Theories of Strategy
1. OVERVIEW
Strategic Management
• The process of strategy - where strategies come from. How do firms actually develop
strategies and how could they do so more effectively?
• The content of strategy - what is good strategy - what good strategies are. Which types of
strategy are there, and which strategies can give firms a competitive advantage?
• The context of strategy - how specific organizational or environmental contexts affect the
process or content of strategy
Corporate Strategy Competitive Strategy (the content)
• Where to compete • How to compete
• Parent level • SBU level
• portfolio decisions • Competitive advantage
Perfect Competition
→ is about a world of 'perfect decentralization' in which rational agents (homo economicus)
interact exclusively through price-mediated exchange
→ What the model considers as maximization of welfare is allocative efficiency: each given
scarce resource in the system is allocated to ist most efficient use --> no opportunity cost
Assumptions:
1. The large number assumptions – decreasing returns, large number of buyers and sellers,
firms are price takers
2. The homogeneity assumption – demand homogenous, standardizes products
3. The mobility assumption – resources are perfectly mobile, free entry & exit
4. The rationality assumption – complete info to maximize untility
5. The transaction cost assumption – transactions are costless
About competition: Competition is price competition (price signals) and free entry/exits to get the
system into general equilibrium without oppportunity cost and max. social welfare
About the firm: Firms are black boxes (sth. Goes in and sth. Comes out), economists do not consider
the firms internal structure but only as a seen as implementing a production function and the firm as
rationally responding to prices (increase production until MP=MC)
About the Human Being: homo economicus, fully rational and self-interested
→ assumptions take away possibility of competitive advantage so that all firms are identical
Limitations of the Neoclassical Model
• The firm is treated as a unitary agent
• The firm is treated as a black box
• Preferences are seen as given
• Technology are seen as given
• Agents are seen as fully rational (and entirely self-interested)
• There is no room for increasing returns
Principle 1: When the assumptions of the model of perfect competition are met, there is no room
for performance differences: all firms earn zero economic profit
Corollary: Any deviation from the assumptions of the model of perfect competition is a possible
source of competitive advantage that can lead to performance differences
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,Stoelhorst J.W. ([1997] 2008), Thinking about Strategy
The Standard Model of Strategy
The typical conception of strategic management is of a three-step process in which strategic analysis
is followed by strategic choice and strategy implementation.
1. Formulate organ. Objectives – take into account stakeholder expectations
2. Analytical Phase – internal & external analysis directed by the organ. Objectives
→ Goal of external analysis – identify opportunities & threats affecting the firm's ability to
meet objectives
→ Goal of internal analysis – identify strengths and weaknesses
→ SWOT analysis that leads to the identification of the strategic issues that the firm faces -->
formulation of these strategic issues is the conclusion of the analysis phase and highlight
the main questions that a firm needs to confront to meet its objectives
3. Generation of Strategic Options – options to deal with strategic issues, tested by:
4. Suitability, acceptability, feasibility
5. Implementation of Strategy
Standard Model is the product of two schools of thought: the design school and the planning school
prescriptive schools of thought, the positioning school and the resource-based school added
substance by which internal and external analyses should be executed
→ approach has strong normative overtones
→ process school is primarily descriptive in nature: how strategy actually takes shape in the
everyday practice of firms.
Prescriptive Schools of Thought
1960s – The design school – strategy as a conceptual process
• idea that the specific characteristics of the firm should be confronted with the external
situation it faces. This idea has of course been made instrumental in the so- called SWOT
analysis (strengths, weaknesses, opportunities, and threats)
• critique Mintzberg: largely focused on the fact that this school underplays the importance
of hands-on learning; that these strengths and weaknesses are generally known
1970s – The planning school – Strategy as a Formal Process
• Similar assumptions to design school; main difference is that the planning school advocates
a formal and very elaborate system for the development of strategy
• planning school developed an impressive arsenal of flowcharts, checklists, and analytical
tools to support a rational and stepwise approach to strategic management
• Ansoff’s (1965) 2x2 matrix classifies growth strategies into market penetration (existing
product/existing market), product development (new product/existing market), market
development (existing product/new market), diversification (new product/new market)
1980s – The positioning school – Strategy as Fit
1. Strategies as fit - The essence of strategy is to find optimal fit between firm and environment by
taking favorable competitive positions in attractive industries
2. There are barriers to competition - Profit is the result of taking positions where the firm is
protected by barriers to competition from forces that would otherwise put pressure on the profit
margins of the firm.
3. Strategies are generic positions in the market - Favorable positions can be taken on the basis of a
limited number of generic strategies
4. The essence of strategy is analysis - Developing a strategy is largely a matter of analysis of the
external environment with the goal of identifying (1) attractive industries, (2) favorable positions
within these industries, and (3) generic strategies that allow the firm to occupy these positions.
