. Hesterly
Part 1. The Tools of Strategic Analysis
Chapter 1. What Is Strategy and the Strategic Management Process?
Strategy and the Strategic Management Process
Defining Strategy
A firm’s strategy is defined as its theory how to gain competitive advantages. The greater the extent
to which the assumptions and hypotheses accurately reflect how competition in this industry
evolves, the more likely it is that a firm will gain a competitive advantage from implementing its
strategies. It is usually very difficult to predict how competition in an industry will evolve, which has
the consequence that is almost always a theory.
The Strategic Management Process
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.
1. A firm’s mission is its long-term purpose.
Missions define both what a firm aspires to be in the long run and what it wants to avoid in the
meantime. Missions are often written down in the form of mission statements. However, it’s
only the first step in the process.
2. 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 are relatively easy to measure and track over time.
3. By conducting an external analysis, a firm identifies the critical threats and opportunities in its
competitive environment. Internal analysis helps a firm identify its organizational strengths and
weaknesses. It also helps understand which resources and capabilities are likely to be sources of
competitive advantage.
4. Strategic choices are made to determine what a firm’s theory of how to gain competitive
advantage will be. 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 advantages by operating in multiple markets or industries simultaneously. The
objective when making a strategic choice is to choose a strategy that: (1) supports the firm’s
mission; (2) is consistent with a firm’s objective; (3) exploits opportunities in a firm’s
environment with a firm’s strengths; and (4) neutralizes threats in a firm’s environment while
avoiding a firm’s weaknesses.
5. Strategic implementation occurs when a firm adopts organizational policies and practices that
are consistent with its strategy. Three policies and practices are important: (1) a firm’s
organizational structure; (2) its formal and informal management control systems and (3) its
employee compensation policies.
What is Competitive Advantage
In general, a firm has a competitive advantage when it can create more economic value than rival
firms. Economic value is simply the difference between what customers are willing to pay for a firm’s
products or services and the total costs of producing these. A temporary competitive advantage is a
competitive advantage that lasts for a very short time. A sustained competitive advantage can last
,much longer. Firms that create the same economic value as their rivals experience competitive
parity. Firms that generate less economic value than their rivals have a competitive disadvantage.
Measuring Competitive Advantage
Despite the very real challenges associated with measuring a firm’s competitive advantage, two
approaches have emerged:
1. A firm’s accounting performance is a measure of its competitive advantage calculated by
using information from a firm’s published profit and loss and balance sheet statements. One
way to use it is with accounting ratios, which are simply numbers taken from a firm’s
financial statement that are manipulated in ways that describe various aspects of a firm’s
performance. These measures can be grouped into four categories: (1) profitability ratios, or
ratios with some measure of profit in the numerator and some measure of firm size or assets
in the denominator; (2) liquidity ratios, or ratios that focus on the ability of a firm to meet its
short-term financial obligations; (3) leverage ratios, or ratios that focus on the level of a
firm’s financial flexibility, including its ability to obtain more debt; and (4) activity ratios, or
ratios that focus on the level of activity in a firm’s business. Using ratio analysis, a firm earns
above-, equal- or below-average accounting performance.
2. Economic measures of competitive advantage compare a firm’s level of return to its cost of
capital instead of the average level of return in the industry. Generally, there are two broad
categories of sources of capital: debt (capital from banks and bondholders) and equity
(capital from individuals and institutions that purchase a firm’s stock). The cost of equity is
equal to the interest that a firm must pay its debt holders to induce them to lend money. The
cost of equity is equal to the rate of return a firm must promise its equity holders to induce
them to invest. A firm’s weighted average cost of capital (WACC) is:
WACC = (market value of a debt / firm’s market value) * after tax cost of debt +
(market value of equity / firm’s market value) * cost of equity.
Using these measurement, firms earn above-normal, normal- or below-normal economic
performance.
The Relationship Between Economic and Accounting Performance Measures
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. It will often be
the case that at the time a firm chooses its strategies, some of the information needed to complete
the strategic management process may simply not be available. In such situation, a firm’s ability to
change its strategies quickly to respond to emergent trends in an industry may be as important a
source of competitive advantage as the ability to complete the strategic management process.