• Porter put the content of strategy center stage and thus complemented the ideas about the
process of strategy from the design school and the planning school
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, • The Industrial Organization - ‘Structure-Conduct- Performance
o ‘Structure’ refers to the structure of the industry, ‘conduct’ refers to the (strategic)
behavior of individual firms, and ‘performance’ to different possible dimensions on
which industries and firms can differ from each other, such as profitability or
innovativeness
o basic idea: industry structure determines performance of the firms within an
industry, but individual firms can do better or worse than the industry average by
choosing successful strategies
• Porter used these insights to derive strategies to increase the profitability of individual firms
by raising barriers to competition
o Porter’s well-known 5-forces model (threat of entry, competitive rivalry, threat of
substitutes, bargaining power of buyers, and bargaining power of suppliers) is his
way to help managers understand the ‘S’ of industry structure
o Porter’s three generic strategies (cost leadership, differentiation, and focus) are his
way to help managers think about the ‘C’ of conduct
o The ‘P’ of performance that Porter is interested in is the profitability of firms. Firms
will be profitable if they occupy favorable positions in attractive industries
1990s – The resource-based school – Strategy as Stretch
1. Strategy as stretch - The environment is malleable and the essence of strategy is to change the
rules of the game in your favor.
2. Resources are the ultimate sources of competitive advantage - Firms differ from each other in
terms of the resources they control. These differences are what explain differences in the
performance of firms.
3. Strategy is therefore about having a clear vision for the future and developing unique resource
combinations to realize this vision - A firm should have a clear ‘strategic intent’ that helps focus the
identification, development, and deployment of core competencies.
• main interest of the resource-based school is to understand the relationship between
differences among firms in terms of their resources, competencies, and capabilities on the
one hand, and performance differentials among these firms on the other hand.
• A central question has been which characteristics make resources a source of sustained
competitive advantage. According to Barney (1991), this is the case when resources are:
• Valuable
• Rare
• Inimitable
• Non-substitutable
==> according to the RBV, a firm will be able to make ‘supra-normal’ profits when it has
valuable resources that other firms do not have; abnormal profits can be sustained over
time when competitors cannot imitate these valuable and rare resources and there are
substitute resources available to perform the same function
• Prahalad & Hamel - define core competencies as ‘the collective learning of the organization,
especially how to coordinate diverse production skills and integrate multiple streams of
technology’ --> focus is on organizational learning and the ability to combine different types
of productive knowledge strategy as a stretch
o core competencies consist of specific technological knowledge, can only be called
‘core’ when: (1) It adds value for buyers in the end products, (2) It is difficult to
imitate, (3) It gives access to a variety of markets
• Schumpeter (1950) emphasized the crucial role of entrepreneurs in shaping markets and
industries through acts of innovation
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, The descriptive school of thought 1980s and onwards
The process school – Strategy as Collective Learning
• Authors from the process school, like James Brian Quinn and Henry Mintzberg, criticized the
rational planning approach to strategy in the standard model
• Carnegie School (Herbert Simon) issue with these assumptions of the neoclassical model
economic agents completely rational Political dimension to strategy, bounded rationality
• Mintzberg (1985): strategies are often ‘emergent’ rather than being the result of a
deliberate planning process --> rationalization for the strategy is typically developed only
after the existence of the strategy is recognized.
1. Strategy as a collective learning process - complex and unpredictable nature of the organization’s
environment precludes deliberate control; strategy making must above all take the form of a process
of learning over time
2. Linking thinking and acting - Collective learning proceeds in emergent fashion, through behavior
that stimulates thinking retrospectively, so that sense can be made of action at the limit, formulation
and implementation become indistinguishable
3. Process comes before content - The role of leadership becomes not to preconceive deliberate
strategies, but to manage the process of strategic learning, whereby novel strategies can emerge
4. Strategies appear first as patterns out of the past, only later, perhaps, as plans for the future, and
ultimately, as perspectives to guide ultimate behavior
Rumelt, Richard P. (2003). What In the World is Competitive Advantage?, Working paper,
Anderson Business School, UCLA.
Competitive Advantage - Confusion
• Porter: “competitive advantage is at the heart of a firm’s performance in competitive
markets means having low costs, differentiation advantage, or successful focus strategy.
• Peteraf: “sustained above normal returns.” defines imperfectly mobile resources as those
that are specialized to the firm and notes that resources “can be a source of competitive
advantage” because “any Ricardian or monopoly rents generated by the asset will not be
offset entirely by accounting for the asset’s opportunity cost” (i.e., its value to others).
• Barney [2002] says “a firm experiences competitive advantages when its actions in an
industry or market create economic value and when few competing firms are engaging in
similar actions.” firm obtains above-normal performance when it generates greater-than-
expected value from the resources it employs. This positive difference between expected
value and actual value is known as an economic profit or an economic rent.”
Areas of Disagreement
1. There is confusion or disagreement about how value is to be conceptualized or measured
2. There is confusion about the meaning of rents
3. There is disagreement or confusion about the appropriate use of the opportunity cost concept
4. There is disagreement or confusion about whether competitive advantage means winning the
game or having enough distinctive resources to maintain a position in the game.
Besanko, David, Dranove, David and Shanley, Mark (2000), Economics of Strategy, 2nd edition,
New York: Wiley. (p. 20-22 ‘Economic Costs and Profitability’
Distinction Accounting vs. Economic Profit
• Accounting Profit=Sales Revenue – Accounting Cost
• Economic Profit = Sales Revenue – Economic Cost
= Accounting Profit - (Economic Cost – Accounting Cost)
o Economic profit is similar to accounting profit but includes the opportunity costs for
taking one action versus another in the period
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