Why you Need to Know About Strategy
,First, it can give you the tools you need to evaluate the strategies of firms that may employ you.
Second, once you are working for a firm, understanding that firm’s strategies, and your role in
implementing those strategies, can be very important for your personal success. Finally, in smaller
and entrepreneurial firms many employees end up being involved in strategic management process.
Chapter 2. Evaluating a Firm’s External Environment
Understanding a Firm’s general Environment
Any analysis of the threats and opportunities facing a firm must begin with an understanding of the
general environment within which a firm operates. This general environment consists of broad
trends in the context within which a firm operates that can have an impact on a firm’s strategic
choices. It consists of six 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. Demographics (trends) is the distribution of individuals in society in terms of age, sex,
marital status, income, ethnicity and other personal attributes that may determine buying
patterns. Understanding this basic information can help a firm determine whether its
products or services will appeal to customers and how many potential it might have.
3. Culture (trends) is the value, beliefs and norms that guide behaviour in a society. Failure to
understand changes in culture, or differences between cultures, can have a very large impact
on the ability of a firm to gain a competitive advantage.
4. The economic climate is the overall health of the economic systems within a firm operates.
When activity in an economy is relative low, the economy is said to be in recession. A severe
recession that lasts for several years is known as a depression. This alternating pattern of
prosperity followed by recessions, 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 trends include events such as civil wars, political coups, terrorism, wars
between countries, famines, and country or regional economic recessions.
The Structure-Conduct-Performance Model of Firm Performance
The term structure in this model refers to industry
structure, with its according measure factors as stated.
Conduct refers to the strategies that firms implements.
Performance has two meanings: (1) the performance of
individual firms; and (2) the performance of the
economy as a whole.
The model in general offers a causal theoretical
explanation for firm performance through economic
conduct on incomplete markets. The market
environment has a direct, short-term impact on the
market structure. The structure then has a direct
influence on the firm’s economic conduct, which in turn
affects its market performance.
, A Model of Environmental Threats
To a firm seeking competitive advantage, an
environmental threat is any individual, group, or
organization outside a firm that seeks to reduce
the level of that firm’s performance. They are
forces that tend to increase the competitiveness of
an industry and force firm performance to competitive parity level. The five common threats are:
1. (Threat from) new competitors are firms that have either recently started operating in an
industry or that threaten to begin operations in an industry soon. They are motivated to
enter into an industry either by the superior profits that some incumbent firms in that
industry are currently earning, or the profits that firms in this industry may earn some time in
the future.
The threat of new competitors depends on the cost of entry, and the cost of entry, in return,
depends on the existence and “height” of barriers to entry. Barriers of entry are: (1)
- Economies of scale exists in an industry when a firm’s costs fall as a function of its
volume of production. Diseconomies of scale exist when a firm’s costs rise as a function
of its volume. Any deviation from an optimal level of production will lead a firm to
experience much higher costs of production.
- Product differentiation means that incumbent firms possess brand identification and
customer loyalty that potential new competitors do not. New competitors not only have
to absorb the standard costs associated with starting production in a new industry; they
also have to absorb the costs associated with overcoming incumbent firm’s
differentiation advantages. If the cost of overcoming these advantages is greater than
the potential return from entering an industry, entry will not occur.
- Cost advantages independent of scale can deter entry because new competitors will find
themselves at a cost disadvantage vis-à-vis incumbent firms with cost advantages.
Examples of these cost advantages, independent of scale, are:
Proprietary technology. When incumbent firms have secret or patented
technology that reduces their costs below the costs of potential entrants,
potential new competitors must develop substitute technologies to compete.
Managerial know-how. When incumbent firms have taken-for-granted
knowledge, skills, and information that take years to develop and that is not
possessed by potential new competitors.
Favourable access to raw materials. When incumbent firms have low-cost access
to critical raw materials not enjoyed by potential new competitors.
Learning-curve cost advantages. When the cumulative volume of production of
incumbent firms gives them cost advantages not enjoyed by potential new
competitors.
- Government regulation of entry occurs most frequently when a firm operates as a
government-regulated monopoly. It has been concluded that it is in a better position to
ensure that specific products or services are made available at reasonable prices.
